Saturday, 11 September 2010

The Black Swan, Nassim Nicholas Taleb

The Black Swan, Nassim Nicholas Taleb
Penguin: £9.99

In more innocent times, before the discovery of Australia, it used to be believed that all swans in the world were white. After all, every swan in history that had been seen up to that point had conformed to this hypothesis. It was inconceivable that a black swan could exist - it ran counter to all human knowledge and experience. Then, at a stroke, this concrete certainty was conclusively and permanently demolished with the discovery of the rather ungainly black-feathered species known as Cygnus atratus.

Nassim Taleb uses the black swan as a metaphor for unpredictable events with potentially immense repercussions. At the heart of his book is the thesis that "[t]he inability to predict outliers implies the inability to predict the course of history". We are largely blind to this, however, and we are prone to serious errors of judgement as a result.  Taleb argues at some length that our intuitions, tools and strategies for assessing probabilities and predicting the course of events are ill-suited to the perilous complexities of the world in which we live.  When black swans hit, their effects can be enormous. Some of the most important discoveries in history, including penicillin and lasers, were made by accident. At the time of the Latin American sovereign debt defaults in 1982, American banks lost in a single summer the equivalent of almost the entire profits of the American banking industry since its inception.

Central to Taleb's ideas are the concepts of Mediocristan and Extremistan.  In some areas of life, variations are quite limited. Take height, for example: most adult humans are between around five and six feet tall, and variations outside these boundaries are limited. You may very occasionally see a seven foot man, but you will never see a seventy foot man. Taleb uses the term 'Mediocristan' to describe the kind of world containing limited variations of this sort. Other areas of life exhibit enormous variability. Individuals' incomes can range from a few thousand pounds (or zero) to multiple millions. The casualty rates in wars likewise differ wildly, from around a thousand in the Falklands conflict to 70 million in World War II. The problem is that modern-day humans live to a large extent in Extremistan but insist on thinking and acting as if they were in Mediocristan. For example, even experts and sophsticates are wont to use bell curve analyses in circumstances where they are utterly inappropriate, and treat human events as if their probabilities could be assessed in the same way as in a game of dice or roulette.

Taleb is acutely alive to the limitations of the human mind. We are severely prone to confirmation bias. We are inclined to the sort of reasoning that claims that OJ is innocent because we had breakfast with him the other day and he didn't kill a single person the whole time we were with him. We fail to realise that being aware of what we don't know is a safer strategy than fooling ourselves about what we do know. We forget that we often only see the successes or the survivors - we remember Casanova and his lucky √©toile but rarely spare a thought for the thousands of other would-be adventurers who crashed and burned. We tend to impose order on the world where none exists. We are inclined to view historical events as inevitable when in fact they were highly contingent and unpredictable. Even the greatest cataclysms of the last century, the two world wars, came as something of a surprise to people at the time.

We encounter similar problems when we try to look into the future. We are not entitled to infer the future from the past any more than a turkey on Christmas eve is entitled to assume from past experience that his human custodians are going to continue to carefully feed and nurture him (Taleb takes this example from Bertrand Russell). Experts are as prone to this as anyone. Research shows that financial analysts are less likely to be on the mark than weather forecasters, despite being more confident about their predictions. The psychologist Philip Tetlock found that specialists in economics and other disciplines were far more likely to make errors in their predictions than they realised, and eminent academics were no more likely to get it right than bog-standard graduates or even journalists - indeed, subjects with the highest reputations tended to do worse than their supposed inferiors.

Philosophically speaking, Taleb describes himself as a "skeptical empiricist".  His worldview comes with a highly respectable pedigree: his intellectual influences range from the classical writer Sextus Empiricus to the mediaeval Arab thinker Al-Ghazali to Sir Karl Popper and Benoit Mandelbrot.  However, Taleb is no ivory tower theorist.  He worked for years on Wall Street - he still does, in fact - and it was a black swan event - the stock market crash of 1987 - that enabled him to become financially independent.

This is an enormously important book.  Taleb is now something of a minor celebrity, and his ideas have apparently influenced our own dear David Cameron.  One senses that he is mostly right, though the stark and forthright way in which he presents his arguments makes one hesitate to accept them wholesale.  It is tempting to sit on the fence and conclude that Taleb is on to something, but that he goes too far in denigrating our predictive abilities and techniques. The man himself is having none of this.  He says of his critics: "The only comment I found unacceptable was, 'You are right; we need you to remind us of the weakness of these methods, but you cannot throw the baby out with the bath water,' meaning that I needed to accept their reductive [bell curve] distribution while also accepting that large deviations could occur - they didn't realize the incompatibility of the two approaches. It was as if one could be half dead. Not one of these users of portfolio theory in twenty years of debates, explained how they could accept the [bell curve] framework as well as large deviations. Not one." This quotation also highlights another characteristic of Taleb's writing: he is a man who allows himself to carry a large measure of disdain for people who disagree with his take on the world. He has no similar reservations about the soundness of his own ideas.

The Black Swan is far from a perfect book.  It is both dogmatic and over-long. Taleb's writing style can be rather irritating, and he clearly fancies himself as a latter-day Montaigne (another of his heroes).   In both this book and his earlier work Fooled by Randomness, he comes across as a somewhat precious and mannered individual - though this reviewer can respect his idiosyncratic approach to life and his willingness to challenge "empty suits" and their straitjacketing orthodoxies.  In all, however, Taleb has written a powerful and largely convincing critique of financial analysis, historiography, attempts to predict the future, deference to experts, and human thought in general.  It is a book that I would unhesitatingly recommend to anyone.