- Taleb, Nassim Nicholas.
Skin in the Game.
New York: Random House, 2018.
ISBN 978-0-425-28462-9.
-
This book is volume four in the author's
Incerto series, following
Fooled by Randomness (February 2011),
The Black Swan (January 2009),
and Antifragile (April 2018).
In it, he continues to explore the topics of uncertainty, risk,
decision making under such circumstances, and how both
individuals and societies winnow out what works from what
doesn't in order to choose wisely among the myriad alternatives
available.
The title, “Skin in the Game”, is an aphorism which
refers to an individual's sharing the risks and rewards of an
undertaking in which they are involved. This is often applied
to business and finance, but it is, as the author demonstrates,
a very general and powerful concept. An airline pilot has skin
in the game along with the passengers. If the plane crashes and
kills everybody on board, the pilot will die along with them.
This insures that the pilot shares the passengers' desire for a
safe, uneventful trip and inspires confidence among them. A
government “expert” putting together a “food
pyramid” to be vigorously promoted among the citizenry and
enforced upon captive populations such as school children or
members of the armed forces, has no skin in the game. If his or
her recommendations create an epidemic of obesity, type 2
diabetes, and cardiovascular disease, that probably won't happen
until after the “expert” has retired and, in any
case, civil servants are not fired or demoted based upon the
consequences of their recommendations.
Ancestral human society was all about skin in the game. In a
small band of hunter/gatherers, everybody can see and is aware
of the actions of everybody else. Slackers who do not
contribute to the food supply are likely to be cut loose to fend
for themselves. When the hunt fails, nobody eats until the next
kill. If a conflict develops with a neighbouring band, those
who decide to fight instead of running away or surrendering are
in the front line of the battle and will be the first to suffer
in case of defeat.
Nowadays we are far more “advanced”. As the author
notes, “Bureaucracy is a construction by which a person is
conveniently separated from the consequences of his or her
actions.” As populations have exploded, layers and layers
of complexity have been erected, removing authority ever farther
from those under its power. We have built mechanisms which have
immunised a ruling class of decision makers from the
consequences of their decisions: they have little or no skin in
the game.
Less than a third of all Roman emperors died in their beds. Even
though they were at the pinnacle of the largest and most
complicated empire in the West, they regularly paid the ultimate
price for their errors either in battle or through palace
intrigue by those dissatisfied with their performance. Today the
geniuses responsible for the 2008 financial crisis, which
destroyed the savings of hundreds of millions of innocent people
and picked the pockets of blameless taxpayers to bail out the
institutions they wrecked, not only suffered no punishment of
any kind, but in many cases walked away with large bonuses or
golden parachute payments and today are listened to when they
pontificate on the current scene, rather than being laughed at
or scorned as they would be in a rational world. We have
developed institutions which shift the consequences of bad
decisions from those who make them to others, breaking the vital
feedback loop by which we converge upon solutions which, if not
perfect, at least work well enough to get the job done without
the repeated catastrophes that result from ivory tower theories
being implemented on a grand scale in the real world.
Learning and Evolution
Being creatures who have evolved large brains, we're inclined to
think that learning is something that individuals do, by
observing the world, drawing inferences, testing hypotheses, and
taking on knowledge accumulated by others. But the overwhelming
majority of creatures who have ever lived, and of those alive
today, do not have large brains—indeed, many do not have
brains at all. How have they learned to survive and
proliferate, filling every niche on the planet where
environmental conditions are compatible with biochemistry based
upon carbon atoms and water? How have they, over the billions
of years since life arose on Earth, inexorably increased in
complexity, most recently producing a species with a big brain
able to ponder such questions?
The answer is massive parallelism, exhaustive search, selection
for survivors, and skin in the game, or, putting it all
together, evolution. Every living creature has skin in the
ultimate game of whether it will produce offspring that inherit
its characteristics. Every individual is different, and the
process of reproduction introduces small variations in progeny.
Change the environment, and the characteristics of those best
adapted to reproduce in it will shift and, eventually, the
population will consist of organisms adapted to the new
circumstances. The critical thing to note is that while each
organism has skin in the game, many may, and indeed must, lose
the game and die before reproducing. The individual organism
does not learn, but the species does and, stepping back
another level, the ecosystem as a whole learns and adapts as
species appear, compete, die out, or succeed and proliferate.
This simple process has produced all of the complexity we
observe in the natural world, and it works because every
organism and species has skin in the game: its adaptation to its
environment has immediate consequences for its survival.
None of this is controversial or new. What the author has done
in this book is to apply this evolutionary epistemology
to domains far beyond its origins in biology—in fact, to
almost everything in the human experience—and demonstrate
that both success and wisdom are generated when this process is
allowed to work, but failure and folly result when it is
thwarted by institutions which take the skin out of the game.
How does this apply in present-day human society? Consider one
small example of a free market in action. The restaurant
business is notoriously risky. Restaurants come and go all the
time, and most innovations in the business fall flat on their
face and quickly disappear. And yet most cities have, at any
given time, a broad selection of restaurants with a wide variety
of menus, price points, ambiance, and service to appeal to
almost any taste. Each restaurant has skin in the game: those
which do not attract sufficient customers (or, having once been
successful, fail to adapt when customers' tastes change) go out
of business and are replaced by new entrants. And yet for all
the churning and risk to individual restaurants, the restaurant
“ecosystem” is remarkably stable, providing
customers options closely aligned with their current desires.
To a certain kind of “expert” endowed with a big
brain (often crammed into a pointy head), found in abundance
around élite universities and government agencies, all of
this seems messy, chaotic, and (the horror!)
inefficient. Consider the money lost when a restaurant
fails, the cooks and waiters who lose their jobs, having to find
a new restaurant to employ them, the vacant building earning
nothing for its owner until a new tenant is
found—certainly there must be a better way. Why, suppose
instead we design a standardised set of restaurants
based upon a careful study of public preferences, then roll out
this highly-optimised solution to the problem. They might be
called “public feeding centres”. And they would work
about as well as the name implies.
Survival and Extinction
Evolution ultimately works through extinction. Individuals who
are poorly adapted to their environment (or, in a free market,
companies which poorly serve their customers) fail to reproduce
(or, in the case of a company, survive and expand). This leaves
a population better adapted to its environment. When the
environment changes, or a new innovation appears (for example,
electricity in an age dominated by steam power), a new sorting
out occurs which may see the disappearance of long-established
companies that failed to adapt to the new circumstances. It is
a tautology that the current population consists entirely of
survivors, but there is a deep truth within this observation
which is at the heart of evolution. As long as there is a
direct link between performance in the real world and
survival—skin in the game—evolution will work to
continually optimise and refine the population as circumstances
change.
This evolutionary process works just as powerfully in the realm
of ideas as in biology and commerce. Ideas have consequences,
and for the process of selection to function, those
consequences, good or ill, must be borne by those who promulgate
the idea. Consider inventions: an inventor who creates
something genuinely useful and brings it to market (recognising
that there are many possible missteps and opportunities for bad
luck or timing to disrupt this process) may reap great rewards
which, in turn, will fund elaboration of the original invention
and development of related innovations. The new invention may
displace existing technologies and cause them, and those who
produce them, to become obsolete and disappear (or be relegated
to a minor position in the market). Both the winner and loser
in this process have skin in the game, and the outcome of the
game is decided by the evaluation of the customers expressed in
the most tangible way possible: what they choose to buy.
Now consider an academic theorist who comes up with some
intellectual “innovation” such as
“Modern
Monetary Theory” (which basically says that a
government can print as much paper money as it wishes to pay for
what it wants without collecting taxes or issuing debt as long
as full employment has not been achieved). The theory and the
reputation of those who advocate it are evaluated by their
peers: other academics and theorists employed by institutions
such as national treasuries and central banks. Such a theory is
not launched into a market to fend for itself among competing
theories: it is “sold” to those in positions of
authority and imposed from the top down upon an economy,
regardless of the opinions of those participating in it. Now,
suppose the brilliant new idea is implemented and results in,
say, total collapse of the economy and civil
society? What price do those who promulgated the theory and
implemented it pay? Little or nothing, compared to the misery
of those who lost their savings, jobs, houses, and assets in the
calamity. Many of the academics will have tenure and suffer no
consequences whatsoever: they will refine the theory, or else
publish erudite analyses of how the implementation was flawed
and argue that the theory “has never been tried”.
Some senior officials may be replaced, but will doubtless land
on their feet and continue to pull down large salaries as
lobbyists, consultants, or pundits. The bureaucrats who
patiently implemented the disastrous policies are civil
servants: their jobs and pensions are as eternal as anything in
this mortal sphere. And, before long, another bright, new idea
will bubble forth from the groves of academe.
(If you think this hypothetical example is unrealistic, see the
career of one
Robert Rubin.
“Bob”, during his association with Citigroup between
1999 and 2009, received total compensation of US$126 million for
his “services” as a director, advisor, and temporary
chairman of the bank, during which time he advocated the
policies which eventually brought it to the brink of collapse in
2008 and vigorously fought attempts to regulate the financial
derivatives which eventually triggered the global catastrophe.
During his tenure at Citigroup, shareholders of its stock lost
70% of their investment, and eventually the bank was bailed out
by the federal government using money taken by coercive taxation
from cab drivers and hairdressers who had no culpability in
creating the problems. Rubin walked away with his
“winnings” and paid no price, financial, civil, or
criminal, for his actions. He is one of the many poster boys
and girls for the “no skin in the game club”. And
lest you think that, chastened, the academics and pointy-heads
in government would regain their grounding in reality, I have
just one phrase for you,
“trillion
dollar coin”, which “Nobel Prize” winner
Paul Krugman declared to be “the most important fiscal
policy debate of our lifetimes”.)
Intellectual Yet Idiot
A cornerstone of civilised society, dating from at least the
Code
of Hammurabi (c. 1754 B.C.), is
that those who create risks must bear those risks: an architect
whose building collapses and kills its owner is put to death.
This is the fundamental feedback loop which enables learning.
When it is broken, when those who create risks (academics,
government policy makers, managers of large corporations, etc.)
are able to transfer those risks to others (taxpayers, those
subject to laws and regulations, customers, or the public at
large), the system does not learn; evolution breaks down; and
folly runs rampant. This phenomenon is manifested most
obviously in the modern proliferation of the affliction the
author calls the “intellectual yet idiot” (IYI).
These are people who are evaluated by their peers (other IYIs),
not tested against the real world. They are the equivalent of a
list of movies chosen based upon the opinions of high-falutin'
snobbish critics as opposed to box office receipts. They strive
for the approval of others like themselves and, inevitably,
spiral into ever more abstract theories disconnected from ground
truth, ascending ever higher into the sky.
Many IYIs achieve distinction in one narrow field and then
assume that qualifies them to pronounce authoritatively on any
topic whatsoever. As was said by biographer Roy Harrod of John
Maynard Keynes,
He held forth on a great range of topics, on some of which
he was thoroughly expert, but on others of which he may have
derived his views from the few pages of a book at which he
happened to glance. The air of authority was the same in
both cases.
Still other IYIs have no authentic credentials whatsoever, but
derive their purported authority from the approbation of other
IYIs in completely bogus fields such as gender and ethnic
studies, critical anything studies, and nutrition science. As
the author notes, riding some of his favourite hobby horses,
Typically, the IYI get first-order logic right, but not
second-order (or higher) effects, making him totally
incompetent in complex domains.
The IYI has been wrong, historically, about Stalinism,
Maoism, Iraq, Libya, Syria, lobotomies, urban planning,
low-carbohydrate diets, gym machines, behaviorism,
trans-fats, Freudianism, portfolio theory, linear
regression, HFCS (High-Fructose Corn Syrup), Gaussianism,
Salafism, dynamic stochastic equilibrium modeling, housing
projects, marathon running, selfish genes,
election-forecasting models, Bernie Madoff (pre-blowup), and
p values. But he is still convinced his current
position is right.
Doubtless, IYIs have always been with us (at least since
societies developed to such a degree that they could afford some
fraction of the population who devoted themselves entirely to
words and ideas)—Nietzsche called them
“Bildungsphilisters”—but
since the middle of the twentieth century they have been
proliferating like pond scum, and now hold much of the high
ground in universities, the media, think tanks, and senior
positions in the administrative state. They believe their
models (almost always linear and first-order) accurately
describe the behaviour of complex dynamic systems, and that they
can “nudge” the less-intellectually-exalted and
credentialed masses into virtuous behaviour, as defined by
them. When the masses dare to push back, having a limited
tolerance for fatuous nonsense, or being scolded by those who
have been consistently wrong about, well, everything, and dare
vote for candidates and causes which make sense to them and seem
better-aligned with the reality they see on the ground, they are
accused of—gasp—populism, and must be
guided in the proper direction by their betters, their uncouth
speech silenced in favour of the cultured
“consensus” of the few.
One of the reasons we seem to have many more IYIs around than we
used to, and that they have more influence over our lives is
related to scaling. As the author notes, “it is easier to
macrobull***t than microbull***t”. A grand theory which
purports to explain the behaviour of billions of people in a
global economy over a period of decades is impossible to test or
verify analytically or by simulation. An equally silly theory
that describes things within people's direct experience is
likely to be immediately rejected out of hand as the absurdity
it is. This is one reason decentralisation works so well: when
you push decision making down as close as possible to
individuals, their common sense asserts itself and immunises
them from the blandishments of IYIs.
The Lindy Effect
How can you sift the good and the enduring from the mass of
ephemeral fads and bad ideas that swirl around us every day?
The
Lindy effect
is a powerful tool. Lindy's delicatessen in New York City was a
favoured hangout for actors who observed that the amount of time
a show had been running on Broadway was the best predictor of
how long it would continue to run. A show that has run for three
months will probably last for at least three months more. A
show that has made it to the one year mark probably has another
year or more to go. In other words, the best test for whether
something will stand the test of time is whether it has
already withstood the test of time. This may, at
first, seem counterintuitive: a sixty year old person has a
shorter expected lifespan remaining than a twenty year old. The
Lindy effect applies only to nonperishable things such as
“ideas, books, technologies, procedures, institutions, and
political systems”.
Thus, a book which has been in print continuously for a hundred
years is likely to be in print a hundred years from now, while
this season's hot best-seller may be forgotten a few years
hence. The latest political or economic theory filling up pages
in the academic journals and coming onto the radar of the IYIs
in the think tanks, media punditry, and (shudder)
government agencies, is likely to be forgotten and/or
discredited in a few years while those with a pedigree of
centuries or millennia continue to work for those more
interested in results than trendiness.
Religion is Lindy. If you disregard all of the spiritual
components to religion, long-established religions are powerful
mechanisms to transmit accumulated wisdom, gained through
trial-and-error experimentation and experience over many
generations, in a ready-to-use package for people today. One
disregards or scorns this distilled experience at one's own
great risk. Conversely, one should be as sceptical about
“innovation” in ancient religious traditions and
brand-new religions as one is of shiny new ideas in any other
field.
(A few more technical notes…. As I keep saying,
“Once
Pareto
gets into your head, you'll never get him out.” It's no
surprise to find that the Lindy effect is deeply related to the
power-law distribution of many things in human experience. It's
simply another way to say that the lifetime of nonperishable
goods is distributed according to a power law just like incomes,
sales of books, music, and movie tickets, use of health care
services, and commission of crimes. Further, the Lindy effect
is similar to J. Richard Gott's
Copernican statement
of the
Doomsday
argument, with the difference that Gott provides lower and
upper bounds on survival time for a given
confidence
level predicted solely from a random observation that
something has existed for a known time.)
Uncertainty, Risk, and Decision Making
All of these observations inform dealing with risk and making
decisions based upon uncertain information. The key insight is
that in order to succeed, you must first survive. This
may seem so obvious as to not be worth stating, but many
investors, including those responsible for blow-ups which make
the headlines and take many others down with them, forget this
simple maxim. It is deceptively easy to craft an investment
strategy which will yield modest, reliable returns year in and
year out—until it doesn't. Such strategies tend to be
vulnerable to “tail risks”, in which an
infrequently-occurring event (such as 2008) can bring down the
whole house of cards and wipe out the investor and the fund.
Once you're wiped out, you're out of the game: you're like the
loser in a Russian roulette tournament who, after the gun goes
off, has no further worries about the probability of that
event. Once you accept that you will never have complete
information about a situation, you can begin to build a strategy
which will prevent your blowing up under any set of
circumstances, and may even be able to profit from volatility.
This is discussed in more detail in the author's earlier
Antifragile.
The Silver Rule
People and institutions who have skin in the game are likely to
act according to the Silver Rule: “Do not do to others
what you would not like them to do to you.” This rule,
combined with putting the skin of those “defence
intellectuals” sitting in air-conditioned offices into the
games they launch in far-off lands around the world, would do
much to save the lives and suffering of the young men and women
they send to do their bidding.
August 2019 