As I was reading Skin in the Game, Nassim Taleb’s latest book, the thought crossed my mind that
the author might classify me as an IYI (intellectual yet idiot). He puts
economists in the IYI category along with psychologists.
Taleb writes:
“Knowing ‘economics’ doesn’t mean knowing
anything about economics in the sense of the real activity, rather than the theories
… produced by economists”.
I agree. Some economists know little about the real
world.
Despite his low opinion of economists, the author
acknowledges that some of the economists I admire, including Friedrich Hayek,
Ronald Coase and Elinor Ostrom, had useful insights about the real world. He
even suggests that Paul Samuelson made a useful contribution by pointing out
that people reveal their preferences in their market behaviour rather than in
what they say.
Rather than viewing Nassim Taleb’s offensive anti-intellectualism
as evidence that he suffers from SFB, I think economists and psychologists
should view it as a clever ploy to attract the attention of their students. I
hope Taleb succeeds, and also hope that his book helps students to pose
difficult questions for some of their professors.
There is some irony in the fact that Taleb has a low opinion
of intellectuals, since Daniel Kahneman views Nassim Taleb as “one of the
world’s top intellectuals”. Kahneman, a psychologist, won the Nobel prize for
economics, largely for his research on asymmetry in the way people value
potential gains and losses in making decisions. Taleb is critical of that research.
The question I raised at the outset was prompted by the
following passage:
“Skin in the game helps to solve the Black Swan
problem and other matters of uncertainty at the level of both the individual
and the collective: what has survived has revealed its robustness to Black Swan
events and removing skin in the game disrupts such selection mechanisms. Without skin in the game, we fail to get the Intelligence
of Time".
It is worth trying to take that apart to understand
the reasoning behind it.
Skin
in the game is about more than just sharing in the benefits of
an activity. It involves symmetry and reciprocity – paying a penalty if
something goes wrong as well as sharing in the rewards for risk taking.
Most people who provide us with goods and services still
pursue occupations where they have skin in the game. The problem is that many
of the people who don’t have skin in the game - for example, politicians,
bureaucrats, bankers and university professors - occupy positions where their
mistakes can have far-reaching consequences.
The Black
Swan problem arises when we ignore extreme events – potential disasters -
that occur infrequently. Taleb’s main point is that there are some risks that we
can’t afford to take even though there is a low probability that they will
occur at any point in time. His book, The
Black Swan, was published in 2007 and made him famous following the 2008
financial crisis. Taleb contends that banks and trading firms are vulnerable to
hazardous Black Swan events. The bank blow-ups occurred in 2008 as a result of
hidden and asymmetric risks in the financial system.
At the level
of the individual, skin in the game helps to solve the Black Swan problem
because it helps people to focus on their need to survive in order to succeed. Taleb
argues for profiting from risk-taking that doesn’t threaten survival. He points
out that Warren Buffet made his billions by picking opportunities that passed a
high threshold, rather than by applying cost benefit analysis.
At the collective
level, skin in the game helps to solve the Black Swan problem because it
requires decentralization of decision-making. Under a decentralized system the
costs of the mistakes made by individuals are borne by those individuals,
without necessarily affecting other participants. Centralized systems are
exposed to the Black Swan problem because they can only be run by people who
are not directly exposed to the cost of errors.
What
has survived has revealed its robustness to Black Swan events. That
applies to ideas, institutions, technologies, political systems, procedures, intellectual
productions, car models, scientific theories etc. The only effective judge of
things is time, because time is equivalent to disorder. The longer things survive,
the more likely it is that they will have survived Black Swan events.
Removal
of skin in the game disrupts selection mechanisms. When
people have skin in the game they are less likely to reject ideas that have
withstood the test of time in favour of new ideas that that have been published
in peer-reviewed journals. A lot of findings published in peer reviewed
journals fail subsequent replication tests.
Without
skin in the game, we fail to get the Intelligence of Time. Time
removes the fragile and keeps the robust. The life expectancy of the nonfragile
lengthens with time. Taleb writes:
The only definition of rationality that I’ve found
that is practically, empirically, and mathematically rigorous is the following:
what is rational is that which allows for survival."I think Nassim Taleb is correct in his view that skin in the game helps to solve the Black Swan problem. Unfortunately, however, when it is comes to consideration of potential Black Swan events that threaten the survival of humanity, the political systems we have inherited do not ensure that political leaders have enough skin in the game for their minds to focus appropriately. Political leaders focus on their survival at the next election rather than on the survival of humanity. It is up to citizens who are concerned about potential Black Swan disasters to initiate appropriate action themselves.