Tags: Taleb | black | swan | flexible

‘Black Swan’ Author Taleb: Institutions Should Roll With Black Swans, Not Resist Them

Tuesday, 20 Nov 2012 08:14 AM

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Institutions these days should be flexible and nimble in nature and able to roll with black swan events like bamboo in a storm rather than resist them and snap a like bigger tree, said Nassim Taleb, the author and financial guru whose 2007 book “The Black Swan” predicted the current financial crisis.

Black swan events, according to Taleb, are incidents that strike unexpectedly and inflict major damage to markets and economies, many of which are obvious in hindsight.

Businesses and governments today often worry when a black swan event might occur, though they would be better to focus on being able to withstand blindside punches by being nimble and flexible like a small outfit rather than bulking up to resist the unknown.

Editor's Note: This Wasn’t an Accident — Experts Testify on Financial Meltdown

“We should try to create institutions that won’t fall apart when we encounter black swans — or that might even gain from these unexpected events,” Taleb wrote in a Wall Street Journal Op-Ed.

“To deal with black swans, we … need things that gain from volatility, variability, stress and disorder. My (admittedly inelegant) term for this crucial quality is ‘anti-fragile.’”

To cultivate anti-fragile businesses, governments must intervene only when needed, such as when natural disasters strike.

Some businesses should be allowed to fail so that those that do survive come out stronger having learned from those who lost, leaving society as a whole to benefit, such as the case with the airline industry after a plane crash, he wrote.

Favor those businesses, and avoid businesses whose failure hurts its sector and the broader economy, such as financial institutions.

Meanwhile, too many big institutions rely on economies of scale to drive their businesses, but “great size in itself, when it exceeds a certain threshold, produces fragility and can eradicate all the gains from economies of scale.”

“I have argued that government decentralization would help to lower public deficits. A large part of these deficits comes from underestimating the costs of projects, and such underestimates are more severe in large, top-down governments,” Taleb wrote.

“Compare the success of the bottom-up mechanism of canton-based decision making in Switzerland to the failures of authoritarian regimes in Soviet Russia and Baathist Iraq and Syria.”

Investors and policymakers, especially former Federal Reserve Chairman Alan Greenspan, as well as current Chairman Ben Bernanke, who intervened heavily with monetary stimulus to avoid uncertainty, often fear volatility, though in reality, it can be an economy’s best friend.

“Modernity has been obsessed with comfort and cosmetic stability, but by making ourselves too comfortable and eliminating all volatility from our lives, we do to our bodies and souls what Mr. Greenspan did to the U.S. economy: We make them fragile,” Taleb wrote.

“We must instead learn to gain from disorder.”

Most policymakers today are scrambling to avoid disorder, namely the fiscal cliff, a combination of tax hikes and spending cuts set to kick in at the same time early next year.

Failure on the part of Congress to steer the economy away from the fiscal cliff could send the economy into a recession next year, according to the nonpartisan Congressional Budget Office and private-sector economists.

“The markets are very shaky,” Greenspan told Bloomberg Television. “The markets will crater if we run into any evidence that we can’t solve this problem.”

A compromise that avoids recession could still slow growth next year, as taxes might rise for some Americans, while public spending could be cut to a degree, as well.

That’s fine, Greenspan said, as slower growth or even a brief downturn is preferable to a messy and avoidable contraction.

“A large increase in taxes is required to fund what currently, on the books, is going to cause a recession, but I think that if we can get away with that as the only cost to this whole problem I think that’s a pretty good deal,” Greenspan said.

Editor's Note: This Wasn’t an Accident — Experts Testify on Financial Meltdown

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