TECH TALK: PM to CII: Of Economic Freedom and Bondage

Continuing with Atanu Dey’s perspective of the speech that the Indian Prime Minister should have made to the CII last month:

Ladies and gentlemen, our society is not today that heaven of freedom which Tagore prayed for, where the world has not been broken up into fragments by narrow domestic walls. . . The industry did not create these walls. The fragmentation of our society along caste and religious lines is the doing of political policies. Our policies of favoring special groups arise out of the dreary desert sands of dead habit of dividing the country for narrow-minded mean political gains.

The industry did not create the divisions in society, it cannot be expected to correct these distortions, and it must not be commanded to perpetuate these odious divisions by hiring based on caste and religious categories. The destruction of whatever the Indian industry has accomplished must not be lost in the cesspool of communal politics. Industry did not create the deep social inequalities. The government by raising the specter of violent social revolt to force industry to assume responsibility for the divisions of society is guilty of criminal negligence and gross dereliction of duty.

The government has failed so far to address the real concerns of its citizens. Universal primary education, although guaranteed by the constitution, is still not a reality after 60 years of independence. It is shameful that half the worlds illiterates are Indian. Surely, the failure of the Indian education system cannot be laid at the doorsteps of Indian industry. Indeed, Indian industry itself suffers as a consequence of the massive failure of the government in providing education. If Indian industry can build world-class corporations, surely it is quite capable of efficiently educating the population provided of course that it is allowed to do so.

Indians are as talented a people as any other. Wherever they have enjoyed economic freedom, they have been among the best, from steel manufacture to high technology. Lets ask ourselves why Indians in the US do so well, to just take one example out of scores of places where Indians shine. They succeed more often outside India than within India because in India they are denied economic freedom. They are forced to leave India to concentrate their entrepreneurial and innovative skills in building things rather than stay and fritter away all their energies in fighting our impossible bureaucracy. Our laws and regulations are so onerous that it can sap the strength if not kill the most talented and dedicated of our entrepreneurs. We have to radically change our regulations and our labor laws.

Indians thrive when they are free to get into the rough and tumble of the competitive marketplace. But our socialistic policies have crippled Indias industries. Allow me to quote Pranab Bardhan, one of Indias foremost economists at UC Berkeley (India loses fine academicians and researchers as well, not just engineers and doctors, due to a lack of freedom). Leftists are understandably wary of the wastes of competition and of the anarchy of the market-place. But the last several decades of socialism have shown us unmistakably that the waste and anarchy of the bureaucratic command system are far more injurious to the health of the economy. Without competition in the sense of rivalry among firms (public or private) and a mechanism for exit for chronically sick firms, no economy can attain or retain its vigour and dynamism.

The market rewards excellence and punishes underperformance. The government does not have to worry about whether you are doing your job to the best of your abilities or not you would not be here if you were incompetent. But in government and politics, competency is not that much of a barrier to entry. The ability to manipulate the system is more valued. It appears that it is politics, not patriotism, which is the last refuge of the Indian scoundrel. Hardened criminals sit in our legislative bodies and we all are apparently powerless to change it. But there is a way out, I believe. If you, the captains of the Indian industry, were to support clean political candidates, you can make a difference. It is choice that you can exercise as citizens of this great democracy.

In conclusion, thank you for helping build the nation. You have my gratitude and you have my promise that I will do everything I can to help you create wealth so that no Indian is poor. Lets make India a great nation.

Continue reading TECH TALK: PM to CII: Of Economic Freedom and Bondage

TECH TALK: PM to CII: Social Contracts

Continuing with Atanu Dey’s perspective of the speech that the Indian Prime Minister should have made to the CII last month:

Friends, the primary job of industries is to produce goods and services. The first necessary condition for a successful economy is that it produces sufficient amount of stuff. If industry cannot meet that goal, all other activities are futile. Distribution of insufficient production however equitably will not solve the problem that we face. Nor will merely generating employment because employment is a means, not a goal, of economic activity. Lets not confuse means with ends. Given sufficient production, the problem of equitable distribution can be tackled if necessary by the government.

Which brings us to one important distinction between industry and government. Baldly stated, industries engage in productive activities whereas the government, at best, engages in activities that are sterile. A government takes part of the production in the form of taxes and redistributes it according to some objective function that is arrived at through a process of political bargaining among the electorate. This redistribution is often necessary but is not costless. Part of what it extracts with the purpose of redistribution, the government consumes in the process of redistribution. That is a deadweight loss which grows not just with the size of the amount redistributed but also with the size of the government mechanism doing the redistribution. One of our former prime ministers, Mr Rajiv Gandhi, had famously stated just only 15 paise out of every Re 1 gets redistributed; the deadweight loss is 85 percent in India. Therefore increasing the efficiency of distribution is paramount if taxes have to be reduced without actually reducing the transfer to those who need it.

Reducing the size of the government is important for increasing the efficiency of transfer, of course. But there is another more compelling reason: reduction of corruption. It is a simple matter to recognize that the larger a government is, larger the control it has, which in turn creates an incentive for people and firms to capture the government. It creates an unholy nexus between the government and industry, with the former being lobbied by the latter for licenses, permits, and quotas.

We both, the industry and the government, have a social contract. Yours is to produce efficiently without imposing social costs, and to make a profit. Market forces will ensure efficiency and the laws will ensure that externalities are compensated for. Our social contract is to make and enforce the laws fairly and efficiently, and to correct for any imperfections that exist in society.

Lets take the matter of employment to distinguish between the two social contracts. You will compete in the marketplace to employ the best that you can. Who you hire and how much you pay is not our business. Today your survival in the global marketplace is determined by how well you run your business. The government will not dictate how you go about conducting your business. If your employment policy discriminates against people based on any criterion not relevant to the job, the discipline of the market will weed you out in short order.

The governments job is to ensure that every citizen irrespective of caste, religion, sex, or economic status has an equal opportunity to be what he or she is capable of being. The government must enforce equality of opportunity but cannot, and must not attempt to, enforce equality of outcome. Discrimination is abhorrent and the government will not practice it nor force the industry to do so. To give equal opportunity, the government will support the education of the poor without discrimination. That is, the playing field will be level but who plays well and who doesnt will depend on the individual.

Your job is to produce as much as you can and as efficiently as you can. Our job is to make the rules and ensure that everyone has a fair shot at playing in the game. To level the playing field, we have to do some appropriate redistribution of production. We must keep the amount we redistribute within reasonable limits so that we dont cripple the industry. We have to become more efficient in effecting the transfer and this means we will reduce the size of the government.

Tomorrow: Of Economic Freedom and Bondage

Continue reading TECH TALK: PM to CII: Social Contracts

TECH TALK: PM to CII: Fair and Just Profit

Continuing with Atanu Dey’s perspective of the speech that the Indian Prime Minister should have made to the CII last month:

Ladies and gentlemen, poverty is a fact in India. The vast majority of Indians over 80 percent actually live on less than Rs 100 a day. They are poor and have been for decades. The socialistic policies followed since independence did not allow for rapid economic growth. Inward-looking autarkic policies isolated India from the economic growth that propelled the economies of East Asia. Only after the mid-80s was the country granted a very small degree of economic freedom, and that too was in response to a severe balance of payment crisis facing the nation.

By the time India gained political independence, it was a very poor country, impoverished by the dictates of colonialism. But why did prosperity elude India even after independence? Could it be that we the leaders of independent India failed to provide the economic rules that promote and sustain economic growth? A dispassionate review of the facts force us to answer that question in the affirmative.

A lot of self-congratulatory chest thumping can be heard from some quarters of the government for having liberalized the economy to some limited extent. But that is like a man claiming that he is a wonderful husband because he has reduced the severity of the daily beatings of his wife. Liberalization of the economy has given us some gains but certainly not enough liberalization has been done. What the government has to do is to reduce the interference of the government in the economy so that the economy can be truly free to grow.

Big governments that control every aspect of the economy are harmful for social welfare for an obvious reason: it creates an incentive for individuals and corporations to seek profit not legitimately by providing goods and services in a competitive marketplace, but by bribing the politically powerful and thus influencing policy to gain undue advantage in the marketplace for making monopoly profits. Big governments force people to engage in what Jagdish Bhagwati, an illustrious son of our soil and one of the most celebrated economists in the world, calls Directly Unproductive Profit-seeking or DUP activities.

In this discussion on Inclusive Growth the Challenge for Corporations I mention the failures of the government because the government is the greatest challenge that corporations face in what they are supposed to do, namely, produce goods and services so that the economy grows. We must remember that inclusive growth is predicated on growth.

Ladies and gentlemen, every segment of any modern large complex economy has distinct roles to play. It can be considered as a higher-level division of labor. Failure of even one segment to properly discharge its duties and responsibilities has repercussions for the whole economy. The governments duty is to create a society that is free, fair, equitable, just and peaceful. Unfortunately, we are well aware that we have not achieved the ideal society and to a very large extent it is the failure of our government. Although it is fashionable in certain circles to lay the ills of our society on corporate doorsteps, I will not do so because it would be clearly hypocritical of me. Furthermore, it would be pointless to expect corporations to address those social ills which it has neither created nor has any particular expertise in addressing.

So what is the basic responsibility of corporations? Stated most simply it is this: To make a profit. Ours is a deep and ancient culture. Our cultural legacy not only includes profound spiritual values but also ethical business values expressed compactly in the dictum of Shubh Labh or Fair and just Profit. When you make a profit honestly supplying goods and services to society, it implies that society gains since the benefits (represented by the price paid) exceed the costs incurred to produce the good or service precisely by the amount of profit. Making that fair and just profit is your corporate social responsibility and nothing else.

I am here not to ask what corporations can do for the government (or even for the society at large) but rather to promise what the government should do to help corporations. Lets examine that next.

Continue reading TECH TALK: PM to CII: Fair and Just Profit

TECH TALK: PM to CII: Governance

Continuing with Atanu Dey’s perspective of the speech that the Indian Prime Minister should have made to the CII last month:

Ladies and gentlemen, the sole objective of a government has to be to provide governance. The raison detre of a government is the creation of social capital, to be a guarantor of civil rights, to maintain law and order, to correct for externalities, to create an environment where individuals and corporations have the freedom to create wealth. The government has to be an enabler in the process of wealth generation, not an inhibitor that it has been for so long.

The role of the government is to set the rules, not play in the great economic game. Nobel prize-winning economist Douglass C. North noted that economic history is overwhelmingly a story of economies that failed to produce a set of economic rules of the game (with enforcement) that induce sustained economic growth. It is a cautionary observation and clearly underlines what lies at the root of our failure so far in sustaining our economic development: the government has abdicated its primary function of designing the rules and enforcing them fairly, and instead entered the game as a player.

The results of the governments involvement in production rather than in rule-making and enforcement are plain to see. Just to take a very critical example, consider the generation, transmission, and distribution of electrical powerthe life-blood of a healthy economy. Public sector power corporations have let us down. The shortage of power is severe, acute, and chronic. Just in the state of Maharashtra, demand outstrips the supply of 15,000 MW by over 5,000 MW. It is a crisis for consumers, but even more for our industries, the producers of wealth. It raises the production costs of our manufacturers and they are handicapped in the global marketplace.
In an era of globalization and international competition, Indian corporations face challenges that are mainly derived from government interference and control. Indian industry faces an acute shortage of trained human resources. It is regrettably reported that only about a quarter of our college graduates are employablea sure sign of our failed education system. Once again, the government needlessly prevented the private sector to be in education, and instead took monopoly control of the sector. The results are as could be expected: poor quality, extreme shortages, and high costs.

The production of goods and services is not the job of the government; that is the job of the private sector. By getting into production too often as a monopolist the government has demonstrated its abject failure. And this is understandable because governments are not capable of inventiveness, entrepreneurship and innovation; qualities that it does not have and thus cannot compete in the marketplace. By wasting its energies on activities that it has no comparative advantage in, the government has neglected what it is required to do: design the rules and enforce them, and create the environment where contracts can be made and enforced. That failure is as costly if not more than the failed attempts by the government to produce goods and services efficiently and in sufficient quantities. Consider the functioning of our legal system, as an example.

Among the institutions of governance are the legislature, the executive, the bureaucracy, and most importantly the judiciary. The statistics of the inadequacy of the judiciary are staggering. There are an estimated over 20,000 cases pending in the Supreme Court, around 3 million in the high courts, and a mind-numbing 22 million cases in the rest of the legal system. There are cases in the high courts which date back to the 1950s. Aside from the deep concern that justice delayed is tantamount to justice denied, the backlog of cases has a detrimental effect on the conducting of business in India. When contracts cannot be enforced, the economy loses from potential trades that do not take place.

The limited liberalization of the economy from the shackles of socialistic control has given us an economy growing at a respectable rate of 7 to 9 percent annually. But unless the governance of the economy is improved, even further liberalization which is sorely needed will be insufficient to sustain growth. And if growth is not sustained, the hundreds of millions so long trapped in poverty will not have a reasonable shot at economic emancipation. Lets consider what needs to be done.

Tomorrow: Fair and Just Profit

Continue reading TECH TALK: PM to CII: Governance

TECH TALK: PM to CII: Division of Labour

In May, the Indian Prime Minister Dr. Manmohan Singh made a widely- discussed speech to the CII. Here is the full-text of that speech. I think the PM missed an opportunity to lay out a vision for a New and Better India. My colleague, Atanu Dey, has written a speech that the Indian PM should have made. Here it is.

Dear Members of the Confederation of Indian Industries:

I am very honored to be invited to share my thoughts with you on the subject of Inclusive Growth the Challenges for Corporate India. I appreciate deeply the critically important role that Indian corporations play in the present and will continue to play in the economic growth and development of India. For that, you have my gratitude; not just mine but the gratitude of the people of a nation that is on the move.

You, more than any other group, certainly understand the source of all wealth production. And what is more, you know how to create wealth. Wealth does not drop like gentle rain from heaven; it does not come as a gift from some government agency; it does not spontaneously arise from some softly spoken magic spell; it does not materialize out of the vain electoral promises of some demagogue; it does not flow unbidden from the earth like some volcanic eruption. No, you know as well as anyone does that it requires hard work, entrepreneurship, risk taking, imagination, skill, investment, and vision to create wealth.

Production that is, the creation of wealth matters because ultimately that is what gets distributed as income to the people. If production were inadequate for whatever reason, even equitable distribution of that production would not eliminate poverty. The problem of a fair distribution of wealth is a much more tractable problem than the production of wealth. Society rightly burdens you the corporations of the economy with the task of producing wealth, and relieves you of the burden of correcting for any unfair distribution and assigns that task to the government. It is an understandable division of labor. Corporations have a comparative advantage in creating wealth. If any redistribution is necessitated, then it is the job of the government to do so.

You the private sector have to do what the government cannot do. The government does not create wealth; you do. In every sphere, wherever you have been allowed to go ahead with your job producing wealth you have surpassed all expectations. Decades of government involvement in attempted production of wealth had resulted in diminished expectations from India and Indians. You have demonstrated that if given the chance, India and Indians are second to none.

Consider for a moment those things that India is known globally for in the world of excellence and achievement. Every sphere in which India competes and comes out among the leaders has been the result of private enterprise, whether it is in IT and ITES, or in manufacturing. What about the government and political leadership? While the captains of our industries the Tatas, Birlas, Kalyanis, Mallyas, Ambanis, and others compare very favorably globally, our political leadership is infamous for being a haven for criminals. The percentage of criminals among the politicians is an order of magnitude greater than that in the general population. That is a fact that we have to keep in mind when we talk about governance of this great nation.

Ladies and gentlemen of the CII, in my talk here I will remind you of your responsibility and your duty, of course. But I will also take this opportunity to remind us of what the governments responsibility is. I further assert that the industry and the government have distinct and important roles, and that separation of industry and government must be maintained if we have to have growth.

Tomorrow: Governance

TECH TALK: Black Swan: More Reviews

The Guardian wrote about Nassim Talebs The BlackSwan: If you are aware of your own ignorance, though, you can use it to make money, as Taleb did on Wall Street, as an options trader. Options are gambles about what the market will do. To sell an option to somebody else, you need to be confident you have some kind of theory about what will happen in the future. If you’re right, you make a small amount of money; if you’re wrong, you lose lots. Taleb, however, realised he had no theories. So he exploited everyone else’s confidence, buying options according to no particular prediction. Most days, his rivals made a small amount of money, and he lost a small amount. But the one thing he could predict was that, if he waited long enough, something unpredictable would happen. When it did, some of his rivals would lose millions, and Taleb would make millions. It happened often enough for him to turn a big profit. It takes a rebellious nature, and an iron stomach, to go against the flow for so long. It is, perhaps, the kind of mindset that comes naturally to someone who lived through the Lebanese civil war – a classic, unpredictable black swan – and then found himself living as an exile, at one remove from American society. We are not all so good at resisting the herd’s way of thinking.

Bloomberg wrote:

There’s an investment strategy to profit from improbability. “Be as hyperconservative and hyperaggressive as you can instead of being mildly aggressive or conservative,” Taleb advises. “Instead of having medium risk, you have high risk on one side and no risk on the other. The average will be medium risk but constitutes a positive exposure to the Black Swan.”

The hand can feed the turkey for 1,000 days until, on day 1,001, it wrings the fowl’s neck for Thanksgiving. The trick is to be the butcher, not the turkey.

“A thousand days cannot prove you right, but one day can prove you to be wrong,” writes Taleb. “I am not urging you to stop being a fool. Just be a fool in the right places.”

With risk measures at or near record lows, including volatility indexes, corporate bond defaults, credit spreads and emerging-market yields, Taleb might help you dodge the next Black Swan.

Business Week wrote:

The Black Swan is not as unprecedented as Taleb claims. You may have encountered pieces of his arguments in recent popular books by the likes of Chris Anderson, James Gleick, Paul Ormerod, Duncan Watts, Steven Strogatz, Aaron Brown, and one of Taleb’s few living heroes, Benoit Mandelbrot.

Moreover, despite Taleb’s best efforts to make The Black Swan a useful guide to life, we human beings aren’t wired to cope well with radical uncertainty. Donald Rumsfeld, the former Defense Secretary, famously cogitated in front of the microphones about “unknown unknowns,” which is precisely Taleb’s conceptand look where the philosophizing got him. Still, The Black Swan is a richly enjoyable read with an important message.

Nassim Talebs The Black Swan is one of the best and most important books you will read. Go get it!

Continue reading TECH TALK: Black Swan: More Reviews

TECH TALK: Black Swan: Mediocristan and Extremistan

The ideas behind Mediocristan and Extremistan in Nassim Talebs The BlackSwan are worth exploring in more depth. Chetan Parikh has reproduced a table from the book which explains the differences between Mediocristan and Extremistan.

The Portfolio wrote:

N.N.T., who lives in New York and has taught at the University of Massachusetts at Amherst, previously traded derivatives on Wall Street. The academics who drive him to tears are the ones who have explainedor misexplainedhis old profession. They think that markets are from Mediocristan when in fact they inhabit Extremistan.

Say what? Mediocristan is the terrain of the ordinary, the part of the world that conforms to the bell curve. It answers to statistics and knowable probabilities. Height resides in Mediocristan. You may find one 7-footer on your block, almost certainly not two. Experience (and biology) enable us to frame the odds. Weight is also from Mediocristan. Pick any 1,000 people and their average weight will be close to that of the general population (even if you include the worlds fattest person). Personal wealth, however, is from Extremistan. For instance, the average wealth of 1,000 people will be very different if one of those people is Bill Gates.

This distinction is potent. In Extremistan, past events are a faulty guide to projecting the future. Gates may be the worlds richest person, but it isnt unthinkable that someday, someone (at Google, perhaps?) will be twice as rich. Wars also reside in Extremistan. Prior to World War II, the planet had never experienced a conflict as terrible. Then we did. Suppose you frequent a pond. Day after day you see swansalways white. Naturally (but incorrectly) you presume that all swans are white. World War II was a black swanhorrific and unpredictable.

The Financial Times added:

Taleb claims that there are too many extreme events in securities markets for such markets to be located in Mediocristan. The black swan of October 1987, when the Dow Jones index fell by about 20 per cent, was the first trigger for his personal reassessment. The event was simply outside the realms of possibility in classical statistics. Taleb would first substitute power laws and the mathematics of extreme statistics for the reassurance of normal distributions. But this still gives more credence to economists and financial analysts than he allows. Probabilities can be defined and predictions made only if the events that are the subject of the probabilities and predictions can be described. Donald Rumsfeld distinguished known unknowns and unknown unknowns. Statistics, old and new, deal with known unknowns. Talebs world is determined by unknown unknowns – black swans.

No one, he says, could have predicted the invention of the wheel or measured the probability that the wheel would be invented, because if you could do either of these things you would already have invented the wheel. The invention of the wheel was a black swan.

Arlene Goldbard went further:

Taleb argues convincingly that we treat far too much of our reality as if it were Mediocristan when in fact much of it often behaves like Extremistan, where there are occasional black swans (his name for the unexpected event and the title of his most recent book) among the white. So, for example, out of the many thousands of books, films and recordings released each year, a small number will account for the largest part of sales, and it is not possible to predict with certainty which of the many works released will find black swan-style success (or failure). Indeed, in any endeavor susceptible to notable, unpredictable exceptions, no amount of examining the past will enable us to foretell the future.

Whats going on here? Taleb discusses many factors contributing to our tendency to see our world as Mediocristan. There is the fact that our brains evolved long ago to deal with a world with many fewer variables, much less organized information, and a vastly smaller number of theories to explain them. The more complex any given situation, the larger number of examples you need to understand what is happening there. For instance, sampling the sales of a few dozen published books each year wont tell you much about the prospects of the thousands of others not sampled. Its just as likely as not that your sample would include one or more black swansunexpectedly huge winners or losersso anything you might conclude based on it would not be generalizable to the rest.

Tomorrow: More Reviews

Continue reading TECH TALK: Black Swan: Mediocristan and Extremistan

TECH TALK: Black Swan: Reviews

Here is what the Economist has to say about Nassim Talebs The BlackSwan:

Nassim Nicholas Taleb, a professor of the sciences of uncertainty (who gave us known unknowns), has no time for the charlatans who think they can map the future. Forget the important things: we can’t even get it right when estimating the cost of a buildingwitness the massively over-budget Sydney Opera House or the new Wembley Stadium.

The problem is that almost all forecasters work within the parameters of the Gaussian bell curve, which ignores large deviations and thus fails to take account of Black Swans. Mr Taleb defines a Black Swan as an event that is unexpected, has an extreme impact and is made to seem predictable by explanations concocted afterwards. It can be both positive and negative. Examples include the September 11th 2001 attacks and the rise of the internet. Smaller shocks, such as novels and pop acts whose popularity explodes thanks to word of mouth, can also be Black Swans.

This is what The Wall Street Journal wrote:

The power-law distribution, by contrast [to the bell-curve distribution], would seem to have little to recommend it. Not only does it disproportionately reward the few, but it also turns out to be notoriously difficult to derive with precision. The most important events may occur so rarely that existing data points can never truly assure us that the future won’t look very different from the present. We can be fairly certain that we will never meet anyone 14-feet tall, but it is entirely possible that, over time, we will hear of a man twice as rich as Bill Gates or witness a market crash twice as devastating as that of October 1987.

The problem, insists Mr. Taleb, is that most of the time we are in the land of the power law and don’t know itIf we accept Mr. Taleb’s premise about power-law ascendancy, we are left with a troubling question: How do you function in a world where accurate prediction is rarely possible, where history isn’t a reliable guide to the future and where the most important events cannot be anticipated?
Mr. Taleb presents a range of answers–be prepared for various outcomes, he says, and don’t rush for buses–but it’s clear that he remains slightly vexed by the world he describes so vividly. Then again, beatific serenity may not be the goal here. As Mr. Taleb warns, certitude is likely to be found only in a fool’s (bell-curve) paradise, where we choose the comfort of the “precisely wrong” over the challenge of the “broadly correct.” Beneath Mr. Taleb’s blustery rhetoric lives a surprisingly humble soul who has chosen to follow a demanding and somewhat lonely path.

Niall Ferguson wrote in The Telegraph:

Taleb’s central point, then, is that we are too much influenced by instinct, history, Plato and Gauss. We assume the entire world is “Mediocristan”, whereas in reality large swathes of it are “Extremistan”.
The trouble is that it is much harder to live with this insight than to live without it. As Taleb’s critics in the financial world will tell you (and he himself admits), merely insuring yourself against fat tail events does not constitute a profitable trading strategy. Knowing that world wars can happen roughly twice a century is like knowing that a student can run amok roughly once a decade: it doesn’t allow you to predict which diplomatic/personality crisis will be the lethal one.

For practical purposes, it turns out, we humans prefer to work with predictions and forecasts, even when they are nearly always wrong. We prefer to regard financial markets as casinos (what Taleb calls “the ludic fallacy” that odds are always calculable), even when they clearly aren’t. And we resist paying excessive insurance premiums to cover ourselves against very remote contingencies.

Tomorrow: Mediocristan and Extremistan

Continue reading TECH TALK: Black Swan: Reviews

TECH TALK: Black Swan: Book Excerpt

Here is an excerpt from Nassim Talebs The BlackSwan (via 800-CEO-Read):

Just imagine how little your understanding of the world on the eve of the events of 1914 would have helped you guess what was to happen next. (Dont cheat by using the explanations drilled into your cranium by your dull high school teacher). How about the rise of Hitler and the subsequent war? How about the precipitous demise of the Soviet bloc? How about the rise of Islamic fundamentalism? How about the spread of the Internet? How about the market crash of 1987 (and the more unexpected recovery)? Fads, epidemics, fashion, ideas, the emergence of art genres and schools. All follow these Black Swan dynamics. Literally, just about everything of significance around you might qualify.

This combination of low predictability and large impact makes the Black Swan a great puzzle; but that is not yet the core concern of this bookThe central idea of this book concerns our blindness with respect to randomness, particularly the large deviations: Why do we, scientists or nonscientists, hotshots or regular Joes, tend to see the pennies instead of the dollars? Why do we keep focusing on the minutiae, not the possible significant large events, in spite of the obvious evidence of their huge influence? And, if you follow my argument, why does reading the newspaper actually decrease your knowledge of the world?

It is easy to see that life is the cumulative effect of a handful of significant shocks. It is not so hard to identify the role of Black Swans, from your armchair (or bar stool). Go through the following exercise. Look into your own existence. Count the significant events, the technological changes, and the inventions that have taken place in our environment since you were born and compare them to what was expected before their advent. How many of them came on a schedule? Look into your own personal life, to your choice of profession, say, or meeting your mate, your exile from your country of origin, the betrayals you faced, your sudden enrichment or impoverishment. How often did these things occur according to plan?

Black Swan logic makes what you dont know far more relevant than what you do know. Consider that many Black Swans can be caused and exacerbated by their being unexpected.

Our world is dominated by the extreme, the unknown, and the very improbable (improbable according our current knowledge)and all the while we spend our time engaged in small talk, focusing on the known, and the repeated. This implies the need to use the extreme event as a starting point and not treat it as an exception to be pushed under the rug. I also make the bolder (and more annoying) claim that in spite of our progress and the growth in knowledge, or perhaps because of such progress and growth, the future will be increasingly less predictable, while both human nature and social science seem to conspire to hide the idea from us.

Tomorrow: Reviews

Continue reading TECH TALK: Black Swan: Book Excerpt

TECH TALK: Black Swan: Definition

One of the books I have been eagerly looking forward to reading is Nassim Talebs The BlackSwan. I first came across Nassim Taleb in one of our Book Club meetings, via Chetan Parikh. I then read Fooled by Randomness, Talebs first book. I also have made references to the Black Swan in a number of my blog posts and Tech Talks (here is one) in the past. And so, it was with great eagerness that I picked up Talebs new book. I recommend you do the same. In this Tech Talk series, I will take you through what various people (including Taleb) have to say about Black Swans.

Lets start with a definition of Black Swan from the book: What we call here a Black Swan (and capitalize it) is an event with the following three attributes. First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme impact. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable[It can be summarized as a triplet]: rarity, extreme impact, and retrospective (though not prospective) predictability.

Business World spoke to Nassim Taleb. Excerpts from the interview:

What is a Black Swan?
Medieval Europeans had only ever seen white swans. In fact, any impossible event was termed a black swan. So, when the first settlers reached Australia, they were shocked to find black swans all over! Taleb’s black swans are those events that were once thought impossible, but when they occur, hit hard. In this extract, he writes about how we create narratives after black swan events; making them seem predictable after they occur.

Why are black swans important?
People say Taleb wants us to worry about meteorites hitting Earth. I want to help people navigate in a world where we dont have a clear understanding of reality. Black Swan is essentially a map of how to deal with such a reality. The book distinguished between [two imaginary places] Mediocristan and Extremistan. In Mediocristan, variations in any sample do not result in large deviations from the average. The question, then, is which domains or areas have highly consequential variables? These places are Extremistan.

What are some of the classic examples of black swan events?
A classic black swan event is the First War (World War I). It was not as predictable as people believe it was. Then you have all this technology computers, lasers. Their future uses could never be predicted when they were invented.

Wired also interviews Nassim Taleb:

With better models and more computational power, won’t we get better at predicting Black Swans?
We know from chaos theory that even if you had a perfect model of the world, you’d need infinite precision in order to predict future events. With sociopolitical or economic phenomena, we don’t have anything like that. And things are getting worse, not better, because the growing complexity of the world dwarfs any improvement in sophistication or computational power.

So what do we do? If we can’t forecast the really important things, how do we act?
You need to ask, “If the Black Swan hits me, will it help me or hurt me?” You cannot figure out the probability of a Black Swan hitting. But if you’re in a business that’s prone to negative Black Swans, like catastrophe insurance, I advise you not to take your forecasting seriously and to think about getting into a different business. You don’t want to be a sucker. What you want are situations where you can have as much of the good uncertainty as possible, where nothing too bad can happen to you, and where you have what I call free options. All of technology, really, is about maximizing free options. It’s like venture capital: Most of the money you make is from things you weren’t looking for. But you find them only if you search.

Wikipedia has more on Nassim Taleb.

Tomorrow: Book Excerpt

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