Skin in the Game

by Nassim Nicholas Taleb

  Indeed, it doesn’t cost us much to refuse some new shoddy technologies. It doesn’t cost me much to go with my “refined paranoia,” even if wrong. For all it takes is for my paranoia to be right once, and it saves my life.

  LOVE SOME RISKS

  Antifragile shows how people confuse risk of ruin with variations and fluctuations—a simplification that violates a deeper, more rigorous logic of things. I make the case for risk loving, for systematic “convex” tinkering, and for taking a lot of risks that don’t have tail risks but offer tail profits. Volatile things are not necessarily risky, and the reverse is also true. Jumping from a bench would be good for you and your bones, while falling from the twenty-second floor will never be so. Small injuries will be beneficial, never larger ones, those that have irreversible effects. Fearmongering about some classes of events is fearmongering; about others it is not. Risk and ruin are different tings.

  NAIVE EMPIRICISM

  All risks are not equal. We often hear that “Ebola is causing fewer deaths than people drowning in their bathtubs,” or something of the sort, based on “evidence.” This is another class of problems that your grandmother can get, but the semi-educated cannot.

  Never compare a multiplicative, systemic, and fat-tailed risk to a non-multiplicative, idiosyncratic, and thin-tailed one.

  Recall that I worry about the correlation between the death of one person and that of another. So we need to be concerned with systemic effects: things that can affect more than one person should they happen.

  A refresher here. There are two categories in which random events fall: Mediocristan and Extremistan. Mediocristan is thin-tailed and affects the individual without correlation to the collective. Extremistan, by definition, affects many people. Hence Extremistan has a systemic effect that Mediocristan doesn’t. Multiplicative risks—such as epidemics—are always from Extremistan. They may not be lethal (say, the flu), but they remain from Extremistan.

  More technically:

  Mediocristan risks are subjected to the Chernoff bound.

  The Chernoff bound can be explained as follows. The probability that the number of people who drown in their bathtubs in the United States doubles next year—assuming no changes in population or bathtubs—is one per several trillions lifetimes of the universe. This cannot be said about the doubling of the number of people killed by terrorism over the same period.

  Journalists and social scientists are pathologically prone to such nonsense—particularly those who think that a regression and a graph are sophisticated ways to approach a problem. Simply, they have been trained with tools for Mediocristan. So we often see the headline that many more American citizens slept with Kim Kardashian than died of Ebola. Or that more people were killed by their own furniture than by terrorism. Your grandmother’s logic would debunk these claims. Just consider that: it is impossible for a billion people to sleep with Kim Kardashian (even her), but that there is a non-zero probability that a multiplicative process (a pandemic) causes such a number of Ebola deaths. Or even if such events were not multiplicative, say, terrorism, there is a probability of actions such as polluting the water supply that can cause extreme deviations. The other argument is one of feedback: if terrorism casualties are low, it is because of vigilance (we tend to search passengers before boarding planes), and the argument that such vigilance is superfluous indicates a severe flaw in reasoning. Your bathtub is not trying to kill you.

  I was wondering why the point appears to be unnatural to many “scientists” (which includes policymakers), but natural to some other people, such as the probabilist Paul Embrechts. Simply, Embrechts looks at things from the tail. Embrechts studies a branch of probability called extreme value theory and is part of a group we call “extremists”—a narrow group of researchers who specialize, as I do, in extreme events. Well, Embrechts and his peers look at the difference between processes for extremes, never the ordinary. Do not confuse this with Extremistan: they study what happens for extremes, which includes both Extremistan and Mediocristan—it just happens that Mediocristan is milder than Extremistan. They classify what can happen “in the tails” according to the generalized extreme value distribution. Things are a lot—a lot—clearer in the tails. And things are a lot—a lot—clearer in probability than they are in words.

  SUMMARY

  We close this chapter with a few summarizing lines.

  One may be risk loving yet completely averse to ruin.

  The central asymmetry of life is:

  In a strategy that entails ruin, benefits never offset risks of ruin.

  Further:

  Ruin and other changes in condition are different animals.

  Every single risk you take adds up to reduce your life expectancy.

  Finally:

  Rationality is avoidance of systemic ruin.

  *1 As with my “Fat Tails” project, economists may have been aware of the ensemble-time problem, but in a sterile way. Further, they keep saying “we’ve known about fat tails,” but somehow they don’t realize that taking the idea to the next step contradicts much of their work. It is the consequences that matter.

  *2 Mental accounting refers to the tendency of people to mentally (or physically) put their funds in separate insulated accounts, focusing on the source of the money, and forgetting that as net owners the source should not matter. For instance, someone who would not buy a tie because it is expensive and appears superfluous gets excited when his wife buys for his birthday the same tie using funds from a joint checking account. In the case under discussion, Thaler finds it a mistake to vary one’s strategy pending on whether the source of funds is gains from the casino or the original endowment. Clearly, Thaler, like other psycholophasters, is oblivious of the dynamics: social scientists are not good with things that move.

  *3 Actually, I usually joke that my death plus someone I don’t like surviving, such as the journalistic professor Steven Pinker, is worse than just my death.

  *4 To show the inanity of social science, they have to muster up the sensationalism of “mirror neurons” to explain the link between the individual and the collective. Relying on neuro-something is a form of scientism called “brain porn,” discussed in Antifragile.

  What Lindy Told Me

  Now, reader, comes the end of the journey—and a fifth installment of the Incerto. So while trying to summarize the book, with the obligatory distillation, I saw the reflection of my face in a restaurant’s mirror: dominated by a whitish beard, and a defiant East-Med (East Mediterranean) Greco-Phoenician pride in aging. It was more than two and a half decades ago that I put pen to paper for the Incerto, before my beard turned gray. Lindy was telling me that, for a certain class of things, I had less to prove, less to explain, and less to theorize. I had overheard someone in the restaurant saying emphatically, “It is what it is,” and the phrase kept repeating itself in my head.

  No summary this time, no summary anymore. Per Lindy:

  When the beard (or hair) is black, heed the reasoning, but ignore the conclusion. When the beard is gray, consider both reasoning and conclusion. When the beard is white, skip the reasoning, but mind the conclusion.

  So let me finish this book with a (long) maxim, via negativa style:

  No muscles without strength,

  friendship without trust,

  opinion without consequence,

  change without aesthetics,

  age without values,

  life without effort,

  water without thirst,

  food without nourishment,

  love without sacrifice,

  power without fairness,

  facts without rigor,

  statistics without logic,

  mathematics without proof,

  teaching without experience,

 
politeness without warmth,

  values without embodiment,

  degrees without erudition,

  militarism without fortitude,

  progress without civilization,

  friendship without investment,

  virtue without risk,

  probability without ergodicity,

  wealth without exposure,

  complication without depth,

  fluency without content,

  decision without asymmetry,

  science without skepticism,

  religion without tolerance,

  and, most of all:

  nothing without skin in the game.

  And thank you for reading my book.

  Two men of courage:

  Ron Paul, a Roman among Greeks;

  Ralph Nader, Greco-Phoenician saint

  Ralph Nader; Ron Paul; Will Murphy (editor, advisor, proofreader, syntax expert and specialist); Ben Greenberg (editor); Casiana Ionita (editor); Molly Turpin; Mika Kasuga; Evan Camfield; Barbara Fillon; Will Goodlad; Peter Tanous; Xamer ‘Bou Assaleh; Mark Baker (aka Guru Anaerobic); Armand d’Angour; Alexis Kirschbaum; Max Brockman; Russell Weinberger; Theodosius Mohsen Abdallah; David Boxenhorn; Marc Milanini; ETH participants in Zurich; Kevin Horgan; Paul Wehage; Baruch Gottesman, Gil Friend, Mark Champlain, Aaron Elliott, Rod Ripamonti, and Zlatan Hadzic (all on religion and sacrifice); David Graeber (Goldman Sachs); Neil Chriss; Amir-Reza Amini (automatic cars); Ektrit Kris Manushi (religion); Jazi Zilber (particularly Rav Safra); Farid Anvari (U.K. scandal); Robert Shaw (shipping and risk sharing); Daniel Hogendoorn (Cambyses); Eugene Callahan; Jon Elster, David Chambliss Johnson, Gur Huberman, Raphael Douady, Robert Shaw, Barkley Rosser, James Franklin, Marc Abrahams, Andreas Lind, and Elias Korosis (all on paper); John Durant; Zvika Afik; Robert Frey; Rami Zreik; Joe Audi; Guy Riviere; Matt Dubuque; Cesáreo González; Mark Spitznagel; Brandon Yarkin; Eric Briys; Joe Norman; Pascal Venier; Yaneer Bar-Yam; Thibault Lécuyer; Pierre Zalloua; Maximilian Hirner; Aaron Eliott; Jaffer Ali; Thomas Messina; Alexandru Panicci; Dan Coman; Nicholas Teague; Magued Iskander; Thibault Lécuyer; James Marsh; Arnie Schwarzvogel; Hayden Rei; John Mast-Finn; Rupert Read; Russell Roberts; Viktoria Martin; Ban Kanj Elsabeh; Vince Pomal; Graeme Michael Price; Karen Brennan; Jack Tohme; Marie-Christine Riachi; Jordan Thibodeau; Pietro Bonavita. I apologize for the near-certain omission.

  Rent Seeking: trying to use protective regulations or “rights” to derive income without adding anything to economic activity, without increasing the wealth of others. As Fat Tony would define it, it is like being forced to pay protection money to the Mafia without getting the economic benefits of protection.

  Revelation of Preferences: the theory, originating with Paul Samuelson (initially in the context of choice of public goods), that agents do not have full access to the reasoning behind their actions; actions are observables, while thought is not, which prevents the latter from being used for rigorous scientific investigation. In economics, experiments require an actual expenditure by the agent. Fat Tony’s summary is “tawk is always cheap.”

  Regulatory Capture: situations where regulations end up being “gamed” by an agent, often in divergence from the original intent of the regulation. Some bureaucrats and businesspersons may owe part of their income to protective regulations and franchises, and lobby for them. Note that regulations are easier to put in than to correct and remove.

  Scientism: the belief that science looks…like science, with too much emphasis on the cosmetic aspects, rather than its skeptical machinery. It prevails in domains with administrators judging contributions according to metrics. It also prevails in domains left to people who talk about science without “doing,” such as journalists and schoolteachers.

  Naive Rationalism: Belief that we have access to what makes the world work and that what we don’t understand doesn’t exist.

  Intellectual Yet Idiot: an idiot.

  Pseudo-rationalism: 1) focusing on the rationality of a belief rather than its consequences, 2) the use of bad probabilistic models to naively decry people’s “irrationality” when they engage in a certain class of actions.

  Agency Problem: misalignment of interest between the agent and the principal, say between the car salesman and you (the potential owner), or between the doctor and the patient.

  Bob Rubin Trade: payoff in a skewed domain where the benefits are visible (and rewarded with some compensation) and the detriment is rare (and unpunished owing to absence of skin in the game). Can be generalized to politics, anything where the penalty is weak and the victims are abstract and distributed (say taxpayers or shareholders).

  Interventionista: someone who causes fragility because he thinks he understands what’s going on. He is not exposed to the filter and discipline of skin in the game. Also, usually lacks sense of humor.

  Green Lumber Fallacy: mistaking the source of important or even necessary knowledge—the greenness of lumber—for another, less visible from the outside, less tractable one. How theoreticians impute wrong weights to what one should know in a certain business, or, more generally, how many things we call “relevant knowledge” aren’t so much so.

  Lecturing-Birds-How-to-Fly Effect: inverting the arrow of knowledge to read academia ➝ practice, or education ➝ wealth, to make it look as though technology owes more to institutional science than it actually does. See Antifragile.

  Lindy Effect: when a technology, idea, corporation, or anything nonperishable has an increase in life expectancy with every additional day of survival—unlike perishable items (such as humans, cats, dogs, economic theories, and tomatoes). So a book that has been a hundred years in print is likely to stay in print another hundred years—provided its sales remain healthy.

  Ergodicity: In our context here, ergodicity holds when a collection of players have the same statistical properties (particularly expectation) as a single player over time. Ensemble probabilities are similar to time probabilities. Absence of ergodicity makes the risk properties not directly transferable from observed probability to the payoff of a strategy subjected to ruin (or any absorbing barrier or “uncle point”)—in other words, not probabilistically sustainable.

  Mediocristan: a process dominated by the mediocre, with few extreme successes or failures (say, income for a dentist). No single observation can meaningfully affect the aggregate. Also called “thin-tailed,” or member of the Gaussian family of distributions.

  Extremistan: a process where the total can be conceivably impacted by a single observation (say, income for a writer). Also called “fat-tailed.” Includes the fractal, or power-law, family of distributions. See subexponentiality in the Appendix.

  Minority Rule: an asymmetry by which the behavior of the total is dictated by the preferences of a minority. Smokers can be in smoke-free areas but nonsmokers cannot be in smoking ones, so nonsmokers will prevail, not because they are initially a majority, but because they are asymmetric. It is held by the author that languages, ethics, and (some) religions spread by minority rule.

  Via Negativa: in theology and philosophy, the focus on what something is not, an indirect definition, deemed less prone to fallacies than via positiva. In action, it is a recipe for what to avoid, what not to do—subtraction, not addition, works better in domains with multiplicative and unpredictable side effects. In medicine, stopping someone from smoking has fewer adverse effects than giving pills and treatments.

  Scalability: The qualities of entities change, often abruptly, when they get smaller or larger: cities are different from large states, continents are very different from islands. Collective behavior switches when the size of the groups increases, an argument for localism and against unfettered globalism.

  Intellectual Monoculture: Journalists, academics, and other slaves without skin in the game in a given subject converge to a “bien pensant” mode that can be manip
ulated and often resists empirical backing. The reason is that penalty from divergence is often penalized with labels such as “Putinist,” “baby killer,” or “racist” (children are always used by charlatans as a sensationalist argument). This is similar to the way ecological diversity decreases when an island gets larger (see The Black Swan).

  Virtue Merchandising: the debasing of virtue by using it as a marketing strategy. Classically, virtue needs to be kept private, which clashes with modern “save the environment”–style messages. Virtue merchandisers are often hypocrites. Further, virtue devoid of courage, sacrifice, and skin in the game is never virtue. Virtue merchandising is similar to simony, which in the Middle Ages allowed someone of means to buy ecclesiastical positions or indulgences, to expunge his or her sins by payment.

  Golden Rule (symmetry): Treat others the way you would like them to treat you.

  Silver Rule (negative golden rule): Do not do to others what you would not like them to do to you. Note the difference from the Golden Rule, as the silver one prevents busybodies from attempting to run your life.

  Principle of Charity: Exercise symmetry in intellectual debates; represent the argument of the opponent as accurately as you would like yours to be represented. The opposite of “strawman.”