The Black Swan

by Nassim Nicholas Taleb

  I will go now into more general defects uncovered by this example. These “experts” were lopsided: on the occasions when they were right, they attributed it to their own depth of understanding and expertise; when wrong, it was either the situation that was to blame, since it was unusual, or, worse, they did not recognize that they were wrong and spun stories around it. They found it difficult to accept that their grasp was a little short. But this attribute is universal to all our activities: there is something in us designed to protect our self-esteem.

  We humans are the victims of an asymmetry in the perception of random events. We attribute our successes to our skills, and our failures to external events outside our control, namely to randomness. We feel responsible for the good stuff, but not for the bad. This causes us to think that we are better than others at whatever we do for a living. Ninety-four percent of Swedes believe that their driving skills put them in the top 50 percent of Swedish drivers; 84 percent of Frenchmen feel that their lovemaking abilities put them in the top half of French lovers.

  The other effect of this asymmetry is that we feel a little unique, unlike others, for whom we do not perceive such an asymmetry. I have mentioned the unrealistic expectations about the future on the part of people in the process of tying the knot. Also consider the number of families who tunnel on their future, locking themselves into hard-to-flip real estate thinking they are going to live there permanently, not realizing that the general track record for sedentary living is dire. Don’t they see those well-dressed real-estate agents driving around in fancy two-door German cars? We are very nomadic, far more than we plan to be, and forcibly so. Consider how many people who have abruptly lost their job deemed it likely to occur, even a few days before. Or consider how many drug addicts entered the game willing to stay in it so long.

  There is another lesson from Tetlock’s experiment. He found what I mentioned earlier, that many university stars, or “contributors to top journals,” are no better than the average New York Times reader or journalist in detecting changes in the world around them. These sometimes overspecialized experts failed tests in their own specialties.

  The hedgehog and the fox. Tetlock distinguishes between two types of predictors, the hedgehog and the fox, according to a distinction promoted by the essayist Isaiah Berlin. As in Aesop’s fable, the hedgehog knows one thing, the fox knows many things—these are the adaptable types you need in daily life. Many of the prediction failures come from hedgehogs who are mentally married to a single big Black Swan event, a big bet that is not likely to play out. The hedgehog is someone focusing on a single, improbable, and consequential event, falling for the narrative fallacy that makes us so blinded by one single outcome that we cannot imagine others.

  Hedgehogs, because of the narrative fallacy, are easier for us to understand—their ideas work in sound bites. Their category is overrepresented among famous people; ergo famous people are on average worse at forecasting than the rest of the predictors.

  I have avoided the press for a long time because whenever journalists hear my Black Swan story, they ask me to give them a list of future impacting events. They want me to be predictive of these Black Swans. Strangely, my book Fooled by Randomness, published a week before September 11, 2001, had a discussion of the possibility of a plane crashing into my office building. So I was naturally asked to show “how I predicted the event.” I didn’t predict it—it was a chance occurrence. I am not playing oracle! I even recently got an e-mail asking me to list the next ten Black Swans. Most fail to get my point about the error of specificity, the narrative fallacy, and the idea of prediction. Contrary to what people might expect, I am not recommending that anyone become a hedgehog—rather, be a fox with an open mind. I know that history is going to be dominated by an improbable event, I just don’t know what that event will be.

  Reality? What For?

  I found no formal, Tetlock-like comprehensive study in economics journals. But, suspiciously, I found no paper trumpeting economists’ ability to produce reliable projections. So I reviewed what articles and working papers in economics I could find. They collectively show no convincing evidence that economists as a community have an ability to predict, and, if they have some ability, their predictions are at best just slightly better than random ones—not good enough to help with serious decisions.

  The most interesting test of how academic methods fare in the real world was run by Spyros Makridakis, who spent part of his career managing competitions between forecasters who practice a “scientific method” called econometrics—an approach that combines economic theory with statistical measurements. Simply put, he made people forecast in real life and then he judged their accuracy. This led to the series of “M-Competitions” he ran, with assistance from Michele Hibon, of which M3 was the third and most recent one, completed in 1999. Makridakis and Hibon reached the sad conclusion that “statistically sophisticated or complex methods do not necessarily provide more accurate forecasts than simpler ones.”

  I had an identical experience in my quant days—the foreign scientist with the throaty accent spending his nights on a computer doing complicated mathematics rarely fares better than a cabdriver using the simplest methods within his reach. The problem is that we focus on the rare occasion when these methods work and almost never on their far more numerous failures. I kept begging anyone who would listen to me: “Hey, I am an uncomplicated, no-nonsense fellow from Amioun, Lebanon, and have trouble understanding why something is considered valuable if it requires running computers overnight but does not enable me to predict better than any other guy from Amioun.” The only reactions I got from these colleagues were related to the geography and history of Amioun rather than a no-nonsense explanation of their business. Here again, you see the narrative fallacy at work, except that in place of journalistic stories you have the more dire situation of the “scientists” with a Russian accent looking in the rearview mirror, narrating with equations, and refusing to look ahead because he may get too dizzy. The econometrician Robert Engel, an otherwise charming gentleman, invented a very complicated statistical method called GARCH and got a Nobel for it. No one tested it to see if it has any validity in real life. Simpler, less sexy methods fare exceedingly better, but they do not take you to Stockholm. You have an expert problem in Stockholm, and I will discuss it in Chapter 17.

  This unfitness of complicated methods seems to apply to all methods. Another study effectively tested practitioners of something called game theory, in which the most notorious player is John Nash, the schizophrenic mathematician made famous by the film A Beautiful Mind. Sadly, for all the intellectual appeal of these methods and all the media attention, its practitioners are no better at predicting than university students.

  There is another problem, and it is a little more worrisome. Makridakis and Hibon were to find out that the strong empirical evidence of their studies has been ignored by theoretical statisticians. Furthermore, they encountered shocking hostility toward their empirical verifications. “Instead [statisticians] have concentrated their efforts in building more sophisticated models without regard to the ability of such models to more accurately predict real-life data,” Makridakis and Hibon write.

  Someone may counter with the following argument: Perhaps economists’ forecasts create feedback that cancels their effect (this is called the Lucas critique, after the economist Robert Lucas). Let’s say economists predict inflation; in response to these expectations the Federal Reserve acts and lowers inflation. So you cannot judge the forecast accuracy in economics as you would with other events. I agree with this point, but I do not believe that it is the cause of the economists’ failure to predict. The world is far too complicated for their discipline.

  When an economist fails to predict outliers he often invokes the issue of earthquakes or revolutions, claiming that he is not into geodesics, atmospheric sciences, or political science, instead of incorporating these fields into his studies and accepting that his field does not exist in i
solation. Economics is the most insular of fields; it is the one that quotes least from outside itself! Economics is perhaps the subject that currently has the highest number of philistine scholars—scholarship without erudition and natural curiosity can close your mind and lead to the fragmentation of disciplines.

  “OTHER THAN THAT,” IT WAS OKAY

  We have used the story of the Sydney Opera House as a springboard for our discussion of prediction. We will now address another constant in human nature: a systematic error made by project planners, coming from a mixture of human nature, the complexity of the world, or the structure of organizations. In order to survive, institutions may need to give themselves and others the appearance of having a “vision.”

  Plans fail because of what we have called tunneling, the neglect of sources of uncertainty outside the plan itself.

  The typical scenario is as follows. Joe, a nonfiction writer, gets a book contract with a set final date for delivery two years from now. The topic is relatively easy: the authorized biography of the writer Salman Rushdie, for which Joe has compiled ample data. He has even tracked down Rushdie’s former girlfriends and is thrilled at the prospect of pleasant interviews. Two years later, minus, say, three months, he calls to explain to the publisher that he will be a little delayed. The publisher has seen this coming; he is used to authors being late. The publishing house now has cold feet because the subject has unexpectedly faded from public attention—the firm projected that interest in Rushdie would remain high, but attention has faded, seemingly because the Iranians, for some reason, lost interest in killing him.

  Let’s look at the source of the biographer’s underestimation of the time for completion. He projected his own schedule, but he tunneled, as he did not forecast that some “external” events would emerge to slow him down. Among these external events were the disasters on September 11, 2001, which set him back several months; trips to Minnesota to assist his ailing mother (who eventually recovered); and many more, like a broken engagement (though not with Rushdie’s ex-girlfriend). “Other than that,” it was all within his plan; his own work did not stray the least from schedule. He does not feel responsible for his failure.*

  The unexpected has a one-sided effect with projects. Consider the track records of builders, paper writers, and contractors. The unexpected almost always pushes in a single direction: higher costs and a longer time to completion. On very rare occasions, as with the Empire State Building, you get the opposite: shorter completion and lower costs—these occasions are becoming truly exceptional nowadays.

  We can run experiments and test for repeatability to verify if such errors in projection are part of human nature. Researchers have tested how students estimate the time needed to complete their projects. In one representative test, they broke a group into two varieties, optimistic and pessimistic. Optimistic students promised twenty-six days; the pessimistic ones forty-seven days. The average actual time to completion turned out to be fifty-six days.

  The example of Joe the writer is not acute. I selected it because it concerns a repeatable, routine task—for such tasks our planning errors are milder. With projects of great novelty, such as a military invasion, an all-out war, or something entirely new, errors explode upward. In fact, the more routine the task, the better you learn to forecast. But there is always something nonroutine in our modern environment.

  There may be incentives for people to promise shorter completion dates—in order to win the book contract or in order for the builder to get your down payment and use it for his upcoming trip to Antigua. But the planning problem exists even where there is no incentive to underestimate the duration (or the costs) of the task. As I said earlier, we are too narrow-minded a species to consider the possibility of events straying from our mental projections, but furthermore, we are too focused on matters internal to the project to take into account external uncertainty, the “unknown unknown,” so to speak, the contents of the unread books.

  There is also the nerd effect, which stems from the mental elimination of off-model risks, or focusing on what you know. You view the world from within a model. Consider that most delays and cost overruns arise from unexpected elements that did not enter into the plan—that is, they lay outside the model at hand—such as strikes, electricity shortages, accidents, bad weather, or rumors of Martian invasions. These small Black Swans that threaten to hamper our projects do not seem to be taken into account. They are too abstract—we don’t know how they look and cannot talk about them intelligently.

  We cannot truly plan, because we do not understand the future—but this is not necessarily bad news. We could plan while bearing in mind such limitations. It just takes guts.

  The Beauty of Technology: Excel Spreadsheets

  In the not too distant past, say the precomputer days, projections remained vague and qualitative, one had to make a mental effort to keep track of them, and it was a strain to push scenarios into the future. It took pencils, erasers, reams of paper, and huge wastebaskets to engage in the activity. Add to that an accountant’s love for tedious, slow work. The activity of projecting, in short, was effortful, undesirable, and marred with self-doubt.

  But things changed with the intrusion of the spreadsheet. When you put an Excel spreadsheet into computer-literate hands you get a “sales projection” effortlessly extending ad infinitum! Once on a page or on a computer screen, or, worse, in a PowerPoint presentation, the projection takes on a life of its own, losing its vagueness and abstraction and becoming what philosophers call reified, invested with concreteness; it takes on a new life as a tangible object.

  My friend Brian Hinchcliffe suggested the following idea when we were both sweating at the local gym. Perhaps the ease with which one can project into the future by dragging cells in these spreadsheet programs is responsible for the armies of forecasters confidently producing longer-term forecasts (all the while tunneling on their assumptions). We have become worse planners than the Soviet Russians thanks to these potent computer programs given to those who are incapable of handling their knowledge. Like most commodity traders, Brian is a man of incisive and sometimes brutally painful realism.

  A classical mental mechanism, called anchoring, seems to be at work here. You lower your anxiety about uncertainty by producing a number, then you “anchor” on it, like an object to hold on to in the middle of a vacuum. This anchoring mechanism was discovered by the fathers of the psychology of uncertainty, Danny Kahneman and Amos Tversky, early in their heuristics and biases project. It operates as follows. Kahneman and Tversky had their subjects spin a wheel of fortune. The subjects first looked at the number on the wheel, which they knew was random, then they were asked to estimate the number of African countries in the United Nations. Those who had a low number on the wheel estimated a low number of African nations; those with a high number produced a higher estimate.

  Similarly, ask someone to provide you with the last four digits of his social security number. Then ask him to estimate the number of dentists in Manhattan. You will find that by making him aware of the four-digit number, you elicit an estimate that is correlated with it.

  We use reference points in our heads, say sales projections, and start building beliefs around them because less mental effort is needed to compare an idea to a reference point than to evaluate it in the absolute (System 1 at work!). We cannot work without a point of reference.

  So the introduction of a reference point in the forecaster’s mind will work wonders. This is no different from a starting point in a bargaining episode: you open with high number (“I want a million for this house”); the bidder will answer “only eight-fifty”—the discussion will be determined by that initial level.

  The Character of Prediction Errors

  Like many biological variables, life expectancy is from Mediocristan, that is, it is subjected to mild randomness. It is not scalable, since the older we get, the less likely we are to live. In a developed country a newborn female is expected to die at around 79,
according to insurance tables. When she reaches her 79th birthday, her life expectancy, assuming that she is in typical health, is another 10 years. At the age of 90, she should have another 4.7 years to go. At the age of 100, 2.5 years. At the age of 119, if she miraculously lives that long, she should have about nine months left. As she lives beyond the expected date of death, the number of additional years to go decreases. This illustrates the major property of random variables related to the bell curve. The conditional expectation of additional life drops as a person gets older.

  With human projects and ventures we have another story. These are often scalable, as I said in Chapter 3. With scalable variables, the ones from Extremistan, you will witness the exact opposite effect. Let’s say a project is expected to terminate in 79 days, the same expectation in days as the newborn female has in years. On the 79th day, if the project is not finished, it will be expected to take another 25 days to complete. But on the 90th day, if the project is still not completed, it should have about 58 days to go. On the 100th, it should have 89 days to go. On the 119th, it should have an extra 149 days. On day 600, if the project is not done, you will be expected to need an extra 1,590 days. As you see, the longer you wait, the longer you will be expected to wait.

  Let’s say you are a refugee waiting for the return to your homeland. Each day that passes you are getting farther from, not closer to, the day of triumphal return. The same applies to the completion date of your next opera house. If it was expected to take two years, and three years later you are asking questions, do not expect the project to be completed any time soon. If wars last on average six months, and your conflict has been going on for two years, expect another few years of problems. The Arab-Israeli conflict is sixty years old, and counting—yet it was considered “a simple problem” sixty years ago. (Always remember that, in a modern environment, wars last longer and kill more people than is typically planned.) Another example: Say that you send your favorite author a letter, knowing that he is busy and has a two-week turnaround. If three weeks later your mailbox is still empty, do not expect the letter to come tomorrow—it will take on average another three weeks. If three months later you still have nothing, you will have to expect to wait another year. Each day will bring you closer to your death but further from the receipt of the letter.