September 13, 2013

Antifragile policy prescriptions

Nassim Nicholas Taleb’s Antifragile.

antifragile (1)

An intriguing point that Nassim Nicholas Taleb made in his earlier book, The Black Swan was that countries like Italy, India or Japan are more likely to be politically stable in the long run compared to seemingly stable regimes such as Saudi Arabia or China. He attributed it to the constant low-level political uncertainty seen in the former set of countries, which makes them ‘robust’ in handling bigger shocks. Countries in the latter set however are fooled by an apparent lack of uncertainty and are likely to implode when faced with larger uncertainties.

While The Black Swan was published in 2007, we have seen this story being played out over the last three years as part of the Arab Spring. One after another, authoritarian regimes in the Middle East and North Africa continue to display varying degrees of ineptitude in handling new-found political uncertainty. While Tunisia looks like it has made a transition to a democracy, ‘mess’ and ‘chaos’ are understatements to describe the situation in Egypt and Syria.

Meanwhile, Taleb has moved on. He is not interested in mere ‘robustness’ any more. His latest book Antifragile  is about systems that grow stronger with uncertainty, systems he terms ‘antifragile’. He was forced to invent the word since there was no existing word in English that described this phenomenon.

In Antifragile, Taleb classifies all systems into three categories – fragile, robust and anti-fragile. Fragile systems are those which get negatively affected by volatility while robust systems are inert to volatility. The most interesting category is that of antifragile systems which are actually helped by volatility.

National governments, as described earlier, are good examples of antifragile institutions. The lack of mild shocks from time to time can lull the government into complacency and lead to chaos when a large shock arrives. Periodic small perturbations, however, lead to institutional knowledge on how to deal with uncertainty, and even when faced with massive disruption, such as the assassination of a Prime Minister or the unearthing of a major scandal, the system continues to thrive.

An interesting concept Taleb talks about is that antifragility is not self-similar, that is, individual components of an antifragile systems need not be antifragile. For example, consider a group of restaurants in a town. Each restaurant is exposed to the vagaries of market forces, and is hence fragile to disruption. This very property of the restaurants, however, makes the entire system of restaurants antifragile. When a bad restaurant fails, the average quality of the remaining restaurants goes up. More importantly, in a system such as this, surviving restaurants learn from the mistakes of those that have failed.

On similar lines, Taleb talks about nations of city-states being more antifragile than nation states, taking the examples of ancient Greece and modern Switzerland to illustrate his point. When city-states make bad policies, they will go down, but the scale of damage is limited. Other city-states learn from the errors of the failed city-state and make sure they don’t repeat the errors. That way,  the nation on the whole prospers better than in a centralised system.

One obvious policy outcome from this is that of greater decentralisation and federalism. With a centralised system, there is little room for experimentation of policy ideas. If you try something and it goes bad, the entire country suffers, and we know that certain decisions are hard to roll back. If, in contrast, we have a high degree of decentralisation, then certain parts of the country can try out certain ideas, and the damage (if any) will be limited to those parts.

In her recent piece in Pragati, Hemal Shah argued that one way to usher labour reforms is by making labour a state subject. It is an antifragile prescription. Currently there is no way for us to test if liberalisation of labour laws is desirable, and if yes, to what extent. If labour were a state subject, different states could try out their own versions in liberalising the law. Soon there will be a natural experiment which will throw up a version that is superior to the others, and the rest of the country can then emulate that. And if you think that a state is too large a unit for such experimentation, the answer is greater federalism.

Another significant policy implication of Antifragility is that large corporations are bad for the system. Forget the profit motive, forget monopoly power. Large corporations are bad simply because they are fragile. When an industry is dominated by a handful of operators, the collapse of any one of them is going to lead to horrible consequences for the entire industry. Imagine there is a single company that supplies turbines to India’s upcoming power projects. For whatever reason (let’s say an accounting scandal), if that company collapses, it will jeopardise the entire electricity capacity expansion programme. But if there are ten suppliers of turbines, one of them going bust would strengthen the rest of the industry, without much disruption to its customers.

Imagine, for example, if the international investment banking system had a hundred banks, rather than less than ten major banks. With a hundred banks, the amount that each bank owed the other would be small compared to the overall size of the banks, and thus the failure of one bank would not put too much risk to the rest of the ecosystem. As it happened, the US government had to bail out a number of banks, which led to further fragility in the system. Armed with the knowledge that the larger they are, the more likely they are to be bailed out, nothing prevents banks from growing even larger, owing each other even larger amounts and putting the entire system at risk.

This applies to countries as well. The theory of comparative advantage, when applied in a textbook fashion, can also lead to fragility. Let us assume, that Scotland has a world monopoly over the supply of Scotch Whiskey. Now if for some reason, all its distilleries are destroyed, the entire scotch supply would abruptly cease. Even if in the short run Scotland were significantly superior to other nations in Scotch manufacture, it would be helpful to retain other sources (however inefficient) as they help mitigate risk. Unfortunately supply of goods such as petroleum is dictated by natural factors and such diversification is not possible. Hence we witness a sharp rise in prices of petroleum every time there is uncertainty in the Middle East.

Then there is the issue of entrepreneurship, which plays a major role in economic development. Taleb blames the saturation of the Japanese economy on the country’s risk-averse culture, where failure is not accepted and failed entrepreneurs are socially ostracised. Taleb argues that to encourage risk-taking, we need to forster a culture where it is okay to take risk and fail and to provide a safety net for such failed entrepreneurs.  In India, business is traditionally done by people belonging to business families, who have family wealth backing them in case of a failure.

However, if we have to broaden the base of people who want to take risk and start businesses, we will need to create systems that lead to broader safety nets. Taleb holds up Silicon Valley as an example of an antifragile economic ecosystem that has thrived.

The book is long and often repetetive. Taleb’s writing style is not simple and he can come across as being pompous. However, once you get started, it rewards you with nuggets of important policy prescriptions—only a few of which have been included here.

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