Skin in the Game

Nassim Taleb has rapidly become one of my favorite authors, with each of his books being a reservoir of interesting and useful ways of thinking. He is a maverick and a dissident and I feel with each chapter I read, I become better at navigating in a complex and random world. I have compiled below my favorite highlights from the book. You may assume that most every word is a direct quote or light rephrasing of text from the book—there is very little personal commentary from me. Rather, this post is to stand as a quick point of reference for me to re-learn the most important highlights of this book.

On Epistemology, Certainty, and Bullsh*t Detection

• In academia there is no difference between academia and the real world; in the real world, there is. A certain class of theoretical people can despise the details of reality. If you manage to convince yourself that you are right in theory, you don’t really care how your ideas affect others. Your ideas give you a virtuous status that makes you impervious to how they affect others.
  • The knowledge we get by tinkering, via trial and error, experience, and contact with the earth is vastly superior to that obtained through reasoning, something self-serving institutions have been very busy hiding from us.
  • We are increasingly populated by a class of people who are better at explaining than understanding, or better at explaining than doing.
  • By definition, what works cannot be irrational; about every single person I know who has chronically failed in business shares that mental block, the failure to realize that if something stupid works (and makes money), it cannot be stupid.
• Using mathematics when it’s not needed is not science but scientism. Scientism is the belief that science looks…like science, with too much emphasis on the cosmetic aspects, rather than its skeptical machinery. True intellect should not appear to be intellectual. People who are bred, selected, and compensated to find complicated solutions do not have an incentive to implement simplified ones.
• Learning is rooted in repetition and convexity, meaning that the reading of a single text twice is more profitable than reading two different things once, provided of course that said text has some depth of content.
• Via negativa is the principle that we know what is wrong with more clarity than what is right, and that knowledge grows by subtraction. Also, it is easier to know that something is wrong than to find the fix. Actions that remove are more robust than those that add because addition may have unseen, complicated feedback loops.
  • The Golden Rule wants you to treat others the way you would like them to treat you. The more robust Silver Rule says do not treat others the way you would not like them to treat you. Why is the Silver Rule more robust? We know with much more clarity what is bad than what is good.
  • The very idea behind the First Amendment of the Constitution of the United States is to establish a silver rule–style symmetry: you can practice your freedom of religion so long as you allow me to practice mine; you have the right to contradict me so long as I have the right to contradict you.
  • Karl Popper’s idea of science is an enterprise that produces claims that can be contradicted by eventual observations, not a series of verifiable ones: science is fundamentally disconfirmatory, not confirmatory. 
• The Intellectual Yet Idiot (IYI) has been proliferating since at least the mid-twentieth century, to reach a local supremum today, to the point that we have experienced a takeover by people without skin in the game. They are what Nietzsche called Bildungsphilisters—educated philistines. Beware the slightly erudite who thinks he is an erudite. The IYI subscribes to The New Yorker, a journal designed so philistines can learn to fake a conversation about evolution, neurosomething, cognitive biases, and quantum mechanics. He speaks of “equality of races” and “economic equality,” but never goes out drinking with a minority cab driver (again, no real skin in the game, as, I will repeat until I am hoarse, the concept is fundamentally foreign to the IYI).
  • Typically, the IYI get first-order logic right, but not second-order (or higher) effects, making him totally incompetent in complex domains. 
  • What we generally call participation in the political process, can be called by two distinct designations: “democracy” when it fits the IYI, and “populism” when plebeians dare to vote in a way that contradicts IYI preferences.
• The most convincing statements are those in which one stands to lose, ones in which one has maximal skin in the game; the most unconvincing ones are those in which one patently (but unknowingly) tries to enhance one’s status without making a tangible contribution (like, as we saw, in the great majority of academic papers that say nothing and take no risks). One should give more weight to research that, while being rigorous, contradicts other peers, particularly if it entails costs and reputational harm for its author.
• The conclusions of IYI theorizing often is less practical than the worldly advice of your grandmother. With psychology studies replicating less than 40 percent of the time, dietary advice reversing after thirty years of dietary fat phobia, macroeconomics and financial economics scientifically worse than astrology, the reappointment of Bernanke (in 2010) who was less than clueless about financial risk as the Federal Reserve boss, and pharmaceutical trials replicating at best only a third of the time, people are perfectly entitled to rely on their own ancestral instincts and to listen to their grandmothers (or to Montaigne and such filtered classical knowledge), who have a better track record than these policymaking goons.
• The detractors of Donald Trump, when he was still a candidate, not only misunderstood the value of scars as risk signaling, but they also failed to realize that, by advertising his episode of bankruptcy and his personal losses of close to a billion dollars, he removed the resentment (the second type of inequality) people may have had toward him. There is something respectable in losing a billion dollars, provided it is your own money.
• People mistake empiricism for a flood of data. Just a little bit of significant data is needed when one is right, particularly when it is disconfirmatory empiricism, or counterexamples: only one data point (a single extreme deviation) is sufficient to show that Black Swans exist. Traders, when they make profits, have short communications; when they lose they drown you in details, theories, and charts.
  • If you want to show that a person has more than, say $10 million, all you need is to show the $50 million in his brokerage account, not, in addition, list every piece of furniture in his house, including the $500 painting in his study and the silver spoons in the pantry. So I’ve discovered, with experience, that when you buy a thick book with tons of graphs and tables used to prove a point, you should be suspicious. It means something didn’t distill right!
• Actors discovered that Broadway shows that lasted for, say, one hundred days, had a future life expectancy of a hundred more. For those that lasted two hundred days, two hundred more. That which is “Lindy” is what ages in reverse, i.e., its life expectancy lengthens with time, conditional on survival. Only the nonperishable can be Lindy. A physical copy of War and Peace can age; the book itself as an idea doesn’t.

Symmetry, Justice, Fairness, Responsibility, and Reciprocity

• The principle of intervention, like that of healers, is first do no harm. Bureaucracy is a construction by which a person is conveniently separated from the consequences of his or her actions.
• The Bob Rubin Trade is 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). Former Secretary of the Treasury Bob Rubin collected more than $120 million in compensation from Citibank in the decade preceding the banking crash of 2008. When the bank, literally insolvent, was rescued by the taxpayer, he didn’t write any check—he invoked uncertainty as an excuse. Heads he wins, tails he shouts “Black Swan.”
  • The hidden risk transfer is not limited to bankers and corporations. Some segments of the population play it quite effectively. For instance, people who live in those coastal areas that are prone to hurricanes and floods are effectively subsidized by the state—hence taxpayers. Although they play victims on television after an event happens, they and the real estate developers are getting the benefits others pay for.
• People who are not morally independent tend to fit ethics to their profession (with a minimum of spinning), rather than find a profession that fits their ethics.
• One is financially free and secure not by their means but by their lack of wants. Ironically, beggars have the equivalent of f*** you money, which we can more easily get by being at the lowest rung than by joining the income-dependent classes. Sometimes, means in wealth or status can be detrimental to freedom. You would think that the head of the CIA would be the most powerful person in America, but it turned out that the venerated David Petraeus was more vulnerable than a truck driver. The fellow couldn’t even have an extramarital relationship.
• People who collect honorary doctorates are typically hierarchy-conscious, and I abide by Cato’s injunction: he preferred to be asked why he didn’t have a statue rather than why he had one.
• Static inequality is a snapshot view of inequality; it does not reflect what will happen to you in the course of your life. Consider that about 10 percent of Americans will spend at least a year in the top 1 percent, and more than half of all Americans will spend a year in the top 10 percent. This is visibly not the same for the more static—but nominally more equal—Europe. Dynamic (ergodic) inequality takes into account the entire future and past life. Dynamic equality is what restores ergodicity, making time and ensemble probabilities substitutable.
• Let us call the collection of people gambling at one time ensemble probability, and call the single person gambling over time time probability. Your cousin goes to the casino a hundred days in a row, starting with a set amount. On day 28 your cousin busts. Will there be day 29? No. He has hit an uncle point; there is no game no more . No matter how good or alert your cousin is, you can safely calculate that he has a 100 percent probability of eventually going bust. Now, when you read material by finance professors, finance gurus, or your local bank making investment recommendations based on the long-term returns of the market, beware. Even if their forecasts were true (they aren’t), no individual can get the same returns as the market unless he has infinite pockets and no uncle points. Probability is non-ergodic if past probabilities do not apply to future processes.
• 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.
• The intuition for ergodicity is as follows: take a cross-sectional picture of the U.S. population. Perfect ergodicity means that each one of us, should he live forever, would spend a proportion of time in the economic conditions of the entire cross-section: out of, say, a century, an average of sixty years in the lower middle class, ten years in the upper middle class, twenty years in the blue-collar class, and perhaps one single year in the one percent. The exact opposite of perfect ergodicity is an absorbing state. A person gets rich by some process, then, having arrived, he stays rich. Or gets poor, and then stays poor. Clearly, when you say that inequality changes from year one to year two, you need to show that those who are at the top are the same people (something Piketty, author of Capital in the Twenty-First Century, doesn’t do).

Signaling

• Products or companies that bear the owner’s name convey very valuable messages. They are shouting that they have something to lose. Eponymy indicates both a commitment to the company and a confidence in the product.
• Those who use foul language on social networks (such as Twitter) are sending an expensive signal that they are free—and, ironically, competent. You don’t signal competence if you don’t take risks for it—there are few such low-risk strategies. So cursing today is a status symbol, just as oligarchs in Moscow wear blue jeans at special events to signal their power.
• Sticking up for truth when it is unpopular is far more of a virtue, because it costs you something—your reputation. If you are a journalist and act in a way that risks ostracism, you are virtuous. Some people only express their opinions as part of mob shaming, when it is safe to do so, and, in the bargain, think that they are displaying virtue.
  • My note: Thus is why journalists keep patting people on the back for “brave” opinions even when they have been popularized, are politically correct, and are not that brave at all. They have to call it brave to fake having skin in the game.

Rationality in Complex Systems

• We will see in depth throughout the book the defects of mental reasoning by educated (or, rather, semi-educated) fools. Their three flaws: 1) they think in statics not dynamics, 2) they think in low, not high, dimensions, 3) they think in terms of actions, never interactions.
  • The first flaw is that they are incapable of thinking in second steps and unaware of the need for them—and about every peasant in Mongolia, every waiter in Madrid, and every car-service operator in San Francisco knows that real life happens to have second, third, fourth, nth steps.
  • The second flaw is that they are also incapable of distinguishing between multidimensional problems and their single-dimensional representations—like multidimensional health and its stripped, cholesterol-reading reduction. They can’t get the idea that, empirically, complex systems do not have obvious one-dimensional cause-and-effect mechanisms, and that under opacity, you do not mess with such a system.
  • The third flaw is based upon the idea that in complex systems the ensemble behaves in ways not predicted by its components. The interactions matter more than the nature of the units. This is called an “emergent” property of the whole, by which parts and whole differ because what matters are the interactions between such parts. And interactions can obey very simple rules.
  • The rule we discuss in this chapter is the minority rule, the mother of all asymmetries. It suffices for an intransigent minority—a certain type of intransigent minority—with significant skin in the game (or, better, soul in the game) to reach a minutely small level, say 3 or 4 percent of the total population, for the entire population to have to submit to their preferences.
    • Examples
      • The kosher population represents less than three tenths of a percent of the residents of the United States. Yet, it appears that almost all drinks are kosher. Why? Simply because going full kosher allows the producers, grocers, and restaurants to not have to distinguish between kosher and nonkosher for liquids, with special markers, separate aisles, separate inventories, different stocking sub-facilities. And the simple rule that changes the total is as follows: A kosher (or halal) eater will never eat nonkosher (or nonhalal) food, but a nonkosher eater isn’t banned from eating kosher.
      • Or, rephrased in another domain: A disabled person will not use the regular bathroom, but a nondisabled person will use the bathroom for disabled people.
      • Another example: do not think that the spread of automatic shifting cars is necessarily due to a majority preference; it could just be because those who can drive manual shifts can always drive automatic, but the reverse is not true.
      • Rory wrote to me about the beer-wine asymmetry and the choices made for parties: “Once you have 10 percent or more women at a party, you cannot serve only beer. But most men will drink wine. So you only need one set of glasses if you serve only wine—the universal donor, to use the language of blood groups.”
      • Genes follow majority rule; languages minority rule. Languages travel; genes less so.
      • 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. 
      • This idea of one-sidedness can help us debunk a few more misconceptions. How do books get banned? Certainly not because they offend the average person—most persons are passive and don’t really care, or don’t care enough to request the banning. From past episodes, it looks like all it takes is a few (motivated) activists for the banning of some books, or the blacklisting of some people.
    • Let us conjecture that the formation of moral values in society doesn’t come from the evolution of the consensus. No, it is the most intolerant person who imposes virtue on others precisely because of that intolerance. The same can apply to civil rights. when asked, “Why didn’t the Poles in Warsaw help their Jewish neighbors more?,” responded that they generally did. But it took seven or eight Poles to help one Jew. It took only one Pole, acting as an informer, to turn in a dozen Jews. Even if such select anti-Semitism is contestable, we can easily imagine bad outcomes stemming from a minority of bad agents.
  • Outcomes are paradoxically more stable under the minority rule—the variance of the results is lower and the rule is more likely to emerge independently across separate populations. What emerges from the minority rule is more likely to be black-and-white, binary rules. An example. Consider that an evil person, say an economics professor, decides to poison the collective by putting some product into soda cans. He has two options. The first is cyanide, which obeys a minority rule: a drop of poison (higher than a small threshold) makes the entire liquid poisonous. The second is a “majority-style” poison; it requires more than half the ingested liquid to be poisonous in order to kill. Now look at the inverse problem, a collection of dead people after a dinner party. The local Sherlock Holmes would assert that, conditional on the outcome that all people drinking the soda having been killed, the evil man opted for the first, not the second option. Simply, the majority rule leads to fluctuations around the average, with a high rate of survival. Not the minority rule. The minority rule produces low-variance in outcomes.
  • This large payoff from stubborn courage is not limited to the military. “Never doubt that a small group of thoughtful citizens can change the world. Indeed, it is the only thing that ever has,” wrote Margaret Mead. Revolutions are unarguably driven by an obsessive minority. And the entire growth of society, whether economic or moral, comes from a small number of people.
• My note: All this discussion of the minority rule is to exemplify the concept that complex systems are not just the sum of their parts. Democracies can be undemocratic when minority rule picks the candidates and majority doesn’t get the options they’d prefer.

Miscellenia

• Nietzsche: “Madness is rare in individuals, but in groups, parties, nations, it is the rule.”
• I discovered the magic of the camera in reestablishing civil/ethical behavior as follows. A man in upstate New York got into my parking spot as I was backing into it. I told him it was against etiquette, he acted as an a**hole. I silently photographed him and his license plate. He rapidly drove away and liberated the parking spot.
• Kids with rich parents talk about “class privilege” at privileged colleges such as Amherst—but in one instance, one of them could not answer Dinesh D’Souza’s simple and logical suggestion: Why don’t you go to the registrar’s office and give your privileged spot to the minority student next in line? Clearly the defense given by people under such a situation is that they want others to do so as well—they require a systemic solution to every local perceived problem of injustice. I find that immoral. I know of no ethical system that allows you to let someone drown without helping him because other people are not helping, no system that says, “I will save people from drowning only if others too save other people from drowning.”
• Is the Pope atheist? At no point during the emergency period did the drivers of the ambulance consider taking John Paul the Second to a chapel for a prayer, or some equivalent form of intercession with the Lord, to give the sacred first right of refusal for the treatment. And not one of his successors seemed to have considered giving precedence to dealing with the Lord with the hope of some miraculous intervention in place of the trappings of modern medicine. This is not to say that the bishops, cardinals, priests, and mere laypeople didn’t pray and ask the Lord for help, nor that they believed that prayers weren’t subsequently answered, given the remarkable recovery of the saintly man. But it remains that nobody in the Vatican seems to ever take chances by going first to the Lord, subsequently to the doctor, and, what is even more surprising, nobody seems to see a conflict with such inversion of the logical sequence. In fact the opposite course of action would have been considered madness. It would be in opposition to the tenets of the Catholic church, as it would be considered voluntary death, which is banned.
  • So we define atheism or secularism in deeds, by the distance between one’s actions and those of a nonatheistic person for an equivalent situation, not his beliefs and other decorative and symbolic matters—which, we will show in the next chapter, do not count.
  • The axiom of revelation of preferences (originating with Paul Samuelson, or possibly the Semitic gods), as you recall, states the following: you will not have an idea about what people really think, what predicts people’s actions, merely by asking them—they themselves don’t necessarily know.