Why We Are Not Prepared for an Actual Black Swan
Dealing with this crisis is new to me. I am no epidemiologist, biologist, or complex systems scientist, but there are a few observations I have made about COVID-19 and our response since late January.
Why We Weren’t Ready For This White Swan
Bill Gates delivered a prophetic TED Talk in 2015 on why we were not ready for the next pandemic. I think part of the problem is that we know, but fail to act as if we know, that each crisis/recession/pandemic is unique. As Tolstoy wrote,
“happy families are all alike; every unhappy family is unhappy in its own way.”
Yet we are surprised when each successive event provides us with new scenarios and obstacles. Just because we may have fixed the mortgage problems associated with the previous financial crisis does not mean we are recession-proof. Currently, people may be thinking of comparing COVID-19 to H1N1. However, as Bill Gates said, with H1N1 people were not immediately contagious. By the time people with H1N1 became contagious they were nearly bedridden.
Going off that point, we must continuously imagine that something can take place that is worse than our previous worst-case scenario. We read about how banks and other institutions perform stress tests, but those are not of much use if the inputs are geared towards scenarios we have already experienced. Saying a bank today would survive the conditions of the Great Depression is not enough. The bank should hypothetically see how it would fare in conditions 100x worse than the Great Depression.
The goal here is not to imagine every scenario possible and prevent anything and everything that could go wrong. Instead, we are trying to clip the left tail of the distribution of possible events. One reason why we find ourselves in this current situation is a lack of redundancies. There is an inherent tradeoff between optimization and redundancy. Recently the pendulum has swung very far to the side of optimization. Luckily when it comes to nature we often do not have a say, because humans have two lungs, kidneys, etc for a reason. Otherwise we could be living in a world where Dwight Schrute has all 10 fingers on his left hand so his right is just a fist for punching. Introducing more redundancies could help mitigate any future pandemic.
This lack of redundancy is why Nassim Taleb’s recent article on bailouts is prescient. We as a society should not be allowing asymmetric payoffs where companies receive all profits and the taxpayer is responsible for all major losses. Taleb writes,
“Why should we spend taxpayer money to bailout companies who spent their cash (and often even borrowed to generate that cash) to buy their own stock (so the CEO gets optionality), instead of building a rainy day buffer? Such bailouts punish those who acted conservatively and harms them in the long run, favoring the fool and the rent-seeker.”
Furthermore, we now face the second-order effect of risk compensation. If bailouts were to become a near certainty for airlines, cruises, and other large companies, they are only incentivized to participate in more risky behavior.
So, what are some things we can do? While buying an abundance of toilet paper may be a little misguided, it is a form of insurance. Going forward there will most likely be increased measures taken by individuals to insure themselves against having to shelter in place. The trick is, when an actual black swan event occurs, we will not be requiring the same supplies as we do now. Each crisis is unique in its own way. Another important aspect of insurance is you cannot time it. That is what we are seeing today, the equivalent of people sending out reinforcements to close the barn door when the horses are long gone.
Lindy Effect and Stockdale Paradox
I would be remiss not to mention the Lindy Effect in relation to current projections regarding the economy. The Lindy Effect is where the future life expectancy of something is proportional to its current age. For example, if construction on a building is currently 1 month past expectation, it will likely go another month past the deadline. In this case, the more short-term targets we set to have the economy back up and running, the longer I anticipate it taking should we pass each date without completion. The same applies for the Tiger King documentary on Netflix. The longer that Joe Exotic seems to remain in the hub of pop culture, the more people I anticipate will watch the show. Each one of us who keeps a to-do list is all too familiar with this effect. The longer an item remains on the list undone, the longer I expect it to remain undone before I get around to it.
How do we combat this obstacle? A few years ago I heard about the Stockdale Paradox in a Virginia Football team meeting and later read more about it in Jim Collins’ book Good to Great. The Stockdale Paradox requires balancing realism and optimism. The origin of the concept involved prisoners of war finding success by remaining optimistic but simultaneously confronting reality. This meant not setting any deadline in their head when they would be free. Similarly, we must not tell ourselves the world will return to its previous state by XYZ date. Earlier I mentioned the tradeoff between optimization and redundancy, here it is important to note there is no tradeoff between our health and the economy.
Taking Advantage and Moving Forward
Surely, being optimistic includes taking advantage of our current situation. This requires introspection. Most of us do not reflect frequently on our habits. That is why we have habits, so we do not have to consciously make the same decision over and over again. However, there come a few times when we are prompted to think about our habits. The most well known times, especially to marketers and retailers, are weddings and pregnancies. This was one interesting insight among many gleaned from Charles Duhigg’s The Power of Habit. Disruption to daily life, as we are seeing with the coronavirus, forces us to examine our routines. Hopefully we use this opportunity to form new, more productive habits. For example, since routine trips to the gyms and restaurants are no more, we may just come out of this crisis more willing than before to exercise and cook at home.
Going back to the Lindy Effect, one book I have had for years but have yet to read is Addiction by Design on the casino industry’s efforts to more efficiently take your money. Well-known tactics include pumping oxygen into the casino and using game formats and stimuli that hold your attention, but I’m more intrigued by the design of their hallways and physical spaces. Some casinos use rounded hallways without any sharp corners. This is because whenever we encounter a sharp corner or fork in the road we are forced to actively make a decision. The more that we are led down a path of passive decision-making, the less likely we are to make changes. Right now we have come to a sharp corner as a society. We are now presented the opportunity to contemplate our actions, habits, and societal structure. We must take this time to form habits more beneficial to society on all levels and help prevent any future black swan events. This virus and its effects were not unforeseeable. Anyone who has read (or claimed to have read) Nassim Taleb’s Incerto should know that these circumstances were not inevitable. Absence of evidence is not evidence of absence.
Another major misconception that we must avoid when the worst of this virus passes is brazenly claiming we will come out of this “stronger.” Nassim Taleb describes in The Black Swan how we commonly express this misconception. To demonstrate an analogy in a different domain we must look to a rat population. Taleb writes about a study of rats who underwent exposure to increasing levels of radiation where many were killed. Only the “strong” survived, so while on average the remaining rat population is “stronger,” we’re dealing with survivorship bias! Not only that, but these “strong” rats were themselves weakened by this exposure.
Our interests should go beyond the first order effects of the coronavirus and the resulting fallout on our economy. There is always the Dunning-Kruger effect to combat, where we must be more aware of unknown unknowns. There is also the problem of domain dependency, where we may recognize mathematical concepts such as exponential growth on a test but not in real life with contagion patterns. Instead, we should pursue the second and third order effects of our current actions with vigor.
Many of us are not engineers or complex systems scientists. That does not mean we cannot take simple steps to chop off the left tail of the distribution and reduce our payoff distribution. Taking more preventative action and recognizing the need for redundancy will keep us from laying the groundwork to exacerbate the next crisis.