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December 3, 2011

The Black Swan of Cairo


When policymakers try to suppress economic or political volatility, they only increase the risk of blowups.
Complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. In fact, they tend to be too calm and exhibit minimal variability as silent risks accumulate beneath the surface. Although the stated intention of political leaders and economic policymakers is to stabilize the system by inhibiting fluctuations, the result tends to be the opposite. These artificially constrained systems become prone to "Black Swans" -- that is, they become extremely vulnerable to large-scale events that lie far from the statistical norm and were largely unpredictable to a given set of observers. -- Foreign Affairs

Posted by gerardvanderleun at December 3, 2011 4:53 PM. This is an entry on the sideblog of American Digest: Check it out.

Your Say

I had done some thinking about this a few years back. The analogy I used was flood control systems. Flood plains are dangerous places to build and live in. When we build dams, levees, and flood control channels, we provide a false sense of security. We always guarantee the system for say a 100-year flood... beyond the lifespan of the average human being. People then begin building in the flood plain since their investment will be "safe" for 100 years instead of the usual 20 or 30 years. When the 100-year flood (or less since the temptation is always to over-promise) inevitably comes along, the damage is several magnitudes of order greater than if we had never built the system in the first place since the natural, unmitigated risk would have discouraged building in the first place.

So while I agree with the authors' contention that risk control systems are ultimately worse than the problem they were designed to fix, I disagree that they "push unobserved risks further into the statistical tails of the probability distribution of outcomes and allow these high-impact, low-probability 'tail risks' to disappear from policymakers' fields of observation." The psychological effect is more temporal than statistical. We delude ourselves into believing that the 100-year guarantee makes the gamble a safe one. We encourage a whole new set of behaviors and investments that never would have taken place had we not built the flood control system. By attempting to mitigate the probability of occurrence, we increase the severity of occurrence.

Posted by: el baboso at December 3, 2011 6:13 PM

Wretchard has a post up about this article. Among other things, he says:

By attempting to centrally manage systems according to some predetermined scheme they actually store up volatility rather than dispersing it. By kicking the can down the road they eventually condemn themselves to bumping into a giant pile of cans when they run out of road.

Posted by: rickl at December 3, 2011 6:31 PM

el baboso, I don't think I've ever heard someone call themselves 'dog drool' before. Is this a Cujo moment?

Posted by: Peccable at December 4, 2011 4:00 AM

I think it depends on the dialect. Un baboso: literally one who drools (my dictionary has "driveller"). Colloquially (obviously not in all dialects): a fool, an idiot.

I like the dog drool thing though.

Posted by: el baboso at December 4, 2011 1:04 PM

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