Sunday, January 22, 2012

Suppressing volatility makes the world more dangerous

It's counterintuitive that suppressing volatility in human affairs would actually make the world a more dangerous place. But that is precisely the thesis of a recent article by Nassim Nicholas Taleb and Mark Blyth which appeared in Foreign Affairs.

Taleb, a former Wall Street trader, achieved fame with his book, The Black Swan: The Impact of the Highly Improbable. In it he was concerned with so-called "Black Swan events," rare, unforeseen, high-impact events that shape human history. His focus has been on markets though he has always tried to make the case that Black Swan events occur in nearly all fields of human endeavor. Now Taleb and his fellow author, Blyth, are extending this analysis to the so-called Arab Spring.

They point out that government policy is often explicitly designed to smooth out fluctuations. We prefer central bank intervention, fiscal stimulus and bailouts to sharp recessions. And likewise, in foreign policy America and Europe have preferred the seeming stability of dictators in the Arab world to the vagaries of democratic governance. But both the world economy and Arab society have now been shaken by events that were not supposed to happen, an economic crash and grassroots uprisings which deposed regime after regime.

Taleb has said again and again that suppressing volatility in markets and in society in general may work for a time. But instead of moderating volatility, it creates rigid systems that prove catastrophically unstable like dams which seem sound until they break.

We humans wrongly believe that by preventing frequent small setbacks, we will avoid any major setbacks. But, just the opposite has turned out to be true. By trying to avoid minor, but frequent recessions and by trying to avoid political unrest and gradual reform in the Arab world, we have unleashed major events that may yet prove far more damaging to our tranquility than if we had allowed more frequent, but smaller upsets.

I have summarized the reasoning in the previously cited Foreign Affairs article because I want to apply it much more broadly. Let's take agriculture. It has enabled humans to store food in large quantities and thus manage difficult times due to such events as a poor harvest or a war. But by smoothing out volatility in the food supply in this way, we have invited famines that result from heavy reliance on a few or even just one crop. That is, we've avoided small frequent failures by designing a system that will break down catastrophically once in a great while.

Modern farming has doubled down on this strategy by increasing yields tremendously at the cost of degrading soil, increasing monoculture farming based on fewer and fewer crops (meaning less genetic diversity to avoid disease), and heavy reliance on a far-flung complex supply chain for the necessary inputs of fertilizer and herbicides.

All the while, the very fossil-based fuels that make modern farming possible--to run the machinery, fertilize the crops, kill the pests and weeds and transport the harvest--these fuels are changing the climate in ways that already threaten harvests and will threaten them even more as our climate careens further and further into volatility--turning suddenly too wet in some places and suddenly too dry in others.

In the area of public health, we have traded natural immunity to diseases for that provided by vaccines. From a moral point of view we can do no less than offer effective vaccines for deadly or debilitating diseases to as many people as possible. Consequently, deaths from infectious diseases have declined dramatically. The volatility in population has essentially been suppressed.

But modern transportation now makes it more and more difficult to isolate deadly pathogens which can travel across the world in a matter of hours in an airliner. Dense urban populations linked by road and air transport make the next deadly worldwide epidemic all but inevitable. And, we must acknowledge that the current population is no longer being selected by natural factors for robustness in the face of disease; that means we can expect that such an epidemic will hit hard, perhaps harder than the one in 1918.

Told that we must eliminate possible disease-causing germs from our immediate environments, we use antibacterial cleaners in our kitchens and our bathrooms and even on our bodies and in our mouths in the form of antibacterial soap and toothpaste respectively.

But it turns out that such agents don't kill all the bacteria and, in fact, eventually select out those that are most robust against our antibacterial agents. We are making matters worse.

In addition, children who grow up in sanitized environments may not be developing proper immune systems and therefore may be more vulnerable to infectious diseases and allergies as they age.

I am not arguing that humans should never attempt to reduce volatility in their lives. I am making the case that not all such attempts will prove advisable or effective. We can take our desire to reduce volatility to such extremes that we achieve the opposite result: even greater volatility.

If we keep this in mind, we can at least ask whether our next attempt to reduce volatility will actually work in the long run or whether we would be better off adjusting to a certain amount of volatility in our lives in exchange for avoiding catastrophic failures when the dam of low volatility breaks. In more concrete terms, can we judge ourselves prudent if we save ourselves from a hangnail every day only to experience the loss of an arm later on because of our actions?


The Peak Oil Poet said...

Until about 65 million years ago dinosaurs filled every ecological niche imaginable. We poor mammals survived by our wits and tactics we evolved to protect our young for as long as possible. Not only us mammals but lots of other species evolved tactics that kept their young hidden - crocodiles, turtles, birds. They were not to know that a black swan event would turn these strategies to advantage. But that's how natural selection works - traits that aided survival for one reason can lead to survival for an altogether different reason.

The dinosaurs happily laid their eggs in the open and for tens of millions of years the balmy climate incubated them. Temperature volatility was unknown. Mom dinosaur need only be nearby to protect her clutch - the climate would do the rest.

Eggs can incubate in a very narrow temperature range. Vary outside of that range and nothing hatches. If by chance you were a species that evolved to hide eggs where how you did so also provided insulation or warming from the ocean or decomposing vegetable matter your eggs would still hatch. If you were carrying your young around inside they too were protected by your high metabolism (developed to better run from hungry dinosaurs).

Came an unforeseen event - a meteor impact that lowered global temperatures by more than eggs could tolerate and lo - there were no longer any dinosaurs (other than the few that survived in some remote isolated warm places that became dwindling islands of last refuge against the explosion of other species that survived - like us).

I sometimes wonder if by blanket inoculation against all disease there will come a time that, because of collapse of our infrastructure, vaccines will no longer be available nor insulin, nor plentiful clean water.

Of course, Murphy always being ready to do his best (worst), such a collapse will come when there are no books left anywhere - we all depend on google for everything and with it gone not only will we not have access to vaccines and modern medicine but we'd not have access to information with which we might recover. We could go from 9 billion to 90 in a matter of decades. Whatever species had been suppressed by us would then be let loose - from viruses and bacteria to everything you can imagine - rats, cockroaches.....

Safety is a two edged sword - one day we too might find ourselves like the dinosaurs - dependent on a very narrow set of conditions.

But then, all species have their life cycle.


Iaato said...

Great post, Kurt. I like the long term large scale perspective on agriculture and what it might mean for us. Cyclical pulsation is the normal, adaptive mechanism for maximum power in systems. If we suppress the pulses, we optimize the very short term, but increase the future risks and problems. The maxim "pay now or pay later" was popular for a reason? Too much pulsing is a system with small storages on the edge of chaos; too little pulsing means you're close to dead. Pulsation cleanses the system, tidies things up, makes the denizens hardy, etc. etc. As you say.

Unknown said...

Thank you Kurt for this fascinating article. I will also read the original piece that set you thinking about volatility.

I am excited as you have touched on a lot of ideas that I have myself been mulling over recently. I would agree with your, and Pop's, and Laato's conclusions. In a way, we humans have defeated evolution, by protecting ourselves so well against foreseeable (not just foreseen) risks that we have all but killed our ability to evolve vis-a-vis unforeseeable risks.

Or put differently, if you put all your eggs in one basket, you make yourself vulnerable. What if we are becoming overly reliant on all our fancy modern advances?

I would love to know what ideas you have had about how to solve this conundrum. How can we preserve humans' capacity to adapt, react, evolve? Should we build a little bit of risk, and a little bit less control, into all human activities? Individually, should we try to leave room in our daily lives for unexpected events that we're forced to adapt to?

Below are my own penny's worth of examples to compare to yours:

First case: passive capital investors

These days, the capital investment sector religiously touts a dogma based on modern portfolio theory - which consists in diversifying investments to become immune to individual risks in any single investment.

More and more investors (especially large institutions) are content to preserve their existing capital. They wouldn’t mind increasing it, but are happy to do so at a fairly conservative rate because they want to avoid running any risk of losing money. Passive management takes so-called “modern portfolio theory” to its extreme logical conclusion: an investor runs the least risk if it is invested in so many different sectors that it won’t lose money if any do less well.

The only risk left is the “systemic” risk of, say, a recession where most companies in the investor’s portfolio lose value.

I think this attitude is partly to blame (alongside the irresponsible high-risk "betting" of short-term investors) for the financial crisis. Ironically, passive investment has become even more popular since the crash, as big capital investors no longer trust "active" investment advisors (asset managers) to make profits. Many supposed investment gurus made losses in the last decade, so more and more institutions are switching to more passive investment strategies.

They are giving up the fight and going to sleep, trusting diversification to protect them from all risks. They have forgotten that some risks cannot be protected against, only adapted to.

Unknown said...

Second case: health in rich countries

It recently struck me that this is very similar to the “first world lifestyle” at the level of individual people. We feel so safe, comfortable and healthy in rich countries that many of us end up being very lazy about our health “capital”. Our main concern becomes avoiding any discomfort/risk of bad health (accidents, hunger, excessive cold or heat, etc.) at all costs.
But by reducing all of the individual health risks we face to a minimum, our body remains exposed to the “systemic” risk of the whole body being unhealthy.

And it turns out that, by reducing all the individual risks we increase the systemic risk. This goes against our intuition (indeed, all life forms’ survival instinct) that reducing individual (visible) risks is always good.

Abstraction to all complex systems: does comfort lead to sclerosis?

In both cases, the consequence of extreme comfort that makes us want to just “sink in” to our existing circumstances – to preserve them at all costs – leads to a kind of sclerosis and rusting of the system (the economy in the first case, the human body in the second). Both become “fatter”, less flexible, less reactive, and less aware of their surroundings.

Whereas in a very primitive economy competition is fierce and the system is extremely flexible (like a rainforest: as soon as a sick tree falls 100 new saplings shoot up to compete for the space). The body of a person/animal concerned with simple survival has excellent systemic health (fitness, constructive outlook on life, etc.) but is much more exposed to individual health risks (accidents, hunger, etc.).

Third case: civilisations
I am almost certain that this is the fundamental conclusion that Jared Diamond reaches in his book about civilisations that collapse. (It is, at least, what he concludes in relation to medieval China, amongst others, in Guns Germs and Steel.) He has predicted that the USA will be next civilisation that "collapses", as it shows many of the right symptoms.

When civilisations become too big, successful, comfortable and face no competition or threat from individual (visible) sources, they could become inflexible/stagnant/sclerotic and more exposed to systemic (invisible) risks.

Alexander Russell