The Black Swan: The Impact of the Highly Improbable

Pascal’s argument is severely flawed theologically: one has to be naïve enough to believe that God would not penalize us for false belief. Unless, of course, one is taking the quite restrictive view of a naïve God. (Bertrand Russell was reported to have claimed that God would need to have created fools for Pascal’s argument to work.)

But the idea behind Pascal’s wager has fundamental applications outside of theology. It stands the entire notion of knowledge on its head. It eliminates the need for us to understand the probabilities of a rare event (there are fundamental limits to our knowledge of these); rather, we can focus on the payoff and benefits of an event if it takes place. The probabilities of very rare events are not computable; the effect of an event on us is considerably easier to ascertain (the rarer the event, the fuzzier the odds). We can have a clear idea of the consequences of an event, even if we do not know how likely it is to occur. I don’t know the odds of an earthquake, but I can imagine how San Francisco might be affected by one. This idea that in order to make a decision you need to focus on the consequences (which you can know) rather than the probability (which you can’t know) is the central idea of uncertainty. Much of my life is based on it.

You can build an overall theory of decision making on this idea. All you have to do is mitigate the consequences. As I said, if my portfolio is exposed to a market crash, the odds of which I can’t compute, all I have to do is buy insurance, or get out and invest the amounts I am not willing to ever lose in less risky securities.

Effectively, if free markets have been successful, it is precisely because they allow the trial-and-error process I call “stochastic tinkering” on the part of competing individual operators who fall for the narrative fallacy—but are effectively collectively partaking of a grand project. We are increasingly learning to practice stochastic tinkering without knowing it—thanks to overconfident entrepreneurs, naïve investors, greedy investment bankers, and aggressive venture capitalists brought together by the free-market system. The next chapter shows why I am optimistic that the academy is losing its power and ability to put knowledge in straitjackets and that more out-of-the-box knowledge will be generated Wiki-style.

In the end we are being driven by history, all the while thinking that we are doing the driving.

I’ll sum up this long section on prediction by stating that we can easily narrow down the reasons we can’t figure out what’s going on. There are: a) epistemic arrogance and our corresponding future blindness; b) the Platonic notion of categories, or how people are fooled by reductions, particularly if they have an academic degree in an expert-free discipline; and, finally c) flawed tools of inference, particularly the Black Swan-free tools from Mediocristan.

In the next section we will go deeper, much deeper, into these tools from Mediocristan, into the “plumbing,” so to speak. Some readers may see it as an appendix; others may consider it the heart of the book.

Part 3: THOSE GRAY SWANS OF EXTREMISTAN

It’s time to deal in some depth with four final items that bear on our Black Swan.

Primo, I have said earlier that the world is moving deeper into Extremistan, that it is less and less governed by Mediocristan—in fact, this idea is more subtle than that. I will show how and present the various ideas we have about the formation of inequality. Secondo, I have been describing the Gaussian bell curve as a contagious and severe delusion, and it is time to get into that point in some depth. Terso, I will present what I call Mandelbrotian, or fractal, randomness. Remember that for an event to be a Black Swan, it does not just have to be rare, or just wild; it has to be unexpected, has to lie outside our tunnel of possibilities. You must be a sucker for it. As it happens, many rare events can yield their structure to us: it is not easy to compute their probability, but it is easy to get a general idea about the possibility of their occurrence. We can turn these Black Swans into Gray Swans, so to speak, reducing their surprise effect. A person aware of the possibility of such events can come to belong to the non-sucker variety.

Finally, I will present the ideas of those philosophers who focus on phony uncertainty. I organized this book in such a way that the more technical (though nonessential) sections are here; these can be skipped without any loss to the thoughtful reader, particularly Chapters 15, 17, and the second half of Chapter 16. I will alert the reader with footnotes. The reader less interested in the mechanics of deviations can then directly proceed to Part 4.

Chapter Fourteen: FROM MEDIOCRISTAN TO EXTREMISTAN, AND BACK