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Black swans, but no need to flap ...

By Gillian Tett Published: March 25 2011 22:11 | Last updated: March 25 2011 22:11

Fifteen years ago, Peter Bernstein, the late New York economist and historian, wrote a thoughtful book on probability theory, Against the Gods. It argues that one of the key issues that distinguishes modern societies from pre-modern societies is how people conceive risk. Pre-modern cultures, he argued, cannot model risk in a systematic way because they lack clocks or complex maths; thus they fatalistically view life as something shaped by capricious gods or natural elements. Modern societies, however, measure risks methodically and develop proactive strategies in response. The revolutionary idea that defines the boundary between modern times and the past is the mastery of risk, he wrote. It is a fascinating distinction to ponder on, given recent disasters in Japan. Until quite recently, I suspect that most people living in the US and Europe assumed that the world around them was so stable that it made sense to believe that risk could always be measured and contained. After all, it has been a long time since a serious war or revolution occurred in the western world. And in the late twentieth and early 21st centuries, the economy seemed so benign that economists sometimes dubbed it the era of the great moderation. Indeed, when Nassim Nicholas Taleb, the American-Lebanese author, published The Black Swan, his book about extreme, unpredictable risks, in early 2007, it became a bestseller partly because black swans seemed such a novel idea. To be sure, somebody over the age of 70 might have seen the devastation of the second world war, while others would have witnessed black swans ranging from the Three Mile Island nuclear disaster to the collapse of the USSR. I am in that second category: in 1991, the community where I was living in the USSR imploded unexpectedly into a brutal civil war, leaving me haunted by the awareness that seemingly impregnable systems can sometimes be very fragile. But in 2007, my own cynicism about the durability of systems was not the majority experience; most people lived in such a cosy, predictable world that they assumed the systems around them would always endure. Black swans were thus fascinating precisely because they seemed so rare. No longer. Just after Taleb published his book, the financial crisis unfolded and banks collapsed in a onceunimaginable way. For a period, it even looked as if the financial system might break down so completely that money would stop coming out of ATM machines. Then entire countries such as Iceland, Greece and Ireland imploded in economic turmoil. Natural disasters erupted. And this year there have been revolutions in Egypt and Tunisia, more financial dramas in the eurozone, war in Libya; and, of course, a terrible earthquake, tsunami and nuclear crisis in Japan. Indeed, black swans have suddenly arrived in such a flock that Wall Street traders have invented a grim new phrase: black swan fatigue. And last week the chief executive officer of one Wall Street bank observed to investors in Paris that he was getting fed up with everyone worrying about black swans, everywhere. Suddenly, it seems that we cannot always master risk; we have become less modern than we thought. Is this a good thing? Not if it breeds reckless or hopeless fatalism. After all, as Bernstein argues, systematic efforts to measure risk are central to economic growth, enabling investment to occur and enterprise to take root. Fatalism, by contrast, breeds either paralysis or extreme recklessness. However, some humbleness about our modern risk-management skills is certainly welcome. Back in the days of the great moderation, the west felt so over-confident about the prediction powers of its computers that there was precious little debate about how robust our modern systems really are. If you think that modern society has mastered probability theory to the point of control, why worry about a scenario where, say, the money stops coming out of ATM machines, the electricity grid fails, the internet collapses, an epidemic spreads, or those scientists in the nuclear power industry get their sums wrong? But, as Japan shows, black swans do exist; and the good news, as Taleb says, is that there are practical steps that societies can take to become more robust. Most notably, instead of building systems which are extremely interconnected, complex and opaque which makes them liable to collapse if a shock hits we could design simpler systems that could break into self-contained small units at a moment of disaster. Diversity and selfsufficiency, in other words, can prevent disastrous forms of contagion; or, as Taleb puts it, create a black swanproof world. Thankfully, this approach already exists in some places in our modern world, such as electricity grids. But it is alarmingly absent in other parts of 21st-century life, such as banking. This needs to change. Our modern society might not be as good at predicting risk as we tell ourselves, but that does not mean we should be fatalist in a premodern sense. The mark of a truly advanced society, by contrast, is to accept that pre-modern black swans can appear and then create systems that can survive, even when our modern prediction techniques go wrong. gillian.tett@ft.com
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