Skin In The Game

By Nassim Nicholas Taleb

Skin in the game is the ultimate BS filter and the engine of evolution. Do not pay attention to what people say, only to what they do, and how much of their neck they are putting on the line

On Skin In Th Game

Taleb writes that “Skin in the game style symmetry, until the recent intellectualisation of life, had been implicitly considered the principle rule for organised society.”

The argument of the book is immediately attractive: if you have no skin in the game, you shouldn’t be in the game. “If you give an opinion, and someone follows it, you are morally obligated to be, yourself, exposed to its consequences.” Hawks in the White House should not be taking decisions about bombs in Iraq when they will remain in their air-conditioned houses with their 2.2 children whatever the result. Bankers are in the “Bob Rubintrade”, named after the former secretary of the US Treasury, who “collected more than $120 million in compensation from Citibank in the decade preceding the banking crash of 2008. When the bank, literally insolvent, was rescued by the taxpayer, he didn’t write any cheque — he invoked uncertainty as an excuse. Heads he wins, tails he shouts ‘Black Swan’.”

Hammurabi’s Law

• Hammurabi’s law was created 3,800 years ago in central Babylon.
• It was a collection of 282 laws and deemed to be the first codification of “Skin in the game”.
• It established symmetries between people in a transaction, so that nobody can transfer hidden tail risk. A tail is an event of extremely low frequency. It is called a tail as it is located in the top left/right of a bell-curve.
• The laws are best summed up by the rule that “If a builder builds a house and the house collapses and causes the death of the owner of the house — the builder shall be put to death”.
• Taleb describes how in our current financial system this principle is not followed with nobody clawing back the past bonuses of bankers when something they did went wrong years later due to an ignored tail risk.

On US Government Intervention

Taleb writes how the US tried regime change in Iraq and Libya and failed both times. They satisfied the objective of “removing a dictator” but failed to establish prosperous and stable democracies. He argues that the hawks had three fundamental flaws.

1. They think in statics not dynamics
2. They think in low, not high, dimensions
3. They think in terms of actions, never interactions

Taleb writes that they are “incapable of thinking in second steps and unaware of the need for them.. every peasant in Mongolia knows that real life happens in second, third, fourth and nth steps.”

“They are also incapable of distinguishing between multidimensional problems and their single dimensional representations…They can’t get that empirically, complex systems do not have obvious one-dimensional cause-and-effect mechanisms, and that under opacity, you do not mess with such a system”.

We saw that interventionists don’t learn because they are not the victims of their mistakes, and as hinted at with pathemata mathemata: The same mechanism of transferring risk also impedes learning.

The curse of modernity is that we are increasingly populated by a class of people who are better at explaining than understanding or better at explaining than doing.

Evolution can only happen if risk of extinction is present. Further, there is no evolution without skin in the game.

Platonification

Taleb’s previous book (The Black Swan) was based around the dangers of Platonification

Missing central but hidden elements of a thing in the process of transforming it into an abstract construct, then causing a blowup.

Humans have a tendency to simplify things to the point of simply not understanding them at all.

Intellectualism & Scientism

Taleb writes that:

• Intellectualism — is the belief that one can seperate an action from the results of such action, that one can seperate theory from pracist, and that one can always fix a complex system by hierachical approaches in a top-down manner.
• Scientism (the sibling of Intellectualism) — a naive interpretation of science as complication rather than science as a process and a skeptical enterprise.

As the world gets more technological there is a growing separation between the maker and the user violating the diatribe by Sextus Empricus against the professors . The rule is:

Those who talk should do and only those who do should talk.

Using mathematics when not needed is not science but Scientism.

The Tragedy Of The Commons + Scalability

The “Tragedy of the commons” is as follows — the commons being a collective property, say, a forest or fishing waters. Collectively, farmers as a community prefer to avoid overgrazing and fishermen overfishing — the entire resource becomes degraded. But every single individual farmer would personally gain from his own over-grazing or overfishing under the condition that others don’t. This is the inherent problem, people’s individual interested to do quite work well under collectivism.

However, the economist Ostrom found that in fact there exists a certain community size below which people act as collectivists, protecting the commons, as if the entire unit became rational.

Groups behave differently at a different scale.

Complex Systems

The main idea behind complex systems it that the ensemble behaves in ways not predicted by its components. The interactions matter more than the nature of the units. Studying individual ants will almost never give us a clear indication of how the ant colony operates. For that, one needs to understand an ant colony as an ant colony, no less, no more, not a collection of ants.

This is called an “Emergent” property of the whole, by which parts and whole differ because what matter are the interactions between such parts.

The Minority Rule

The Minority rule is describes as “the mother of all asymmetries” with it being sufficient for an intransigent minority with say 3–4% of the total population for the entire population to have to submit to their preferences.

For example, the kosher population in the US represents less than 3/10th of a percent of the total, yet it appears that almost all drinks are kosher as a kosher eater will never eat non-kosher food, but a non-kosher eater isn’t banned from eating kosher.

Taleb proposes to call the minority a intransigent group and the majority a flexible one. Taleb describes how the food lobby was leading a campaign to ease people’s fears about Genetically Modified Organisms but that they missed the minority rule that a GMO eater would eat non-GMO foods but not vice versa. Therefore, for the campaign to be successful the GMO lobby would have to convince not only the majority but + 97% of the existing population to prevent the minority from ruling.

The Collective

The average behaviour of the market participant will not allow us to understand the general behaviour of the market.

Taking this a step further into the social sciences

The psychological experiments on individuals showing “biases” do not allow us to automatically understand aggregates or collective behaviour, nor do they enlighten us about the behaviour of groups.

The higher the dimensions, the higher the number of possible interactions, and the more disproportionally difficult it is to understand the macro from the micro, the general form from the simple units. This is called the “Curve Of Dimensionality”.

One-Way Street Of Religion

Taleb argues that Islam was able to grow at such a speed due to 2 main reasons.

• Under Islamic law if a non-muslim man marries a Muslim women, he needs to convert to Islam while if either parent of a child happens to be Muslim, the child will be Muslim.
• Once you are a Muslim it is irreversible as apostasy is the heaviest crime under the religion and is sanctioned by the death penalty.

As a result, all you need is a small rate of interfaith marriage for the religion to blossom.

The Static vs The Dynamic

Taleb writes that the problem with economists is that they have mental difficulties with things that move and are unable to consider that things have different attributes from things that don’t.For example, they focus on static inequality but this does not reflect what happens to you in the course of your life.

Consider that about 10% of Americans will spend at least a year in the top 1%, and more than half of all Americans will spend a year in the top 10%.

Instead economists should focus on Dynamic inequality which takes into account the entire future and past life. The way to make society more equal is by forcing (through skin in the game) the rich to be subjected to the risk of exiting from the 1%.

Data

What we learn from professionals in the real world is that data is not necessarily rigour.

Taleb describes how he left data out of the Black Swan as it seems to him that people flood their stories with numbers and graphs in the absence of solid or logical arguements.

Just a little bit of significant data is needed when one is right. With large books filled with graphs and statistics being another way “to substitute the true with the complicated”.

The Grandmother Vs. The Researcher

Taleb writes that one should be highly skeptical of academic advice and instead should trust age old wisdom.

If you read anything by psychologists and behavioural scientists, odds are that it works at less than 10%, unless it is has been covered by the grandmother and the classics, in which case why would you need a psychologist?

The Lindy effect is a concept that the future life expectancy of some non-perishable things like a technology or an idea is proportional to their current age, so that every additional period of survival implies a longer remaining life expectancy.

Taleb writes that a recent effort to replicate the hundred psychology papers in prestigious journals of 2008 found that, out of a hundred, only thirty-nine replicated. The point is made that a lot of what has been proposed by modern Psychology is simply repackaged wisdom of the ancient words.

• Cognitive Dissonance — The feelings of discomfort that result when your beliefs run counter to your behaviours and/or new information that is presented to you. This was seen first in the Aesop tale of sour grapes

Driven by hunger, a fox tried to reach some grapes hanging high on the vine but was unable to, although he leaped with all his strength. As he went away, the fox remarked ‘Oh, you aren’t even ripe yet! I don’t need any sour grapes.’ People who speak disparagingly of things that they cannot attain would do well to apply this story to themselves

• Loss Aversion—A theory in which a person feel a the pain of a loss more than the pleasure of gaining something. This was proposed in Livy’s Annals — men feel the good less intensely than the bad.
• Anti-fragility — Antifragility is beyond resilience or robustness. The resilient resists shocks and stays the same; the antifragile gets better.

Overcomplicating

People who have always operated without skin in the game seek the complicated and centralised, and avoid the simple like the plague…People who are bred, selected, and compensated to find complicated solutions do not have an incentive to implement simplified ones…with these people being rewarded for perception, not results.

Ensemble Vs One-Time Probability

Taleb proposes an idea of 10,000 people going to a roulette wheel and betting on a number. You will able work out the probability of a person winning or losing and the ruin of one person does affect the person behind him. However, this is different to 1 person going to the wheel 10,000 times as a single loss for him would result in the game being stopped as he has no money to bet.

Using this example Taleb differentiates between:

• Ensemble probability — When 10,000 individuals place bets.
• One time probability — When a single person places 10,000 bets.

Taleb warns the reader “when you read material by finance professor making investment recommendations based on the long-term return of the market beware. Even if their forecasts were true no individual can get the same returns as the market unless he has infinite pockets.

I organised all my life around the point that sequence matters and the presence of ruin disqualifies cost-benefit analysis.

Systematic Risk

Taleb writes that there are two categories in which random events fall:

• Mediocristian — Risk that affects the individual without correlation to the collective.
• Extremistan — Risk that affects the collective.

Taleb makes the point that Mediocristian risks are subject to the Chernoff bound and therefore we should not worry about them compared to Extremistan. The Chernoff bound is based around the idea that getting 9,999 thousands heads from flipping a coin 10,000 times has a probability approaching 0. Therefore, the probability that the number of people who will drown in the world will double next year is very small as the risk if Mediocristian and therefore relies completely on chance.