September 21, 2010

Did clueless economist types help sink ancient societies as well?

Nassim Taleb, in his new afterword to The Black Swan and throughout his website, emphasizes how much the expert economists pushed the ideology of over-leveraging that played a key role in the current crisis. Why keep your money sitting around unproductively when you can optimize your rate of return by investing in the stock market or whatever? Well, because if something really bad happens, you won't lose all your money.

Taleb's "barbell" strategy for investing shows how to make yourself robust to catastrophes. Rather than investing 100% in medium-risk instruments, invest a large amount like 80% in the safest instruments such as cash and the remaining 20% in very high-risk / high-return instruments. The average risk could be the same in both cases, but if something really bad happens, the person who has 100% invested will lose everything, while the barbell person will only lose that 20% and still have 80% in cold hard cash. The supposed inefficient use of the 80% being stuffed under the mattress rather than being used to borrow a ton and bet it in the stock market is actually a form of insurance or redundancy -- just in case.

So, by pushing the idea of putting everything to use rather than letting it sit idle, which appears sub-optimal, economists helped to make our society more fragile. Taleb notes that the three major Semitic religions all have some form of a ban on debt, and that this cultural practice made their societies more robust to large negative shocks than if everyone took 90% of their money, used it to borrow 1000 times as much, and put it to even medium-risk uses. We should relearn the wisdom of the ancients, he says.

But aside from their scorn for debt and usury, were the ancients so free from the overly optimizing expert economist mindset, where idle uses are not seen as a source of redundancy that will save us when the shit hits the fan, but instead as an inefficient mistake that needs correction?

In War Before Civilization, Lawrence Keeley discusses how bands that raid each other tend to move apart after really nasty raids, leaving a buffer zone in between their territories. This keeps them from bumping into each other and setting off another round of brutal raids, though at the cost of not giving this land the good ol' slash-and-burn and using it to cultivate food. However, Keeley says that when agrarian societies begin to form -- the sedentary agricultural groups, not the nomadic slash-and-burn groups -- the opportunity cost of this buffer land becomes much greater. After all, by leaving it idle they are foregoing a lot more food because agrarian methods of cultivation are a lot more productive per unit area compared to the more primitive slash-and-burn method.

The tendency then is to leave less and less of this land idle and to incorporate it into the main territory and put it to use for growing crops. I mean, who needs that worthless buffer zone anyway? Even if we need some buffer, does it really have to be that big? Surely it's more efficient to whittle it down to almost nothing and replace it with wheat fields to feed ourselves. You can just hear the ancient version of the clueless economist having a consulting lunch with the local headman.

The analogy to debt vs. savings is clear. Those pre-agrarian groups were practicing Taleb's barbell strategy -- keep a big chunk of land idle as a form of insurance that will save our group (and the neighboring one) from going extinct in the event that we crossed paths and started raiding each other again. Use the remainder of the territory for more productive uses. But those settled agrarian societies fell into the trap of equating idleness with worthlessness, and they all but eliminated a key source of redundancy. Now when some disaster strikes, they literally have no buffer to protect them.

What if a band of violent nomads comes storming through? No time to prepare -- once the nomads reach your territory, they've already reached highly valuable stuff to steal, and they've already reached people to kill or abduct.

What if there's another settled agrarian society just across from you, again with little or no buffer? Well you're both in the same Hobbesian trap of wanting to raid before you're raided yourself, except now it's more like protracted warfare rather than raid and counter-raid. You wouldn't feel so nervous -- correctly -- about their presence if they were separated by a buffer zone.

Hell, what if there's a deadly epidemic burning through the neighboring peoples and is headed in your direction? Once that disease reaches your vast buffer zone where population density is nearly 0, that is the opposite of the crowd environment where it thrives. Thus, it is far less likely to reach you and kill off most of your group. Forget letting infected outsiders get close to your core territory as long as they sit in quarantine -- don't even let them within 10 miles! Mind you, this epidemic doesn't necessarily have to be one that primarily affects humans. It could primarily affect, say, rats and the fleas they carry -- like the Black Plague -- and still spell your doom. Or some infectious crop disease could spread from the next agrarian state over to your crops. Or some infectious livestock disease could spread to your animals.

The convincing models of state breakdown highlight how the society first makes itself fragile from within, for example when the elites lose solidarity with one another and are on the verge of civil war. (Turchin summarizes this family of ideas by Ibn Khaldun, Goldstone, Collins, and others.) Still, there often is some coup de grace that comes from an invasion of more solidaristic people -- the Germanic barbarians who overran Rome, the Mongols who swept over much of Eurasia, and so on.

So buffer or no buffer, the most important dynamics are those within a society that tear apart the social fabric and lead up to civil war. However, if you're at this point, wouldn't you like to have a large territorial buffer and "only" go through a bloody civil war, rather than have no buffer and be conquered by outsiders on top of it? England is fortunate to enjoy island status (minus border raiding with Scotland), so they never had the choice to shrink their buffer down to zero in the name of productivity. After the War of the Roses or the later 17th C. Civil War, at least they weren't invaded, pillaged, and butchered by barbarians like the Roman or Khwarezmid empires were.

I wonder if this is a big part of what makes island states special. People focus on the territorial buffer zone that they have and that landlocked states do not, but they speak about the latter fact as if it were determined by geography. Instead, it's by the conscious choices of the decision-makers to shrink their buffer zone down to zero in order to settle and cultivate it rather than "irrationally" let it sit idle. An island state then is like a person who has a big chunk of their wealth locked up in a cash trust fund that they can't access. They may be getting a lower rate of return for the first 9 out of 10 years, but when the whole system blows up in the final year, they'll be OK while those who put most or all of their wealth to good productive use in the stock market will get wiped out.

So, it looks like we have to go all the way back to slash-and-burn horticulturalists or even hunter-gatherers to find groups who appreciated the insurance value of idleness. Once settled agrarian societies sprung up, they already began to worship efficiency over robustness, even if they weren't wholly devoted to this ideology, as shown by their proscriptions against debt. In the modern world, of course, we've exposed ourselves even more to black swan events. This greater vulnerability of ours is what spawned the welfare state, whose main function is to try to protect people from this excessive fragility, and which is growing more and more unstable, but that's a story for another time (maybe tomorrow).

10 comments:

  1. Harmonious Jim9/21/10, 2:06 PM

    Maybe today's investors and yesterday's peasants both misunderstood risk. But, when peasant societies ate up their buffer zones, it was because of the dull compulsion of population pressure, not the seductive ideologies of clueless proto-economists.

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  2. Pretty interesting stuff. I think that the United States has benefited from buffer zones more than England has as evidenced by the lack of any seriously threatening invasion since the War of 1812. (You could maybe count Pearl Harbor and the Pacific front vs. Japan but I'm talking about the mainland.) It doesn't get much bigger than two oceans separating you from the rest of the Western world.

    I had never noticed but I have unintentionally been doing this 80/20 thing for a while. My 401k is all high risk but most of my savings is actually in the form of a bank account.

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  3. A problem for an agrarian society who tries to create a buffer zone is that its neighbours would likely cultivate it. Then the neighbours would be close AND they would have more resources. To keep the buffer, you'd need to physically stop outsiders from moving in, but that would mean using resources to militarily control the area without getting any produce out of it.

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  4. Everything you say is correct, but it misses the point. If you're only goal is robustness, then sure let that land sit idle. But still being here in a thousand years is not the only things humans are interested in. We make ourselves and our societies more fragile because it brings other benefits.

    Consider just in time inventory practices. The goods are made at the factory right before they are shipped to the wholesaler, who gets them right before he distributes them to retailers, who get them right before customers come in and buy them off his shelves. Instead of letting lots of goods sit idly at any of the three stages, where there are inventory costs, we have developed a much more efficient system. We can get a much larger variety of goods at a much cheaper price than before, allowing us to buy even more things.

    Of course, if there was a catastrophe and this supply chain broke down, there would not be enough food for everyone for more than a few days, since there is no spare inventory, and there would be mass starvation.

    There is an opportunity cost inherent in achieving robustness.

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  5. I might to tempted to think about your theory except that you credit that wacko Taleb.

    I recently read both of his books. He at one time was a trader with a method based on the insight that the risks in financial markets were typically calculated using normal curve assumptions but that it would be better to use fat tail assumptions. That's it. All the rest is just self promotion.

    He spins a morality fable about how his colleagues enjoyed themselves for a while but came to ultimate ruin. Nasim, boopy, I've got news for you our shared destiny is ultimate ruin. Gladwell's magazine piece on him revealed the truth, while he was a trader he was always miserable, nervous and afraid. He exhibited several psychological maladies. His great method - lose everyday - while you bet on an unlikely crash is a prescription for misery.

    I think he's so much happier now that he has gone into the guru business.

    Albertosaurus

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  6. I think Taleb can overstate things, but Albertosaurus actually raised my opinion of him. First off, Gladwell is a nitwit. I can't count how many times people have pointed out he got things backward. Second of all, that Taleb could endure the daily grind of expecting to lose because he knew in the long run he could make up for it, is commendable. For a better critique of Taleb, try Eric Falkenstein.

    An empty buffer state full of productive land does not sound like a stable equilibrium. Even if there wasn't a neighboring tribe to snap it up given the chance, you'd have to periodically purge it of landless suckers heading out to homestead.

    It occurs to me that Taleb's barbell idea doesn't sound that different from the recommendations of standard portfolio theory (with volatility being the standard example tradeoff).

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  7. I was going to go with what TGGP said. Actual economists have been telling people to diversify and not to try to beat the market, basically forever. Taleb's trading strategy doesn't seem to outperform over the long run. His problem? Actual market participants seem to price in a lot of tail risk already. They're smarter than someone's back of the envelope calculation from 1973.

    If Taleb talked less crap I'd take him more seriously, since he does have quite a bit to say as a popular writer about inference. His style, though, is a bit too much like Malcom Gladwell with Tourette's. Art DeVany is more to my taste, but he's one of these economists that you don't like. ;)

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  8. Agnostic,

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  9. Huh, I thought agnostic would like De Vany. De Vany is big on paleo diets & exercise. I think he's also friends with Taleb.

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  10. I thought Agnostic had mentioned De Vany appreciatively a few times, like his book about the moviebiz. Anyway, put me down as another fan of De Vany's.

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