Black Swans and Antifragility: A Vivid Reconceptualization of Risk and Resilience

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Black Swan
Johan Swanepoel / Shutterstock.com

This recent Wall Street Journal essay (paywall) by risk engineering expert Nassim Nicholas Taleb is as thought-provoking as they come, so we thought we’d give our readers a summary of his key points. Taleb offers the concept of “black swans,” which he defines as “large events that are both unexpected and highly consequential.” He says “we never see black swans coming, but when they do arrive, they profoundly shape our world.”

His point is that “just about everything of consequence comes from black swans; ordinary events have paltry effects in the long term.” The volatility of black swans is unavoidable and in some ways healthy. The challenge is “to create institutions that won’t fall apart when we encounter black swans—or that might even gain from these unexpected events.” Taleb argues that “we instead need things that gain from volatility, variability, stress and disorder.” He calls those things “antifragile” (Taleb is also a former derivatives trader, a field which uses the term “‘long gamma’ to describe financial packages that benefit from market volatility.”)

He suggests five rules for “establish(ing) antifragility as a principle of our socioeconomic life,” which we think have some applicability to the nonprofit sector’s ability to withstand and benefit from black swans:

  1. He argues that institutions have to be encouraged to be self-healing, that “Stifling natural fluctuations masks real problems, causing the explosions to be both delayed and more intense when they do take place.” He contends, therefore, that government has to be careful to intervene to where it needs to and not to jump in and waste resources where it shouldn’t. He believes in a safety net for people, but is much more reluctant to bail out the business sector: “In the long run, bailing out people is less harmful to the system than bailing out firms; we should have policies now that minimize the possibility of being forced to bail out firms in the future, with the moral hazard this entails.”
  2. “Favor businesses that benefit from their own mistakes, not those whose mistakes percolate into the system.” Pointing out that some industries learn from mistakes and failures, he suggests that others, as they are currently structured are not. His specific example of an industrial sector that is “irremediably fragile” is the banking sector: “every bank failure weakens the financial system… Errors end up becoming large and threatening. A reformed financial system would eliminate this domino effect, allowing no systemic risk from individual failures.” He argues that firms with highly leveraged debt are fragile and susceptible to the calamitous effects of black swans.”
  3. “Small is beautiful, but it is also efficient.” It’s worth quoting Taleb at length here: “Experts in business and government are always talking about economies of scale. They say that increasing the size of projects and institutions brings costs savings. But the ‘efficient,’ when too large, isn’t so efficient. Size produces visible benefits but also hidden risks; it increases exposure to the probability of large losses. … Great size in itself, when it exceeds a certain threshold, produces fragility and can eradicate all the gains from economies of scale. …So we need to distribute decisions and projects across as many units as possible, which reinforces the system by spreading errors across a wider range of sources.”
  4. “Trial and error beats academic knowledge.” Taleb contends that, “Things that are antifragile love randomness and uncertainty, which also means—crucially—that they can learn from errors. Tinkering by trial and error has traditionally played a larger role than directed science in Western invention and innovation.”
  5. “Decision makers must have skin in the game.” Taleb argues for the upside and down side of skin: “the idea of incentive in capitalism demands some comparable form of disincentive. In the business world, the solution is simple: Bonuses that go to managers whose firms subsequently fail should be clawed back, and there should be additional financial penalties for those who hide risks under the rug.”

At NPQ, we enjoy people who offer different ways of looking at the world. We aren’t talking about facile sloganeers and faddists, but people who see things differently and give us new perspective. We don’t know how applicable Taleb’s five points for building a culture of antifragility might be to the nonprofit sector, but they are clearly fodder for some intriguing debates.