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20211225 – Most Things Fail

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MAIN IDEA:

The author formulated the main idea of this book as consisting of three themes:” The main theme of this book is to develop a general explanation of the pervasive nature of failure in the world of human societies and economies. Though there are striking parallels between the social and economic world and the world of biology there is, however, a fundamental difference between the two: the process of evolution in biological species cannot be planned. Species cannot act with the intent of increasing their fitness to survive. In contrast, in human society, individuals, firms and governments all strive consciously to devise successful strategies for survival. They adapt these strategies over time and alter their plans as circumstances change. Yet, despite this apparent contrast, eventually, in both biological evolution and human social and economic activity, failure strikes.

A second theme of this book is to understand this seeming paradox. How can it be that not just failure, but the patterns of failure, are so similar in biology and human organization when there is such a sharp contrast between the abilities to act with the conscious intent of improving one’s prospects for survival?

The third theme, developed in particular towards the end of the book, is that failure can be highly beneficial. In the real world in which strategies evolve and which is itself the outcome of a dynamic process of change, failure at the level of the individual component part can, paradoxically, enhance the fitness of the system as a whole.”

DETAILS:

Introduction
After stating his opinion about the general inevitability of failure, the author refers to two examples of consistent long-term failure: racism and poverty. He then refers to Evolution that clearly demonstrates the necessity of failure for development. Finally, the author presents key themes of this book and stresses that his primary method is comparing the theory with evidence, unlike many other works in social sciences and economics that avoid such comparison, often substituting it with complex mathematical models.    

1 The Edwardian Explosion
Here the author uses the analogy of the Cambrian explosion from evolutionary biology to characterize the economic explosion in England in the late XIXth century. It featured outside investors financing the new venture based on limited liability protecting them. The author then discusses the improvement in living standards that resulted from the rapid economic growth. However, this development’s outcome also included an increase in scale of business enterprises and the creation of monopolies. From this, the author moves to discuss multiple business failures and provides a nice table:

2 A Formula for Failure
Here the author expands the discussion to the search for reasons for failures after noting that the economic profession generally tends to ignore failures even though it is the fate of 10% of all businesses every year. The economic methodology is mainly directed to the search of market equilibrium, and the author discusses how little this approach helps explain real-world economic processes. The special attention the author allocates to the failure to properly analyze risk vs. uncertainty:” Risk refers to situations in which the outcome cannot be known with certainty, but the probability of any given outcome is understood perfectly. A simple example would be a toss of a fair coin. There is a fifty– fifty chance of it being either heads or tails. If we are gambling on the next toss being heads, there is a risk that we will lose our money if it turns out to be tails. But we know precisely what the chances are. Uncertainty, in its strict sense, refers to situations in which the probability of the various outcomes is itself unknown.” The author also uses multiple examples of real-life events and studies demonstrating a considerable difference between economic decision-making as presented in theory and as real live decision makers actually do it. From this, the author makes a pretty reasonable inference:” The capacity of firms to deal with market situations in a cognitive sense, their capacity to process information and turn it into knowledge, is small compared to the sheer scale of the problems which confront them. Companies can never deal completely with the complexity of the real world. The uncertainty that shrouds the future is not so much a veil as an iron curtain. In the current state of scientific knowledge, it cannot be penetrated. There is ample opportunity at any point in time for any firm, no matter how large, to fail.”

3 Up a Bit, Then Down a Bit
The author begins this chapter by briefly recounting the story of the increase of governments expenses and overall influence on the economy. Then, he specifically looks at the impact of this increase on the unemployment data and finds that it was not that significant:” If we compare the period from 1946 to the present day with the period 1870–1938, we see that, on average, as a proportion of the economy as a whole, the public sector was well over twice as large. Yet the average unemployment rate from 1946 has been no less than 4.5 per cent. In other words, only very marginally lower than in the period 1870–1938, despite the massive rise in the importance of the public sector in the economy. And although the highest rate in any single year, at 11 per cent, was less than the 14 per cent of the 1930s, unemployment never fell below 1 per cent in the entire period since the Second World War.” After that, the author looks at social mobility and Gini coefficients within countries and between countries:

At the end of this chapter author once again refer to a critical intellectual construct of economics: general-equilibrium theory and stresses how inconsistent it is with real-life developments. He makes this statement:” In order to control a system – any system, whether an economy, a biological system or a machine – we need to be able to do two things: first, make forecasts which are reasonably accurate in a systematic way over time; and second, understand with reasonable accuracy the effect of changes in policy on the system one is trying to control.” And, since the only thing really proved about economic forecasts is their persistent failure, he concludes:” It may seem implausible that economic systems behave as if they were almost random. However, this near-random quality does not mean in any way that the individual components of an economy – people, firms, governments – take decisions at random. On the contrary, they act with purpose and intent. But the consequences of these millions upon millions of individual decisions, interacting with each other all the time, lead to an overall outcome, for total output (GDP), say, that appears as if it were close to being random. The sheer dimensions of the problem are simply too great for the system to be understood properly. There are simply too many factors that determine the outcome, and whose relative importance alters over time, for the complete picture ever to be grasped.”4 Making Sense of Segregation
This chapter starts with reference to Marx and Engels and their indirect responsibility for innumerable crimes committed in the name of communism. Then, he discusses the complete failure of Marxism as a politico-economic theory. From this point, the author discusses various forms of segregation, both geographical and housing, between groups of people along class or religious or racial lines. Next, he discusses the persistence of such segregation despite the multitude of efforts by the government to promote integration. Finally, the author discusses the reasons and process of segregation, including the fascinating example of algorithmically generated segregation based on a very simple rule of preferences:

5 Playing by the Rules
This chapter begins with reference to Alfred Marshall, Francis Edgeworth and their debate whether the market could be analyzed and understood based on supply/demand equilibrium or it is just too complex and unpredictable to obtain any meaningful understanding and correspondingly correct forecast.  The author then discusses the general development of economic theory and the addition of the game theory and later psychology to the mix. At the end of the chapter, the author presents his conclusion:” A key paradox begins to emerge from all this. Humans, whether acting as individuals or making collective decisions in companies or governments, behave with purpose. They take decisions with the aim of achieving specific, desired outcomes. Yet our view of the world which is emerging is one in which it is either very difficult or even impossible to predict the consequences of decisions in any meaningful sense. We may intend to achieve a particular outcome, but the complexity of the world, even in apparently simple situations, appears to be so great that it is not within our power to ordain the future.”

6 A Game of Chess
This chapter discusses the incompleteness of information available to acting agents, contrasting it with complete information available to chess players. He begins with another paradox:” Humans can take decisions with intent, acting with the purpose of achieving specific targets. As we noted in the Introduction, this ability to act with intent is sharply different from the process of biological evolution, which takes place at random. Yet both cases, whether human strategy or the evolution of species, are characterized by widespread failure. The human ability to act with purpose and intent seems not to imply in any way that the actual outcome will be the desired one.”

The author then proceeds to discuss the contemporary economic theory that moved beyond the notion of full informed agents making perfect choices based on supply and demand to the concepts of partially or even wholly misinformed agents acting not only based on external data but also based on their internal psychological processes. However, even for chess, in which the quality of the game improved over time, the author suggests limitations of improvements due to the game’s complexity. As to the game of life, which is infinitely more complex than chess:” Individuals, firms, governments, households may lack access to complete information. Even more importantly, they do not have the cognitive ability to process it in a way which finds the single, optimal choice. Particularly when confronted with decisions that have consequences in the future, the problem of finding the ‘best’ move, the best strategy, is simply too hard. Instead, agents look for reasonably good strategies which avoid obvious loss, and they find it very difficult to learn better strategies. Armed with this view of the world, we return to the problem of failure and extinction.”

7 ‘The Best-Laid Schemes …’
Here the author expands the chess analogy further, noting that it is not only incomplete information but also the character of the rules of the game that make a difference. In real life, rules and goals are dynamic and constantly change, unlike static and well-known rules of chess. The author provides some examples and discusses in detail Harold Hotelling’s beach and ice cream model that demonstrates an exponential increase in complexity with any change in assumptions that make the model more realistic. He makes the point that this complexity makes a complete solution impossible. However, at the same time, he demonstrates that a simple strategy could produce “good enough” results.

8 Doves and Hawks
The author discusses another model in this chapter: Armen Alchian’s “Dove and Hawks”. He demonstrates how volatility is embedded in complex biological systems, sometimes leading to cyclical changes when some parameter, such as the ratio of lynx to hares, moves periodically from one extreme to another. The author also discusses Vito Volterra’s work:” A Mathematical Theory of the Struggle for Life, ” describing dynamic equilibrium between species. Finally, the author also describes some relevant samples of English literature.  

9 Patterns in the Dark
Here, the author continues juxtaposing biology, Darwin’s evolution and economy, and Adam Smith’s capitalism. He describes the process of evolution and stresses that the pace of evolution is variable, referring to the “Cambrian explosion”. Moreover, the research shows that there is some multi-million years cycle of extinction with the interdependency of size and frequency:

The author then sets up the framework for moving to economics in the next chapter:” Excitingly, power law, or very near power law, relationships have been identified very recently in many areas of economic activity. Perhaps most exciting of all, the relationship that describes the pattern of extinctions amongst firms appears to be virtually identical to that which describes biological extinctions. For certain types of system, as diverse as those in which biological species and modern firms flourish and die, we may have the first inklings of a general theory not of evolution but of extinction.”

10 The Powers that Be
The author begins this chapter with the statement that describes biological processes fully apply to economics with:” the size distribution of the largest American companies was well described by a power law, a finding subsequently generalized across all US firms”. The author then discusses the relation between the size of cause and scale of the event:” Most of the time, small events, small shocks to the system, will only have small impacts, and large shocks will usually have big consequences. But the fact that we observe power-law behavior in a system tells us that the system operates in ways that mean that these relationships do not always hold. Sometimes, a very small event can have profound consequences, and occasionally a big shock can be contained and be of little import.”  He also presents some analysis of types of networks and resulting variance in their behavior, illustrating all this by the story of financial debacle such as LTCM. Finally, the author also provides an extinction graph for both economic and biological species:

11 Take Your Pick?
In this chapter, the author reviews two theoretical approaches to the problem of extinction. One approach assigns cause to external shocks, while the other to the internal development of the system. The author uses business cycles as an example when one approach points to an external event such as a war that violates the equilibrium of the economic system. At the same time, another looks for internal causes such as money supply than misallocation of resources, eventually leading to a crash.

The author discusses Mark Newman’s exogenous model of extinctions and Richard Sole and S. Manrubia’s endogenous model. Interestingly enough, both models: “capable of generating results that are compatible with the key empirical evidence on extinction in the biological fossil record.”

12 Resolving the Dilemma
The author begins here by noting that there are clear cases of purely exogenous or endogenous causes and then discusses various parameters of a system that sometimes provide for the survival of the strong shocks but sometimes lead to extinction from the much smaller ones. The conclusion the author presents is this:” In the biological world, both the exogenous and endogenous extinction models in their pure form can account for the key patterns observed in the extinction of species, but the strictly endogenous model, in which firms are connected to each other and have impacts on each other’s fitness, translates far better into socio-economic systems than does the strictly exogenous one.

However, as we have noted several times, in the human world of social and economic organization, in practice failure and extinction almost certainly arise from a combination of endogenous and exogenous factors, of external shocks and the purely internal interactions of the component parts of the system. The internal network of connections and how it evolves over time are the most important causes of extinctions, but external shocks will often play a role as well. We now explore the implications of making the model even more realistic by introducing external shocks into the self-generating explanation of extinction.”

13 Why Things Fail
Here the author discusses the results of testing models in real-life that demonstrate their very limited usability. An example he looks at in detail is the Philips Curve. However, the author also stresses that: “A great advantage of a theoretical model is that we can create artificial worlds. In other words, we can change the rules of behavior and see what happens.”

The author concludes this chapter with clear inference:” To repeat a key phrase which needs to be hard-wired into the brain of every decision-maker, whether in the public or private sector, intent is not the same as outcome. Humans, whether acting as individuals or in a collective fashion in a firm or government, face massive inherent uncertainty about the effect of their actions. Whether it is the great characters of tragedy or giant corporations such as Microsoft, the future remains covered in a deep veil to all. Species, people, firms, governments are all complex entities that must survive in dynamic environments which evolve over time. Their ability to understand such environments is inherently limited.

These limits are a fundamental feature of the systems we have discussed, whether biological or whether in the realm of human social and economic organization, in which the individual agents are connected through networks which evolve over time. These limits can no more be overcome by smarter analysis than we are able to break binding physical constraints, such as our inability to travel faster than the speed of light. This is why things fail.

14 What Is to Be Done?

The author begins this chapter by stating that:” Yet humanity is not completely powerless in the face of the Iron Law of Failure. There are positive attitudes, positive steps that policy-makers, in both the public and private domains, can take. Moreover, failure at the individual level can paradoxically be beneficial for the health of the system as a whole.” He then proceeds by discussing works of Schumpeter and Hayek, the former advocating some degree of monopoly as preferable to pure competition, while the latter theoretically demonstrated that market-based economies are superior to planned ones due to superiority of distributed specific knowledge processing over-concentrated and therefore necessarily simplified knowledge processing. The author then uses examples with civil aviation industries and practically unregulated money supply in the USA until the early XX century that successfully supported a colossal expansion of the American economy for more than a century. The author then looks at the relation between extinction fitness of agents and the system as a whole, demonstrating its inverse relationship in the model:

After that, the author reviews and laments the current policies of big governments that support various agents for political reasons, consequently negatively impacting the system’s overall fitness. However, the author also stresses that:” But it is not the size of the state as such which has brought this about. Different western countries have experienced different sizes of state intervention in the economy, and there is no obvious relationship between this and economic performance. And, as we have seen, the period in which the state has seen a massive increase in its importance in western society has also been the period in which most countries moved away from rather than towards the outcomes that the social democratic model promised. Unemployment is up. Crime has increased. Income inequality has widened. And social mobility has fallen.”

In the end, the author provides his solution to the problem of the unpredictability of results and inevitable failures, which is: “‘Innovate, innovate!’ – that is the guiding principle which companies have used to try to overcome the inherent and pervasive uncertainty which surrounds all their decisions. It is the best strategy for individual survival, and it is a strategy from which we all, as consumers and citizens, have benefited immensely.”

MY TAKE ON IT:

My views are in complete agreement with the main positions of the author of this book: the future is unpredictable, and all that one can do is to try developing maximum fitness and flexibility to avoid extinction due to the wider range of shocks, endogenous or exogenous. I think it is applicable for all levels, from individuals to businesses of all sizes to the states and nations. I believe insufficiently highlighted is the tradeoff between redundancy and efficiency, necessitated by all this. The improvement in extinction fitness requires investment in a broader range of functionality that would necessarily decrease efficiency. The only way such increase is possible is if decision makers’ well-being strongly depended on the consequences of these decisions because otherwise, they would always prefer current efficiency. The lack of solid feedback for government or big business bureaucracy is probably the most crucial reason for societal failures at all levels.

A good example would be the decision of American airlines to avoid implementing security measures similar to Israeli airlines before 9/11 because of their cost, which was just a few thousand dollars. The following disaster had little impact on the lives of either airline’s management or government bureaucrats “responsible” for security while costing a lot in lives and treasure for people. If it were a small private business, its owners would be out of business and probably wholly wiped out by lawsuits forcing all others to include effective security measures as a necessary cost of doing business. As it is, the government implemented costly and ineffective bureaucracy of TSA, which demonstrated by such reports:” Federal agents posed as passengers and attempted to sneak fake guns and explosives onto flights. The results showed they were successful in getting past security 95 percent of the time. https://edition.cnn.com/2019/12/20/politics/tsa-whistleblower-airport-safety-invs/index.html”


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