Wednesday, April 1, 2009

The Reverse Black Swan, Part I

(Michael Mandel on Nassim Nicholas Taleb’s book) Because technological innovation really is fundamentally unpredictable, increasing the amount spent on R&D and innovation does not lead to diversification and a reduction of uncertainty. Taleb writes:

In spite of our progress and the growth in knowledge, or perhaps because of such progress and growth, the future will be increasingly less predictable.

This is especially true in the U.S. The way that the global economy developed in recent years, the U.S. has outsourced production to other countries, and kept the high-end task of design and innovation. As Taleb puts it:

The American economy has leveraged itself heavily on the idea generation.

This is precisely the point that I missed in my 2004 book, Rational Exuberance. In that book, I argued that a “hot” financial system—one with lots of highly mobile capital —would boost growth by seeking out and funding the development of the most promising innovations. I also argued that this growth-enhancing effect was worth the added possibility of financial crises. This is what I wrote then:

During boom times, the U.S. is able to fund innovative and growing new businesses with financial instruments--venture capital and junk bonds--that barely exist anywhere else. And then when the inevitable bust comes, the U.S. financial system is highly liquid and far more diversified than elsewhere, able to cope with sharp plunges without freezing up.

Har de har har. How stupid could I have been...

In my (weak) defense, I acknowledged in that book the possibility that the pace of innovation would slow, leading to lower real wages for college-educated workers. What's more, I pointed out that in the absence of innovation: will become a lot harder to service all the debt that companies and people took on during the 1990s. Housing prices will slump and perhaps even plummet.

But despite this nod to the potential Black Swan of the financial crisis, I didn't really wrap my mind around the possibility that all this money out there might not get results. The fundamental unpredictability of technology means exactly that--we could summon up all this capital, and not get the big innovation. The big potential innovations such as biotech didn't take off in the post-2000 era, as was expected. As a result, that big pot of hungry money had no outlet except for housing. The innovations didn't happen.

What did happen was a big negative Black Swan--the financial crisis. And a Taleb-type analysis tells us that such negative unexpected events--a sudden acceleration of global warming, global war, a breakdown of the Internet, you name it--are almost guaranteed over a long enough time span.

So here's the thing. What reading Taleb tells me is that as a technological optimist, I need to accept three statements.

1) Unexpected technological breakthroughs are possible. That's good

2) The timing and nature of the breakthroughs cannot be controlled. That's bad

3) Unexpected large bad events are possible as well. That's bad. In fact, we can get bad events which have as big an impact, in the negative direction, as the technological innovations.

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