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Publisher: Random House
The fifth book in Nassim Nicholas Taleb’s landmark “Incerto” series, “Skin in the Game” – in the words of its author – is about four topics in one: 1) uncertainty and the reliability of knowledge; 2) symmetry in human affairs (that is, fairness, justice, responsibility, and reciprocity); 3 information sharing in transactions, and 4) rationality in complex systems and in the real world. A provocative combination of practical discussions, philosophical tales, and scientific and analytical commentary, the book “challenges many long-held beliefs about risk and reward, politics and religion, finance and personal responsibility.” So, get ready for a few counterintuitive insights from one of the world’s most attention-grabbing intellectuals!
You may have already heard this story; but, even so, it’s worth repeating here. In Shakespeare’s famous play “The Merchant of Venice,” Bassanio, a young Venetian nobleman, asks his friend Antonio for 3,000 ducats which he needs to woo a wealthy heiress named Portia. Antonio doesn’t have the money at the moment but tells Bassanio that he would gladly be his guarantor if Bassanio finds someone who will lend him the necessary sum. Bassanio finds Shylock, a Jewish moneylender, who agrees to give Bassanio the money, but on one condition: if Antonio can’t pay him back “the pounds,” Shylock will get “a pound” of Antonio’s flesh.
That, right there, is a quite literalized version of the phrase “skin in the game” as Taleb understands it. It means having some part of you at stake in the transaction you’re making; it means “Having a share of the harm, paying a penalty if something goes wrong.” When skin in the game is absent from an interpersonal transaction, one actor tends to get all the rewards, whereas the other gets stuck with the risks. This is what Taleb refers to as “asymmetry.” Skin in the game, on the other hand, is symmetrical by design: it’s what guarantees that actions will have consequences on the actor, not on the nonparticipant or the spectator.
Before the “recent intellectualization of life,” comments Taleb, skin-in-the-game symmetry “had been implicitly considered the principal rule for organized society.” Take, for starters, the Code of Hammurabi, a Babylonian legal text composed in the first quarter of the second millennium before Christ. The originator of the well-known “eye for an eye” principle, the Code of Hammurabi attempts to correct the asymmetries of life by forcing skin in the game where it might not be naturally present. One of its best-known injunctions states the following: “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.”
By forcing the builder to have something significant to lose, the law protects the owner, the user of his services, from potential incompetence. You’d have to be pretty confident in your abilities to build someone a house when your life is at stake. As a result, from the position of someone buying a house, you can rest assured that its builder did his best to make it safe for living. Albeit in an exaggerated form, that’s what skin-in-the-game symmetry is. What it does, as the Code of Hammurabi explicitly states, is it prevents the strong from oppressing the weak. Moreover, it fixes the problem of incentives better than thousands of laws and regulations. Finally, it also makes ethics less abstract. Regrettably, modern history is the story of substituting symmetry with asymmetry. As far as justice and fairness are concerned, we seem to know less than our ancestors.
“An eye for an eye, a tooth for a tooth” is the oldest and – if taken literally – most primitive formulation of skin-in-the-game symmetry. Not only can you find it in Ancient Babylon, as the underlying principle of the Code of Hammurabi, but you can also find it, word-for-word, in Exodus 21:24. In the Old Testament, you will find another similar phrase, a “sweetening of Hammurabi’s rule,” as described by Taleb. Although it is more famous today as Jesus’ second great commandment, “Love your neighbor as yourself” is actually derived from Leviticus 19:18, the third book of the Torah.
Nevertheless, there is a more developed expression of the “skin in the game” principle in the New Testament. It’s not just sweetening of Hammurabi’s Code, but its crystallization. “In everything,” says Jesus during his Sermon on the Mount (Matthew 7:12), “do to others what you would have them do to you, for this sums up the Law and the Prophets.” Known as the Golden Rule, this symmetrical principle is at least six centuries older than Christ and dates back to the Chinese concept of “shu.” “Is there any one rule that could guide a person throughout life?” asks Zu Gong his teacher, Confucius, in “Analects” 15:24. “Yes,” replies the Master. “How about ‘shu,’ the rule of reciprocity: ‘Do not treat others the way you would not like them to treat you.’”
Even at first glance, an important distinction is observable between Confucius and Christ. Namely, whereas Christ asks his followers to act by addition (via positive), Confucius asks them to act by removal (via negative). For Taleb, Confucius’ principle – which he names the Negative Golden Rule, or the Silver Rule for short – is far more robust and healthy. Why? First of all, because doing no harm to others, even if not better, is easier than doing them good. Secondly, because we know with much more clarity what is bad than what is good. Finally, because if everybody minded their own business instead of deciding what is “good” for others, everybody would be better off. In short, even if better in theory, Jesus’ Golden Rule is much more error-prone in practice than Confucius’ Silver Rule.
Unsurprisingly, it is the Silver Rule that made its way to the Hippocratic Oath, even though we’re talking about an oath of ethics taken by people whose very job is to help others – physicians. “Before doing any good,” advises Hippocrates, “first, do no harm.” For Taleb, a contemporary of Hippocrates named Isocrates embodied the skin-in-the-game principle better than anyone in history. “Conduct yourself toward your parents as you would have your children conduct themselves toward you,” he advised, in a rare dynamic version of the Golden Rule. Even there, however, the Silver Rule should work better: don’t treat your parents today the way you wouldn’t want your children to treat you tomorrow.
In the 18th century, German philosopher Immanuel Kant attempted to universalize the Golden Rule in an absolute, unconditional requirement. “Act only in accordance with that maxim through which you can at the same time will that it will become a universal law,” Kant wrote in what is known as the first formulation of his categorical imperative. In Taleb’s translation: “Behave as if your action can be generalized to the behavior of everyone in all places, under all conditions.” In practical terms, don’t lie, because if everybody lied, truth would stop existing. Just as well, don’t steal, because if everybody stole, you would end up being robbed.
The problem with Kant’s formulation is that, as much as it may sound great on paper, it is quite disastrous in practice. As Taleb writes, we need simple practical rules to behave properly, rules that focus on our immediate environment. Thinking in general and abstract terms, rather than making things better, makes things worse as it gives “self-righteous psychopaths” such as politicians and bankers the justification to enact seemingly sound policies which actually hide frightening asymmetries, and expose other people to risks while granting the policy makers the rewards. In simpler terms, what Kant didn’t get was that we are local and practical animals and that what seems good for the collective needn’t be good for the individual, and vice versa.
Modernity, however, didn’t go with Hammurabi and Confucius; even if merely by proxy, it went with Kant. Whether corrupt politicians or social justice warriors, bankers or professors, bureaucrats or investors, they all seem to prefer the abstract over the particular. By this means, they end up treating people as categories rather than individuals, often destroying the very group of persons they may have attempted to help. That’s the greatest danger of universalism, even if advocated by Kant: by transforming tangible local transactions into abstract macro-constructs, it either produces or misses central asymmetries that hurt individuals daily, and may one day cause a systemic blowup.
Consider the world of finance, as embodied in Robert Rubin, a former Secretary of the United States Treasury and the synonym for all that’s evil in the world in Taleb’s glossary. In the decade preceding the financial crash of 2008, Rubin collected more than $120 million in compensation and bonuses from Citibank, where he worked as a temporary chairman. He lost none of that money when the bank’s common stock dropped to well below $1 in November 2008, even though he was one of the main contributors to the downfall. To make matters worse, when the bank, literally insolvent, was rescued by the government using taxpayer’s money, Rubin didn’t write any check – he merely invoked uncertainty as an excuse. In Taleb’s words, “Heads he wins, tails he shouts ‘Black Swan’.”
The central objective of the Code of Hammurabi, and most ancient legal and philosophical systems, was to establish tangible symmetries between people in different transactions, so nobody could transfer hidden risks to innocuous individuals, Robert Rubin–style. Today, unfortunately, multifarious bureaucracies conveniently separate risk-takers from the consequences of their actions, thereby increasing large structural asymmetries. Harking back to Rubin and the world of finance, Taleb highlights the main issue of modern administration thus: “If bankers’ profits accrue to them, while their losses are somewhat quietly transferred to society, there is a fundamental problem by which hidden risks will continuously increase, until the final blowup.”
Before you say “well, that’s what regulations are for,” reconsider the problem of Kant’s universalism yet again. Namely, whereas – as individuals – we are great at understanding small and local arrangements, we are practically incapable of comprehending complex systems. Multidimensional problems cannot be boiled down to their single-dimensional representations for the same reason that multidimensional health cannot be stripped to a cholesterol reading. “Complex systems,” explains Taleb, “do not have obvious one-dimensional cause-and-effect mechanisms: under opacity, you do not mess with such a system.” Consequently, while regulations may appear to be a remedy on paper, they often exacerbate the problems they try to solve because they facilitate risk-hiding. Justice and fairness are the result of the opposite: making risks and rewards transparent.
Let’s go back to ancient times once again. In “On Duties,” Roman statesman and sceptic, Marcus Tullius Cicero, posits the following question: “If a man knowingly offers for sale wine that is spoiling, ought he to tell his customers?” Diogenes of Babylon thought that the seller is obligated to disclose only as much as civil law requires from him. Most people feel the same way today: whatever the law allows is allowed. That’s why there are things such as “stuffing” in the financial world, wherein traders “unload” securities they have in excess on unassuming clients by convincing them they are buying something that perfectly fits their portfolio. The tacit rule is that the buyer is responsible for their own learning, and that the seller is permitted to take advantage of what won’t visibly hurt the buyer, at least not in the short-term.
Unlike Diogenes, Stoic philosopher Antipater of Tarsus believed that everything ought to be disclosed, so that there was nothing that the seller knew that the buyer didn’t. Ethics, he assumed justly, must go beyond the law, since whereas laws come and go, morals stay. Taleb’s foremost ethical rule, as expressed in “Antifragile,” was, “Thou shalt not become antifragile at the expense of others.” We can now translate this rule into the language of “Skin in the Game”: “Thou shalt not transfer your own risks to others nor shall you take actions the risks of which you cannot take upon yourself.” It’s only fair that if someone else experiences loss due to your own slipups that you experience some loss yourself as well.
Understanding how the subparts of the brain work will probably never allow us to understand how the brain works as a whole. Case in point, even though scientists have sequenced the entire genome of the roundworm, and even though they have devised a comprehensive map of all of its neural connections, they still haven’t comprehended how its brain works, nor have they been able to reproduce it. The reason is simple: a collection of units rarely behaves like a sum of units. The group has a mind of its own, different from that of any of its members. You can’t understand the behavior of the market by understanding the behavior of its participants. Just as well, it’s not rare that a team of superstars loses a game of football to a team of above average players. “In complex systems,” remarks Taleb, “the interactions matter more than the nature of the units.”
There’s probably no better way to illustrate the accuracy of that statement than by describing “the minority rule, the mother of all asymmetries.” Consider the following. The kosher population represents less than 3% of the residents of the United States; yet, most American drinks are kosher. Just as well, 70% of lamb imports from New Zealand to the United Kingdom are halal, even though the practicing Muslim population in both of these countries is insignificant as a percentage of the whole. Whence the discrepancies? Simply put, because going full kosher or full halal is more convenient for producers, grocers and restaurants, for it allows them to not have to distinguish between drinks and meat with special markers or separate inventories. The simple rule that guides this logic can be stated as follows: “A kosher or halal eater will never eat nonkosher or nonhalal food, but a nonkosher eater isn’t banned from eating kosher.”
The minority rule explains not only how a small, intolerant segment of the population can inflict its preferences on the general population, but also why complex systems are best left undisturbed. A group of people – whom Taleb calls “intellectuals yet idiots” (IYIs) – can’t seem to grasp this simple idea and still believe that regulations, interventions, by-laws and condescending lectures can make the world a better place, despite all of them being founded in half-truths at best. The actual truth is that all of us know a lot less than we say – or even think – we do. Moreover, almost by design, we are much better at doing things than understanding them: you don’t need to be able to explain how a bicycle works to ride it. Yet, the world is increasingly populated by IYIs, people who are only good at explaining things, and nothing else.
“Those who can, do, and those who cannot, teach,” remarked Scottish playwright George Bernard Shaw a century ago. “Leave people alone under a good structure and they will take care of things,” adds Taleb, rather angrily.
“Skin in the Game” is probably not Nassim Nicholas Taleb’s best book (that would be “Antifragile,” in our opinion) but it may be his most provocative and practical one yet. Moreover, it is at least as enjoyably entertaining and counterintuitively insightful as Taleb’s previous bestsellers. Highly recommended.
There should always be some kind of symmetry between actions and consequences. Where there is none or little, there is also no skin in the game. And where there is no skin in the game, there is neither justice nor honor as well.
Nassim Nicholas Taleb is a Lebanese American author, former hedge fund manager, derivatives trader, and a scholar dealing with probability and uncertainty. He holds degrees in mathematical finance and worked as a researcher at... (Read more)
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