Skin in the Game: Hidden Asymmetries in Daily Life by Nassim Nicholas Taleb
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Do not mistake skin in the game as defined here and used in this book for just an incentive problem, just having a share of the benefits (as it is commonly understood in finance). No. It is about symmetry, more like having a share of the harm, paying a penalty if something goes wrong.
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For I just don’t like reading books that inform me of the obvious. I like to be surprised. So as a skin-in-the-game-style reciprocity, I will not not drive the reader into a dull college-lecture-type predictable journey, but rather into the type of adventure I’d like to have. Accordingly, the book is organized in the following manner. It doesn’t take more than about sixty pages for the reader to get the importance, prevalence, and ubiquity of skin in the game (that is, symmetry) in most of its aspects.
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To figure out why ethics, moral obligations, and skills cannot be easily separable in real life, consider the following. When you tell someone in a position of responsibility, say your bookkeeper, “I trust you,” do you mean that 1) you trust his ethics (he will not divert money to Panama), 2) you trust his accounting precision, or 3) both? The entire point of the book is that in the real world it is hard to disentangle ethics on one hand from knowledge and competence on the other.
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We retain from this first vignette that, just like Antaeus, you cannot separate knowledge from contact with the ground. Actually, you cannot separate anything from contact with the ground. And the contact with the real world is done via skin in the game—having an exposure to the real world, and paying a price for its consequences, good or bad.
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I have shown in Antifragile that most things that we believe were “invented” by universities were actually discovered by tinkering and later legitimized by some type of formalization. The knowledge we get by tinkering, via trial and error, experience, and the workings of time, in other words, contact with the earth, is vastly superior to that obtained through reasoning, something self-serving institutions have been very busy hiding from us.
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The first flaw is that they are incapable of thinking in second steps and unaware of the need for them—and about every peasant in Mongolia, every waiter in Madrid, and every car-service operator in San Francisco knows that real life happens to have second, third, fourth, nth steps. The second flaw is that they are also incapable of distinguishing between multidimensional problems and their single-dimensional representations—like multidimensional health and its stripped, cholesterol-reading reduction. They can’t get the idea that, empirically, complex systems do not have obvious one-dimensional cause-and-effect mechanisms, and that under opacity, you do not mess with such a system. An extension of this defect: they compare the actions of the “dictator” to those of the prime minister of Norway or Sweden, not to those of the local alternative. The third flaw is that they can’t forecast the evolution of those one helps by attacking, or the magnification one gets from feedback.
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The principle of intervention, like that of healers, is first do no harm (primum non nocere); even more, we will argue, those who don’t take risks should never be involved in making decisions.
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And the last Byzantine emperor, Constantine XI Palaeologus, was last seen when he removed his purple toga, then joined Ioannis Dalmatus and his cousin Theophilus Palaeologus to charge Turkish troops with their swords above their heads, proudly facing certain death. Yet legend has it that Constantine had been offered a deal in the event of a surrender. Such deals are not for self-respecting kings. These are not isolated anecdotes. The statistical reasoner in this author is quite convinced: less than a third of Roman emperors died in their beds—and one can argue that given that only few of these died of really old age, had they lived longer, they would have fallen either to a coup or in battle. Even today, monarchs derive their legitimacy from a social contract that requires physical risk-taking. The British Royal family made sure that one of its scions, Prince Andrew, took more risks than “commoners” during the Falkland war of 1982, his helicopter being in the front line. Why? Because noblesse oblige; the very status of a lord has been traditionally derived from protecting others, trading personal risk for prominence—and they happened to still remember that contract. You can’t be a lord if you aren’t a lord.
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Some think that freeing ourselves from having warriors at the top means civilization and progress. It does not. Meanwhile, Bureaucracy is a construction by which a person is conveniently separated from the consequences of his or her actions. And, one may ask, what can we do since a centralized system will necessarily need people who are not directly exposed to the cost of errors? Well, we have no choice but to decentralize or, more politely, to localize; to have fewer of these immune decision makers. Decentralization is based on the simple notion that it is easier to macrobull***t than microbull***t. Decentralization reduces large structural asymmetries.
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For instance, bank blowups came in 2008 because of the accumulation of hidden and asymmetric risks in the system: bankers, master risk transferors, could make steady money from a certain class of concealed explosive risks, use academic risk models that don’t work except on paper (because academics know practically nothing about risk), then invoke uncertainty after a blowup (that same unseen and unforecastable Black Swan and that same very, very stubborn author), and keep past income—what I have called the Bob Rubin trade. The Bob Rubin trade? Robert Rubin, a former Secretary of the United States Treasury, one of those who sign their names on the banknote you just used to pay for coffee, collected more than $120 million in compensation from Citibank in the decade preceding…
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But the worst casualty has been free markets, as the public, already prone to hating financiers, started conflating free markets and higher order forms of corruption and cronyism, when in fact it is the exact opposite: it is government, not markets,…
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Now, if you are going to highlight only one single section from this book, here is the one. The interventionista case is central to our story because it shows how absence of skin in the game has both ethical and epistemological effects (i.e., related to knowledge). We saw that interventionistas don’t learn because they are not the victims of their mistakes, and, as we hinted at with pathemata mathemata: The same mechanism of transferring risk also impedes learning. More practically, You will never fully convince someone that he is wrong; only reality can.
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In biology, learning is something that, through the filter of intergenerational selection, gets imprinted at the cellular level—skin in the game, I insist, is more filter than deterrence. Evolution can only happen if risk of extinction is present. Further, There is no evolution without skin in the game.
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Via negativa: the principle that we know what is wrong with more clarity than what is right, and that knowledge grows by subtraction.
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The more robust Silver Rule says Do not treat others the way you would not like them to treat you.
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Likewise the crux of the idea of The Black Swan was Platonification, missing central but hidden elements of a thing in the process of transforming it into an abstract construct, then causing a blowup.
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Avoid taking advice from someone who gives advice for a living, unless there is a penalty for their advice.
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The agency problem (or principal-agent problem) also manifests itself in the misalignment of interests in transactions: a vendor in a one-shot transaction does not have his interests aligned to yours—and so can hide stuff from you.
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Our message is to focus on those who are professionally slanted, causing harm without being accountable for it, by the very structure of their own occupation. For the professionally asymmetric person is rare and has been so in history, and even in the present. He causes a lot of problems, but he is rare. For most people you run into in real life—bakers, cobblers, plumbers, taxi drivers, accountants, tax advisors, garbage collectors, dental cleaning assistants, carwash operators (not counting Spanish grammar specialists)—pay a price for their mistakes.
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cup. The designer (who either doesn’t ride trains or rides trains but doesn’t drink coffee while reading), thinking it is an aesthetic improvement, made the ledge slightly tilted, so it is impossible to put the cup on it. This explains the more severe problems of landscaping and architecture: architects today build to impress other architects, and we end up with strange—irreversible—structures that do not satisfy the well-being of their residents; it takes time and a lot of progressive tinkering for that.
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Specialization, as I will keep insisting, comes with side effects, one of which is separating labor from the fruits of labor.
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Things designed by people without skin in the game tend to grow in complication (before their final collapse). There is absolutely no benefit for someone in such a position to propose something simple: when you are rewarded for perception, not results, you need to show sophistication. Anyone who has submitted a “scholarly” paper to a journal knows that you usually raise the odds of acceptance by making it more complicated than necessary.
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Let us return to pathemata mathemata (learning through pain) and consider its reverse: learning through thrills and pleasure. People have two brains, one when there is skin in the game, one when there is none. Skin in the game can make boring things less boring. When you have skin in the game, dull things like checking the safety of the aircraft because you may be forced to be a passenger in it cease to be boring. If you are an investor in a company, doing ultra-boring things like reading the footnotes of a financial statement (where the real information is to be found) becomes, well, almost not boring. But there is an even more vital dimension. Many addicts who normally have a dull intellect and the mental nimbleness of a cauliflower—or a foreign policy expert—are capable of the most ingenious tricks to procure their drugs. When they undergo rehab, they are often told that should they spend half the mental energy trying to make money as they did procuring drugs, they are guaranteed to become millionaires. But, to no avail. Without the addiction, their miraculous powers go away. It was like a magical potion that gave remarkable powers to those seeking it, but not those drinking it.
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A confession. When I don’t have skin in the game, I am usually dumb. My knowledge of technical matters, such as risk and probability, did not initially come from books. It did not come from lofty philosophizing and scientific hunger. It did not even come from curiosity. It came from the thrills and hormonal flush one gets while taking risks in the markets. I never thought mathematics was something interesting to me until, when I was at Wharton, a friend told me about the financial options I described earlier (and their generalization, complex derivatives).
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When there was risk on the line, suddenly a second brain in me manifested itself, and the probabilities of intricate sequences became suddenly effortless to analyze and map. When there is fire, you will run faster than in any competition. When you ski downhill some movements become effortless. Then I became dumb again when there was no real action.
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But if you muster the strength to weight-lift a car to save a child, above your current abilities, the strength gained will stay after things calm down. So, unlike the drug addict who loses his resourcefulness, what you learn from the intensity and the focus you had when under the influence of risk stays with you. You may lose the sharpness, but nobody can take away what you’ve learned. This is the principal reason I am now fighting the conventional educational system, made by dweebs for dweebs. Many kids would learn to love mathematics if they had some investment in it, and, more crucially, they would build an instinct to spot its misapplications.
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More critically, people with good lawyers can game regulations (or, as we will see, make it known that they hire former regulators, and overpay for them, which signals a prospective bribe to those currently in office).
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The other solution is to put skin in the game in transactions, in the form of legal liability, and the possibility of an efficient lawsuit. The Anglo-Saxon world has traditionally had a predilection for the legal approach instead of the regulatory one: if you harm me, I can sue you.
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Anything you do to optimize your work, cut some corners, or squeeze more “efficiency” out of it (and out of your life) will eventually make you dislike it. Artisans have their soul in the game. Primo, artisans do things for existential reasons first, financial and commercial ones later. Their decision making is never fully financial, but it remains financial. Secundo, they have some type of “art” in their profession; they stay away from most aspects of industrialization; they combine art and business. Tertio, they put some soul in their work: they would not sell something defective or even of compromised quality because it hurts their pride. Finally, they have sacred taboos, things they would not do even if it markedly increased profitability. Compendiaria res improbitas, virtusque tarda—the villainous takes the short road, virtue the longer one. In other words, cutting corners is dishonest.
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For instance, in the early 2000s, the writer Fay Weldon was paid by the jewelry chain Bulgari to advertise their brand by weaving recommendations for their great products into the plot of her novel. A nightmare ensued; there was a generalized feeling of disgust on the part of the literary community.
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Now, something very practical. One of the best pieces of advice I have ever received was the recommendation by a very successful (and happy) older entrepreneur, Yossi Vardi, to have no assistant. The mere presence of an assistant suspends your natural filtering—and its absence forces you to do only things you enjoy, and progressively steer your life that way. (By assistant here I exclude someone hired for a specific task, such as grading papers, helping with accounting, or watering plants; just some guardian angel overseeing all your activities). This is a via negativa approach: you want maximal free time, not maximal activity, and you can assess your own “success” according to such metric. Otherwise, you end up assisting your assistants, or being forced to “explain” how to do things, which requires more mental effort than doing the thing itself. In fact, beyond my writing and research life, this has proved to be great financial advice as I am freer, more nimble, and have a very high benchmark for doing something, while my peers have their days filled with unnecessary “meetings” and unnecessary correspondence.
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Having an assistant (except for the strictly necessary) removes your soul from the game. Think of the effect of using a handheld translator on your next trip to Mexico in place of acquiring a robust vocabulary in Spanish by contact with locals. Assistance moves you one step away from authenticity.
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Companies beyond the entrepreneur stage start to rot. One of the reasons corporations have the mortality of cancer patients is the assignment of time-defined duties. Once you change assignment—or, better, company—you can now say about the deep Bob Rubin–style risks that emerge: “It’s not my problem anymore.” The same happens when you sell out, so remember that: The skills at making things diverge from those at selling things.
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Eponymy indicates both a commitment to the company and a confidence in the product. A friend of mine, Paul Wilmott, is often called an egomaniac for having his name on a mathematical finance technical journal (Wilmott), which at the time of writing is undoubtedly the best. “Egomaniac” is good for the product. But if you can’t get “egomaniac,” “arrogant” will do.
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By some mysterious mental mechanism, people fail to realize that the principal thing you can learn from a professor is how to be a professor—and the chief thing you can learn from, say, a life coach or inspirational speaker is how to become a life coach or inspirational speaker. So remember that the heroes of history were not classicists and library rats, those people who live vicariously in their texts. They were people of deeds and had to be endowed with the spirit of risk taking. To get into their psyches, you will need someone other than a career professor teaching stoicism.
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Simply: if you can’t put your soul into something, give it up and leave that stuff to someone else.
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It felt like cheating not knowing the ancient text the way it was read and recited at the time. In addition, one of my episodic hobbies is Semitic philology, so I had no excuse. So I have been distracted by an obsession to learn enough Akkadian in order to recite Hammurabi’s law with Semitic phonetics, sort of having some soul in the game. It may have delayed the completion of this book, but, at least, when I mention Hammurabi, my conscience doesn’t make me feel I am faking anything.
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What I didn’t forecast is that my dream of a tranquil life lasted only a few weeks. For I exhibited no skills whatsoever in retirement activities such as contract bridge, chess, lotto, visits to the pyramids in Mexico, etc. I once, by happenstance, tried to solve a mathematical brain teaser, and it lead to five years of compulsive, time-invasive mathematical practice, with the obsessive bouts that plague people inhabited with problems.
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Seeing the psychologist Steven Pinker making pronouncements about things intellectual has a similar effect to encountering a drive-in Burger King while hiking in the middle of a national park.
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Beware of the person who gives advice, telling you that a certain action on your part is “good for you” while it is also good for him, while the harm to you doesn’t directly affect him.
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As a trader, you learn to identify and deal with upright people, those who inform you that they have something to sell, by explaining that the transaction arises for their own benefit, with such questions as “Do you have an ax?” (meaning an inquiry whether you have a certain interest). Avoid at all costs those who call you to tout a certain product disguised with advice. In fact the story of the turtle is the archetype of the history of transactions between mortals.
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The ethical is always more robust than the legal. Over time, it is the legal that should converge to the ethical, never the reverse.
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Simply, as the aim is for both parties in a transaction to have the same uncertainty facing random outcomes, an asymmetry becomes equivalent to theft. Or more robustly: No person in a transaction should have certainty about the outcome while the other one has uncertainty. Gharar,
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And that is what plagues socialism: people’s individual interests do not quite work well under collectivism. But it is a critical mistake to think that people can function only under a private property system. What Ostrom found empirically is that there exists a certain community size below which people act as collectivists, protecting the commons, as if the entire unit became rational. Such a commons cannot be too large. It is like a club. Groups behave differently at a different scale.
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We removed the skin in the game of journalists in order to prevent market manipulation, thinking that it would be a net gain to society. The arguments in this book are that the former (market manipulation) and conflicts of interest are more benign than impunity for bad advice. The main reason, we will see, is that in the absence of skin in the game, journalists will imitate, to be safe, the opinion of other journalists, thus creating monoculture and collective mirages.
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In sum, both the doctor and the patient have skin in the game, though not perfectly, but administrators don’t—and they seem to be the cause of the troubling malfunctioning of the system. Administrators everywhere on the planet, in all businesses and pursuits, and at all times in history, have been the plague.
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In promoting genetically modified food via all manner of lobbying, purchasing of congressmen, and overt scientific propaganda (with smear campaigns against such persons as yours truly, much about which later), big agricultural companies foolishly believed that all they needed was to win the majority. No, you idiots. Your snap “scientific” judgment is too naive for these types of decisions. Consider that transgenic-GMO eaters will eat non-GMOs, but not the reverse.
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why some fast-food chains, such as McDonald’s, thrive. It’s not because they offer a great product, but because they are not vetoed in a certain socio-economic group—and by a small proportion of people in that group at that.
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In the rivalry between the two languages, English won as commerce grew to dominate modern life; the victory has nothing to do with the prestige of France or the efforts of their civil servants in promoting their more or less beautiful Latinized and logically spelled language over the orthographically confusing one of trans-Channel meat-pie eaters.
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But things work both ways, the good and the bad. While some believe that the average Pole was complicit in the liquidation of Jews, the historian Peter Fritzsche, when asked, “Why didn’t the Poles in Warsaw help their Jewish neighbors more?,” responded that they generally did. But it took seven or eight Poles to help one Jew. It took only one Pole, acting as an informer, to turn in a dozen Jews. Even if such select anti-Semitism is contestable, we can easily imagine bad outcomes stemming from a minority of bad agents.
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Outcomes are paradoxically more stable under the minority rule—the variance of the results is lower and the rule is more likely to emerge independently across separate populations. What emerges from the minority rule is more likely to be black-and-white, binary rules.
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Can democracy—by definition the majority—tolerate enemies? The question is as follows: “Would you agree to deny the freedom of speech to every political party that has in its charter the banning of freedom of speech?” Let’s go one step further: “Should a society that has elected to be tolerant be intolerant about intolerance?”
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So we summarize this chapter and link it to hidden asymmetries, the subtitle of the book. Society doesn’t evolve by consensus, voting, majority, committees, verbose meetings, academic conferences, tea and cucumber sandwiches, or polling; only a few people suffice to disproportionately move the needle. All one needs is an asymmetric rule somewhere—and someone with soul in the game. And asymmetry is present in about everything.
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Understanding the genetic makeup of a unit will never allow us to understand the behavior of the unit itself. A reminder that what I am writing here isn’t an opinion. It is a straightforward mathematical property. The mean-field approach is when one uses the average interaction between, say, two people, and generalizes to the group—it is only possible if there are no asymmetries.
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In short, every organization wants a certain number of people associated with it to be deprived of a certain share of their freedom. How do you own these people? First, by conditioning and psychological manipulation; second, by tweaking them to have some skin in the game, forcing them to have something significant to lose if they disobey authority—something hard to do with gyrovague beggars who flout their scorn for material possessions.
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But employees are expensive. You have to pay them even when you’ve got nothing for them to do. You lose your flexibility. Talent for talent, they cost a lot more. Lovers of paychecks are lazy…but they would never let you down at times like these. So employees exist because they have significant skin in the game—and the risk is shared with them, enough risk for it to be a deterrent and a penalty for acts of undependability, such as failing to show up on time. You are buying dependability.