Nassim Taleb, author of â€œThe Black Swanâ€; gives us another example of how to predict. His strategy is to predict eventualities that are possible only remotely, yet are highly consequential. This is also called the Chicken Little Strategy – ‘the sky is falling’. Like global warming.
Models and agents argues this approach (like anthropogenic global warming), is largely disengenuous. Like climate change, the current economic crisis is not a black swan. The worldâ€™s economic history has suffered numerous credit and banking crises. Not only are credit crises predictable; they can be a no-brainer if they involve extending huge loans to people with no income, no jobs and no assets.
Taleb, like Prof. Garnaut, also recommends that we buy insurance against black swansâ€”that is, investments with a tremendous (though still highly remote) upside but limited downside. For example, you could buy insurance against global warming by converting coal-fired electricity plants to solar, and look good if it happens. Only if global warming is catastrophic, everyone suffers the same fate.
I think models and agents gets it right. Ultimately, the problem lies in our failure to use our brain. Only â€œusing our brainâ€ does not mean taking out dubious insurance. It means identifying strategies that are diversified, productive and viable, improve our quality of life and create jobs. It also means testing our models, and overriding them when they fail. The big problems you find in academia are:
1) People often grossly exaggerate confidence in models, usually because they take their assumptions literally. they act as though the model is exactly reality.
2) Academia is so specialized, one may understand his narrow area well, but little else.
3) Intuition and high level thinking is grossly under-rewarded.