Our weekly explainer on economics using lessons from popular culture. In Installment 37, The Titanic sinks as economics rises.
There’s a lot of economics to be learnt from the 1997 Oscar-winning movie Titanic, a film about the grandest ship of its time crashing into an iceberg and drowning 1500 of its passengers. And no, I’m not talking just about sunk costs.
The sinking of the Titanic on its maiden voyage was caused by a deadly cocktail of engineering shortcomings and human error. It was a disaster of gigantic proportions that no one could have possibly predicted. The finance professional-turned-writer Nassim Nicholas Taleb calls such occurrences ‘Black Swan’ events.
Taleb, often contemptuous yet crisp in his writing, points out that managers and planners tend to underestimate and neglect the potentially devastating calamities that can occur as the result of highly improbable events until they finally do occur. In The Black Swan: The Impact of the Highly Improbable, he lays down the definition of a black swan. Taleb defines it as “an event with the following three attributes”:
1. It is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility.
2. It carries an extreme impact.
3. In spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.
Black Swan theory states that the occurrence of these events does not make it easier to compute the probability of other rare events using scientific methods, due to the very nature of small probabilities. This happens due to the innate psychological biases that blind us, both individually and collectively, thus leading to uncertainty and Black Swan events.
Our brains are programmed to make general assumptions from past experiences. But in reality, a black swan event can occur after a whole life of witnessing only white ones. Therefore it might help in humbly admitting the fact that we know quite little, and that there are often faults in our reasoning making it impossible to predict black swan events, but giving us a chance to be more prepared for them.
The black swan is a metaphor for not only the limits of our knowledge but also more significantly our baseless confidence in our knowledge. Freidrich Hayek in his essay ‘Pretence of Knowledge’ made a similar claim about markets:
The study of such complex phenomena as the market, which depend on the actions of many individuals, all the circumstances which will determine the outcome of a process will hardly ever be fully known or measurable.
It is no surprise then that in The Black Swan, there is a section titled, ‘They Still Ignore Hayek,’ in which Taleb lauds the Austrian’s focus on the pretence of knowledge.
Taleb makes a case that most scientific discoveries, historical episodes and artistic achievements are “black swans”, not directed or predicted in any manner. He also cites the advent of the Internet, the invention of the personal computer, the disintegration of the Soviet Union, and the 9/11 attacks as examples of black swan events.
So the next time you meet an economist at a dinner party, mention the link between The Titanic and Black Swan events. I assure you that it will be a worthy ice-breaker.