The Brexit vote in the UK is an epic watershed event, of course, upending 40 years of settled expectations about the shape and direction of the international system. But it’s time to keep calm.
The violence of the market reaction today is partly because of misplaced predictions that the vote would be to remain, as investors had to cover their positions. At one point late yesterday financial markets had it at 80% chance that the UK would still be in the EU today. Expensive private polls conducted by financial institutions also reportedly indicated a remain vote.
As ever, excessive confidence in expert ability to predict political and economic events is foolish, and made people much more vulnerable to damage.
But that also means it’s time to be skeptical about the usefulness of the endless amounts of analysis and prognostications that the media and banks will now publish in the next week or two. Most of the pundits didn’t understand what was going on before and they don’t understand now. Yes, there are likely to be negative economic consequences, especially for the UK economy. Yes, the legitimacy of the EU and the international legal framework has been damaged. But people also adapt and find ways to mitigate the impact of change. It will take time for the full consequences to work themselves out. So it’s time for some patience and moderation.
It’s often the side-effects of decisions, mostly overlooked at the time, which turn out to be most significant. Polls are showing a significant lead for Brexit this morning, which would be one of the biggest geopolitical shocks of the decade. Of course, trusting polls has been a bad idea in recent times, and there are many who think the UK will draw back at the last moment. But let’s say there is at least some chance Britain may exit. How did this happen? It’s a chain of side-effects.
In October 1973, Syria and Egypt launched a surprise attack against Israel. The US supplied arms to Israel to defend itself.
One side-effect was an oil embargo by Arab oil producers against Western countries, which led to the first oil shock and a quadrupling in the price of oil. That naturally led to a huge transfer of wealth to the oil producers, including Saudi Arabia.
One side-effect was a huge increase in the influence and power of the Saudis, one of the most backward and retrogressive parts of the Islamic world, with “kings” allied to perhaps the most puritanical, backward religious sect in all of Islam. It as if in the United States Bo and Luke Duke suddenly become multibillionaire monarchs, kept in power by paying billions to the Ku Klux Klan every year.
One side-effect was many billions of dollars were paid by the Saudis to promote the least tolerant, most aggressive forms of Islam all around the world.
One side-effect was the rise of Islamic terrorism, like (Saudi) Osama Bin Laden, who attacked American targets culminating in 9/11.
A side-effect of 9/11 was the US attacked Iraq, a secular dictatorship which had not been directly involved in the strike on the US. The US won a decisive victory and overthrew Saddam Hussein much faster and with fewer losses than detractors forecast. Overconfident US officials removed Ba’ath party officials from the Iraqi government and Sunnis feared they would lose their traditional dominance of the country.
One side-effect was Iraq was destabilized and slid into a civil war that trapped the US for a decade, costing thousands of US military casualties and several trillion dollars which had not been anticipated.
One side-effect was the US public became wholly averse to more boots-on-the-ground in the Middle East. Another side-effect was the turmoil in Iraq eventually spread to Syria. But public resistance meant the US refused to commit military forces, as did the UK and other EU countries.
One side effect was a breakdown in Syria, and a huge wave of refugees that headed towards Europe. Angela Merkel believed setting no limits on refugee numbers was a moral choice, and over a million refugees flooded into Germany.
One side-effect was that European public opinion became agitated and alarmed about the migrant influx, which appears to many to be accelerated by the EU’s open borders under the Schengen agreement. Populists who had already made advances over the previous decade suddenly benefitted from a new resurgence of public support. Meanwhile, Merkel dealt with concerns about Syrian migration by promising visa-free entry to Europe to Turks. It appeared to many that she and the EU had lost control of borders.
One side-effect was that immigration began to dominate over economic consequences in the UK Brexit debate, a focus that boosted the “Leave” side in the final weeks before the vote. The British, already dealing with heavy migration from within the EU, feared they could not control their borders.
So a “leave” vote in Britain is now possible, partly caused by a civil war thousands of miles away in Damascus and Egyptian attacks on the Sinai forty years ago.
And one side effect may be similar referendums in other countries and a partial break up of the EU itself. In retrospect it is possible that Merkel’s decision to admit refugees without limit may have as a side-effect unintentionally wrecked seven decades of German promotion of EU integration.
Of course, you can dispute the exact causation and many other factors were involved too. You could easily construct other chains of unintended side-effects and argue it different ways, and it’s partially a game. The point, however, is that direct choices and intentions and calculations are only a small part of what happens in the international economy and international affairs. It’s often the side-effects that matter most. Chains of cause and consequence quickly get too involved and intricate for anyone to figure out, often even in retrospect let alone predicting the future.
I’ve often argued overconfident prediction is usually a sign of self-delusion. In fact, it’s often the things that don’t even occur to us to predict that matter most, not even just the things we recognize we get wrong.
So it’s not your models or forecasts or ideologies that matter. Instead, it is being on the lookout for side-effects and unintended consequences, especially those you’d prefer not to see at all. If you see them, you can at least try to do something about them. Instead, most elites blunder forward blindly, clinging to their preferred model and plans.
One interesting thing about markets (and politics and foreign policy) is that predictions from gurus and self-important experts have a remarkable tendency to turn out wrong. Take this Bloomberg report:
Goldman Sachs to clients: whoops. Just six weeks into 2016, the New York-based bank has abandoned five of six recommended top trades for the year.
The dollar versus a basket of euro and yen; yields on Italian bonds versus their German counterparts; U.S. inflation expectations: Goldman Sachs Group Inc. was wrong on all that and more.
In fact, the best investors tend not to show significantly better predictive ability than anyone else either. The brutal truth is no-one is reliably good at predicting short-term market movements, although smarter players are more alert to some of the potential mistakes in their perspective.
Instead, they’re mainly better at changing their mind quickly – cutting their losses and getting out of positions that move against them. They manage their risks and survive to fight another day. They figure out when they are wrong faster.
They don’t make huge overconfident predictions. Instead, they watch their exposure, as Nicholas Nassim Taleb argues.
Of course, it’s unlikely that Goldman was putting its own money behind these predictions to the bitter end. The successful traders at investment banks historically don’t pay much attention to their own economists and research in any case. As they see it, the research is really for the pension fund managers in Cleveland or Edinburgh. And press reporting of market swings is the lowest “dumb money” tier of all – something to bear in mind when the markets are scary like today.
“What went wrong?” is the underlying question in David Frum’s much-talked about piece in the Atlantic on the “Republican Revolt”. How could an establishment candidate like Jeb Bush, who was expected to be almost irresistible and has raised more than $100 million now be running at 3-4% in the polls? How can the GOP primary race have been hijacked by a reality TV star at the expense of experienced Governors and Senators?
Let’s leave aside the betting on who will finally get the nomination, or how good or bad Trump is, as most of the media focuses on little else and most journalistic speculation is essentially useless. To be sure, despite his consistent lead, the Donald may not be inevitable as the field thins out and the ‘ground game’ of turnout becomes important.
It’s just that as of now, some of the most powerful, elite and supposedly expert people in US politics look like losers. This is really not where they want to be.
So let’s coolly step back and look at the pattern. How could the establishment miscalculate so badly? What does this tell us about why decisions go wrong? Could other elites have the same problem?
In a nutshell, people refused to see contrary evidence.
Many establishment policies were not popular with the GOP base, Frum says. Less than 17% favored cuts in social security, for example. Most wanted more deportations of illegal immigrants, the exact opposite of a pathway to citizenship.
As a class, big Republican donors could not see any of this, or would not. So neither did the politicians who depend upon them. Against all evidence, both groups interpreted the Tea Party as a mass movement in favor of the agenda of the Wall Street Journal editorial page. One of the more dangerous pleasures of great wealth is that you never have to hear anyone tell you that you are completely wrong.
They could not see things that did not fit in their frame. They could not learn from errors or defeats. The establishment had been shocked at Romney’s loss in 2012, for example.
And yet, within hours of Romney’s defeat, Republican donors, talkers, and officials converged on the maximally self-exculpating explanation.
That meant Republican leaders decided the problem was Romney’s talk about more immigration enforcement alienating Latinos, the very issue where the establishment differed most with their base and where hard evidence of votes to be gained in the center was (Frum says) mostly lacking.
Otherwise, the party yielded on nothing and doubled down on everything. No U-turns. No compromises.
Instead of adjusting to minimize or forestall the chance of a revolt, or finding a smart alternative way forward, the leadership interpreted things in self-serving terms and escalated.
This, of course, is a problem that is extremely widespread and not confined to the GOP. We saw exactly the same thing on all sides in the last midterm elections.
Perhaps the establishment will be able to adapt now that their problem is (you would think) undeniable and it is darkest before dawn for them. Or they can double down again. But serious damage has been done, and some ground rules of US politics – like the importance of raising money – have been rewritten.
Here’s the takeaway. Once again we see in this example that the fundamental problem with decisions is not really bias, or lack of formal rigor, or failure to gather data. It’s that people most often don’t change their mind in response to evidence. Or they fail to adapt until so late in the game that all the choices are bad. That’s what we need to fix, and would save countless billions of dollars and tens of thousands of companies and careers.
The most brilliant investors intuitively realize this. But as this incident demonstrates, most leaders and managers and policymakers do not. They are surrounded by yes-men. They stick with the familiar. They are clever enough to explain away facts which do not fit their narrative.
People get stuck, and persist too long in self-delusion. They fail to adapt and move when they still have the chance. If you can mitigate that, you can do more than most crystal balls could ever do. After all, if the only thing you see in a crystal ball is your own wishful thinking, what good is it?
There’s another problem. Major conflicts are often not about particular immediate interests or ideology, but about legitimacy, the acceptability of the ground rules of the game. Europe tore itself apart repeatedly for centuries over things like the divine right of kings or national “aspirations”. Indeed, it’s possible to tell the story of “epochal wars” over the last six centuries as fundamentally about issues of what the nature of the state and the grounds of its legitimacy ought to be, and what state and people owe each other. It also turns out the resolution of one problem or challenge tends to lay the seeds of the next major conflict.
I looked at how Volkswagen could go so wrong the other day. There is almost always a rush to blame human error or subordinates, I said. Some of them may be genuinely criminal and deserve jail time. But the problem is more usually also systemic: management doesn't see or want to see problems coming.
Now here's a piece in Harvard Business Review on the issue. Of course, it was rogue employees, says Volkswagen management.
Testifying unhappily before America’s Congress, Volkswagen of America CEO Michael Horn adamantly and defiantly identified the true authors of his company’s disastrous “defeat device” deception: “This was not a corporate decision. No board meeting or supervisory meeting has authorized this,” Horn declared. “This was a couple of rogue software engineers who put this in for whatever reason.”
Ach, du lieber! Put aside for the moment what this testimony implies about the auto giant’s purported culture of engineering excellence. Look instead at what’s revealed about Wolfsburg’s managerial oversight: utter and abysmal failure. No wonder Chairman and CEO Martin Winterkorn had to resign. His “tone at the top” let roguery take root.
The author is an MIT expert on the software processes at issue.
Always look to the leadership. Where were Volkswagen’s code reviews? Who took pride and ownership in the code that makes Volkswagen and Audi cars run? For digitally-driven innovators, code reviews are integral to healthy software cultures and quality software development.
Good code is integral to how cars work now, he says. And to write good code the Googles and Facebooks of the world have code review systems with some form of openness, even external advice or review, so that murky code is found out.
As we learned from financial fiascoes and what will be affirmed as Volkswagen’s software saga unwinds, rogues don’t exist in spite of top management oversight, they succeed because of top management oversight.
It can be comforting , in a way, to think that problems or bad decisions occur only because of individual stupidity or bias or error or ignorance. If people, and organizations as a whole don't even consciously see many problems coming, or ignore trade-offs, it's more disturbing and harder to solve. Most information and analysis will tend to reinforce their point of view. Single-minded mania also often produces short-run financial success.
Until the darkness comes. Leaders have to be held accountable for finding their blind spots. They can't claim ignorance after the fact.
It may turn into one of the most spectacular corporate disasters in history. What were Volkswagen thinking? Even after it became apparent that outsiders had noticed a discrepancy in emissions performance in on-the-road tests, the company still kept stonewalling and continued to sell cars with the shady software routines.
We won't know the murky, pathological details for a while. But understanding how this happens is urgent. If you ignore this kind of insidious problem, billion-dollar losses and criminal prosecutions can occur.
In fact, it's usually not just one or two “bad apples,” unethical criminals who actively choose stupid courses of action, although it often suits politicians and media to believe so. It's a system phenomenon, according to some of the classic studies (often Scandanavian) like Rasmussen and Svedung.
.. court reports from several accidents such as Bhopal, Flixborough, Zeebrügge, and Chernobyl demonstrate that they have not been caused by a coincidence of independent failures and human errors. They were the effects of a systematic migration of organizational behavior toward accident under the inﬂuence of pressure toward cost-effectiveness in an aggressive, competitive environment.
It's not likely anyone formally sat down and did an expected utility calculation, weighting financial and other benefits from installing cheat software, versus chances of being found out times consequent losses. So the usual way of thinking formally about decisions doesn't easily apply.
It's much more likely that it didn't occur to anyone in the company to step back and think it through. They didn't see the full dimensions of the problem. They denied there was a problem. They had blind spots.
It can often be hard to even find any point at which decisions were formally made. They just … happen. Rasmussen & co again:
In traditional decision research ‘decisions’ have been perceived as discrete processes that can be separated from the context and studied as an isolated phenomenon. However, in a familiar work environment actors are immersed in the work context for extended periods; they know by heart the normal ﬂow of activities and the action alternatives available. During familiar situations, therefore, knowledge-based, analytical reasoning and planning are replaced by a simple skill- and rule-based choice among familiar action alternatives, that is, on practice and know-how.
Instead, the problem is likely to be a combination of the following:
There scarcely seems to be a profession or industry or country without problems like this. The Pope was just in New York apologizing for years of Church neglect of the child abuse problem, for example.
But that does not mean that people are not culpable and accountable and liable for things they should have seen and dealt with. Nor is it confined to ethics or regulation. It is also a matter of seeing opportunity. You should see things. But how? That's what I'm interested in.
It's essential for organizational survival to confront these problems of misperceptions and myopia. They're system problems. And they are everywhere. Who blows up next?
Jeremy Corbyn just won the most sweeping party leadership victory in British political history, beating his nearest rival by a margin of 40%. Tom Clark, in the Guardian:
At the beginning let it be said that we commentators and media pundits deserve the first slice of humble pie. None of us saw this coming. Spending too much time, perhaps, talking to professional politicians and to each other, we missed the anger and the desperation for change which we now know was pulsating through the broader Labour community out in the country after May’s unexpected outright Conservative win.
They talked to all the obvious people. They spent hours with multiple primary sources. They failed completely to see the most decisive win ever coming.
Or take this: Andrew Marr, in the Spectator;
This is the Corbyn summer. From the perspective of a short holiday, my overwhelming feeling is one of despair at my own semi-trade — the political commentariat, the natterati, the salaried yacketting classes. Who among us, really, predicted that Jeremy Corbyn would romp ahead like this? Where were the post-election columns pointing out that David Cameron’s victory would lead to a resurgent quasi-Marxist left?
And that’s just the beginning: how many of the well-connected, sophisticated, numerate political writers expected Labour to be slaughtered in the general election? Not me, that’s for sure. Going further back, how many people in 1992 told us John Major was an election winner? That Parris, I vaguely recall, but anyone else?
What do we take from this? At least they have the integrity and honesty to admit they were wrong, which is surprisingly rare. People mostly make excuses or change the subject.
What it shows (again) Is the whole idea of prediction in complex fields like politics or markets is broken, as I keep arguing. The betting odds when the contest opened was 200:1 against Corbyn.
Of course, if you put money on him them you’d be rich, just as if you found El Dorado you’d be rich. But the record is no one can actually do that consistently. El Dorado, the city of gold waiting for conquest, is a wonderful idea: apart from the minor inconvenience it does not exist.
So you need a better way, an alternative to making overconfident predictions that blow up just when things are changing and you are most vulnerable. Instead of prediction, you need agility, and leverage, and resilience. And it’s overreliance on journalism and punditry and theory which stops you being agile.
People fall in love with their predictions, and it blinds them to what they can do to position themselves. They need to find blind spots, not prophecies.
So how did the predictions from polls and pundits and consultants do on Greece so far? I’ve been arguing that people shouldn’t put so much faith in prediction, but look for potential errors and blind spots. The key is to look for leverage and resilience, not get trapped into vain prophecy when you can be doing something to adapt to the situation instead.
But is that justified by the latest events?
Unsurprisingly, the latest predictions are yet another tale of epic illusion and incompetence, on the evidence which Nate Silver examines here. The polls were bad:
Coming on the heels of the U.K. general election, the Israeli general election, the Scottish referendum and the U.S. midterms, Sunday’s Greek referendum looks like the latest in a series of bad outcomes for pre-election polls across the globe. While the last few polls before the vote showed “Oxi” (“no”) ahead by just 3 to 4 percentage points, it in fact took 61 percent of the vote to 39 percent for “yes,” a margin of more than 22 percentage points. It was a landslide: “Yes” didn’t win a single parliamentary constituency.
The pundits and market conventional wisdom were even worse.
When I use the term “conventional wisdom” in this article, I mostly mean the opinions of political pundits and journalists. In the case of Greece, however, the failure also extended to betting and financial markets. One bookmaker, Paddy Power, was so convinced that “yes” would win that it pre-emptively paid out “yes” bets. Most banks and financial institutions expected a “yes” vote. Betting markets like Betfair continued to show “yes” favored even after the polls had turned back toward “no.”
Markets are full of people who want stupid overconfident predictions, and even more people who will provide them to the gullible. There were plenty of instant experts on Greek politics. Plenty of journalists we’d convinced they knew what would happen. Did you believe them?
The answer? Not to be gullible. Instead of journalism and forecasting, which don’t work, look for ways to be resilient and adaptable. There’s all too many people who will believe the current conventional wisdom.
If you can avoid being naive, that’s 90% of the battle.