The Japanese Tragedy and the Black Swan

Sta. Ana coordinates Action for Economic Reforms. This piece was published in the March 21, 2011 edition of the BusinessWorld, pages S1/4 to S1/5

 

“We share your grief.”  This is a short, simple, sincere message that nationalities across the world have expressed to the Japanese people.

 

It is in times of great tragedy marked by death and devastation that we note the emergence of the peoples’ best behavior—the acts of heroism, solidarity, empathy, generosity, and kindness. Yet this is not a case of simple altruism, for likewise lurking behind such altruism is self-interest.  For everyone fears that the disaster in Japan can happen anywhere. Nature’s incalculable havoc threatens all nations and peoples, rich or poor.

 

The Japanese people are most prepared in dealing with natural disasters and in responding to emergencies.  After all, tremors are a daily occurrence in Japan. Yet, in spite of Japan’s preparedness and its command of technology and resources, the recent earthquake and tsunami overwhelmed this proud, prosperous nation.

 

No one, not even the most outstanding scientists, could have predicted the intensity of the disaster and its catastrophic consequences.  A metaphor—now in vogue—comes to mind to describe such phenomenon. It is the metaphor of the Black Swan.

 

The Black Swan, the title of a book authored by Nassim Nicholas Taleb published in 2007, says that what matters in the real world is the uncertainty or the unpredictability of random events. What may seem improbable (as distinguished from what is impossible) is real. The unusual events—outliers that are oftentimes taken for granted—have the greatest impact.  Amidst success and exuberance, The Black Swan indeed presaged the crash of financial markets and the global economy in late 2007.

 

The theory of the Black Swan provided a neat explanation to the global economic crisis. Information asymmetry, ideological biases, rigid models, and perverse incentives contributed to the rise of the Black Swan in the global economy.

 

The Black Swan, though it has been applied mainly to finance, economics and politics, can also explain natural phenomena.  Although in the abstract sense the Japanese government has always been ready to respond to the most severe earthquakes, it did not anticipate that an improbable but not an impossible event could happen.  Ex ante, a nuclear accident, given the rigorous high standards of technology and regulation that Japan follows, was unlikely. But this is what the Black Swan precisely cautions—the unlikely suddenly becomes real.

 

This has a deep ramification on how society creates rules or institutions.  For instance, what is called minimalist government—which has been interpreted as shrinking the role of government in economic or development activities—has to be re-examined.  The Black Swan suggests that public rules, policies, programs and strategies cannot be moderate. Remember that the most severe impacts on society originate from the extreme, not from the normal.  This calls for a smart combination of both conservative and radical approaches.  As applied to financial markets, commercial banks must remain prudent and conservative even as government has to impose bold controls to check overheating and volatility.

 

In facing natural disasters, the same approach of combining conservatism and radicalism is relevant.  For developing countries like the Philippines with weak or nascent institutions, this will require enabling the State to generate resources and savings to prepare for unforeseen disasters, effectively and promptly deliver the public goods, correct market failures like supply shortage, and unite and mobilize its citizens.

 

This kind of thinking is as old as Adam Smith’s ideas.  Why for example do nation-states maintain large armies, incurring massive economic costs, even if war is remote?

 

The lesson is we always have to be prepared for the worst developments.  To weather such crises, we will need a responsive State, which is able to command its citizens and willing to use unconventional tools. This is a lesson we can learn from Japan and the disaster.

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