Radical Uncertainty

The question ‘What is going on here?’ sounds banal, but it is not. In our careers we have seen repeatedly how people immersed in technicalities, engaged in day-to-day preoccupations, have failed to stand back and ask, ‘What is going on here?’ We have often made that mistake ourselves.

By ‘uncertain’ knowledge, let me explain, I do not mean merely to distinguish what is known for certain from what is only probable. The game of roulette is not subject, in this sense, to uncertainty; nor is the prospect of a Victory bond being drawn. Or, again, the expectation of life is only slightly uncertain. Even the weather is only moderately uncertain. The sense in which I am using the term is that in which the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention, or the position of private wealth-owners in the social system in 1970. About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know.18

Uncertainty is the result of our incomplete knowledge of the world, or about the connection between our present actions and their future outcomes.

A mystery cannot be solved as a crossword puzzle can; it can only be framed, by identifying the critical factors and applying some sense of how these factors have interacted in the past and might interact in the present or future. Puzzles may be more fun, but in our real lives the world increasingly offers us mysteries – either because the outcome is unknowable or because the issue itself is ill defined.

The claim of the modern science of decision theory is that most mysteries can be reduced to puzzles by the application of probabilistic reasoning. Such reasoning can provide solutions to puzzles, but not to mysteries. How to think about and cope with mysteries is the essence of managing life in the real world and is what this book is all about.

But we must expect to be hit by an epidemic of an infectious disease resulting from a virus which does not yet exist. To describe catastrophic pandemics, or environmental disasters, or nuclear annihilation, or our subjection to robots, in terms of probabilities is to mislead ourselves and others.

Real households, real businesses and real governments do not optimise; they cope. They make decisions incrementally. They do not attain the highest point on the landscape, they seek only a higher place than the one they occupy now. They try to find outcomes that are better and avoid outcomes that are worse.

For all that has recently been said about ‘the wisdom of crowds’, the authors prefer to fly with airlines which rely on the services of skilled and experienced pilots, rather than those who entrust the controls to the average opinion of the passengers.

Intelligent people do not make important decisions on matters about which they are ignorant when additional data are readily available. And any bar-room conversation, or presidential tweet, will remind you that the degree of confidence with which a proposition is expressed is not the same as the probability that the proposition is true.

That is how good decisions are made in a world of radical uncertainty, as decision-makers wrestle with the question ‘What is going on here?’

Human minds approach problems in ways that are markedly different from those of computers. In particular, whereas computers are efficient in solving well-defined puzzles, humans excel at finding ways to cope with open-ended mysteries. And the human capacity for, and pleasure in, storytelling is a central element of that ability.

The World Values Survey shows a strong positive correlation across countries between per capita income and answers to the question ‘Do you think that most people can be trusted?’

Perhaps rational economic man dies out because no one would want to mate with him.

Good decision-makers, by contrast, listen respectfully, and range widely to seek relevant advice and facts before they form a preliminary view. And when they do arrive at a view, they invite challenge to it, before drawing the discussion to a conclusion. Well conducted, the case method of the business school is an exercise in teaching future executives to think in this way.

As David Tuckett, a social scientist and psychoanalyst, has argued, decisions require us ‘to feel sufficiently convinced about the anticipated outcomes to act’.

Sam Walton, who founded the Walmart chain of stores, recalled that ‘I have concentrated all along on building the finest retail company we possibly could. Making a personal fortune was never particularly a goal of mine.’

The Central Limit Theorem of probability states that if a variable is the sum of a large number of factors which are themselves random and independent of each other, the resulting distribution of that variable will be normal.

Sloan emphasised consultation, collegiality and concern to establish ‘what is going on here’: ‘I never give orders. I sell my ideas to my associates if I can. I accept their judgment if they convince me, as they frequently do, that I am wrong. I prefer to appeal to the intelligence of a man rather than attempt to exercise authority over him.’18

It is our experience too that when data yield a counter-intuitive result, the most common explanation is that there is something wrong with the data. Not always, of course,

The efficient market hypothesis is a powerful reality check. Everyone knows that Amazon is a successful retailer and that Apple products are attractive to consumers – and the stock price of these companies already reflects this. Anyone who is offered, or believes he or she has identified, an unexploited business or investment opportunity should ask themselves ‘Why have other people not already availed themselves of that opportunity?’ Of course, there may be a good answer to the question. But posing it can help you avoid expensive mistakes.

The more regulators attempt to define precise, detailed rules, which confuse more than clarify, the more likely is a counter-productive outcome. If only someone would stand back and ask ‘What is going on here?’ rather than tweak processes which have acquired their own seemingly irresistible momentum!

An American investor who remained asleep from 1926 to 1936 or a Briton who suffered similar catalepsy from 1972 to 1982 would have noticed nothing untoward in his or her portfolio.11

the three pillars of modern finance theory – efficient portfolio theory, the capital asset pricing model and the efficient market hypothesis. As we suggested there, the rational investor in a world of radical uncertainty must know these models, but should not take them either too literally or too seriously.

Broad diversification, involving building a portfolio which will be robust and resilient to unpredictable events, is the best protection against radical uncertainty, because most radically uncertain events will have a significant long-run effect on only some of the assets which you own. The kind of diversification which leads Silicon Valley titans to buy rural properties in New Zealand which they hope will survive the apocalypse – and which has become sufficiently popular to lead that country to impose restrictions on purchases of domestic properties by foreigners – is perhaps fanciful, but the style of thought is sound.12

Buffett, history’s most successful investor, was well aware of this. He wrote of proponents of the efficient market hypothesis: ‘Observing correctly that the market was frequently efficient, they went on to conclude incorrectly that it was always efficient. The difference between these propositions is night and day.’15 For Buffett, the value of that difference is $70 billion – the reward for taking advantage of Knight’s insightful identification of the relationship between radical uncertainty and entrepreneurship.

Keynes said of Tinbergen, ‘The worst of him is that he is much more interested in getting on with the job than in spending time in deciding whether the job is worth getting on with.’

Human intelligence is effective at understanding complex problems within an imperfectly defined context, and at finding courses of action which are good enough to get us through the remains of the day and the rest of our lives.

Successful decision-making under uncertainty is a collaborative process. Having arrived at the best explanation, it is important to open that explanation to challenge and be ready to change the guiding narrative when new information emerges.

The false assumption that good process leads to good outcome is pervasive in public sector organisations, where good often means lengthy, involves many people with little responsibility for the result, and is imbued with ill-defined concepts of fairness centred around issues of representativeness and statistical discrimination. Process has become the policy, with deleterious effects on outcomes.

we make better decisions in groups, because in a radically uncertain world the group holds more information than any individual member. The committee is wasting time when its members bring their opinions rather than their distinctive knowledge, and when it becomes a mechanism for diffusing rather than acknowledging responsibility for the outcomes. The effective leader is one who recognises that his membership of the group is marked by his superior responsibility rather than his superior wisdom.