One of my favorite aspects of Skin in the Game was how Nassim Nicholas Taleb analyzes bad reasoning. For him, the problem most people have with reasoning is not a failure to understand basic cause and effect – the problem is understanding how the effect eventually becomes the cause for the next step. The typical error, he notes, is to calculate the effect of the first step correctly without accounting for how this step alters the calculations for subsequent steps.
To put it another way, almost everything in life has a ‘then what?’ element. Taleb describes this as the ‘nth order effect’ – the step that comes beyond the easily seen second, third, and even fourth step in any calculation. This explanation appealed to me because I’ve often described (though some would say oversimplified) economics in the same way – the subject is all about asking ‘then what?’ and understanding the ramifications of what happens after the initial event.
In the larger context of the book, Taleb relates the ‘then what?’ element to how a transfer of risk burden from the risk-taker to some other element of a complex system can (almost always) have negative consequences for the health of the system. One example he mentions is how carpenters were once liable for the death penalty if a house they built fell apart and caused the death of its residents. When society recognized that carpenters were always building houses as sturdily as possible, these penalties were (rightfully) repealed. From here, the ‘then what?’ line of reasoning that follows leads first to better ease of mind for carpenters – no need to worry anymore about fluke factors causing the house to fall over.
But then, with the penalty for bad work reduced, carpenters are free to build slightly riskier homes. As homes start falling over again, insurance policies become available to protect against financial liabilities. Eventually, the result of all this lets us look back and say that the change in punishment allowed carpenters the freedom to build slightly riskier homes – ironic given that the punishment was originally changed to reflect how carpenters never built risky homes.
