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Is There a Link Between a Black Swan and Economics?

Do you remember your first thought on the morning of 8th November 2016, when Donald Trump won the US presidential elections? Well, I do. And to put my thoughts into appropriate language, I remember thinking: “This did not just happen!”. I believe that the majority of people in the world felt the same way. Changing my TV from one channel to another, from CNN to BBC and back to CNN, I was trying to make sense out of something that seemed so odd, almost impossible, but, yet, deep deep inside very likely. In fact, it wasn’t the first time that I experienced such a feeling in the year of 2016. I felt exactly the same way on June 23, when 51,9% of the participating UK electorate voted to leave the EU. Again, I was both surprised and not surprised at the same time. As a matter of fact, there is a whole theory developed around the occurrence of such events and it was given a name: The Black Swan Theory.

Before the discovery of Australia in 1679 by Dutch explorers, people in the old world were convinced that all swans were white — an indisputable belief as it seemed completely confirmed by empirical evidence. However, if you haven’t seen a black swan, that doesn’t mean that there are no black swans. The sighting of the first black swan might have been an interesting surprise for a few ornithologists (and others extremely concerned with the coloring of birds), but that is not where the significance of the story lies. You probably wonder why am I bringing up something that is totally irrelevant to economics or politics? Surprisingly, it is, in fact, very relevant! Black swans have shaped the history of technology, science, business, and culture. So what are these black swans? Black swans are highly consequential but unlikely events that are easily explainable — but only in retrospect. It is a phenomenon that comes about as a surprise but has an extremely significant effect on the future. Think of Donald Trump winning the US elections, Brexit, the 9/11 terrorist attack, or the annexation of Crimea in 2014; events that came almost out of nowhere, yet, looking back, they seem almost inevitable. Daniel Kahneman and Amos Tversky have demonstrated that people think that implausible events are more likely to occur if people argue about them: the more you talk about it, the less that scenery seems impossible.

Black Swan Theory was first introduced by Nassim Nicholas Taleb, who has devoted his life to emerging himself in problems of luck, randomness, human error, probability and the philosophy of knowledge. Prof. Taleb defines a black swan as a highly improbable event with three principal characteristics: 1) it is unpredictable, it lies outside of realm of regular expectations; 2) it carries a massive impact; 3) after the fact, we concoct an explanation that makes it appear less random, and more predictable than it was. In fact, Taleb is not attempting to predict events which are unpredictable. The theory rather illustrates a severe limitation to our learning from observations or experience and the fragility of our knowledge. One single observation can invalidate a general statement derived from millennia of confirmatory sightings of millions of white swans. All you need is one single black bird.

‘Black Swans underlie almost everything about our world, from the rise of religions to events in our the everyday life’, says Prof. Taleb. Go through an easy exercise. Just think of the events in your personal life that did not occur according to a plan but have had an immense impact on your life? I can definitely think of a few. For instance, my unexpected move from Scotland to the Netherlands — a black swan in my life that I would have never been able to predict or expect. Just like my personal example, there are a number of examples of the unpredicted global events. Every black Swan is linked to a risk, both financial and political. Here’s an example of three economic black swans that the world has experienced.

1)        Internet Bubble (1990s)

The bursting of the dot-com bubble, which was characterized by a rapid rise in equity markets sustained by investments in Internet-based companies. The value of equity markets grew exponentially with the by technology dominated  NASDAQ index growing almost 5 times between 1995 and 2000, and then dropping almost by 78% in 2001, leading to trillions of dollars of investment capital being vanished.

2)        Global Financial Crisis (2008)

Probably the most discussed example through my whole bachelor’s programme. A crisis that started off as a filed bankruptcy by Lehmans Brothers and that grew into a subprime-mortgage-induced financial crisis that is considered to be the worst crisis since the Great Depression.

3)        The sovereign debt crisis in Europe

Sovereign risk, according to a number of studies, was perceived as an unlikely issue to be crystallized in Europe. Following the global financial crisis, financially stronger countries like Germany were not capable of funding weaker countries, such as Greece (146,2% debt to GDP), Portugal (96,2% debt to GDP) and Spain (60,1% debt to GDP), out of their debt. Thus, they had a need for a bailout. The debt crisis led to a crisis of confidence for European businesses and economies.

All of the events described above were not predicted to happen, leading to severe circumstances and required a long period of time to recover from them, thus, can be described as black swans.

Predicting a Black Swan is quite impossible, because if you predict one – it will not be a Black Swan anymore. Can we understand health without taking into consideration heavy diseases and epidemics? Can we investigate a criminal affair by assessing only what a perpetrator does in his ordinary life? So what is the conclusion? Indeed, the “normal” is often irrelevant.  Almost everything in social life is produced by rare but consequential shocks. That is why the black swans in retrospective are often easily explainable. Our world is dominated by what is unknown and highly unlikely, thus we need to use “black swans” as a starting point rather than something exceptional and extraordinary hiding under the carpet.


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