Book Summary — Skin in the Game
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1 paragraph summary:
A refreshing read with humour which explains complex systems in a simple and engaging way. I loved the concepts of asymmetry, rationality and the need for skin in the game to share the downside as well as upside.
Chapter 1 — Introduction
Skin in the game is about 4 topics:
- Uncertainty and Reliability of Knowledge = bullshit detection
- Symmetry in human affairs = fairness, justice, responsibility, reciprocity
- Information sharing in transactions
- Rationality in complex systems in the real world.
That these four can’t be disentangled is obvious when one has skin in the game.
Skin in the game is necessary to understand the world.
- Bullshit detection is about the difference of theory and reality (in academia, there is no difference between theory and practice, in the real world there is)
- Distortions of symmetry = if you get the rewards, you must also get the risks, not let others pay the price of your mistakes
- Information sharing — what should be shared
- Rationality and the test of time
Do not mistake skin in the game as defined here and used in the book for just an incentive problem, just having a share of the benefits (as it is commonly understood in finance). No. It is about symmetry, more like having a share of the harm, paying a penalty if something goes wrong.
The principle of intervention, like that of healers, is first do no harm; even more, we will argue, those who don’t take risks should never be involved in making decisions.
Bureaucracy is a construction by which a person is conveniently separated from the consequences of his or her actions.
What can we do since a centralised system will necessarily need people who are not directly exposed to the cost of errors?
We have no choice but to decentralise or localise to have fewer of these immune decision makers.
Decentralisation is based on the simple notion that it is easier to macrobullshit than to microbullshit. Decentralisation reduces large structural asymmetries.
If we do no decentralise and distribute responsibility, it will happen by itself, the hard way, a system that doesn’t have a mechanism of skin in the game, with a buildup of imbalances, will eventually blow up and self-repair that way. If it survives.
Bob Rubin Trade — former secretary of US treasury, collected $120m payout before banking crash and invoked uncertainty as an excuse. Heads he wins, tails he shouts “Black Swan”. He transferred risk to taxpayers.
Interventionistas don’t learn because they are not the victims of their mistakes, and, as we hinted at with pathemata mathemata:
The same mechanism of transferring risk also impedes learnings.
More practically,
You will never fully convince someone that he is wrong, only reality can.
Actually, to be precise, reality doesn’t care about winning arguments: survival is what matters.
There is no evolution without skin in the game.
Systems learn by removing parts, via negativa.
Many bad pilots are currently in the bottom of the Atlantic. Many dangerous bad drivers are in the local quiet cemetry.
Transportation didn’t get safer just because people learn from errors, but because the system does. The experience of the system is different from that of indviduals, it is grounded in filtering.
Skin in the game keeps human hubris in check.
Symmetries and Negativas
The Golden Rule wants you to Treat others the way you like the them to treat you. The more robust Silver Rule says Do not treat others the way you would not like them to treat you.
More robust? How? Why?
It tells you to mind your own business and not decide what is “good”f or others. We know with more clarity what is Bad than Bood. The Silver Rule is a Negative Golden Rule.
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If bankers’ profits accrue to them, while their losses are somewhat quietly transferred to society, there is a fundamental problem by which hidden risks will continuously increase, until the final blow up. Regulations, while appearing to be a remedy on paper, if anything, exacerbate the problem as they faciliate risk-hiding.
Agency Problem
Avoid taking advice from someone who gives advice for a living, unless there is a penalty for their advice.
The agency problem (or principal-agent problem) manifests itself in the misalignment of interest in transactions: a vendor in a one-shot transaction does not have his interests aligned to yours — and so you can hide stuff from you.
Disincentive is not enough: the fool is a real thing. Some people do not know their own interst — addicts, workaholics, people in bad relationships, press, book reviewers, etc
Fools of randomness are purged by reality so they stop harming others.
Remember that is is at the foundation of evolution that systems get smart by elimination.
We may not know beforehand if an action is foolish — but reality knows.
What people “think” is not relevant. People’s “explanations” for what they do are just words, stories they tell themselves, not the business of proper science. What they do, on the other hand, is tangible and measurable and that’s what we should focus on.
A diamond, particularly when it is onerous to the buyer, is vastly more convincing a commitment (and mcuh less reversible) than a verbalk promise.
Forecasting (in words) bears no relation to speculation (in deeds).
I personally know rich horrible forecasters and poor “good” forecasters. Because what matters in life isn’t how frequently one is “right” about outcomes, but how much one makes when one is right. Being wrong, when it is not costly, doesn’t count — in a way that’s similar to trial-and-error mechanism of research.
By definition, what works cannot be irrational. If something stupid works (and makes money), it cannot be stupid.
What is rational is what allows the collective — entities meant to live for a long time — to survive.
In that sense, contrary to what psychologists will tell you, some “overestimation” of tail risk is not irrational by any metric, as it is more than required overall for survival. There are some risks we just cannot afford to take. And there are other risks (of the type academics shun) that we cannot afford not to take. This dynamic is called “ergodic”.
Things designed by people without skin in the game tend to grow in complication (before the final collapse).
There is no incentive to propose something simple: when you are rewarded for perception, not resulsts, you need to show sophistication.
Regulations vs Legal Systems
There are two ways to make citizens safe:
- Enact regulations — restrict individual freedom and lead to predation by the state, its agents and cronies. People with good lawyers game regulations. Regulation once in, stays in, as politicians are afraid of repealing them, under pressure from those benefiting them. Regulations are additive. We soon end up tangled in complicated rules that choke enterprise and life. Regulatory recapture (people benefiting from regulation) cancels out the effect of that a regulation is meant to do.
- Skin in the game— legal liability and the possibility of efficient lawsuits.
If you can’t effectively sue, regulate.
Some of us believe that freedom is one’s first most essential good. This includes the freedom to make mistakes (those that harm only you), it is sacred to the point that it must never be traded against economic or other benefits.
Soul in the Game
Skin in the game is about honor as an existential commitment, and risk taking as a separation between man and machine and a ranking of humans.
If you do not take risks, for your opinion, you are nothing.
My definition of success is the one of leading an honorable life.
It is dishonorable to let other die in your stead.
Honor implies there are some actions you would categorically never do (not for any amount of money ie sell your body). And also that there are things you would do unconditionally, regardless of the consequences.
Artisans
However, there are activities in which one is imbued with a sense of pride and honor without grand-scale sacrifice: artificial ones.
Anything you do to optimise your work, cut some corners, or squeeze more “efficiency” out of it (and out of your life) will eventually make you dislike it.
Artisans have their soul in the game.
- Artisans do things for existential reasons.
- They have some type of “art” in their profession. Combine art and business.
- They put soul in their work: they would not sell something defective or compromised.
- They have sacred taboos, things theyw ould not do even if it markedly increased profitability.
Entrepreneur Caveat
Entrepreneurs are heroes in our society.
They fail for the rest of us.
Many people mistaken for entrepreneurs have their aim to cash out or sell their company. This is a financing scheme and let’s exclude these people from “entrepreneurs”.
This form of entrepreneurship is the equivalent of bringing great-looking and marketable children into the world with the sole aim of selling them at age four. We can easily identify them by their ability of writing a convincing business plan.
Companies beyond the entrepreneur stage start to rot.
One of th reasons corporations have the mortality of cancer patients is the assignment of time-defined duties. Once you change assignment — or, better, company — you can now say about the deep Bob Rubin-style risks that emerge: “It’s not my problem anymore.”
Products or companies that bear the owner’s name convey very valuable messages. They are shouting that they have something to lose.
“Egomaniac” is good for the product. But if you can’t get “egomaniac”, “arrogant” will do.
People fail to realise that the principal thing you can learn from a professor is how to be a professor — and th chief thing you can learn from, say, a life coach or inspirational speaker is how to become a life coach or inspirational speaker.
So remember, the heroes of history were not classicists and library rats, those people who live vicriously in their texts. They were people of deeds and had to be endowed with the spirit of risk taking.
Skin in the Game — Literally
Illustrated on a painting of the Judgement of Cambyses. A judge could make mistakes with impunity. King Cambysesflayed Persion judge Sisamnes alive as a punishment for violating the rules of justice.
Chapter 2 — A First look at Agency
Symmetry and agency in risk sharing.
Laws come and go, ethics stay.
Chapter 3 — Greatest Asymmetry
Minority rule by which a small segement of the population inflicts preferences on the general public.
Do not think that the spread of automatic shifting cars is necessarily due to a majority preference, it could just be because those who can drive manual shifts can always drive automatic, but the reverse is not true.
The method of analysis employed here is called a “renormalisation group”.
Chapter 4— Wolves Among Dogs
Dependence — why employees exist because they have more to lose than contractors.
A company man is someone who feels that he has somthing huge to lose if he doens’t behave as a company man — that is, he has skin in the game.
The company man is sort of gone, he has been replaced by the companies person. For people are no longer owned by a company but by something worse: the idea that htey need to be employable. The employable person is embeded in an industry, with fear of upsetting not just their employer, but other potential employers.
Perhaps, by definition, an employable person is the one you will never find in a history book, because these people are desgined to never leave their mark on the course of events. They are, by design, uninteresting to historians.
The best slave is someone you overpay and who knows it, terrified of losing his status.
Multinational companies created the expat category, a diplomat with a higher standard of living who presents the firm far away. Why? Becaues the furter away from home the more autonomous the unit, the more you want him to be a slave so he does nothing strange of his own.
Freedom entails risks — real skin in the game. Freedom is never free.
What matters isn’t what a person has or doesn’t have, it is what he or she is afraid of losing.
The more you have to lose, the more fragile you are.
Chapter 5 — Being Alive Means Taking Certain Risks
Risk taking makes you look superficially less attractive, bu vastly more convincing.
Scars signal skin in the game.
People can detect the difference between front- and back-office operators.
Chapter 6— The Intellectual Yet Idiot
Skin in the game makes you understand the world.
The Intellectual Yet Idiot knows at any given point in time what his words or actions are doing to his reputation.
But a much easier market: he doesn’t even deadlift.
Chapter 7— Inequality
Inequality in risk vs Inequality in salary: you can be richer, but then you should be a real person and take some risk.
The public despises people who make a lot of money on a salary.
We perceive inequality when it is someone just like us getting ahead.
Chapter 8— Lindy Effect
The NYT commentators on experts are not themselves experts.
Who will judge the judge? Who questions the expert? Survival does.
Being reviewed or assessed by others matters if and only if one is subjected tot he judgement of future — not just present — others.
Someone with a high public presence who is controversial and takes risks for his opinion is less likely to be a bullshit vendor.
Chapter 9— BS detection heuristics
Choose the person who doesn’t look the part and had to overcome hurdles to get to where they are.
In any type of activity or business divorced from the direct filger of skin of the game, the great majority of people know the jargon, play the part, and are intimate with the cosmetic details, but are clueless about the subject.
Hire the successful trader, conditional on a solid track record, whose details you can understand the least.
What can be phrased and expressed in a clear narrative that convices suckers will be a sucker trap.
Chapter 10— Rich people are suckets falling prey to people complicating their lifestyles
When people get rich, they shed their skin-in-the-game-driven experiential mechanism. Theylose control of their preferences, substituting constructed preferences for their own, complicating their lives unnecessarily, triggering their own misery.
It is easy to scam people by getting them into complications — the poor are spared that type of scamming.
Chapter 11— Deeds Before Words
Threats vs Real Threats — own an enemy without killing
The best enemy is the one you own by putting skin in the game and letting him know that exact rules that come with it.
Godfather — an offer that you can’t refuse.
Verbal threats reveal nothing beyond weakness and unreliability.
Chapter 12— The Facts are True, The News is Fake
Agency Problem in Journalism
You can’t fool people more than twice.
You never cure structural defects, the system corrects itself by collapsing.
“Give me a few lines writte by any man and I will find enough to get him hung” goes the saying attributed by Voltaire.
Chapter 13 — Virtue requires risk taking
It is much more immortal to claim virtue without fully living with its direct consequences.
Exploiting virtue for image, personal gain, careers, social status, these kinds of things — and by personal gain I mean anything that does not share the downside of a negative action.
If your private life conflicts with your intellectual opinion, it cancels your intellectual idea, not your private life.
If a car salesman is selling you a Detroit car, whilst driving a Honda, he is signaling that the wares he is touting may have a problem.
Virtue is not something to advertise. It is not an investment strategy. It is not a cost-cutting scheme.
Courage it the only virtue you cannot fake.
Virtue is not inherently unpupular, but unpopular acts signal some risk taking and genuine behaviour.
Sticking up for truth when it is unpopular is far more of a virtue, because it costs you something — your reputation.
Chapter 14— Agency problem in historians
If you understand nothing about the problem and have no skin in the game, then everything is seen through the prism of geopolitics.
Real people are interested in commonalities and peace, not conflicts and wars.
Chapter 15— Religion, Belief and Skin in the Game
Avoid the verbalistic “religions” they are all different.
My lifetime motto is that mathematicians think in objects and relations, jurists and legal thinkers in constructs, logicians in maximally abstract operators and … fools in words.
Chapter 16— Risk and Rationality
Rationality is all about actions, not verbs, thoughts and talk.
When we look at religion we should look at what purpose it solves, not at the notion of “belief”. In science, belief is a literal belief, it is right or wrong, never metaphorical.
The same applies to distortions of belies. Are visual deceits any different from leading someone to believe in Santa Claus, if it enhances his or her holiday aesthetic experience? No, unless it causes harm.
Survival comes first, truth, understanding and science later.
In other words, you do not need science to survive, but you must survive to do science. Better safe than sorry.
Beliefs are cheap talk.
By a mechanism called bias-variance tradeoff, you often get better results making “errors”, as when you aim slightly aawy from the target when shooting. Making some types of errofs is the most rational thing to do, when the errors are of little cost, as they lead to discoveries. Most medical discoveries are accidental to something else. An error-free world would have no penicillin, no chemotherapy… almost no drugs, and most probably no humans.
Chapter 19— The Logic of Risk Taking
Errors concerning small-probability events. Courage and prudence are not in contradiction provided one is acting for the benefit of the collective.
The difference to successful and really successful people is that really successful people say No to almost everything.
One may be risk loving yet completely averse to ruin.
In a strategy that entails ruin, benefits never offset risks of ruin.
Every single risk you take adds up to reduce your life expectancy.
Rationality is avoidance of systematic ruin.
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