ESG and Nassim Taleb, author of Black Swan and Antifragile, are not the best of friends. And yet, maybe ESG can learn from Taleb and maybe vice versa, too.
ESG and Taleb and Antifragile
ESG boils down to risk. Business, too, is about risk. But then again, everything is a risk, and somehow we have to balance risk against potential rewards. ESG helps mitigate against risk while simultaneously providing the allure of competitive advantage.
Nassim Taleb is most famous as the author of Black Swan — all swans were considered white until we discovered a black swan; then, we had to reconsider our definition of a swan. Taleb says that rare events — what he calls black swan events — are more common than is generally realised. And investors must plan for black swan events. Recent examples of black swan events include sub-prime mortgage securitisation, which was said to pose no risk to global finance until it caused the 2008 crash, and lockdowns, totally unthinkable until Covid came along.
Taleb is something of a probability enthusiast and fumed when the publishers of Black Swan proposed putting dice on the cover of the book, in the process showing they hadn’t understood the book.
Taleb is also the author of Antifragile.
He says that the global economy is fragile — too susceptible to risk, lacks redundancy, which he says is essential for limiting risk.
More on Antifragile — why we have two kidneys
Nature, by contrast, encourages redundancy; that is why we have two kidneys, suggests Taleb. For most of the time, we only need one kidney — the second is redundant, and yet having a backup can come in rather handy on extreme occasions.
He suggests that if economists designed the human body, we might have one kidney shared between 12 people.
Taleb says: “Layers of redundancy are the central risk management property of natural systems. We, humans, have two kidneys (this may even include accountants), extra spare parts, and extra capacity in many, many things (say, lungs, neural system, arterial apparatus), while human design tends to be spare and inversely redundant, so to speak—we have a historical track record of engaging in debt, which is the opposite of redundancy (fifty thousand in extra cash in the bank or, better, under the mattress, is redundancy; owing the bank an equivalent amount, that is, debt, is the opposite of redundancy). Redundancy is ambiguous because it seems like a waste if nothing unusual happens. Except that something unusual happens—usually.”
So that’s Antifragile — reducing risk to extreme events by having backups which are not necessary for most of the time.
Just in time manufacturing process is fragile because it relies on everything going to plan, with no unexpected delays in the supply process.
The fragile supply chain is a supply chain that can go horribly wrong when extreme events occur.
We are seeing an example of a fragile supply chain right now, with over-reliance on Russian oil and gas.
ESG and the anti-fragile supply chain
Some think ESG has been caught napping by the Ukrainian crisis.
The critique may or may not be fair.
But it would appear ESG should consider geopolitical risks of dealing with regimes whose approach to human rights, etcetera, are not; errr, how can put this tactfully? Let’s say, “are not up to the mark.”
Paul Clements-Hunt, whose claim to fame is that he invented the ESG acronym, told Bloomberg that the G in ESG means you need to factor in the political regimes of countries in your supply chain or, in the case of investing, assets in your portfolio. He said: “If you don’t factor in autocracy and a malevolent government, then you have failed in your ESG assessment.”
But then times change. Three months ago, avoiding Russian exposure was not something that was considered a priority. So it is not fair to blame ESG for not considering the Ukrainian crisis.
Now, attention is turning to China and its human rights and potential invasion of Taiwan.
What is the ESG response? First, it could at least encourage an Antifragile supply chain such that companies can flip suppliers when the G in ESG demands it.
Taleb and ESG are not obvious bedfellows. He once said called the ESG fraternity: “Intellectual yet idiots.”
But then Taleb is also co-authored a paper: “Climate models and precautionary measures.”
The paper argued that “We have only one planet. This fact radically constrains the kinds of risks that are appropriate to take at a large scale. Even a risk with very low probability becomes unacceptable when it affects all of us - there are no reversing mistakes of that magnitude.”
In short, the Antifragile argument says we need to care deeply about climate change as there is no redundant system we can fall back on if things go wrong (The Elon Musk case for colonising Mars builds upon a similar argument.)
In other words, it would seem that Antifragile and ESG are compatible with each other — we have to manage the risk of climate change, and the Antifragile argument might suggest that the risk needs to be, in this case, be, reduced so that it is extremely low.
To put it another way, if climate change is a potential Black Swam event, ESG is a potential way of reducing our exposure.
Let’s finish with another Taleb quote on risk-taking and ethics.
“The best way to verify that you are alive is by checking if you like variations. Remember that food would not have a taste if it weren’t for hunger; results are meaningless without effort, joy without sadness, convictions without uncertainty, and an ethical life isn’t so when stripped of personal risks.”