Title: Why Most Things Fail: Evolution, Extinction and Economics
Author: Paul Ormerod
Scope: 4 stars
Readability: 3.5 stars
My personal rating: 4 stars
See more on my book rating system.

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Topic of Book

The author seeks to explain why most things fail, whether it is the bankruptcy of corporations, the extinction of species or the failure of government policy, is a rule of life.

For another evolutionary perspective on human history, read my book From Poverty to Progress: How Humans Invented Progress, and How We Can Keep It Going.

My Comments:

I believe that Ormerod shows why a key foundation to progress is having governmental and economic institutions compete against each other. No matter how smart and dedicated their leaders are, they will forced to make decisions based upon little more than educated guesses. It is only when the worst of these educated guess lead to the failure of the organization that society can receive the benefits of those decisions. Monopolies ensure that society absorbs the costs the worst of the educated guesses.

Key Take-aways

• Most things fail, it is only a question of how long it takes to fail.
• Careful planning by very smart people with huge amount of computer-analyzed data cannot overcome this fact.
• Humans face massive inherent uncertainty about the effect of their actions.
• The world is so complex and ever-changing that leaders have very limited capacities to acquire knowledge about the true impact either of their strategies. And they are ignorant of that fact.

Important Quotes from Book

“An argument I first made ten years ago in my book The Death of Economics noted that conventional economics views the economy and society as machines, whose behaviour, no matter how complicated, is ultimately predictable and controllable. On the contrary, however, human society is more like a living organism.”

“In this book, I address what is probably the most fundamental feature of both biological and human social and economic systems: failure… The documentation of failure, the identification of subtle patterns amongst the apparent disorder of failure, and analyzing why failure arises are the main themes of this book.”

“Failure is all around us. Failure is pervasive. Failure is everywhere, across time, across place and across different aspects of life. Ninety-nine point nine nine per cent of all biological species which have ever existed are now extinct.”

“The main theme of this book is to develop a general explanation of the pervasive nature of failure in the world of human societies and economies. Though there are striking parallels between the social and economic world and the world of biology there is, however, a fundamental difference between the two: the process of evolution in biological species cannot be planned. Species cannot act with the intent of increasing their fitness to survive. In contrast, in human society, individuals, firms and governments all strive consciously to devise successful strategies for survival. They adapt these strategies over time and alter their plans as circumstances change. Yet, despite this apparent contrast, eventually, in both biological evolution and human social and economic activity, failure strikes.

A second theme of this book is to understand this seeming paradox. How can it be that not just failure, but the patterns of failure, are so similar in biology and human organization when there is such a sharp contrast between the abilities to act with the conscious intent of improving one’s prospects for survival?

The third theme, developed in particular towards the end of the book, is that failure can be highly beneficial.”

 “We do know that the average lifespan of small firms is shorter than very large ones, but this is accounted for almost entirely by relatively high death rates in the very early years of existence… But, after the first few years of existence, the difference between large and small firms’ survival potential narrows dramatically. Their prospects of surviving the next year become more or less the same. And, eventually, age claims them. Most firms fail.”

“The existence of failure on this scale is simply not recognized in economics. Instead, in much of economic theory, getting the right strategy, the right policy, is straightforward. ”

“In order to control a system—any system, whether an economy, a biological system or a machine—we need to be able to do two things: first, make forecasts which are reasonably accurate in a systematic way over time; and second, understand with reasonable accuracy the effect of changes in policy on the system one is trying to control.”

“Nevertheless, many people continue to believe that, in order to design effective policies, all we need to do is collect more information and statistics, analyze the data and produce a plan which will solve whatever problem confronts us. But there are deep underlying reasons for the inability to plan and control outcomes successfully… The historical data which we have is dominated by noise rather than by signal and contains very little true information. ”

“It may seem implausible that economic systems behave as if they were almost random. However, this near-random quality does not mean in any way that the individual components of an economy—people, firms, governments—take decisions at random. On the contrary, they act with purpose and intent. But the consequences of these millions upon millions of individual decisions, interacting with each other all the time, lead to an overall outcome, for total output (GDP), say, that appears as if it were close to being random. The sheer dimensions of the problem are simply too great for the system to be understood properly.”

“So we have evidence suggesting the existence of mild preferences on racial grounds by individuals, yet we observe marked racial segregation at the level of the system as a whole. This seeming paradox is entirely typical of many social and economic issues.”

“A key paradox begins to emerge from all this. Humans, whether acting as individuals or making collective decisions in companies or governments, behave with purpose. They take decisions with the aim of achieving specific, desired outcomes. Yet our view of the world which is emerging is one in which it is either very difficult or even impossible to predict the consequences of decisions in any meaningful sense.”

“So chess is another example of a game which can be described very simply, but where the dimension of the problem of solving it scales in a super-exponential way. Even very powerful modern computers can only solve a limited proportion of all possible six-piece combinations, yet, to reiterate, the game itself involves thirty-two pieces.”

“But the last taboo seems to be the idea that, even if agents do not or cannot gather complete information, even if they do not or cannot carry out maximizing behaviour at a given point in time, they learn. They learn a better strategy, which may even begin to approach a maximizing strategy.”

“Instead of a futile search for the best possible move, most of the time chess grandmasters use their skill and experience to make what they consider to be a reasonable one. They make moves that seem good and that avoid obvious loss, exactly in the way experimental economics leads us to believe individuals and firms behave.”

“Running a business or a government is much harder than playing chess.”

“One obvious difference is that in chess the rules of the game are fixed. ”

“Chess is also simplified dramatically by the fact that there is just a single, known opponent in any particular game. More importantly, the opponent does not change during the course of a game.”

“A further crucial difference between chess and real-life decision-making is that chess has a single, unequivocal goal: you win by checkmating the opponent’s King. This is the sole purpose of strategy. There is no other way of winning. In business, defining the criteria for success is not completely straightforward. ”

“In general, it is rare for a government to have a single criterion of success. So many competing and conflicting goals exist.”

“They lend the impression that the captains of industry chart strategic courses, steering their tanker carefully and gracefully through the straits. The view from the inside more closely resembles white-water rafting. “Oh my God! Huge rock dead ahead! Everyone to the left! NO, NO, the other left!” ’ Eller goes on, ‘Reality is rarely a simple story and is probably more like a Dilbert cartoon.”

“Unilever, RJR Nabisco, GM and Microsoft all face the same virtually impenetrable veil over the future as the smallest one-person firm. The giants are less likely to make elementary errors of operation than small firms, but otherwise there is no difference. The possible permutations of outcome are vast. Firms and governments certainly act with intent; they intend to succeed. But success often arrives purely by chance. And so does failure.”

“Close to the other extreme, we can postulate that it is as if most agents lack cognitive ability and take random decisions, but that a minority are able to discover a rule of behaviour that gives them a better than random chance of survival. Some of the majority will survive by pure chance. The rule discovered by the minority might only give them a very slight edge, like discovering that a coin is not in fact true but is biased 51:49 in favour of heads. Some of these will be made extinct at random, through bad luck, but a greater proportion of them will survive than will amongst the rest of the population.”

“Failure is by far the single most important feature that biological species have in common.”

“This juxtaposition of the political economist Adam Smith and the biologist Charles Darwin is not accidental. This book is about the striking parallels between evolution and extinction in the biological world and in the sphere of human activities.”

“An intellectual revolution is taking place in many aspects of the biological and natural sciences, which is now being extended into the sphere of social and economic analysis. In the first part of the twentieth century, quantum physics overturned conventional views of causality at the highly micro, subatomic level of behaviour. Now, the discovery of so-called power law behaviour in widely different areas challenges perceptions of causality at the system-wide, macro level.”

“The fact that different investors hold different views about what might happen may seem such a truism as to be not worth stating, but it is the reason why markets exist at all. If all investors held absolutely identical views and opinions, including, I may say for the benefit of any mainstream economist who happens to be passing by, their tastes and preferences towards risk, a market could not exist,”

“The relationship that describes the connection between the frequency and size of extinctions of biological species is the same as that which describes extinctions of companies. The timescales differ dramatically, but frequency and size are connected identically in both.”

“The implication is that it is as if—at last a useful and meaningful way in which to use the economists’ favourite phrase!—firms acted at random, as if they were unable to act with intent and try to plan their futures. The massive uncertainty which often exists even in apparently simple situations means quite simply that intent is not the same as outcome. Firms try all the time to achieve favourable outcomes, but often they fail. And often they become extinct.”

“To recap, there are two key features of extinctions, whether of species or firms, which any theoretical account needs to be able to explain: first, the size of extinctions over time varies in irregular waves; and, second, there is nonetheless a distinct pattern which can be found in this seemingly random movement…

We can add a third fact as far as the disappearance of companies is concerned: the probability of failure, or extinction, is known to be highest when the company is first formed. It then falls away rapidly.

“Perhaps more surprisingly, there seems to be very little connection between the size of a firm, once the first few fraught years of existence are passed, and its probability of survival in any given period.”

“In short, despite the ability of humans and human institutions to act with intent, in reality it is as if they operate close to the paradigm of the agent with zero cognitive ability. They do not have to mimic it completely, and a small amount of ability to translate intent into desired outcome is compatible with the evidence we observe, but no more than that.”

“The clear implication of this abstract theoretical model is that agents, firms, individuals, governments have very limited capacities to acquire knowledge about the true impact either of their strategies on others or of others on them. The model passes stringent scientific tests of validation. The properties that emerge from it, which are not at all obvious from a description of its component rules, accord very well with the subtle but clearly defined patterns of extinction which we observe. And we have seen that even the world’s largest firms are capable of making huge mistakes about the possible effects of their strategies.

To repeat a key phrase which needs to be hard-wired into the brain of every decision-maker, whether in the public or private sector, intent is not the same as outcome. Humans, whether acting as individuals or in a collective fashion in a firm or government, face massive inherent uncertainty about the effect of their actions.

“These limits are a fundamental feature of the systems we have discussed, whether biological or in the realm of human social and economic organization, in which the individual agents are connected through networks that evolve over time. These limits can no more be overcome by smarter analysis than we are able to break binding physical constraints, such as our inability to travel faster than the speed of light. This is why things fail.”

“When we analyze the connection between the overall fitness of the system and the rate of extinction, we see quite clearly that periods immediately following large extinctions tend to have relatively high overall fitness, as new firms are rushed in to fill the gaps opened up by the eliminations. In other words, extinctions essentially play the role described by Schumpeter in his phrase ‘creative destruction’. Weaker firms are eliminated and replaced by firms which, on average, have higher levels of fitness.”

“strong market positions will be created temporarily for particularly successful innovators. They will be able to exercise market power and raise their profit margins. This is the reward to innovation at the individual level but, as we have seen, this also brings benefits to the system as a whole.

The market power, the monopoly, will not be permanent, because at some unpredictable point a new innovation will spread which will undermine the basis of the existing market power of the monopolist. As long as the institutional rules under which the system operates encourage innovation, we should not worry about market power being exercised by individual firms, for eventually they will be undermined by the process of competition and innovation. Microsoft, for example, may appear to bestride the world at present, but eventually it will undermined by innovation,”

“Conventional economics and regulatory authorities do not see the world in this way at all. They want to undermine market power, even when it arises from successful innovation, and seek to create a world in the image of their own theory.”

“In terms of the public policy implications, the authorities need to recognize that within a single industry co-operative relationships between firms are necessary for the fitness of the industry as whole. If competition is enforced too strongly, the overall fitness of the industry is reduced. But protection for the industry as a whole also tends to reduce overall fitness. Firms need an external environment which is competitive but require as well a certain level of co-operative behaviour within the industry.”

For another evolutionary perspective on human history, read my book From Poverty to Progress: How Humans Invented Progress, and How We Can Keep It Going.