Tag Archives: Optionality

Optionality and Economic Change

The book America 3.0 (available for purchase from Amazon and Barnes & Noble) describes three long economic periods, based on agriculture, industry, and information, as driving profound social change.

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When we fought the Revolution against Britain, America’s economy was based on agriculture and the hydrological cycle. Along with the constants of soil and sun, water (where it fell, how it needed to be diverted, where it ran) determined American economic life. Know a man’s relationship to water, and you knew his realtionship to wealth.

american_rivers_map_md

Around the time of the Civil War against the southern rebels, sun, soil, and water were surprased by coal and rail as the foundation of power and privilege. The great rail network, centered around Chicago, enabled greater economies of scale than had ever been seen before in history. The story of the next century, from the racial strife of the 1860s to the racial strife of the 1960s, was the story of industrialization, scale, and how the benefits of coal would be shared.

american_railroads_md

We’re now changing again. “Information” appears to be valuable, and the economic giants of the day are information racketeers such as Google, Apple, Amazon, and Facebook. The world is becoming much less heavy, and manufacturing on demand (from computer-driven milling to 3D printing) may accelerate the acceleration the eclipse of coal by data.

american_cell_maps_md

We do not know what is next. The industrial age seemed to come to an apogee in the late 1940s, as economies around the world (the US, the UK, France, Germany, the USSR, China, Taiwan, both Koreas, and Japan) established bureaucratic-industrial welfare states managed by experts, with only quixotic variations based on national culture and ideology. But that was a false sunlight, as phony as the widespread popularity of the concentration camps (brought to the US by Franklin Delano Roosevelt) of the 1930s.

We know the world is changing. We know now what comes next.

In this environment, we should focus on giving learners many low cost opportunities and few high-cost high-risk paths. In other words, we should give students “optionality,” where they have many opportunities and few long-term costs. We’re not in an industrial age where we know economies of scale will rule the day, nor even in the long hydraulic age where water was the great idol. Students will have to find their own ways. We should help them.

To do this we should (except for core majors that are needed for national security — say science, technology, engineering, and mathematics) make much of the curriculum optional, and allow students “low-risk” trials in different career paths.

As Tren Griffen and Nassim Taleb posted:

If you ‘have optionality,’ you don’t have much need for what is commonly called intelligence, knowledge, insight, skills, and these complicated things that take place in our brain cells. For you don’t have to be right that often. All you need is the wisdom to not do unintelligent things to hurt yourself (some acts of omission) and recognize favorable outcomes when they occur. (The key is that your assessment doesn’t need to be made beforehand, only after the outcome.)” Being able to make decisions which do not require correctly forecasting the future is a wonderful thing. Not one of the great value investors identified in the series of posts in this blog relies on macro forecasts of the future. Instead, value investors use the optionality of cash to buy after the outcome exists (i.e., a significant drop in intrinsic value). Regarding venture capital, Warren Buffett believes: “If significant risk exists in a single transaction, overall risk should be reduced by making that purchase one of many mutually- independent commitments. Thus, you may consciously purchase a risky investment – one that indeed has a significant possibility of causing loss or injury – if you believe that your gain, weighted for probabilities, considerably exceeds your loss, comparably weighted, and if you can commit to a number of similar, but unrelated opportunities. Most venture capitalists employ this strategy.

It is certainly evil to trick an 18 year old into non-bankruptable loans of tens of thousands of dollars on a worthless major. A 16 year old would be better off learning a trade than learning Shakespeare, especially if that student could learn Shakespeare later. An 18 year old would surely be better off selling drugs (say from a pharmacy, an alcohol ball, a tobacconist shop, or so on) and learning that part of the economy than borrowing money to study political science.

Help our students prepare for an uncertain future, for America’s next stage of economic development. Give them low-cost opportunity and easy failures. Not non-bankruptable student loans.

Optionality and Education

This post introduces optionality, optionality in the context of foresight and then raises implications for education.

Discussing Optionality

A bit ago, both Tren Griffen and Nassim Taleb discussed “optionality” on their blogs.

“Optionality” refers to an investment decision where the reasonable upside is much larger than the reasonable downside.

Here are some of Tren’s thoughts on optionality:

Optionality is lost when you’re initial investments are so large, you cannot afford to abandon your initial plans:

“A rigid business plan gets one locked into a preset invariant policy, like a highway without exits —hence devoid of optionality.” I am at my self-imposed 999 word limit so what follows including this quotation must largely stand on its own without commentary…

“Optionality… explains why top-down centralized decisions tend to fail” …

“Like Britain in the Industrial Revolution, America’s asset is, simply, risk taking and the use of optionality, this remarkable ability to engage in rational forms of trial and error, with no comparative shame in failing again, starting again, and repeating failure.” Entrepreneurs harvest optionality when they tinker and experiment as they run their businesses and as a positive externality benefit their city/region/nation/the world in the aggregate by generating productivity and genuine growth in the economy even if legions of entrepreneurs may fail. Taleb: “Most of you will fail, disrespected, impoverished, but we are grateful for the risks you are taking and the sacrifices you are making for the sake of the economic growth of the planet and pulling others out of poverty. You are the source of our antifragility. Our nation thanks you.”

Optionality in the Context of Foresight

Unlike rigidly planned investment strategies, optionality emphasizes only maintaining flexibility and recognizing success when it happens:

“If you ‘have optionality,’ you don’t have much need for what is commonly called intelligence, knowledge, insight, skills, and these complicated things that take place in our brain cells. For you don’t have to be right that often. All you need is the wisdom to not do unintelligent things to hurt yourself (some acts of omission) and recognize favorable outcomes when they occur. (The key is that your assessment doesn’t need to be made beforehand, only after the outcome.)” Being able to make decisions which do not require correctly forecasting the future is a wonderful thing. Not one of the great value investors identified in the series of posts in this blog relies on macro forecasts of the future. Instead, value investors use the optionality of cash to buy after the outcome exists (i.e., a significant drop in intrinsic value). Regarding venture capital, Warren Buffett believes: “If significant risk exists in a single transaction, overall risk should be reduced by making that purchase one of many mutually- independent commitments. Thus, you may consciously purchase a risky investment – one that indeed has a significant possibility of causing loss or injury – if you believe that your gain, weighted for probabilities, considerably exceeds your loss, comparably weighted, and if you can commit to a number of similar, but unrelated opportunities. Most venture capitalists employ this strategy.”

“Optionality” is related to the career advise given by Jim Collins. Instead of simply cataloging your skills, and applying for high-paying jobs in which those skills are required, Collins recommended first looking at (a) what you love, (b) what you can be great at, and (c) what you can make money doing. The goal isn’t to aim for some perfect job sometime later in your life, but to set yourself up in an area where you enjoy practicing and you adaptable for those opportunities that appear.

3-circles-hedgehog-concept

Implications for Education

Optionality is an investment choice that has a small potential downside but large potential upside. You don’t need a strict plan, lots of foresight, or even great environmental awareness to look for investment choices that have optionality. You simply need to keep from making bad decisions, and need to tolerate “getting it wrong” (which means simply starting over).

So what does this mean for education?

Student loans are an anti-optionality catastrophe.

Student loans are impossible to get rid of in bankruptcy. They also require a lot of foresight and planning — and worst of all, require it of 18 year old idiots (that is, virtually all 18 year olds).

Being an idiot isn’t a bad thing — if you have optionality, you try, fail, and learn from experience. But being an idiot with debt is a horrible fate.

At the very least, non-bankruptable student loans should never be offered for non-Science/Technology/Engineering/Mathematics majors. To force someone with no work history to take ten thousand, twenty thousand, or more in non-forgivable debt for a worthless English literature degree is horrid. It is the closest thing to “usury” that exists in our world outside of organized crime.

Not only do non-bankruptable student loans kill optionality by making education have a big potential downside, they make that downside more likely. Student loans for non-STEM majors encourage failure by getting students to loan up to enter a ghetto of low wages and few jobs. This is the opposite of encouraging wise investments.

We need to close the on-ramp to the ghetto by discouraging youth from making choices that don’t have optionality. We need to end non-STEM student loans.

seattle_ghost_ramps_blocked

It’s better for an 18 year old to be a drug dealer or go-go-dancer than to take non-bankruptable loans to study sociology. Those options may have optionality. Sociology doesn’t.