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Business News/ Opinion / Views/  The big lesson of 2020: Pay more attention to tail risks

The big lesson of 2020: Pay more attention to tail risks

We need global coalitions to mitigate the risk of events that are very unlikely but devastating all the same

As individuals and as a society, we evaluate the chances of events, the risk posed by those events, and make plans accordinglyPremium
As individuals and as a society, we evaluate the chances of events, the risk posed by those events, and make plans accordingly

In June 2019, if someone had warned us about a global pandemic that would bring the world to a standstill for months, we would’ve dubbed him or her a scaremonger, and such a pandemic a highly improbable event. Having lived through one, it now seems inevitable. Oddly, both reactions are sensible. Until it occurs, we don’t take it seriously, because the covid pandemic is a low-probability event—what we statistically describe as a tail risk. But one important lesson of 2020 is that we should take tail risk mitigation more seriously.

Tail events get their name from the shape of a normal (Gaussian) distribution, or a bell curve. If we distribute the chances of various events—the largest number of observations centre around the middle (median) and observations decline to the left and the right. Human height is a classic example of a normal distribution. In India, the average height of a woman at 18 years is just below 5 feet. Based on the properties of a normal distribution, 95% of Indian women at 18 will be between 4-ft-6-in and 5-ft-5-in. The chances of finding a woman over 6 feet tall or under 4 feet is very low; less than 1% of Indian women will fit that description. These are the “tails" in the height distribution for women.

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We don’t pay attention to tail events because they are low-probability. But some tail events can be catastrophic. The pandemic certainly qualifies, and prior pandemics like the Spanish Flu and Black Death also fit that description. But pandemics are not the only types of disruptive tail events. The eruption of super-volcanoes, solar flares disrupting global communication systems, high-intensity earthquakes, asteroids hitting the Earth, and sudden extreme climate change are such tail risks. These are not zero-probability events; each of these has happened at some point in history.

Consider an asteroid hitting the Earth. In their 1994 paper in the journal Nature, Clark R. Chapman and David Morrison estimated that there is a one-in-10,000 chance that a 2km diameter asteroid or comet will collide with the Earth during the next century, disrupting the ecosphere and killing a large proportion of the global population. This represents a higher chance of dying from an asteroid impact than in a plane crash or a flood.

That may sound surprising, but the reason is that even though an asteroid hit is rarer than plane crashes and floods, if one occurs, a very large number of deaths is inevitable.

A much larger asteroid, with a diameter of around 10km caused the Cretaceous-Tertiary (KT) extinction. Based on simulations, scientists today believe that when it hit 66 million years ago, about 75% of all species went extinct, more than 99.9999% of all living organisms on Earth died, and the carbon cycle came to a halt.

Such asteroids are estimated to have an Earth- collision likelihood of about one-in-a-hundred million per year, but with it comes the certain extinction of the human race.

Another example is a solar flare—a brief eruption of intense high-energy radiation from the Sun’s surface, causing electromagnetic disturbances on the Earth and impacting radio frequency communications and power line transmissions.

One such flare, known as the Carrington Event, knocked out the telegraph system in North America in 1859. If it were to happen today, it would knock out all our electronic and communication systems. Imagine large cities without electricity for weeks, or even months, and the world without electronic communication systems.

Writing about climate change, Nobel Laureate William Nordhaus specifically warns us about fat tails. Fat tails are deviations from normal distributions; i.e. probability distributions with relatively high likelihoods of extreme outcomes. For instance, a 5% chance of a 10-degree Celsius temperature change, or a 1% chance of a 20-degree Celsius temperature change.

Nordhaus has conducted cost-benefit analysis to guide governments in public goods investment towards climate change mitigation, both gradual and extreme. In 2015, Microsoft co-founder and philanthropist Bill Gates warned the world that we are underprepared for a global epidemic and that a virus would likely cause more death than war in the next decade. He backed it up by making investments in public health and sanitation, and through an initiative for vaccine delivery to less-developed nations. Economist Alex Tabarrok has warned of asteroid collisions and made a case for larger investment in global public goods, like space research on asteroid deflection.

As individuals and as a society, we evaluate the chances of events, the risk posed by those events, and make plans accordingly. We usually pay very little attention to very-low-probability events despite warnings from these experts. Citizens as well as governments have a tendency to address high-probability events affecting larger numbers of people on a daily basis—like education, health, and public infrastructure—and perhaps rightfully so. It is important to pay attention to higher probability events that may affect us adversely and impact large numbers.

However, not paying any attention at all to catastrophic tail risks could have dire consequences, as 2020 has revealed. It is time to build global coalitions across countries, organizations and associations to collaborate and start investing in mitigating some of these tail risks.

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Published: 05 Jan 2021, 05:41 AM IST
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