Sep 28, 2022 7 min read finance

🏅Extremistan - The Place Where Winners Take it All

But are winners safe?

I normaly listen to Workinonit by J Dilla when I make these collages.

The top 1% of Chess Players have 90% of medals, the top 1% of books get 99% of sales, the top 1% of researchers get all the credit, the rich seem to get richer and the poor seem to get poorer.

Let's talk about some inequalities.

I wanted to get more in-depth on this concept, Extremistan, that I mentioned in a previous post (Intelligent Investments with Nassim Taleb).

But I'll keep introductions short so everyone can grasp the concepts.

Behind the Extremistan is a very curious 2000 years old effect.

Cumulative Advantage

Here's Matthew 13:12:

For whosoever hath, to him shall be given, and he shall have more abundance: but whosoever hath not, from him shall be taken away even that he hath.

It's amazing to see that this was understood back in a time when people didn't know anything about exponential functions or cumulative returns.

This is the consequence of cumulative advantage, and it can be applicable to fame/status/money/etc. This effect can also be applied to the popularity of ideas(More on this at a later post when we discuss Karl Popper and his ideas regarding scientific research).

Matthew Effect - Preferential Attachment

The term Matthew Effect was coined by two sociologists: Robert K. Merton and Harriet Zuckerman. At first, it was used by social scientists when describing the inequality among themselves in how their research papers were ranked.

This sociological term was then used to describe the fact that renowned scientists would often get more credit than lesser-known ones, even if their themes or objects of study are similar.

It follows then that those who are already famous will get more credit. And that even applies to a singular project, the senior researcher will get more credit for a paper even if most of the work was done by a graduate student.

But the key thing is that Merton argued that not only did the most famous get more credit for equal valid work, but even high-quality articles by lesser known scientists would get inferior citations and credit than worse ones by famous scientists.

The result of this would lead famous scientists to feel more self-confident and end up exploring more risky areas of research.

But then scientists and economists realized that this comes up in many other contexts. The systems that follow the Matthew Effect are said to show preferential attachment (That's the catch name common to all the different articles and publications out there if you are wondering).

Examples

Network Science

Nodes with more links attract newer links more often than nodes with fewer links, even if the links were randomly generated at the starting point(Source).

That can show how a social network is preferred over another that has fewer peers.

Notice how we didn't even mention WHY one node would have more links than another? It could be due to random chance and the effect still applies.

Metabolic Networks

There have been research papers demonstrating the same pattern of connectivity amongst enzymes inside Escherichia Coli (Source).

Sexual Networks and Actors in Hollywood

Preferential attachment (Matthew Effect) has been demonstrated with a ceiling limit(likely due to physical limits) in sexual contact networks and the number of co-actors in a movie.

Interestingly it seems as if the number of collaborators or co-actors in a movie might have a lower limit than the number of maximal feasible sexual partners (Source).

In simple terms and grossly oversimplified: "It's easier to have more sex with a large number of people than it is to have a large number of collaborators/co-actors in a movie".

Extremistan

Now we get to the end result of an environment based on the Matthew Effect. This is a place where very little data can have a huge impact on the overall statistical properties of a system.

This is where we rank all people with Chess Medals and 1% of players have 99% of medals, and also pick everyone that lives in the isle of Manhattan and compute their net worth.

If there is one billionaire in this group, their money will dominate over the sum of all the other folks there combined.

So when you see Extremistan, remember this: one small observation can significantly change the overall amount observed.

We have then one piece of what characterizes the Extremistan, which is how one observation can dominate over the observed data measurement results.

But there's still one piece missing about what Extremistan actually is.

Merton Missed a Spot

In Merton's idea, the Matthew Effect would mean that the winners would keep on winning, and the losers keep on losing forever. But that's not quite what happens...

Sometimes a winner comes out of nowhere to replace the current #1. In fact, we have lots of data points to show this as it happened in the past.

Netflix replaced Blockbuster.

BlackRock became the world's biggest investment firm in the last 10 years(their story is indeed impressive, look it up)

Homo Sapiens came out and wiped 99% of fauna before we even invented agriculture.

Google Replaced Alta Vista. And there have been reports of how the new generation(Gen Z) are using TikTok as their main search engine(Source). As Nassim pointed out, he is ready to replace Google with some newcomer in the next editions of his books.

No one is safe.

Theories involving preferential attachment don't explain newcomers taking all the wins from previous winners. They only explain a part of the picture, not all of it.

How did Rome, with over 1.2 million habitants in the first century AD end up with a population of 12000 in the third century AD? How did Philadelphia's economy get obfuscated by New York's? How did the US come to replace England as a World power?

Just because you are winning today, it does not mean you are protected from Black Swans (highly unlikely events that completely change the properties observed in a system) taking over your spot.

We can have lots of fun looking at authors that were renowned in a specific century and completely forgotten in the next one.

Luck is the Great Equalizer

Just like luck might have gotten you a headstart on the preferential attachment game, it might eventually lower you down and lift up someone else. And that is especially true in the Extremistan, where the unseen changes the game.

Just like no one is safe, no one is completely doomed to extinction either. Where there is life, there is hope.

It's true that the internet creates a small concentration of the most accessed websites (Google is one of them). But it also allows proto-Googles to quietly emerge, and also the inverse-Google: People with a specific product or service to have a small, stable monetizable audience.

Let's see an example for book writers. A small bookshop down the street that can store about 5 thousand books can't afford to offer books the owner knows aren’t best-sellers. They can't afford the risk.

Even a big Barnes&Noble can't afford it with its 130k book storage.

But an online bookshop? Because Amazon or other websites that sell books have the option of listing a book without having it in storage, they allow newcomers to publish without the risk that physical bookstores face. Newcomers might get enough traction on their books and eventually get to a point where preferential attachment runs its course.

There's even more exciting news. Now Printing on Demand is becoming a real thing for online creators, people are able to design t-shirts, books, hats, and all sorts of things, and companies like Printful will handle the manufacturing only when an item gets sold.

Fat Tails

Remember Fat Tails? here's a refresher:

Fat tails host rare, never seen before events that completely change the observed environment.

Those events give the small fish in the sea a collective power to dominate a considerable market share for culture and commerce (more on successful businesses with small client bases in a later post).

Thanks to the internet all the niches and specialties can survive in an environment whereas before it they would never have the chance (think of all the content creators with themes such as how to train a dog to do X and Y trick, how to create houses made of pure mud and clay, yes they exist, look it up on youtube).

The Extremistan becomes a little bit less unfair than we’d initially assumed, sure we'll live in an ocean with a few enormous fish and a lot of small ones which focus on specific niches. But every once in a while a newcomer will knock out a big fish and take its place. This is the environment we are living in, both economically, culturally, and even in the realm of ideas.

This is the Extremistan. It is ever-changing, no one is safe forever, and no one is doomed to extinction either.

Fat tails are the foundation of the Extremistan. The world isn't fair to small fish but it's at least a bit better for them than a world of pure Matthew Effect. And the world then becomes much more unfair to big fish when compared to the pure Matthew Effect, they don't have their spot forever, and need to constantly watch out for newcomers.

Now that we know what Extremistan is, we can learn to recognize our advantages in it and how to gain from all this luck and chance.

Next, we'll talk about how to position ourselves, and our portfolio, in a way to not only protect ourselves but also benefit from Chaos.

👏 Special Thanks

Thanks to my mate André Mariano for helping me review the text and giving me some tips on which parts I could make clearer.

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