Why You Should Have Paid Attention In Statistics Class

by Stuart Shapiro

Well, there are a lot of reasons but here’s one that is particularly relevant today.  After the financial crisis, many analysts of financial risks, talked about how we were insufficiently prepared for “long tail” events.  These are events that are low probability but have huge consequences (think an asteroid hitting the planet and causing huge damage).  Then people stopped talking about it.  Now in the wake of the Japanese tsunami, again the idea of “long tail” events has come back.  Steven Pearlstein connects the dots.

Even those who say they can assess risks and probabilities to the third decimal point have a history of wildly overestimating their predictive powers. By their calculation, the BP spill could never happen. Nor could the collapse of national real estate prices or the nuclear crisis in Japan.

Part of the problem is that we don’t know what we don’t know. The other part is that small miscalculations of probabilities can have large effects on outcomes when dealing with long periods of time. Think of the sailor who sets off on a voyage a few degrees off course. A few miles out, the error is small, but by the time he crosses the ocean, he may find himself hundreds of miles from the intended destination.

Pearlstein goes on to discuss how globalization and our increasing interconnectedness has made the damages that occur when these low probability events actually occur far greater than at any time in history.  As a result we underestimate both the probability and the consequences of such disasters.  This pattern calls for a greater risk aversion in our public policy making and in our private decision making.

By: Stuart Shapiro

Stuart is a professor and the Director of the Public Policy
program at the Bloustein School of Planning and Public Policy at Rutgers
University. He teaches economics and cost-benefit analysis and studies
regulation in the United States at both the federal and state levels.
Prior to coming to Rutgers, Stuart worked for five years at the Office
of Management and Budget in Washington under Presidents Clinton and
George W. Bush.