‘Keep It Simple Silly’ is all very fine as rhetoric goes. The harsh truth is we end up making things complex, as evindenced in the Barclays’ controversy over manipulating Libor rates.
Theory says that ants will always find the shortest route to a food source. Why? Imagine that two ants leave the nest in search of food at the same time, each taking a different path. Both leave some chemical markers to trace the path they have taken when they return to their nests. The ant that located a source of food nearest to the nest would obviously return first and, as is its custom, would leave those chemical markers on the way back too.
Smart insects that ants undoubtedly are, they correctly deduce that the path that has more chemical markers (remember that the ant that returned with a morsel of food would have left twice the amount of these markers compared to the one that took a longish route to a food source and is therefore yet to return) is also the route to the nearest source of food.
Of course, it also helps that ants have none of the ego hassles that ordinary human beings seem afflicted with, that always prompt them to entertain such doubts as, ‘‘is it indeed the correct route?”, “why should I follow that idiot?’’ and so on. But it would seem that ants have their idiosyncratic moments as a German television channel found out to its dismay some years back. They wanted to shoot a programme to demonstrate the metronomic efficiency of ants, hoping it would resonate better with a German audience, who are, if anything, more wedded to the notion of process efficiency than ants could ever possibly be.
Unfortunately, the Argentinean ants they chose, to demonstrate the phenomenon, did not play ball, as it were, when the researchers helping the television crew with the programme, conducted the experiment. They simply kept taking a longer route to the food source!
The researchers who had built a huge research practice around the idea of what they described as ‘swarm intelligence’, were clearly not amused. They however chose to explain it away by saying that the ants haven’t suddenly become irrational.
It is just that the bright lights that the television crew used to light up the path that they expected the ants to take actually threw them off balance. So, they ended up taking the longer route which was then the only path with any markers at all.
Of rational expectations
The story is really not about whether ants are rational creatures or not. Nor indeed is it about the presumed rationality of human behaviour — a defining principle for pretty much everything in economics.
One can actually argue both ways. If ants aren’t rational, that only strengthens the case for greater rationality among human beings. It is a case of, that’s-why-ants-are-the-lowly-creatures-that-they-are and-we-are-what-we-are.
On the other hand, one could argue that if even ants are expected to not behave rationally at all times (at the very least), can human beings be expected to do so? So out goes the theory of rational expectations guiding human behaviour.
But there is a third way of looking at it. Whether you are an Argentinean ant or a human being, all living creatures, whether by nature or by circumstances, are forced to choose more complex alternatives when simpler ones are available. “Keep It Simple Silly’’ is all very fine as rhetoric goes. The harsh truth is we end up making things complex for ourselves.
The current controversy about Barclays manipulating the LIBOR rate ‘fixings’ is an apt case of the banking industry coming up with a complex response to what was after all a simple requirement.
London had just become the global financial centre with both lenders and borrowers congregating to do business. The lenders did not want to lock themselves to a fixed rate of interest on their loans, given that they would have to raise funds for short durations of time.
The interest rates needed to be a variable one with a base rate that reflected the cost of funds for short durations of time. So, what should have been the logical answer under the circumstances?
Banks should have reported their transactions of short-term borrowings to a central clearing house (British Banks Association) on a daily basis and the Association could have put out a median rate that would have formed the benchmark for everyone to fix an actual lending rate for individual loan transactions. Instead, what they came up with as a model was where each bank was expected to come up with an estimate of what it thought it would have had to pay on the off-chance that it would need to raise funds for short spells of time. The system was thus tailor-made for “match fixing” if one may call it that.
It is no coincidence that the process of arriving at the Libor rate was called the ‘fixing’! After some time, even the pretence that this had something to do with banks’ own borrowing requirements was given up. It became a banker’s estimate of the rate at which the banking industry, meaning every one other than themselves, would be able to raise funds. The circle of complexity was thus neatly closed. The rest is history.
Watered down solution
Banking industry is not unique. Others in the corporate world were just as prone to this affliction. The company where I was once employed as an internal auditor was in the process of putting up an iron foundry. But casting molten metal into various forms and shapes has always been a dirty process.
The company was, therefore, keen to locate the core process of casting molten metal underground so that visitors to the plant would get to see only the more elegant aspects of manufacturing automotive castings.
But the construction company which was entrusted with the job of erecting the factory soon ran into a problem. The basement got flooded. The area had to be dewatered simultaneously, keeping the construction activity going. Since dewatering was not envisaged to be an aspect of work for putting up the foundry, the question before the company was: How was the civil engineering contractor to be remunerated for this additional piece of work?
You would have thought that the answer to that problem would be to estimate the cost of pumping out a litre of water over a certain height and install a flow meter to measure the quantum of water pumped out. Instead, the company came up with the answer that it will be based on the hours that the pump was operated never mind that there actually might not be any water to pump out.
As it happened, the company got billed for many, many hours that if the pump had to be run that long to evacuate such abundant supply of water at just 100 feet of depth, the land should really have been used for farming the whole neighbourhood instead of being used for producing castings for automotive engines.
A worse example of the preference for an intricate solution where a simpler and a more straight-forward approach would have sufficed could not have been devised.