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Second order thinking

Dear readers, I am so excited to be starting 2024 with you and hope we have some great discussions. Today's blog (#90) is relevant for the investing series but is also relevant to all aspects of our world. Today's main questions are: 1) what is second order thinking? and 2) why should we incorporate more of it?

Second order effects in action

The "Barbra Streisand Effect" is named after a 2003 incident involving the singer/actress Barbra Streisand. Streisand attempted to prevent photographs of her home in California appearing online by suing the photographer for violation of privacy. However, the legal action drew more attention to the photos. Prior to the lawsuit, the images were rarely seen, but the legal action sparked media coverage and public interest, leading to far more people viewing the photographs. The second order impacts of the legal action were not considered.

What is second order thinking?

First order thinking considers the first impact e.g. a company has a good product so I should buy its stock.

Second order thinking considers further questions e.g. how does the price of the stock look compared to its prospects? What are the risks and opportunities?

In general, second order thinking not only considers the immediate consequences but trying to anticipate what happens next.

In science, this is like knowing the position of everything. You know exactly where everything is at the given moment. But how do you figure out where they will be a second from now? What are the moving parts? A day from now? A year from now? You can’t without understand how they are moving or how they interact.

Examples of bad second order effects

Let's get away from the abstractions and consider some practical examples:

  1. Opportunity Costs: Taking a mediocre opportunity means that first-order you will benefit from the mediocre opportunity, but second-order it will remove optionality for you to take an amazing opportunity that might come through later.

  2. Financial Incentives: Whilst financial incentives and penalties might feel like a very pure system, second-order they often lead to short-term behaviour and sometimes lead to unethical practices.

  3. Health hacks: There is a huge industry of sleeping pills, weight loss drugs and other lifestyle medicines. Whilst they might be essential in extreme cases, second-order they do not encourage people to make the lifestyle changes that produced those ill-effects.

  4. Buying a 'cheap' product: Buying a low-priced product might be a saving today, but over the lifetime of its use are you really saving anything when you consider quality of use, repair costs and risk of failure?

  5. Hiring for the job not the career: When you hire people for a job not a career you risk ending up with someone that does not have the attitude or aptitude to be promoted or be transferred to an area that needs people. I believe that in hiring, an excellent attitude to learning is a pre-requisite and in some cases trumps more immediately applicable skills.

These are all negative second order effects, but we can sometimes also neglect thinking about positive second order effects.

  1. Technological Advance from space exploration: materials science, telecommunications, and even the development of consumer products like memory foam were unexpected second order effects of the space race.

  2. Adding cycle lanes to cities: Cities that have invested in cycle lanes have reported not only lower traffic but health and wellbeing benefits for their residents, including reduced obesity rates.

  3. Investing in education: Often the first order effect of improving knowledge and skills, can lead to broader economic growth, but also drive innovation, productivity, attract higher-paying industries and promote social mobility.

These illustrate how some activities can have far-reaching, positive consequences that extend beyond the original intent.

When should I use second order thinking?

My hypothesis after 90 blogs, is that our brain values time and energy. The cognitive biases that we talk about, aren't necessarily design errors. If we agonised over every decision we would get very little done. Overthinking leads to information overload and analysis paralysis. There are times though, when we should give extra attention to make sure we avoid making obvious mistakes and put ourselves in the path of second order benefits.

Second order thinking is most important when:

  1. Decisions have long term consequences need you to consider different things when thinking of a policy for 5yrs compared to 50yrs

  2. Dealing with complex systems like the economy, health, societies where actions can have far reaching and complex impacts

  3. Where there is risk of catastrophic downsides or material ethical considerations at play (when should you fire your your nuclear weapons?)

It is no coincidence that these criteria also are when modelling outcomes are least reliable. Whilst analysis can help shine a light on things, it will have a very large margin for error. Many complex systems will result as Donald Rumsfeld famously said "Unknown unknowns", these are the unexpected impacts of any actions that could not have reasonably been considered at the start.

How can you do more second order thinking?

The best time to engage in second order thinking is when you identify you are working on an important decision. The following questions will help you get those second order juices flowing:

  1. What system am I making this decision in, and what are the various factors that might effect it? (Systems thinking)

  2. What are the unlikely but nevertheless possible outcomes? (Scenarios)

  3. How confident am I that the result will be positive? (Probabilities)

  4. What bad scenarios are there for me, and how can I mitigate the impacts? (Risk management)

  5. If this decision has gone wrong in a certain way, what might the second order effects have been? (This is a pre-mortem, trying to work out how it went wrong in advance)

  6. Am I fixing the symptoms or getting to the root of it? (Fixing or patching)

  7. Who might be impacted by this and how might they react? (Psychology)

  8. What other situation that I have looked at does this look like? (Mental models)

  9. What have other people who know something about this said? (Perspectives)

  10. Does this help or hinder us with our long-term goals? (Alignment)

The benefits of second order thinking

Second order thinking improves outcomes in complex situations. Importantly it highlights that outcomes are uncertain, risks and upsides are inevitable and therefore ideally managed in advance. Knowing that outcomes are uncertain allows people to be nimble and adapt to new circumstances rather than be flat-footed if the expected does not happen.

Most of the world's inventions have been driven by unconventional thinking. The Wright brothers used their edge as bicycle mechanics to think differently about flight and crack the challenges. They incorporated second order impacts that others had not considered.

How can you improve your second order thinking?

There are four techniques I use to help improve my second order thinking:

  1. Experiment: Sometimes it is low risk to try out something new. A new route, new exercise or new recipe has low downside and therefore on an intuition I will give it a go. Low risk experiments helps you get exposed to some possible unexpected outcomes and help exercise those second order muscles.

  2. Get new perspectives: Ask people who have experience, and ask them about what unexpected things have happened to them.

  3. Document Your Thinking: When you make a decision, try and outline some second order impacts. This can help clarify your thoughts and be something you can refer to later.

  4. Review Past Decisions: Look back at decisions and the rationale you gave at the time. Did it pan out as expected? Where and how did it deviate. What unanticipated things happened?

So what?

  1. Second order thinking goes beyond immediate effects to consider further consequences. It's not only what does this do now, but what are the systems, scenarios, psychology and probabilities of the situation.

  2. People can make mistakes and miss out on benefits by not considering second order effects. Hiring for the job instead of the career, or building a cycle lane has second effects.

  3. When decisions have long-term impacts, are parts of a complex system or involved some significant risks we should employ second order thinking by asking ourselves the right questions. We can improve our second order thinking by conducting low-risk experiments, seeking diverse perspectives, documenting decision-making processes, and reviewing past decisions to understand deviations from expected outcomes.

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