I got a mail from a student. Nikhil wrote:

Your approach to multidisciplinary thinking is highly pragmatic but it is an approach never taken in the entirety of our education. Throughout we are taught subjects individually and each of the problems that we are given is confined to the context of that particular subject only, even in our MBA the cases that we have usually try to deal with a business case within the context of a few concepts from a particular field such as marketing, finance or operations. Hence my problem is that I find it very difficult to be able to come out of the confines of one particular subject and think of a problem in a more holistic manner which would be useful in real life as well. The key issue is making a connect between the problem at hand and the list of mental models that you have stored away in the back of your head. Your functional equivalence approach is very useful but again how do you learn to apply it in situations? Can you guide me as to how I can start training myself to think in such a fashion, looking at a problem and coming up with a set of concepts to apply as in like the check-list you mentioned?

Nice mail.

I promised Nikhil that I will write a teaching note. This is that note.

Socratic Solitaire

I am going to play a game based on ideas derived from Socrates and Charlie Munger. We will start with “Socratic Questioning” which is described as

disciplined questioning that can be used to pursue thought in many directions and for many purposes, including: to explore complex ideas, to get to the truth of things, to open up issues and problems, to uncover assumptions, to analyze concepts, to distinguish what we know from what we don’t know, to follow out logical implications of thought, or to control the discussion.

Socratic Questioning relates to “Socratic Method,” which is:

a form of inquiry and debate between individuals with opposing viewpoints based on asking and answering questions to stimulate critical thinking and to illuminate ideas.

Charlie Munger started using these two Socratic devices in a variation he called Socratic Solitaire, because, instead of a dialogue with someone else, his method involves solitary play.

Munger used to display Socratic Solitaire at shareholder meetings of Wesco Corporation. He would start by asking a series of questions. Then he would answer them himself. Back and forth. Question and Answer. He would do this for a while. And he would enthral the audience by displaying the breadth and the depth of his multidisciplinary mind.

I am going to play this game. Or at least, I am going to try. Watch me play.

Rules

What are the rules? Here are some tips from Charlie.

If you want to get smart, the question you have to keep asking is “why, why, why, why?” [Being Curious] Relate the answers to a structure of deep theory. You’ve got to know the main theories. And it’s mildly laborious, but it’s also a lot of fun. If you get into the mental habit of relating what you’re reading to the basic structure of the underlying ideas being demonstrated, you’ll gradually accumulate wisdom. [Connecting experience with mental models using pattern recognition] To a man with a hammer, everything looks like a nail. Don’t try to answer the question which begins with “why” by using the first explanation that comes to mind. Use a checklist. [First Conclusion Bias]

So, that’s what I’ll do. I will pick up the newspaper and identify a story. I will then ask a question relating to the story which I will try to answer by relating what I read to multiple mental models in my head. As I do that, I will experience related thoughts. I will not control those thoughts. More questions will arise. I will continue to relate my thoughts and questions to mental models from multiple disciplines. I will allow my mind to wander from one discipline to another finding more questions and looking for answers. In seeking answers, I will need some tools.

Tools

I will use five tools: (1) My brain; (2) My computer; (3) Wikipedia; (4) Google; (5) a couple of cards from Creative Whack Pack; and (5) My Kindle.

Each of these has its own benefits and disadvantages. My brain cannot store everything, but is good at recognising patterns. I have a ton of stuff I have collected on my computer over the years and I am likely to find something interesting that is related to whatever I am investigating but my computer can’t possibly have everything that’s worth knowing on the subject. So, I’ll get leads and I will investigate by going to Wikipedia, which is a great free resource for research but I have to be careful about its accuracy. Google is a great search engine but it also produces results which can cause unnecessary distractions. On the other hand, my Kindle has a a better organised body of knowledge – my library of 396 books. Kindle has a search function which allows me to search for terms across all my e-books which solves the “I-know-I-have-seen-something-like-this-before-but-I-don’t-remember-where” problem in paper books. Moreover, I expect to serendipitously find things related to my search terms – things I did not know existed in my library but have popped up while I was searching. At the same time, I must be careful not to get too distracted.

So I have my tools near me. Now I need a topic.

Topic

Let these pictures give us the topic.

Oh Shit! Who died? Why are these women crying?

What’s going on here? What are these people doing? What’s that building in the background?

These people are protesting against the construction of a nuclear power plant on India’s East coast in a place called Kundankulam in Tamil Nadu. The building in the background is Kundankulam Atomic Power Station and the women in the earlier photograph are crying because they are petrified at the idea of living near a nuclear power plant. You can read more about the ongoing protests from here.

Cards on the Table

But wikipedia only tells us about this one project. Our task however, begins from here. Let me now put one of the cards from Creative Whack Pack on the table.

Let’s get curious like Leonardo da Vinci and ask some questions.

Why are these people protesting? What are they scared of? How can we learn more about what’s happening in Kundankulam? Are there any precedents? What do they tell us? Is is only about nuclear power or are there other situations where similar protests happen?

Before I attempt to answer these questions, let me first put my second card from Creative Whack Pack on the table.

Now, I am going to use my associative brain, together with my research tools to study this topic.

Letting My Mind Wander (but not too far from topic)

Here are some thoughts that immediately occur to me – in no particular order. I record them in a mind-mapping software. While playing socratic solitaire I am essentially brainstorming with myself, so organizing thoughts is not as important as capturing them in the first place.

While you read about these thoughts, also notice how my associative memory (connection with a mental model) works. Here are some thoughts.

Clearly there is Recency effect here (Bias from Availability Heuristic). People over-react to recent event and a recent event that’s clearly effecting these people is the Fukushima disaster. Vividness (Bias from Availability Heuristic) is clearly there. The media coverage of the Fukushima situation was so vivid that it’s easy to see why these people are worried. Clearly there is loss aversion here. Precisely because of the recency and vividness effects, people over-react to extremely low probabilities. When fear is looming in their heads, they don’t think probabilities, they think possibilities. Events that are extremely bad but also extremely unlikely are likely to be over-weighed if they occupy people’s minds. Moreover because losses loom larger than gains, people who lose over-react to the loss of perceived security, while people who gain from cheap and abundant electricity don’t value gains equivalently. This will happen despite the fact that number of people who have died in nuclear accidents is a tiny fraction as compared to the number of people who die because of lung cancer caused by pollution due to proximity to coal fired power plants. This is insensitivity to base rates. People ignore prior statistical experience in favour of influential stories. Nuclear and radiation accidents have, from 1961 till date, resulted in only 69 deaths. Globally. Nuclear power plants are among the safest things engineers build in the world (Margin of Safety). But try telling that to a person who is contemplating living near a nuclear power plant. Hang on! This reminds of the situation of those people who already live near Dams. How do they treat the threat of dam bursting. It turns out that the closer they stay near the dam, the less worried they are. This is psychological denial and i wrote about it almost seven years ago. Notice, I don’t use the label of “psychological denial” in my head. For me people suffering from psychological denial, which is an extreme form of bias from commitment and consistency are the functional equivalents of Jared Diamond’s “Dam Fools.” (It’s good to use catchy labels like “Dam Fools” and “Boiling Frogs” instead of boring one like “psychological denial” and “slow contrast.” Is there a generalised model which explains why people don’t want power stations, railway stations, airports etc near where they live? Yes of course! It’s called NIMBY – Not In My Backyard. NIMBY is a subset of incentive-caused bias. People realise that they need electricity but they don’t like to have power stations (and especially Nuclear Power Stations) in their backyards. They conclude, incorrectly, that what’s bad for them is also bad for civilisation. Clearly there are other “interests” involved. For example people with a political agenda have an interest in provoking the protesters by bringing the fear factor to the forefront of their minds (Availability Heuristic). Pavlovian association which arises out of Representativeness heuristic clearly exists here – in the minds of people who live near nuclear power stations, all nuclear power accidents are comparable, even when they are not. Let me think a bit about how the problem from society’s viewpoint instead of the viewpoint of people protesting and other people with political motives. How should a right thinking leader think about this NIMBY problem? What are the possible solutions. Well, I know what the solution isn’t. (Invert, always invert). Ben Franklin’s advice then “if you were to persuade, appeal to interest, not reason” applied here in hordes. No amount of statistical evidence based reasoning as in “This installation is super safe and you have no cause to get worried blah blah blah” will ever work. (Insensitivity to base rates). An appeal to reason won’t work. So what will? Hmmmm. I have to appeal to interest. I have to find a way for people to want to live near a nuclear power station. Reminds me of the Tom Sawyer story in which Tom uses the “scarcity” principle to get his friends to paint a fence – a task that was boring to begin with but became desirable when it became scarce. What if there was an auction in which people bid money to get a right a to stay right in the vicinity of the nuclear power station? To invoke the scarcity principle, the govt may mandate that free electricity will be given to all homes within 10 km radius of the power station. That’s the incentives superpower. Wouldn’t that get many people interested in living there? Who knows? But I think it’s the right way to approach the problem. Appealing to reason won’t work, appealing to interests, just might. If people in Mumbai couldn’t care less about living right next to a nuclear plant, why should people living in Kundankulam care? Maybe people in Mumbai can influence scared-to-shit people in Kundankulam. Maybe social proof will work. Incentives should work better. But these things are not mutually exclusive. Why not try both? What’s the downside?

Interesting ten thoughts, no? And they began after I saw a couple of vivid photos. Now I want to allow serendipity to help me even more. I will do this by employing the remaining two research tools: my computer and my kindle.

Searching My Computer

Over the years, I have accumulated so many documents on my computer that the space they take up adds up to about 300 gigabytes!

Now I know serendipity works beautifully. So let me search for the term “NIMBY” on my computer. Who knows what I might find? Let’s see.

Searching, searching, displaying search results…

Whoa! What an astonishing gem I found. Granted, it may not be directly related to NIMBY, but its bloody interesting to me especially in context of what’s happening in Indian power sector. What did I find?

I found extracts from talks given by Warren Buffett and Charlie Munger. Let me reproduce them here. Their words:

Buffett: Politicians don’t like to face major brownouts. They can try and blame it on someone else – and they may well be accurate in blaming it on someone else. But the public is going to, at least partially, blame political leaders if this country runs out of electricity – because it hasn’t run out of the ability to build generators. We could create all the generators we need to have plenty of electricity – and we could create the transmission lines and all of that.

But you do need a flow of capital to the industry. And the law restricts that flow to quite a degree, I would say.

Munger: Well, the production of electricity, of course, is an enormous business – and it’s not going away. And the thought that there might be something additional that we might do in that field is not at all inconceivable. It’s a very fundamental business.

You’re certainly right in that we have an unholy mess in California in terms of electricity. It reflects, I’d say, a fundamental flaw in the education system of the country; that so many smart people of all kinds – utility executives, governors, legislators, journalistic leaders – seemingly had difficulty recognising that the most important thing with a power system is to have a surplus of capacity. Is that a very difficult concept?

Everybody understands that if you’re building a bridge, you don’t want abridge that will handle exactly the maximum likely load and no more. You want a bridge that will handle a lot more than the maximum likely load. And that margin of safety is just enormously important in bridge-building.

Well, a power system is a similar thing. Why do all of these intelligent people ignore the single most obvious and important factor – and just screw it up to a fair-thee-well?

Buffett: Charlie’s obviously right in that from a societal standpoint, you’ve got perhaps three goals in what you would like your electric utility business to be. One is that you would like it to be reasonably efficiently operated. Secondly, since it does tend to have in many situations monopoly characteristics, you would want something that produced a fair return, but not a great return, on capital – enough to attract new capital. And then third, you’d want this margin of safety – this ample supply.

When you’ve got a long lead time to creation of supply –which is the nature of putting on generation capacity – you need a system that rewards people for fulfilling that obligation to maintain extra capacity. A regulated system can do that. If you give people a return on capital employed so that if they keep a little too much capital employed they get paid for it, then they’ll stay ahead of the curve – they’ll always have 15-20% more generating capacity than needed.

One of the disadvantages of that regulation and the monopoly nature is that it doesn’t have the spur to efficiency. They try to build it in various ways, but it’s difficult to have a spur to great efficiency if somebody can get a return on any capital they spend. Therefore, utility regulators have always been worried about somebody just building any damn thing and getting whatever the state-allowed return is.

But I’d say that the problems that would arise from, say, a little bit of sloppy management are nothing compared to the problems that arise from inadequate generation.

So in California, in my view speaking as an outsider, utilities had the incentive at one time to maintain a little extra generating capacity because they were allowed to earn a decent return on it – a return sufficient to attract capital.

But they you had, I think, the forced sell-off of something like half of their generating capacity. And they sold it at multiples of book value to a bunch of people who became generators who are deregulated and don’t have an interest in having too much supply. They’ve got an interest in having too little supply. So they totally changed the equation – because the fellow with the deregulated asset for which he paid 3 times book now has to earn a return on that 3 times book what the fellow was formerly earning under the regulated environment at 1 times book.

So he’s not going to build extra generating capacity. All that does is bring down the price of electricity. He hopes things are tight. If you’ve got a utility plant that was put in place at X and then you go out and encourage entrepreneurs to buy it at 3X, you can’t expect electricity prices to fall. So you’ve created a situation, in my view, where the interests of the utility companies have diverged in a significant way from the interests of society. And that was a very, very basic mistake. It just doesn’t make any sense to me – but maybe I don’t understand it fully.

I really think that the old system made more societal sense: Let people earn a good return (not a great return, but a return that attracts capital) on investment that has built into it incentives to keep ahead of the game on capacity because you can’t fine-tune it that carefully. And you do have this long lead time.

Now, what you do with the scrambled eggs now – with all the political forces back and forth… I think that you better have a system that encourages building extra capacity because you don’t know how much rainfall there will be in the Pacific Northwest and therefore, how much hydro will be available. And you don’t know what natural gas prices will do and, therefore, whether it’s advantageous for a gas-fired turbine to be operating.

The old system really strikes me as somewhat better than this semi-deregulated environment that we have more or less stumbled into. Charlie, what do you think?

Munger: Of course, even the old system got in some troubles. Everybody had the NIMBY syndrome – “Not In My Back Yard.” Everybody wanted new power plants to be anyplace not near me. If everybody feels that way and if the political system means that the obstructionists are always going to rule – which is true in some places in terms of zoning and other matters – you’re in deep trouble. If you let the unreasonable, self-centered people make all of the decisions of that kind, you may well get so that you just run out of power. That was a mistake.

And we may make that mistake with the oil refineries. We haven’t had many new big oil refineries in the last period. So you may get to do this all over again.

Shareholder: You talked about your interest in investing in new electrical capacity. Would you expound a little bit in terms of what you think would be a rational business model and a fair social model for doing so?

Munger: Well, of course, the energy situation in California is a disgrace. It’s a disgrace to our educators who turned out people who could make such dumb decisions in spite of going to the best colleges and the best business and law schools. It’s a disgrace to both political parties who sat around. It’s a disgrace to the executives that participated in making the decisions. There‚s enough disgrace to go around. There was an easy idea to retain when you’re running hospitals in the middle of a desert where it’s 110 degrees outside. It was not a radical, hard-to-grasp idea that the one thing the civilization always wanted was a surplus of generating power. Is that really difficult to understand? Well, of course it isn’t difficult. But all these people had these other models: If we simply have free enterprise‚ meaning deregulation, as they called it‚ it will automatically cause a surplus. Well, of course, it didn’t automatically cause a surplus. To have a surplus of generating capacity, you’ve got to have a surplus of well-fueled plants capable of generating the electricity.

And of course, there’s the system of allowing NIMBYism (Not In My Back Yard)‚ everybody wants the school, but not near me. So no new school is created for 10 years in Los Angeles and the kids are in unspeakable conditions. Everybody wants a power plant, but not near me. And if you just allow that kind of paralysis in our governmental system‚ We richly deserved this miserable result. We earned it fair and square by extreme stupidity and indifference. And we’re doing the rest of the country an immense favor. We’re like the canary in the mine that dies, but saves the other miners. State after state is looking at California and saying, Boy, have those guys done us a favor. That is one kind of stupidity we don’t want to have.

So, obviously, we need excess generating capacity. And we’ve got to reduce the pollution as much as we can. But once we’ve got it down as low as it’s feasible to get it, we’ve got to have the capacity. We also need conservation. We also need utility rates which encourage the right habits. There are perverse incentives built into the rates. And there are all kinds of ways that could have been done better. It’s obvious what should be have been done: the right incentives in the rates, always a surplus of power. This does not take great brain power. But we just mushed around in the same crazy way we did with the public schools‚ and we allowed something very important to go to hell. It was really awful behavior‚ awful cognition.

And what’s really bad is that you can go to modern academia right now and nobody’s ashamed of these recent bad results. They think if you teach about Beowulf, you’ve done your duty. And the fact that the people leave you and can’t think their way out of a paper sack is not their fault. But that’s not true. We should be graduating people from our educational institutions that can think better and behave better. Sometimes you have to stand up and do things that are against your own interests, but in the interests of the larger civilization. And we have all failed to a fair-thee-well.

That said, we’re going to need a lot more power. And there’ll be all kinds of creative ways to handle the thing. There will be some opportunities in the future. It’s a great, big permanent business. And electrical power is not going to be obsolete. There aren’t many fundamental things in nature. And one of them is electrical power‚ electromagnetism. It’s not going away.

Wow! Cool isn’t it? And how did I find this? By storing it when I read it many years ago, then forgetting about it, then while working on this project letting my mind wander and searching for NIMBY on my computer and finding it all over again!

Never ever underestimate the power of serendipity.

So what should we learn from the above extracts from Buffett and Munger?

Indian power tariffs just have to go up. The state electricity boards are bankrupt. If India wants more electricity it has to produce the right incentives. And allowing a decent rate of return isn’t sufficient. You have to ensure that the return is actually realized. If state electricity boards can’t and won’t pay electricity bills of generators, then the promised return is not earned, so India can forget about attracting private capital. Those half finished power plants which depended on “cheap” south-east Asian coal that became expensive later on won’t be finished unless tariffs were increased. It doesn’t matter what power purchase agreements say. If coal price is not allowed as pass-through the regulator or government can’t say too bad! If they do that, the plants won’t get finished and India must live with electricity shortage. Incentives matter.

If you keep on giving free electricity to farmers, then you will eventually get shortages. People will have perverse incentives to divert power from agricultural usage to non-agri usage. It’s very hard to stop it. Gujarat has done it. Every state must follow what it did. But do the politicians have the will (balls?) I doubt it. So until the politicians can be “convinced” that to get surplus power, the generators must be more than adequately incentivised, India power sector will suffer and India will suffer along with it. Nuclear power is cheap, and much safer as compared to coal power especially when health costs are concerned. Kundankulam Project must be finished.

Cool, now that I have given my sermon, I can move on to the last tool I will use for this exercise.

Searching my Kindle

There are many reasons why my wife is jealous of my Kindle but one huge reason why I love it so much is it has an awesome feature. As I type this blog, I find that I have 440 books on my Kindle. That’s an enormous library isn’t it? When all my books were on paper, I had this problem which inevitably made me say these words:

Shit man, I have read about NIMBY in some of my books but I don’t remember which ones!

And then I would spend hours browsing through books looking for that elusive sexy girl called NIMBY but I could never find her. I had a faint recollection of spending some very enjoyable time her but I could not find her anymore.

Enter Kindle. End of problem. Kindle allows you to search across all your books on the device for NIMBY or SUZIE or any woman or idea or concept you want to search. It’s like a google search engine on your books.

So I will do that now. I will search for NIMBY on my Kindle.

Switch Kindle on. Go to Search. Type NIMBY. Hit enter. Searching searching searching. A list of book appears. I go though them one by one.

Whoa! Look what I found! This from an excellent book called The Little Book that Builds Wealth.

Moody’s, the slot machine industry, and the for-profit education industry are all examples of single licenses or approvals giving companies sustainable competitive advantages. But this kind of moat isn’t always based on one large license; sometimes a collection of smaller, hard-to- get approvals can dig an equally wide moat.

My favorite example of this is what I call the NIMBY (“not in my backyard”) companies, such as waste haulers and aggregate producers. After all, who wants a landfill or stone quarry located in their neighbourhood? Almost no one, which means that existing landfills and stone quarries are extremely valuable. As such, getting new ones approved is close to impossible.

Trash and gravel may not sound exciting, but the moat created by scores of mini-approvals is very durable. After all, companies like trash haulers and aggregate firms rely on hundreds of municipal-level approvals that are unlikely to disappear overnight en masse.

What really makes these locally approved landfills and quarries so valuable for companies like Waste Management and Vulcan Materials is that waste and gravel are inherently local businesses. You can’t profitably dump trash hundreds of miles from where it is collected, and you can’t truck aggregates much farther than 40 or 50 miles from a quarry without pricing yourself out of the market. (Trash is heavy, and gravel is even heavier.) So, local approvals for landfills and quarries create scores of mini-moats in these industries.

Contrast waste and gravel with another industry that has strong NIMBY characteristics—refining. Although there hasn’t been a new refinery built in the United States for decades, and local approvals for expansions of existing refineries are pretty tough to come by, the economic situation of a refinery isn’t nearly as good as that of a landfill or quarry. The reason is simple: Refined gasoline has a much higher value-to-weight ratio, and it can also be moved very cheaply via pipelines.

So, if a refinery tried to raise prices in a particular area, gasoline from more distant refineries would flow into the locality to take advantage of the higher prices. As a result, while there are regional variations in gasoline pricing, refiners generally can barely eke out high-single-digit to low-teens returns on capital over a cycle, while aggregate producers and waste haulers enjoy much steadier returns on invested capital in the mid to upper teens over many years.

A Journey Ends and Another One Begins

Absolutely incredible!!! Isn’t it?

We started this journey with a couple of photos of emotionally distressed people. As we dug deeper into the likely causes of their distress, we encountered several models from psychology, engineering, and economics. By allowing our minds to wander a bit like Leonardo da Vinci and by employing a technique invented by Socrates and polished by Munger, we discovered possible explanations to something that needed an explanation using a multidisciplinary toolbox. We also used serendipity and the associative nature of our minds to unravel various facets of a gal called NIMBY.

Her most interesting facet, to an investor, was hiding in a book on investing in moats. How one thing leads to another! Now NIMBY will take me for a holiday to a bunch of very exotic islands called MOATS. I will tell you that story on another day. Right now I am going to have some fun with her.

Don’t look.

END