Compounding blindness

The mean temperature of the earth today is 16°C – about 1 degree more than the previous century. How much adverse impact can this much change have over the next 10 years?

Trader A makes, on average, 10% better market decisions than trader B. How much more should you pay trader A than trader B?

C and D are companies that build machine learning algorithms to read X-rays. Assuming the only difference between them is that C has 10% more reliable training data than D, how much higher would the valuation of C be over that of D?

In all these cases, the starting point does not seem drastic to us. 1 degree on average doesn’t seem like much – we can hardly sense it. The easy answer to question 2 and 3 would be to make linear extrapolations – pay trader A 10% more, and value company C 10% more. But all of those are bad decisions, owing to our inability to look at how these situations would evolve. More precisely, we fail to look at their compounding effects.

A 1°C change in temperature causes more polar ice caps to melt, increasing the surface area of dark blue ocean water exposed to the sun. This causes more warming and melts more ice caps, which in turn, causes more warming.

The investment decisions that a trader makes over the years tend to pile up. A trader with 10% better judgement makes higher (and safer) profits, giving her more capital and knowledge to work with for subsequent investment cycles. Over the course of 10 years, Trader A would make millions of dollars more than Trader B.

If company X has 10% more training data, and is similar to company Y in all other respects, more people would choose X’s product because of its initial superiority. But this would give org X more user data from their new customers, making their product even better and would cause it to grow exponentially larger than Y’s product in the years that follow. This is why starting generic search engines, online marketplaces or social networks are all terrible business ideas.

The vast majority of humans in the world do not comprehend how compounding works. While a minority benefits as a consequence, humanity’s most deadly crisis in the 21st century stares us in the eye.

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