The Code of Hammurabi: The Best Rule To Manage Risk
Hammurabi was a fair leader and concerned with the well-being of his people. He transformed the area, ordering the construction of irrigation ditches to improve agricultural productivity, as well as supplying cities with protective walls and fortresses. Hammurabi also renovated temples and religious sites.
By today’s standards, Hammurabi was a dictator. Far from abusing his power, however, he considered himself the “shepherd” of his people. Although the Babylonians kept slaves, they too had rights. Slaves could marry other people of any status, start businesses, and purchase their freedom, and they were protected from mistreatment.
At first glance, it might seem as if we have little to learn from Hammurabi. I mean, why bother learning about the ancient Babylonians? They were just barbaric farmers, right?
It seems we’re not as different as it appears. Our modern beliefs are not separate from those of people in Hammurabi’s time; they are a continuation of them. Early legal codes are the ancestors of the ones we now put our faith in.
Whether a country is a dictatorship or democracy, one of the keys to any effective legal system is the ability for anyone to understand its laws. We’re showing cracks in ours and we can learn from the simplicity of Hammurabi’s Code, which concerned itself with practical justice and not lofty principles. To even call it a set of laws is misleading. The ancient Babylonians did not appear to have an equivalent term.
Three important concepts are implicit in Hammurabi’s Code: reciprocity, accountability, and incentives.
We have no figures for how often Babylonian houses fell down before and after the implementation of the Code. We have no idea how many (if any) people were put to death as a result of failing to adhere to Hammurabi’s construction laws. But we do know that human self-preservation instincts are strong. More than strong, they underlie most of our behavior. Wanting to avoid death is the most powerful incentive we have. If we assume that people felt and thought the same way 4000 years ago, we can guess at the impact of the Code.
Imagine yourself as a Babylonian builder. Each time you construct a house, there is a risk it will collapse if you make any mistakes. So, what do you do? You allow for the widest possible margin of safety. You plan for any potential risks. You don’t cut corners or try to save a little bit of money. No matter what, you are not going to allow any known flaws in the construction. It wouldn’t be worth it. You want to walk away certain that the house is solid.
Now contrast that with modern engineers or builders.
They don’t have much skin in the game. The worst they face if they cause a death is a fine. We saw this in Hurricane Katrina —1600 people died due to flooding caused in part by the poor design of hurricane protection systems in New Orleans. Hindsight analysis showed that the city’s floodwalls, levees, pumps, and gates were ill designed and maintained. The death toll was worse than it would otherwise have been. And yet, no one was held accountable.
Hurricane Katrina is regarded as a disaster that was part natural and part man-made. In recent months, in the Grenfell Tower fire in London, we saw the effects of negligent construction. At least 80 people died in a blaze that is believed to have started accidentally but that, according to expert analysis, was accelerated by the conscious use of cheap building materials that had failed safety tests.
The portions of Hammurabi’s Code that deal with construction laws, as brutal as they are (and as uncertain as we are of their short-term effects) illustrate an important concept: margins of safety. When we construct a system, ensuring that it can handle the expected pressures is insufficient.
A Babylonian builder would not have been content to make a house that was strong enough to handle just the anticipated stressors. A single Black Swan event — such as abnormal weather — could cause its collapse and in turn the builder’s own death, so builders had to allow for a generous margin of safety. The larger the better. In 59 mph winds, we do not want to be in a house built to withstand 60 mph winds. But our current financial systems do not incentivize people to create wide margins of safety. Instead, they do the opposite — they encourage dangerous risk-taking.
Nassim Taleb referred to Hammurabi’s Code in a New York Times opinion piece in which he described a way to prevent bankers from threatening the public well-being. His solution? Stop offering bonuses for the risky behavior of people who will not be the ones paying the price if the outcome is bad. Taleb wrote:
…it’s time for a fundamental reform: Any person who works for a company that, regardless of its current financial health, would require a taxpayer-financed bailout if it failed should not get a bonus, ever. In fact, all pay at systemically important financial institutions — big banks, but also some insurance companies and even huge hedge funds — should be strictly regulated.
The issue, in Taleb’s opinion, is not the usual complaint of income inequality or overpay. Instead, he views bonuses as asymmetric incentives. They reward risks but do not punish the subsequent mistakes that cause “hidden risks to accumulate in the financial system and become a catalyst for disaster.” It’s a case of “heads, I win; tails, you lose.”
Bonuses encourage bankers to ignore the potential for Black Swan events, with the 2008 financial crisis being a prime (or rather, subprime) example. Rather than ignoring these events, banks should seek to minimize the harm caused.
Some career fields have a strict system of incentives and disincentives, both official and unofficial. Doctors get promotions and respect if they do their jobs well, and risk heavy penalties for medical malpractice. With the exception of experiments in which patients are fully informed of and consent to the risks, doctors don’t get a free pass for taking risks that cause harm to patients.
The same goes for military and security personnel. As Taleb wrote, “we trust the military and homeland security personnel with our lives, yet we don’t give them lavish bonuses. They get promotions and the honor of a job well done if they succeed, and the severe disincentive of shame if they fail.”
Hammurabi and his advisors were unconcerned with complex laws and legalese. Instead, they wanted the Code to produce results and to be understandable by everyone. And Hammurabi understood how incentives work — a lesson we’d be well served to learn.
When you align incentives of everyone in both positive and negative ways, you create a system that takes care of itself. Taleb describes Law 229 of Hammurabi’s Code as “the best risk-management rule ever.” Although barbaric to modern eyes, it took into account certain truisms. Builders typically know more about construction than their clients do and can take shortcuts in ways that aren’t obvious. After completing construction, a builder can walk away with a little extra profit, while the hapless client is unknowingly left with an unsafe house.
The little extra profit that builders can generate is analogous to the bonus system in some of today’s industries. It rewards those who take unwise risks, trick their customers, and harm other people for their own benefit. Hammurabi’s system had the opposite effect; it united the interests of the person getting paid and the person paying. Rather than the builder being motivated to earn as much profit as possible and the homeowner being motivated to get a safe house, they both shared the latter goal.
The Code illustrates the efficacy of using self-preservation as an incentive. We feel safer in airplanes that are flown by a person and not by a machine because, in part, we believe that pilots want to protect their own lives along with ours.
When we lack an incentive to protect ourselves, we are far more likely to risk the safety of other people. This is why bankers are willing to harm their customers if it means the bankers get substantial bonuses. And why male doctors prescribed contraceptive pills to millions of female patients in the 1960s, without informing them of the risks (which were high at the time). This is why companies that market harmful products, such as fast food and tobacco, are content to play down the risks. Or why the British initiative to reduce the population of Indian cobras by compensating those who caught the snakes had the opposite effect. Or why Wells Fargo employees opened millions of fake accounts to reach sales targets.
Incentives backfire when there are no negative consequences for those who exploit them. External incentives are based on extrinsic motivation, which easily goes awry.
When we have real skin in the game—when we have upsides and downsides—we care about outcomes in a way that we wouldn’t otherwise. We act in a different way. We take our time. We use second-order thinking and inversion. We look for evidence or a way to disprove it.
Four thousand years ago, the Babylonians understood the power of incentives, yet we seem to have since forgotten about the flaws in human nature that make it difficult to resist temptation.