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Cipola and Human Stupidity Laws
📌 In 1976, Carlo Cipolla, a professor of economic history who investigated human stupidity laws, derived a social law by which we can group people into four categories: The first he called “the helpless,” the second “the intelligent,” the third “the bandits,” and the last “the stupid.” Cipolla warned that the stupid person is the most dangerous type of person and in groups far more potent than the Mafia, the Military, or Communism.
📌 To arrive at this conclusion, we must understand his five Basic Laws of Human Stupidity:
First Law of Human Stupidity
First Law: Always and inevitably, everyone underestimates the number of stupid individuals in circulation.
Second Law of Human Stupidity
Second Law: The probability that a certain person be stupid is independent of any other characteristic of that person. Education, wealth, or status have nothing to do with it.
Third Law of Human Stupidity
Third Law: A stupid person is a person who causes losses to another person or to a group of persons while himself deriving no gain and even possibly incurring losses.
Fourth Law of Human Stupidity
Fourth Law: Non-stupid people always underestimate the damaging power of stupid individuals. In particular, non-stupid people constantly forget that at all times and places and under any circumstances to deal and/or associate with stupid people infallibly turns out to be a costly mistake.
Fifth Law of Human Stupidity
Fifth Law: A stupid person is the most dangerous type of person. A stupid person is more dangerous than a bandit.
Cipola and Four Factors of Human Behavior
📌 Cipolla then considers four factors of human behavior. A person can cause benefits to others, benefits to themselves, losses to others, and losses to themselves:
a. If Tom takes an action and suffers a loss, he’s helpless.
b. If Tom benefits himself while also benefiting Jerry, he’s intelligent.
c. If Tom helps himself but causes Jerry a loss, he’s a bandit.
d. And if Tom does something of no benefit to him but causes Jerry a loss, he’s stupid.
📌 Ineffectual people are in the center. Let’s now look at the effects of these groups on society. Helpless people contribute to society but are taken advantage of by others, especially bandits. And so their contribution is limited.
📌 Note that extreme altruists or pacifists may willingly accept a place in this category for moral reasons. Intelligent people contribute to society and leverage their contributions to create reciprocal benefits. Their actions lead to a net gain for society, so helpless people should always support intelligent ones.
📌 Bandits pursue their self-interest and enrich themselves, even when doing so harms society. Helpless and intelligent people should try to stop them. Stupid people always contribute to a net loss to society. But not only that. As they do so for no apparent reason, their actions also frustrate, anger, and confuse everyone else.
📌 Against major cultural trends among his fellow intellectuals, Cipolla was convinced that men are unequal. Some are stupid, others are not, and the difference is determined by nature and nothing else. One is stupid in the same way one is red-haired, he wrote. Cipolla warned that the damaging potential of the stupid person, therefore, depends on the amount of stupidity inherited and their position of power in society.
📌 Among bureaucrats, generals, and politicians, one has little difficulty in finding clear examples of basically stupid individuals whose damaging capacity was alarmingly enhanced by the position of the power they occupied.
Human Stupidity and Capital Market
Carlo Cipolla’s five laws of human stupidity provide a humorous yet insightful framework for understanding human behavior, which can be applied to various fields, including the capital market. Here’s an argument that these laws are being used extensively in the capital market:
Argument for the Application of Cipolla’s Laws in the Capital Market
1. First Law: Always and inevitably, everyone underestimates the number of stupid individuals in circulation.
In the capital market, this law is evident in the frequent underestimation of the impact of irrational behaviors on market dynamics. Investors often assume that most market participants act rationally, following fundamental and technical analysis. However, the presence of numerous investors making irrational decisions, driven by emotions, misinformation, or lack of knowledge, often leads to unexpected market movements and volatility. The 2008 financial crisis, for instance, was partly fueled by a widespread underestimation of the number of individuals making reckless investment decisions.
2. Second Law: The probability that a certain person be stupid is independent of any other characteristic of that person.
This law suggests that stupidity is evenly distributed across the population, regardless of education, wealth, or professional background. In the capital market, even highly educated or experienced investors can make foolish decisions. The collapse of high-profile funds, such as Long-Term Capital Management in 1998, demonstrates that even Nobel laureates and seasoned professionals can fall victim to poor judgment and irrational behavior, highlighting the pervasiveness of human stupidity in the market.
3. Third Law: A stupid person is a person who causes losses to another person or to a group of persons while himself deriving no gain and even possibly incurring losses.
This law is particularly relevant to market manipulation and speculative bubbles. Individuals or entities engaging in pump-and-dump schemes, for example, artificially inflate the price of a stock, leading other investors to incur losses when the price inevitably crashes. These manipulators often derive no long-term benefit and may even face legal consequences, yet their actions cause significant harm to other market participants.
4. Fourth Law: Non-stupid people always underestimate the damaging power of stupid individuals. In particular, they constantly forget that dealing and/or associating with stupid people is a costly mistake at all times and places and under any circumstances.
In the capital market, this law can be seen in the tendency of investors and financial institutions to underestimate the impact of irrational market behavior. During the dot-com bubble of the late 1990s, many investors failed to recognize the extent to which speculative fervor and irrational exuberance were driving market valuations. When the bubble burst, the resulting losses were catastrophic, demonstrating the high cost of underestimating the influence of irrational market participants.
5. Fifth Law: A stupid person is the most dangerous person.
According to Cipolla, stupid individuals are more dangerous than malicious individuals because their actions lead to losses for others without any gain for themselves. In the capital market, this danger is magnified by the interconnected nature of financial systems. The actions of a few irrational investors can trigger a chain reaction, leading to market crashes or systemic crises. The subprime mortgage crisis is a prime example, where the irresponsible behavior of lenders and borrowers, driven by short-term gains and poor risk assessment, led to a global financial meltdown.
Conclusion
Cipolla’s laws of human stupidity provide a valuable lens through which to view the capital market. The presence of irrational, unpredictable, and often detrimental behavior among market participants highlights the need for robust risk management, regulatory oversight, and a healthy skepticism of market trends. By acknowledging and accounting for the pervasive influence of human stupidity, investors and institutions can better navigate the complexities and uncertainties of the capital market.
