Saturday 2 October 2004 ACT New Zealand Upper South
Regional Conference The Wisdom Of Crowds - Roger Kerr
Executive Director Christchurch New Zealand Business
Roundtable
THE WISDOM OF CROWDS Those of us who are
engaged in public affairs may sometimes feel tempted to
feel nostalgic for an age – probably a mythical golden age –
when informed ‘public opinion’ reigned unchallenged. The
nineteenth century sometimes seems like such an age:
earnest, educated people read serious journals and wrote
literate and thoughtful letters to newspapers that were read
by everyone who counted. They shared an unquestioned belief
in science, civilisation and progress that inspired
effective movements for reform of all kinds. Wouldn’t
public policy benefit if we could rediscover their
self-confidence, self-discipline and commitment?
Not
according to James Surowiecki, a financial columnist for the
New Yorker. The disconcerting message of his recent book
The Wisdom of Crowds is that consensus among the
well-informed is quite likely to be wrong. In many areas,
wisdom is dispersed throughout society, often very thinly,
but where it can be articulated, it is usually more reliable
than the wisdom of elites.
Surowiecki begins his book
with an anecdote. It’s about Francis Galton, a British
authority on statistics and the science of heredity who was
active about a century ago. Galton was interested in
heredity because he believed that only a few people had the
necessary intelligence and ability to run society. It
followed that only if power was concentrated in their hands
could society flourish.
In 1906 Galton‘s interest in
breeding led him to an agricultural show, where he came
across a weight-judging competition. A fat ox was on
display and members of the public could place wagers on its
weight after it had been slaughtered and dressed. Assuming
that the average punter would be hopelessly wrong, Galton
borrowed the several hundred betting slips from the
organisers and calculated the mean guess. To his surprise,
it was 1,197 pounds: just one pound short of the right
answer.
Galton had stumbled on what Surowiecki calls a
“simple but powerful truth … under the right circumstances,
groups are remarkably intelligent, and are often smarter
than the smartest people in them … when our imperfect
judgements are aggregated in the right way, our collective
intelligence is often excellent” (pp xiii–xiv).
It’s
worth mentioning that this idea is an old one. Indeed, it
was advanced by the ancient Greek philosopher Aristotle in
the fourth century BC. In his Politics, Aristotle defended a
form of democracy by reference to the ‘wisdom of crowds’:
It is possible that the many, no one of whom taken singly
may be a good man, may yet taken all together be better than
the few, not individually but collectively … Each individual
will be a worse judge than the experts, but when all work
together, they are better, or at any rate no worse.
Note
that, for Aristotle as much as for Surowiecki, the wisdom of
a crowd doesn’t depend on any member of the crowd being
wise; indeed, every member of the crowd could be hopelessly
foolish. But in a crowd the mistakes are likely to run in
all directions and cancel one another out, leaving a sound
judgment in the aggregate.
One anecdote does not
establish a thesis, but the reader of the entire book is
likely to be convinced that Surowiecki is on to something.
Here are a couple more examples.
In 1986, the American
space shuttle Challenger exploded soon after it was
launched, with the loss of all its crew. Within minutes,
the stock market reacted: the shares of the four companies
that had most to do with the construction of the shuttle had
all lost value. But one of them, Thiokol, the manufacturer
of the solid-fuel booster rocket, lost more ground than the
others. Moreover, the next day, when the shares of the
other three companies began to recover, Thiokol’s continued
to fall. Six months later, the official enquiry confirmed
what the stock market (but no one else) apparently knew from
the start: that the seals on the booster rocket were
defective and had caused the explosion. An academic study
of the unique, almost immediate and – as it happened –
well-founded collapse of Thiokol’s stock turned up no
evidence to support likely explanations, such as media
speculation or Wall Street hype. In the end, the researchers
concluded that there must have been some insider dealing,
although they couldn’t prove it. But Surowiecki thinks the
most likely explanation is that it is another example of the
wisdom of crowds.
The other anecdote I’ll mention is
closer to home but perhaps more conclusive. In the
television quiz show Who Wants to be a Millionaire?
contestants stumped by a question can enlist the aid of
friends or relatives chosen on the basis that they think
they are smarter or better informed than themselves. They
can also opt to ask the studio audience. The ‘experts’
turned out to be right 65 percent of the time. But the
members of the audience – supplying answers anonymously and
independently of one another – were collectively right 91
percent of the time. If you ever appear on that show, you
may do better to rely on the crowd than on your smart
friends!
Clearly, we are happy to accept the intuitions
of Surowiecki’s thesis in fashioning some of our social
arrangements. The most obvious in the modern world is
democratic politics. We rely on a universal, unweighted one
person–one vote franchise to choose our governments. The
merits of that form of democracy were by no means so obvious
historically; Aristotle, after all, was challenging Plato’s
advocacy of rule by a philosopher king. Sometimes, as with
Lee Kwan Yew, such rule can be benign, indeed inspired. But
the lesson of the twentieth century is that for every Lee
Kwan Yew there are a dozen or more Joseph Stalins, Idi Amins
and Robert Mugabes.
In choosing a political system, as
with other public policy choices, what matters is the
performance of alternative arrangements on average and over
time. It is unwise to bet against the odds. Democracy is
not perfect but we put faith in the wisdom of crowds for
choosing our governments on the basis that democracy is
better than any alternative. Looking back on the choices of
the New Zealand electorate in the past 25 years, I find it
hard to argue that that faith has been grossly misplaced.
An immediate objection to Surowiecki’s thesis is that there
is plenty of counter-evidence showing the folly of crowds.
The book openly acknowledges this evidence. Witch-hunts,
the rise of Adolph Hitler, and stock market bubbles could
all reasonably be cited as examples of crowds, sometimes
entire nations, taking collective leave of their senses.
Indeed, the assumption that crowds are more likely to get
things wrong than right seems to underlie many of our
familiar arrangements and practices. Where knowledge is
concerned, we have entrenched divisions between experts and
laypeople. While we believe in democracy, we usually stick
with the indirect, representative kind: the idea is that we
are better to let the decisions be made by an elected elite
that has some incentive to become well-informed about
issues, and let the people as a whole judge the results at
the next election. It follows that, if Surowiecki is right
and that “under the right circumstances”, as he puts it, the
amateur masses may be wiser than the professional elites,
some of those practices and arrangements should be reviewed.
Naturally I am interested in the implications of
Surowiecki’s thesis for public policy and I consider some of
these later on.
Under what conditions, then, are crowds
more likely to be wise than foolish? Surowiecki’s thesis
naturally depends very greatly on the soundness of this part
of his analysis. He says that crowds are likely to be wise
when four conditions are met: diversity of opinion (everyone
has a bit of private information, however small);
independence (people’s opinions are not influenced by those
of others); decentralisation (people can specialise and draw
on local knowledge); and aggregation (there must be a
mechanism for turning individuals’ private judgments into
collective decisions).
In the economic sphere we can
note at once a familiar example of ‘crowd wisdom’ as
Surowiecki defines it: the marketplace. The market is driven
by diverse tastes and preferences; consumers normally make
private judgments about those tastes and preferences and can
act on them; the market, being driven by individual choice,
is as decentralised as any institution can possibly be; and
consumers’ choices are continually aggregated by the price
mechanism.
Today it is uncontroversial to argue that,
like democracy, the free market economy outperforms
alternative systems. Again this was not always the case.
Serious scholars in the twentieth century, not to mention
political demagogues, advocated central planning of the
economy. Putting resource allocation decisions in the hands
of ‘experts’, it was argued, would lead to more growth and
prosperity than leaving them to the spontaneous and
unpredictable workings of competitive markets.
The
collapse of socialist central planning has dispelled this
illusion for most. Central planners have neither the
information nor the incentives to make good decisions
compared with the knowledge and incentives of decentralised
economic actors, ie the people at large. Yet we continue to
see innumerable examples of government interventions based
on the premise that politicians and bureaucratic experts in
Wellington can spend people’s money and run their lives
better than they can themselves.
A more specific economic
illustration of the wisdom of crowds is the operation of
financial markets. The prices of financial assets (such as
bonds, stocks and currencies) are determined through
competitive trading. A great deal of research indicates
that these markets are very efficient in the sense that they
reflect all publicly available information about the
fundamental value of these assets. Unless investors or
traders have information that is not publicly available, it
is very difficult for them to ‘beat the market’ – to do
better than the collective assessment of the vast numbers of
people dealing in financial markets every day.
Nevertheless, crowd wisdom is not infallible, and Surowiecki
devotes much of his book to showing how the absence of any
of his four conditions diminishes it. Diversity is
especially important to correct the ‘groupthink’ that can so
easily creep up on teams of experts and lead them astray.
Experiments have shown that groups of people of mixed
ability are often better at solving problems than groups
comprising only smart people. The problem seems to be that
experts tend to share, but also to exclude, a good deal of
knowledge as a result of their training, whereas less smart
types may bring useful information that experts have
collectively forgotten or never had. (Surowiecki cites by
way of examples of failures of ‘expert’ wisdom the
persistently poor performance of professional financial
advisers and the failure in 2003 of NASA to register fears
among some NASA staff about damage to the space shuttle
Columbia, which eventually caused the shuttle to break up
when it re-entered the earth’s atmosphere.) The point is not
that expertise is to be avoided, but that experts can often
learn from lay people, so the best decisions are likely to
be a joint product of both types – if that can be
arranged.
Independence – each member of the crowd should
form a judgment without being directly influenced by the
other members – is an equally important condition for the
wisdom of crowds. Its absence can explain the examples of
mass folly we mentioned earlier. A stock market bubble can
occur when investors stop making independent judgments and
become overly influenced by what other investors think. So
much is clear. But independence also tells against
consensus. The wisdom of crowds is emphatically not
something that emerges from negotiation among the members of
a crowd. Surowiecki cites research showing that group
discussion tends to make the group and its individual
members more extreme in their views than they were
originally (perhaps special interest lobbies bear this out).
This idea too has a good pedigree in classical
democratic theory. The eighteenth-century philosopher
Rousseau argued in The Social Contract that in making
decisions the members of the sovereign assembly should have
no communication with one another and “each citizen should
think only his own thoughts”. Otherwise, Rousseau argued,
the assembly would become corrupted with special interests
and would lose sight of its shared interests. Indeed, we
recognise the political importance of independence of
judgment in the secret ballot, which protects each voter
from undue pressure from other voters: we want voters to
make their own judgment, not one that reflects the influence
of the last person they spoke to.
Decentralisation is
probably the least controversial condition for the emergence
of the wisdom of crowds, since we obviously want every
member of the crowd to contribute to its collective
judgment, and decentralisation encourages specialisation and
diversity. As for aggregation, the last condition,
Surowiecki uses a topical example to illustrate its
indispensability: the activities of America’s intelligence
agencies. As we know, some agents were trying to warn about
the possibility, even the likelihood, of an imminent
terrorist attack on American soil. But as we also know, the
agencies had not worked out a way of bringing together the
collective view of their staff, and so the warnings did not
register where they should have.
I said earlier that I
was interested in the public policy implications of the
‘wisdom of the crowd’ thesis. I’ve already cited the market
as an area in which we generally accept that the crowd is
wise or, at the very least, less foolish than any other
source of judgment. The New Zealand Business Roundtable is,
of course, well-known for its advocacy of markets, and of
extending market processes into certain areas presently
dominated by the state, such as health and education, where
evidence of the wisdom of bureaucratic elites is indeed hard
to come by. These sectors, which are vital to economic and
social progress, remain largely nationalised and centrally
planned; we are still operating, so to speak, behind the
Berlin Wall. In education, for example, school zoning, an
extensive national curriculum, teacher employment
arrangements and the absence of a level playing field with
the private sector heavily constrain decentralised decisions
by individual parents. Not surprisingly, the frustrations
of parents, teachers and the community at large run high.
Worldwide trends towards school autonomy, parental choice
and a greater role for the private sector suggest that the
days of the Berlin Wall are numbered. The shape of the
system would then be determined less by education planners
and more by the cumulative decisions of individual families.
But the more original public policy implications of
Surowiecki’s thesis are for our democratic political system.
Representative democracy, through the universal and secret
ballot, is, on the analysis offered in the book, a way of
eliciting the wisdom of crowds in making collective
decisions. But it is not the only way. Another, which
Surowiecki does not explore, is to make more use of direct
democracy, that is, referenda.
One of the arguments
for representative or indirect democracy, as I mentioned
earlier, is that our elected representatives are in a
position to become informed about issues and that the
general public’s role should therefore be confined to
judging a government’s overall performance. However, this
argument is open to Surowiecki’s objection that groups of
experts are liable to become impervious to relevant
information that non-experts can supply. Governments are, of
course, far from insulated from public opinion. But one of
the causes of the malaise that infects Western democracy is
the rise of politics as a profession, as a result of which
politicians as a whole, whatever party they belong to, seem
to have more in common with one another than with their
electorates, and, along with their advisers and top public
servants, can with some justice be said to constitute a
‘political class’ that is vulnerable to groupthink. That is
to say, representative assemblies are becoming less truly
representative as they lose diversity. Referenda are a way
of counteracting that tendency and getting more diversity
and hence more relevant information into the political
system. They also enhance decentralisation by allowing
members of the public to express views on particular issues,
which they cannot easily do in general elections when they
typically vote for a political party or coalition.
Thus,
contrary to the 1986 Royal Commission on the electoral
system, I see merit in greater use of referenda for making
those decisions that have to be made collectively. It is
surely high time, for example, that the country was given
another say on whether to retain the mixed member
proportional (MMP) electoral system. Even the prime
minister has said that should happen, but has to date argued
that it is too soon to have another referendum. That
argument is becoming less and less credible. In my view the
nuclear ship visit issue is one that would be well-suited to
a referendum; I, for one, would be happy to accept ‘crowd
wisdom’ in weighing up competing claims. And in a report
which the Business Roundtable is releasing this month, the
case is made for amending the Fiscal Responsibility Act 1994
to require voter approval via referenda for new taxes or tax
rate increases.
An intriguing proposal that Surowiecki
discusses is the possibility of a policy analysis market.
This idea seems to have grown out of the Iowa Electronic
Markets (IEM) project that was set up in 1988 as a
competitive alternative to opinion polls. The IEM is simply
a market for betting on the outcome of elections: any member
of the public can “buy and sell futures ‘contracts’ based on
how they think a given candidate will do in an upcoming
election” (p 17). The interesting thing is that between
1988 and 2000 the IEM generally outperformed opinion polls,
even though only a few hundred people participated in them.
Note the difference between a betting market and an opinion
poll. In the betting market, people are making bets on how
other people will vote and backing their judgment with their
own money. In a poll, people say how they themselves intend
to vote, but there are no sanctions if they don’t give a
truthful answer or if they change their minds later. The
incentive to get a forecast right is obviously much greater
in a betting market.
Some private corporations have
tried to tap the wisdom of their employees by setting up
‘decision markets’, based on the same principle as the IEM,
on the likely success of their new products. Those cited by
Surowiecki – Hewlett-Packard’s on new printer sales, and
Innocentive’s on which new drugs were likely to win approval
from the US Food and Drug Administration – have been
remarkably accurate. How much easier for humble employees
to contribute their knowledge, and to gain from doing so,
through an anonymous market rather than through some
consultation committee, with its built-in biases, managers
unwilling to register inconvenient information, and
employees afraid of the consequences of speaking up.
A
leading advocate of decision markets is Robin Hanson, of
George Mason University in the United States. In an article
written in 1999, he says: … we suffer from a serious failure
to share information. The so-called Information Revolution
has greatly improved our ability to find out what others
have said. However, it has done much less to improve our
ability to find out what other people know … Speculative
markets are a neglected way to help us find out what people
know. Such markets … have many advantages over standard
institutions for information aggregation, such as news
media, peer review, trials, and opinion polls. Speculative
markets are decentralised and relatively egalitarian, and
can offer direct, concise, timely, and precise estimates in
answer to questions we pose. Just as self-interest
motivates us to influence the market price of a good by
buying it or not buying it, so the gains from betting can
motivate us to contribute accurate and relevant information
to a collective decision, and more reliably so than through
mechanisms where no such incentives exist.
How then would
a policy analysis market work? The term comes from one such
market that was set up by the Pentagon in 2003 to provide
intelligence on the Middle East. The general public would
be invited to make bets on possible events in the region,
with a view to allowing policy-makers to bypass the vested
interests of intelligence agencies in their pet theories and
analyses and get some new, informal but reliable information
into the policy-making arena. But it was not to be.
Congressional pressure forced the Pentagon to scrap the idea
on the grounds that it was morally wrong to encourage people
to profit from bets on terrorist outrages, even though it
was not on that sort of question that the policy market was
expected to focus. Yet would we not approve if a government
agent profited in career terms as a result of accurately
forecasting the attacks of 9/11? (Surowiecki, who is
naturally a fan of policy analysis markets, passes on the
good news that in March 2004 NetExchange, the company that
set up the market for the Pentagon, announced that it would
open a new one, without government involvement, devoted to
forecasting broad economic and military trends in the Middle
East. Surowiecki also cautions that the events wagered on
would have to be appropriately framed to allow a reliable
market to emerge. They would have to deal with the problem
of a wager becoming self-defeating; for example, a forecast
assassination could be successfully anticipated and
forestalled. But that would only confirm the reliability
and indeed the very usefulness of such markets.)
It’s
interesting to speculate on how policy analysis markets
could be developed to cover the entire field of policy. A
private organisation – a think tank, a newspaper, a
television or radio company, even a public opinion polling
company – could set up a betting market on, say, whether our
current Labour-led government will, on present policies,
achieve its ‘top priority’ objective of returning New
Zealand to the top half of the Organisation for Economic
Cooperation and Development (OECD) income rankings by some
specified date. The qualification ‘on present policies’
would be necessary because the government could react to a
betting market forecast of failure by changing its policies
to ones more likely to succeed. And that is exactly how
such a market could help improve public policy. It could be
expected to be more reliable, and hence more heeded, than
opinion polls, which are vulnerable to politicians’ growing
skill in manipulating voter apathy, ignorance, and cynicism.
I’m tempted to keep speculating in this vein. What, I
wonder, would a betting market have forecast on whether the
Coalition that invaded Iraq would find weapons of mass
destruction, and with what effect? But rather than continue
along these lines, let me sum up.
We live in an age of
mass higher education; every topic one can think of can be
studied somewhere for a qualification, so that it has its
official ‘experts’. One thing I’ve discovered is that people
with educational qualifications certainly tend to believe
that they know more than laypersons, and they also tend not
to be backward in promoting new legislation that embodies
their expertise, regardless of the cost. So whatever its
benefits, expertise needs to be accountable. The best
mechanism for making it accountable is the market, where the
consumer is sovereign but also ensures that any benefits of
expertise are recognised and rewarded.
Where markets are
not workable, as with pure public goods, the elitism of
ordinary politics could benefit from the additional
accountability provided by the referendum. And betting
markets in policy areas could amount to a sort of continuous
popular referendum – a more reliable and stable one than
that offered by volatile opinion polls, as well as being a
lot of fun.
ENDS
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