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Prediction markets and policy making

December 31, 2009

Corporate prediction markets work like this: Employees, and potentially outsiders, make their wagers over the Internet using virtual currency, betting anonymously. They bet on what they think will actually happen, not what they hope will happen or what the boss wants. The payoff for the most accurate players is typically a modest prize, cash or an iPod.

For years, public prediction markets have been used for politics, like the Iowa Electronic Markets and Intrade, where buyers and sellers bet on which candidate will win a particular race. And there are prediction markets where people place bets on news events (Hubdub, among others), video game sales (simExchange) or movie box-office receipts (Hollywood Stock Exchange).

Robin D. Hanson, an economist at George Mason University, proposes a “futarchy,” a form of government enhanced by prediction markets. Voters would decide broad goals of national welfare, but betting in speculative markets would determine the policy steps to achieve those goals. Full story.

I think the idea of prediction markets is extremely useful– depending on what you want to achieve. But the futarchy idea does not sound like a good application– what Surowiecki argued in The Wisdom of Crowds is that a knowledgeable crowd makes a better decision because collectively, more information is being used to solve a problem. But the individuals in his “crowd” have expertise that contribute to an improved solution. The general public as a whole, would not be adding more expertise to the market.

I would argue that a better alternative would be to create  a policy prediction market that encompassed all those who would have useful knowledge to contribute. For example, in implementing the new US health care bill that will hopefully be passed, the market would include: health care providers, insurance industry insiders, members of the public, politicians, administrators, lawyers, health care academics, economists, demographers, pharmacists, pharmaceutical industry specialists, actuaries, government health care workers at all levels of government, etc. etc.

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