Regression to the mean

Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies, and Nations

In the summer of 2003, analysts at the Department of Defense had an unusual idea. To predict important events in the world, including terrorist attacks, they would create a kind of market in which ordinary people could actually place bets. The proposed Policy Analysis Market would allow each of us to invest in our predictions about such matters as the growth of the Egyptian economy, the death of Yasir Arafat, and the likelihood of terrorist attacks in the United States. Investors would win or lose money on the basis of the accuracy of their predictions. Predictably, the Policy Analysis Market produced a storm of criticism. Ridiculed as "offensive" and "useless," the proposal was abandoned.

Amid the war on terrorism, why was the Defense Department so interested in the Policy Analysis Market? The answer is simple: it wanted to have some help in predicting geopolitical events, including those that would endanger American interests, and it believed that a market would provide that help. It speculated that if a large number of people could be given an incentive to aggregate their private information, in the way that the Policy Analysis Market would do, government officials would learn a great deal.

Does this idea seem ludicrous? Since 1988, the University of Iowa has run the Iowa Electronic Markets, which allow people to bet on the outcome of presidential elections. As a predictor, the Iowa Electronic Markets have produced extraordinarily accurate judgments, often doing better than professional polling organizations. In the week before each of the last four elections, the predictions in the Iowa market have shown an average absolute error of just 1.5 percentage points, a significant improvement over the 2.1 percentage point error in the final Gallup Polls. Or consider the Hollywood Stock Exchange, in which people predict Oscar nominees and winners, as well as opening weekend box-office successes. Here, too, the level of accuracy has been exceptionally impressive, with (for example) correct predictions of thirty-five out of forty Oscar nominees in 2002.

In fact, prediction markets are springing up all over the Internet, allowing people to make bets on the likely outcomes of sports, entertainment, finance, and political events. On tradesports.com, people have been betting on whether Donald Rumsfeld will resign soon (extremely unlikely), whether Osama bin Laden will be captured by June 2004 (extremely unlikely), whether John Edwards will be selected as John Kerry's running mate (a good chance, but probably not), and whether George W. Bush will be re-elected (more likely than not). One can imagine prediction markets on any number of questions: Will gas prices reach $3 per gallon? Will cellular life be found on Mars? Will smallpox return to the United States? Will there be a sequel to Master and Commander? Will the Federal Communications Commission be abolished? (I didn't make these up; they are actual or proposed questions on existing markets.)

James Surowiecki is fascinated by prediction markets. In his opinion, they demonstrate that crowds are often wise. He rejects the widespread view that groups of ordinary people are usually wrong--and that we do better to ignore them and follow experts instead. Even when individuals blunder, he believes, groups can excel: "Under the right circumstances, groups are remarkably intelligent, and are often smarter than the smartest people in them." This is so even when "most of the people within the group are not especially well-informed or rational." What is wonderful, and surprising, is that "when our imperfect judgments are aggregated in the right way, our collective intelligence is often excellent." Instead of chasing experts, we should consult that collective intelligence.

I teach a seminar titled "Ideas of Human Nature" in which I restrict enrollment to 15 students. Others typically want to get in, and yet much of the class's popularity stems from the benefits that come from keeping it small. Most students understand the advantages of small classes, and they wouldn't want everyone who wishes admittance to get in; just themselves! If everyone gets in, the class becomes too big and discussion is inhibited, to everyone's disadvantage. And so, each year I find myself in the difficult position of telling a number of students that there simply isn't room for them. Each student turned away from this class understands the logic, but nonetheless, each would like the limit to be expanded -- by just one.