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Use Markets to Discipline Ideologues and Policy Makers

One of the great advances in human history has been the discovery of our collective ignorance (link no longer available). We now understand that there is so much that we do know about the world and need to discover. Unfortunately, many politicians and policymakers miss out on this truth.  Much of our politics consists of ideologues and policy makers making claims about the wonderful effects of their own policies and the bad effects of their opponents’ proposals.  Our politics would improve if we held these entrepreneurs more responsible for their claims.

Philip Tetlock and Peter Scoblic recently wrote a fine New York Times oped arguing that policymakers should be asked to provide specific predictions about what their policies will accomplish—specific enough to assess whether their objectives have been achieved.  Tetlock and Scoblic show that when they have done this experimentally both conservatives and liberals modify their predictions to make them more modest and realistic. This kind of tournament of predictions makes experts across the ideological spectrum more responsible, because they will be held accountable. Most people do not want to look foolish.

Their proposal could would benefit from one additional component.  As I argue in Accelerating Democracy, we should put up these measurable policy predictions on information markets where people can bet on whether they will occur. Policy experts do not have a monopoly on wisdom and indeed sometimes have collective biases and overconfidence. And putting up predictions of what the effects of a policy will be before the policy is adopted, can help us choose the policy with a better effect.

Thus, for instance, we could ask what would be the effect of a specific tax cut about to be voted on by Congress on the rate of economic growth versus keeping the tax rate the same. Even more generally, we could ask for predictions of the  what economic growth rate and unemployment rate will be from 2017-2021 conditional on the election of a Democratic presidential candidate and conditional on the election of  the Republican candidate. This market would provide useful information not only to policy makers but the electorate.

Fortunately,  Predictit.org,  has  recently begun making information markets. They have received a dispensation from the Commodities Future Trading Commission from regulations that would otherwise make such markets illegal.  So far, however, they have only made markets in the horse races of politics, such as who will win the presidency.  They should add markets that bet on the effects of policy and elections. Many politicians claim we need more government to discipline markets, but we need more of these markets to discipline government.

Reader Discussion

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on October 20, 2015 at 17:12:58 pm

[W]e could ask what would be the effect of a specific tax cut about to be voted on by Congress on the rate of economic growth versus keeping the tax rate the same. Even more generally, we could ask for predictions of the what economic growth rate and unemployment rate will be from 2017-2021 conditional on the election of a Democratic presidential candidate and conditional on the election of the Republican candidate. This market would provide useful information not only to policy makers but the electorate.

How would this work?

Yes, we could take bets on the economic growth rate and unemployment rate as of a date certain, assuming the Democrat wins, and a separate bet assuming the Republican wins. Who would be the counter-parties to these bets?

We could then observe how people’s expectations would differ depending on the party of the person winning the presidency. But we couldn’t compare the accuracy of these two bets, because presumably only one person would win. Thus, we’d eventually end up with bets about the expected economic growth rates and unemployment rates, with some anonymous people being too optimistic and some being too pessimistic. And this would demonstrate … what?

Yes, we could take bets about the effect of various tax cuts. And again some people would be too optimistic and some too pessimistic. But moreover, circumstances would change between the time the tax cuts were proposes and the time they would be implemented. So anybody asked to defend a prediction about a tax cut would simply claim that her prediction was 100% accurate all else being equal, but circumstances did not prove to be equal. Again, this would demonstrate … what?

For example, Obama (or some proxy) made predictions about the outcome of the federal stimulus plan, and those predictions did not pan out. In his defense, Obama said that circumstances took a turn for the worse – and this demonstrated how much greater need there was for stimulus than he initially thought, and how wise we were to adopt even the meager bit of stimulus we did. As it happens, I largely share this view (although I have no knowledge about whether Obama really thought the package was appropriately sized to deal with the problem, or merely sized to be acceptable to Congress). In short, Obama’s predictions were not accurate – but far from suggesting that Obama was wrong and overconfident, it suggests he was right but too timid (or too constrained by politics). Again, what would a betting parlor teach us about this situation?

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nobody.really
on October 20, 2015 at 18:22:34 pm

" but far from suggesting that Obama was wrong and overconfident, it suggests he was right but too timid (or too constrained by politics)."

You're not serious are you?

too timid - should he have inflated the national debt to, let's say, $25 TRILLION, in order to make his policies work.
Insanity is doing the same thing and expecting different results - that's democrat policy making for you!

On a more serious note, perhaps we can call McGinnis's online betting parlors, PolDuel with incessant advertising on all the sports channels or even better, how about we call it "GRAFT-KINGS" - it has a certain ring to it as well as being rather apt!

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gabe
on October 20, 2015 at 20:17:23 pm

Prof. McGinnis:

Linked to Amazon; read brief comments on book; one caught my eye.

It appears that you argue that this "information market" cannot work effectively unless and until some semblance of Federalism is restored. Agree wholeheartedly - yet that is a rather significant hope and undertaking.
It is an interesting proposition offering as it does the possibility of a broader spectrum of policy initiatives, considerations and more specifically "laboratories in which to conduct the policy experiments.

Yet, the concern I have is this: Given the current makeup of our political parties, where the Democrat party is rapidly becoming (or at least acknowledging its socialist predilections) an outright European Socialist Party, and the Stupid Party appears to be determined to be viewed, and behave, as the _me-too-but smaller doesage Party, one wonders how wide will be the range of policy options.
Surely, these "information" parlors will not be canvassing, or soliciting from, me or similarly situated knuckleheads, for policy prescriptions.
What then are the input flows for these policy markets? As I said, it does not appear that they will be taking policy proposals from me and nobody.really for that matter.
So how do we assure a wide assortment of policy options - other than from the the Tweedle-dee and tweedle-dum(b) Party?

Also, I would add that I am not quite so certain as you that our current "pols" will be constrained by the thought of being perceived as "foolish" - I mean all one need do is listen to John Kerry, Hillary Cliton, the Big O, Johnny Boy McCain, etc. etc. It certainly has not held these bright lights back from uttering some of the most ill-informed opinions / policy prescriptions and historical analyses that I can recall.

Then again, I ain't been afraid of it either - but nobody.really is going to be betting on me.

But the book does look interesting - may have to get it (why is hardback cheaper than paperback on Amazon?).

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gabe
on October 26, 2015 at 08:50:29 am

These are all reasonable questions. But fortunately they also have reasonable answers of which the best rendition I am capable of follows:

First, you need baseline futures markets on economic aggregates. A good example would be Scott Sumner's "trills." A trill for any given year is worth exactly one trillionth of the the nominal GDP of the United States in that year. Anybody can issue whom the market trusts to make good on their commitments can issue trills and anybody can buy trills.

Ideally, to avoid complicating the picture with interest rate and inflation expectations (unless that it what this particular market is looking for, of course), no cash would switch hand when you buy a trill. Instead it would be best to just settle the difference at the time the trill is evaluated (i.e., when the final official estimate of GDP for the year is released). For example, if I had sold you a $18 trill for 2014, no money would have changed hands immediately. Rather, when the final figure was released ($17.914 trillion), you'd pay me the difference (9.86 cents for every $18 trill you bought from me). If one or both of us is not guaranteed to be liquid at the time of the consummation, we'd need to get the backing of somebody who is, like a brokerage. That party, in turn, would be kept safe by holding our portfolio and evaluating it on a mark-to-market basis with some margin on deposit. When margin calls came, we'd either meet them or our portfolios would be automatically liquidated.

Similar unconditional instruments can easily be created for any aggregate over which people have disputed predictions, but can agree on the outcomes retrospectively. Hence, we can get instruments on the unemployment rate (unemps?), the inflation rate, the budget deficit, etc.

Next step: Create policy-conditional instruments.

These would be just like the unconditional instruments and derive from the same underlying variables. The only difference is that each of these instruments only becomes effective if a specified, exactly defined, policy or set of policies is adopted within a given time frame. So, in 2009, we could have had unemps conditional on no stimulus being passed,unemps conditional on a $1 trillion stimulus being passed, or unemps conditional on a $4 trillion stimulus being passed.

If the policy-conditional occurs, then the conditional instruments just turns into the equivalent unconditional instrument (which is useful because that renders it part of the same, larger, more liquid market). If it doesn't, the conditional instrument goes poof and nobody owes anybody anything.

You can see how one would now use the market prices of these instruments to help find good policies.

For example, if you are right about the stimulus, the prices of unconditional 2010 unemps, 2010 unemps conditional on no stimulus, and 2010 unemps conditional on a trillion dollar stimulus would all have had pretty much the same prices. But 2010 unemps conditional on a four trillion dollar stimulus would have implied substantially lower unemployment.

That would have told us that a trillion dollar stimulus would--according to the best estimate of smart people with a lot of their own cash on the line and no incentive to lie--most likely be useless, but that a four trillion dollar stimulus could work. That doesn't necessarily mean that the benefits of the four-trillion-dollar stimulus would have outweighed the costs. But at least you'd know what to weigh against what.

It is true that proponents of the one-trillion dollar stimulus could have claimed with great confidence that the markets are just wrong. That is possible--markets are wrong all the time or we wouldn't need to publish new stock prices every day. But if these advocates are so sure that the one-trillion dollar stimulus would work, they'd be equally sure that the current market prices for 2010 unemps conditional on a trillion dollar stimulus are way out of whack. In other words, if they are right, they can easily and safely make a fortune in the markets.

So, one might very well ask, these proponents how much of their own personal fortune they have invested in 2010 unemps conditional on a trillion dollar stimulus? The answer might be very revealing about the true beliefs and confidence of these proponents.

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