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Who are the Wise Guys?

The Wisdom of Crowds by James Surowiecki
A well-functioning market will make everyone better off than they were when trading began—but better off compared to what they were, not compared to everyone else. On the other hand, better off is better off.” Page 107
It is always a pleasure to read a book featuring the work of economists that doesn’t imply we are idiots. (For an endless tirade against economists read The Black Swan by Nassim Taleb—but more on his book in a later post.) Surowiecki clearly understands the research he writes about and interprets it in an entertaining  and easy to understand way.  He is much like Malcolm Gladwell in that regard.  (Come to think of it both of these guys wrote for the New Yorker so it might be the influence of their editors.) According to the book, ordinary markets are a great example of the wisdom of crowds. (Preaching to the choir here.) The results of ordinary markets give us insight into why they are created for unusual things.   Surowiecki gives us many examples of this: election markets can predict a presidency, sports markets can predict the outcome of the big game, and decision markets can decide if a particular product will make it in the business market place.  I found his example of how a conventional market like the stock market predicted who was really to blame for the Space Shuttle Challenger explosion within minutes of the explosion fascinating. For crowds to be wise they have to have the following characteristics: (Note how markets meet the qualification.)
  1. Diversity (the more diverse the better)—markets have lots of people in them, some rational and some not.  The crazies out there in the market place don’t seem to matter. In large groups, irrational people together can make rational decisions as long as the people are different from each other.
  2. Independence—most players in markets do not coordinate with each other in any systematic way (although bubbles can happen if they do).
  3. Decentralized but aggregated—players react to their unique situations but the value of their individual information is aggregated up in some meaningful way.  In markets, price acts as the ultimate aggregation.
This book dispenses with the jargon of economists and gets to the main idea about why markets are so terrific.

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Comments (1)

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    Valrie Strube

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    Great post, many thanks for showing the initiative to come up with it

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