Using Information Markets to Improve Public Decision Making

By Hahn, Robert W.; Tetlock, Paul C. | Harvard Journal of Law & Public Policy, Fall 2005 | Go to article overview
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Using Information Markets to Improve Public Decision Making


Hahn, Robert W., Tetlock, Paul C., Harvard Journal of Law & Public Policy


I.   INTRODUCTION
II.  AN INTRODUCTION TO INFORMATION
     MARKETS
III. GETTING BETTER INFORMATION FOR MAKING
     POLICY CHOICES
     A. A New Approach
     B. Extending the Framework
     C. The Potential for Improving Fairness
     D. Potential Problems with This Approach
        1. Versatility of the Approach
        2. Project Governance
        3. Measurement Issues
        4. Market Design Issues
IV.  A BENEFIT-COST ANALYSIS OF INFORMATION
     MARKETS
     A. A More Informed Assessment of Policy
        Proposals
     B. Greater Transparency and Accountability
        in Decision Making
     C. Greater Availability of Assets for
        Financing Projects and Spreading Risks
     D. Cost of Information Markets
     E. Comparison of Direct and Indirect
        Approaches for Information Markets
V.   SIGNIFICANCE FOR POLICY DESIGN AND
     EVALUATION
     A. Information Markets in the Policy
        Process
     B. Solving Some Difficult Government
        Oversight Problems
     C. The Potential Role for Government and
        Researchers
VI.  CONCLUSION
VII. APPENDIX

I. INTRODUCTION

Many legal scholars have studied how to improve public decision making. Justice Breyer, for example, argues that technical problems could benefit from greater scientific expertise, and suggests using such analysis to help prioritize among competing social needs. (1) Cass Sunstein argues for the judicious use of cost-benefit analysis in a variety of areas, but also points out its limitations. (2) Sunstein's proposal, and the proposals of other scholars, would rely heavily, albeit not exclusively, on cost-benefit analysis to evaluate public policy decisions. (3)

Cost-benefit analysis is a tool used by decision makers to help inform the policy process. Cost-benefit analysis examines how different policies affect the overall level of net benefits to society, or benefits minus costs. A cost-benefit analysis may also be used to explore equity issues, examining how the distribution of net benefits varies across key groups, such as minorities or small businesses. (4)

A fundamental problem with cost-benefit analysis of new policies is that the analysis is conducted before such policies are implemented. When conducting ex ante analyses, it is difficult to predict the future values of key variables that could be affected by a policy. (5) For example, an analyst might predict that a worldwide carbon tax of $100 per ton would reduce world GDP by 1% in 2010. (6) How confident should we be in such a prediction?

In this paper, we present a new framework for addressing such uncertainty; this framework has the potential to substantially improve public decision making. We argue that decision makers can be more confident in analytical results if these results are based more directly on market data. Our framework introduces "information markets" that allow people to profit from superior knowledge about the future. (7) For example, if an information market suggested that expected GDP would fall by 1% with a carbon tax, (8) this estimate would theoretically incorporate all publicly available information about that policy's effects. We also argue that if these information markets are designed well, information from the prices in these markets is likely to be much more accurate than other forecasts.

An information market allows individuals to purchase contracts, using real money, that yield returns to their owners contingent upon the uncertain outcome of a future event. (9) With the advent of the Internet, information markets are becoming more common. They are used in a number of contexts, ranging from assessing the likelihood that the Federal Reserve will raise interest rates to assessing the odds that a particular presidential candidate will be elected.

As an example, consider the online exchange at TradeSports.com. This exchange allowed its members to trade contracts that yielded $10 to their owners if President Bush was reelected in November 2004.

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