Myth of the wisdom of the crowd

Romney Is Unwise to Believe in Wisdom of Markets - Bloomberg: ..."In some clever experiments, mathematician Jan Lorenz and others from the Swiss technology university ETH Zurich tested how ordinary human interactions affect the wisdom of crowds. They had volunteers answer questions -- such as “How many murders were there in Switzerland in 2006?” -- for which the true answers were known. In some trials, the participants knew what others chose (in detail, or on average) before making their own choice."

Not Wise

As it turns out, the crowd really isn’t so wise, even when people do act on their own. The average response on the murders question, with no social influence, was 838, compared with a true number of 198. The error reflects a known bias: When people try to estimate numbers for things they know little about, they often tend to guess for the right scale or magnitude. Is it roughly 10, 100 or 1,000? That’s a useful thing for individuals to do, but it doesn’t make a crowd wiser.

When given access to others’ estimates, the participants did even worse. They tended to revise their own guesses to fit more closely with those of others, a dynamic that pushed the average answer toward the periphery of the range of estimates. This is doubly discouraging, because the narrowing range of individual opinions makes the group appear more certain of its answer. In short, we have a recipe for stupidity.

The illusory certainty of the crowd also gets transferred to individuals. Interviews after the experiments found that social influence, while it didn’t make the crowd’s estimate any more accurate, did fill the participants with a strong belief in the group’s infallibility. Rather than the “wisdom of crowds,” we have the “unwarranted confidence of crowds.” I can’t help but relate this to some of the biggest blunders of recent years, such as the belief that Iraq had weapons of mass destruction and the expectation that house prices would only go up. (There’s some further discussion of these experiments on my blog.)

Now let’s think again about whether markets know best about anything. It’s hard to imagine a more socially influenced environment than modern finance, with rumors flying through the business press and corporate boardrooms, fund managers herding like cattle to fashionable investments, financial analysts mostly making the same predictions as other financial analysts. We have a host of reasons to expect very little wisdom in the verdict of the crowd as expressed in the market.

Whoever wins the presidential election, the market will react. If we have to give it a personal spirit, it will “render its verdict.” It won’t be inherently wise or anything else. Up, down, left, right or inside out, the result won’t tell us much about the wisdom of current policies. It’s just the market, not a miraculous machine for good governance.

(Mark Buchanan, a theoretical physicist and the author of “The Social Atom: Why the Rich Get Richer, Cheaters Get Caught and Your Neighbor Usually Looks Like You,” is a Bloomberg View columnist. The opinions expressed are his own.)