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August 14, 2003

The Future Market

The recent brouhaha on the DARPA idea to create a market to serve as a tool for predicting world events related to terror amused me. Oh, I understood the immediate revulsion that was the response of many; I felt it myself. But then I remembered who are those guys at DARPA who were instrumental, among other things, in the creation of this once winked at medium, this medium which is the most powerful communications tool invented since writing. I asked myself, "What were they thinking?" not in the shocked fashion that was the fashion, but in the suddenly interested "Why not?" sense.

Then I immediately thought, "But what does the creation of such a tool have to do with government?" The obvious answer is nothing. I thought about pitching the idea of building such a market using the template of the online casinos to some friends. Then I decided we would be way too little and late, as there had to be others already with resources in place who would leap on the idea. Sure enough, this morning The Volokh Conspiracy is pointing to the site that aims to become The American Action Market. (Tyler Cowen thinks it's a prank. Maybe it is. But that doesn't mean someone else won't take it seriously.)

Once I considered the idea, I thought it was brilliant. The idea of using the mass unconscience has been pitched in science fiction, and there's the Delphi model out there, so it's not exactly new. The form of it perhaps is. The basic principle behind it is that most of us have hunches that are most likely comprised of a lot of unconsious observation and correlation of information that does not rise to the level of provable. We tend to make decisions partly on this data. Of course, any one of us can be very wrong. But taken as aggregate, the records of futures markets show that markets operated in a fashion where those who "guess" right are rewarded tend to predict better things that are otherwise very hard to predict. If nothing else such a tool could help governments prioritize preparations to deal with a list of events that approaches the theoretically infinite.

After reflection I decided the ethical issues of this sort of market is no different from existing issues in the stock and futures markets. Buying pork bellies and orange futures is betting the farmers will have a hard time, scarcities are coming, and prices will rise. In a country where we overproduce food, we think nothing of it. In Etheopia it would be a bet aimed at fending off starvation. The principle is the same. We bet on or against the misfortune of others all the time. We don't label it as such. That's the real difference.

That some will use the market to profit from their own anti-social acts is not new either. Criminal have always tried to do (and sometimes succeeded in doing) this with the stock and futures markets, as any casual perusal of the histories of the markets will prove. Betting that terrorist action will kill over 10000 people in the U.S. in 2004 might seem cold, but as we saw after September 11, such actions already swing markets dramatically. All we're doing is moving the measure closer to the actual mark of the events that we are interested in predicting. Those who were short on September 10 in airline stocks made a fortune.

The reason for the market, however, isn't to profit from misfortune. It's to hedge against misfortune in the same way that the commodities futures markets do. Yes, some will profit. If no one is trying to profit the market will not work. But the profits will not exceed the losses. And the information gained by those who study the market will in the long run help us to stave off some negative events, or to prepare better for dealing with them if they do happen.

Sure, terrorists may try to profit on their acts by trading in the markets themselves. We hope so. Remember the stock market has in place controls to prevent insiders from using information to manipulate the market. This is because such manipulation actually can work. But in the case of the sort of market we're dealing with here that is a major goal. We want those who plan anti-social acts to put their money where their mouth is. If they do this they tip their hand. And they don't have to do it themselves, a proxy act using a mule will send the exact same message at the market level. If they are stupid enough to leave tracks, of course, they just handed us one more chance to thwart their plans.

Some will wonder if such a market will not create a demand for anti-social acts of the sort they are planned to measure. That poses an interesting question. My first thought was that this would be an unintended consequence. It might prove to be the case. But my second though was that the market predicts equally that events will not happen. The bets against an event happening will necessarily equal those for it happening, so the demand for the execution of an event will equal the demand for preventing the event. And the net effect, through the predictive information gathered, should swing the balance a finite amount towards the prevention side.

Of course, unintended consequences always result from an incomplete understanding of the future. We can't predict (though the market could help) whether such a market will lead to more terrorism or less. But if it gives us a tiny edge in stopping terrorist actions, or in preparing to deal with them, it will stop some which would have otherwise happened. If it can raise the bar for success in that sort of act, fewer will decide to plan those actions. We can never stop all such acts, some people truly are operating under a set of values, and within such a warped worldview, that they simply don't respond to information in the way that the vast majority of us do. The key is to shift a percentage of the world's population from the "maybe" to the "I will not" camp.

Right now terrorists and populations prone to terrorist acts perceive that they can succeed. We need to do everything we can to change that perception. Once those with that bent shift their belief of success from easy, or possible, to difficult, improbable or impossible we will have won a battle in the war. A predictive market can be one weapon in that war, though as with any weapon, it can also be turned to the enemy's use. We shouldn't stop manufacturing guns just because some will fall into the hands of the enemy.

Posted by dan at August 14, 2003 11:54 AM