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October 1, 2012 | by  | in Opinion |
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C.R.E.A.M. – Cash Rules Everything Around Me

Put your money where you mouth is

You may have heard of New Zealand’s own online prediction market. It allows anyone who wants to join to bet real money on real world political, economic and scientific outcomes, and generates probabilities of a particular event occurring. There are hundreds of ‘stocks’ ranging from a Labour victory at the next election (42 per cent chance at time of writing) to Kim Dotcom being extradited by 2014 (20 per cent).

A broad array of academic literature suggests that in the right circumstances prediction markets can accurately assess the probabilities of real world outcomes. Take for example a study examining events following the 1986 Challenger disaster: After the space shuttle crash it took a panel of government experts several months to examine the evidence and determine which part of the shuttle failed. But within days of the crash the share price of the firm which supplied the faulty parts had collapsed (other suppliers did not experience the same fall), suggesting that those with inside information had worked out the cause of the fault much more quickly.

The potential for prediction markets in policy making has not gone unnoticed. In 2001 the US Department of Defence started experimenting with a project called ‘Future Markets Applied to Prediction’ (FutureMAP) to gather strategic intelligence on future political and economic indicators in Middle Eastern countries, and conditional probabilities of future events, e.g. the likelihood of a major terrorist attack on US soil, the probability of top Al Qaeda officials being found or whether Israel will launch a pre-emptive strike on Iran. It doesn’t take a genius to see the policy- making potential of FutureMAP. Imagine the stock ‘Nuclear weapons to be discovered in Iraq by December 31 2005 if America invades in 2003’. Knowing that such weapons did not exist, Iraqi military officials could bet heavily against the stock, making money from the defence department but giving away information many times more valuable.

So why haven’t you heard of FutureMAP? The programme was cancelled in the summer of 2003 under a barrage of congressional criticism. Two Democratic senators attacked the program, describing it as a “terrorism betting parlour” and asking why America was “spending millions of dollars on some kind of fantasy league terror game”.

These criticisms are clearly ridiculous, but they made me wonder what these senators would think of ‘Futarchy’, a system of government designed by economist Robin Hansen based on prediction markets. A Futarchy would still have elected politicians, but only to define measures of national welfare. Prediction markets would determine which policies to implement to achieve national welfare targets. Is this a plausible replacement for western democracy? Almost certainly not, but the public service could do worse than considering FutureMAP as a tool in their policy analysis armoury.

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