The Wisdom of Crowds - Why the Many are Smarter than the Few



Book Author: James Surowiecki

Book Review by : S S George
Director, ICMR (IBS Center for Management Research)


James Surowiecki, Iowa Electronic Markets, IEM, futures contracts, Hollywood Stock Exchange, HSX, forecasting, Policy Analysis Market, 9/11 attacks

Abstract: In this book, James Surowiecki, a staff writer with the New Yorker, describes how the collective intelligence of a group of people is often superior to the intelligence of even the smartest individual in the group. But, there's a catch. Crowds are not always smart. They are smart only when the conditions are just right.

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One of the many types of contracts available at the IEM is for predicting the winning candidate in an election. For example, you can buy a contract on a particular candidate's win, and the contract would pay you one dollar if the candidate actually won the election. You would get nothing if the candidate lost. The price at which this contract is traded in the market gives the probability of the candidate winning in the election. If a candidate is popular, and many people believe that she will win the election, more people would want to buy future's contracts on the candidate's win; consequently, the contract will trade at a price closer to the value of the payout. For example, if the contract for a candidate's win is trading at 80 cents, there is an 80 percent probability that the candidate will win.

The IEM has been remarkably successful at predicting the winners in US elections, and their margins of victory - much more so, in fact, than the elaborate and costly opinion polls carried out by national research agencies. And interestingly, the number of traders in the exchange was never very large - it never exceeded 800 in number at any time. The traders also did not constitute a representative sample of voters, as most of them were men, and from Iowa.

After the demonstrated success of the IEM, several decision markets have come up - one, for example, being the Hollywood Stock Exchange (HSX), where people can bet on academy award winners, or box office returns for newly released movies. Like the IEM, the HSX has had some notable successes in forecasting. And although its forecasts were not as accurate as the IEM, it is believed to be more accurate than other tools to predict box office success and similar events in Hollywood. However, an attempt to set up a similar market - the Policy Analysis Market - to forecast developments in the middle east never got off the ground, owing to public and political opposition. Presumably, the market would have had people betting on events such as the likelihood of a new terrorist attack similar to the 9/11 attacks, and this proved to be a distasteful notion for many.

Decision markets are just one of the many examples which the author gives to illustrate the wisdom of crowds. However, equally importantly, he also writes about the stupidity of crowds - how stock market bubbles develop and grow, for example.

The wisdom, or the equally frequent lack of wisdom, of groups is quite visible in a corporate context. Several decades ago, the British historian C. Northcote Parkinson wrote about how the time a committee spends on an item is often inversely proportional to the value or cost of the item. For example, a committee may spend hours discussing expenditures on office supplies, while a proposal to construct a nuclear power plant may be accepted with much less discussion. Committee members simply spend more time on subjects they know well (the price of pencils and pens, for example), rather than on subjects that matter, but about which they know little.

It is not that organizations are averse to making use of the wisdom of groups. (If all the books on the virtues of teamwork and an egalitarian work culture written in the past twenty years were laid end to end, it is quite possible that they would encircle the earth several times.) In reality though, owing to their own limitations, even companies with the best intentions are unable to make the full use of the strength of groups.

The book is certainly interesting, and the examples thought provoking. However, while the wisdom of crowds has tremendous potential to make organizations more efficient and effective, with human nature and corporate politics being what they are, it is quite unlikely that the way you (or I, for that matter) work will change significantly because of one book.