Archive for January, 2009

Free markets take advantage of the wisdom of crowds

Tuesday, January 13th, 2009

The recent near-collapse of the financial markets has lead to a call for tighter regulation; and, a higher proportion of news pieces mock of free markets.  There is comfort in the thought of a kind and wise government that protects its citizens from harm.   As a result, support is growing for the belief that free markets have soured and that government should take a more active role in controlling the economy.  Paradoxically, the root cause of our problems may be that our markets are not free enough.

The free market operates on the principle that complex information can be better processed by large numbers of people, each person being a tiny social neuron, that when combined into a crowd, can out think even the brightest individual or think tank.    The wisdom of crowds is not just an abstract idea.

Michael Shermer’s essay in Scientific American (http://www.nd.edu/~busiforc/handouts/Other%20Articles/Wisdom%20of%20Crowds.PDF) gives compelling evidence for the wisdom of crowds.  The gist of the thesis is that when a large group of diverse and independent individuals are given a problem, their solution will on average be optimal and superior to a consensus view of experts.  The free market, be it a market of ideas or a system of trade, works most efficiently when individuals make decisions by applying their unique expertise to the available information.

(more…)