December 23, 2008

The Wisdom of Crowds

The Wisdom of Crowds: Why the Many Are Smarter Than the Few and How Collective Wisdom Shapes Business, Economies, Societies and Nations by James Surowiecki

Under the right circumstances, groups are remarkably intelligent and are often smarter than the smartest people in them. Groups do not need to be dominated by exceptionally intelligent people in order to be smart. Even if most of the people within the group are not esp. well informed or rational. It can still reach a collectively wise decision.

Diversity and independence are important because the best collective decisions are the product of disagreement and contest, not consensus or compromise (contradiction is the best way of communication?)

Characteristics of wise crowds:

* Diversity of opinion - Each person should have private information even if it's just an eccentric interpretation of the known facts.

* Independence - People's opinions aren't determined by the opinions of those around them.

* Decentralization - People are able to specialize and draw on local knowledge.

* Aggregation - Some mechanism exists for turning private judgments into a collective decision.

If a group satisfy those above conditions, its judgment is likely to be accurate.

Example – Google search results (pagerank and popular sites), audience poll during “Who wants to be a millionaire” picked right answer 91% of the time, Gallup poll, IEM,HSX, etc.

As per Mackay, in his book – Extraordinary Popular delusions and the madness of crowds - says “crowds are never wise and they were never reasonable; they think in herds.

Surowiecki book concentrates on three kinds of problems.


Questions to which there may not be a single right answer, but to which some answers are certainly better than others (e.g. what is the best place to build new swimming pool)


This is to figure it out how to coordinate their behavior with each other, knowing that everyone else is trying to do the same (e.g. how can you drive safely in heavy traffic?) Coordination problem explained by “El Farol problem”


Involve challenges of getting self-interested, distrustful people to work together, even when narrow self-interest would seem to dictate that no individuals should take part.(e.g. dealing with pollution)

After 21minutes of Challenger crash in 01/28/86, one of the major contractor’s share values went down by 12% and there was no explanation why this contractor’s share value went down compared to others who suffered only 3%. “While markets appear to work in practice, we are not sure how they work in theory”. Later US commission found fault with this contractor’s product that caused the crash; but share market (crowds) already acted minutes after the crash.

With most things, the average is mediocrity (average speed of 100 people running 100 meter will not be same as fastest person’s speed in that 100 people group). With decision-making, it’s often excellence.

Jeff Bezos’s comparison of Cambrian explosion to Internet boom. What makes a system successful is its ability to recognize losers and kill them quickly. Or, rather what makes a system successful is its ability to generate lots of losers and then to recognize them as such and kill them off.

Diversity helps because it actually adds perspectives that would otherwise be absent and because it takes away or at least weakens some of the characteristics of group decision-making.

Armstrong’s seer-sucking theory “No matter how much evidence exists that seers do not exist, suckers will play for the existence of seers”. Experts and accuracy are unrelated. Experts beyond a minimal level are of little value in forecasting change.

Independence is important decision making for 2 reasons. First, it keeps the mistakes that people make from becoming correlated (Errors in individual judgment won’t wreck the group’s collective judgment). Secondly independent individuals are mote likely to have new information rather than the same old data everyone is already familiar with.

John Maynard Keynes says in his book – The general theory of employment, interest and, money – says, “ Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally”. However there is the fact that the crowd is right much of the time, which means that paying attention to what others do should make you smarter, not dumber.

Information cascade could be another issue to this as well. This problem starts when people’s decision are not made all at ones, but rather in sequence. So, if the initial decision-makers are making wrong judgment, then the rest will blindly follow it.(e.g. share market rise ). So after a certain point, it becomes rational for people to stop paying attention to their own knowledge and to start looking instead at the actions of others and imitate them. Regarding why people bought at prices they had to know were crazy, people would say “ Sure I knew that prices were way too high, but I saw other people buying and selling at high prices. I figured I could buy, collect dividends or two and then sell at the same price to some other idiot”. Everyone was convinced the greater fool was out there.

In short, collective decisions are only wise, when they incorporate lots of different information).

Decentralization – the idea of the wisdom of crowds also takes decentralization as a given and a good, since it implies that if you set a crowd of self-interested, independent people to work in a decentralized way on the same problem, instead of trying to direct their efforts from the top down, their collective solution is likely to be better than any other solution you could come up with (e.g. bay of pigs invasion, Challenger project, PAM, etc..)(Ant colonies and beehives – even without a center, proved robust and adaptable)

Decentralization is also crucial (as Fredrich Hayek described) , tacit knowledge. Tacit knowledge can’t be easily summarized or conveyed to others because it is specific to a particular place or job or experience.

The virtues of decentralization are twofold. On the one hand, the more responsibility people have for their own environments the more engaged they would be. The second advantage is it makes easier to coordination (e.g. Toyota TPS )

Trust – In 18th and early 19th century in Britain, nation’s economy was run by members of religious sect known as the Quakers (Barclays, Lloyds were Quaker institutions). Quakers were well knows for their personal emphasis on absolute honestly. And as Quaker prosperity grew, people drew a connection between that prosperity and the sect’s reputation for reliability and trustworthiness. For a economy to prosper, what’s needed is basic confidence in the promises and commitments that people make about their products and services. As the economist Thomas Schelling has put it” One has only to consider the enormous frustration of conducting foreign aid in an underdeveloped country, or getting a business established there, to realize what an extraordinary economic asset is a population of honest conscientious people”.

Establishing confidence has been a central part of history of capitalism.

Guardian bank & Trust company in Cayman for money laundering where decent people tried to use that system from paying hefty taxes to IRS. This is a classic example of cooperation problem. Everyone reaps benefits from the services that taxes fund. The problem is that you can reap the benefits of all these things whether or not you actually pay the taxes.

Tx n Rd

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