Bastiat’s Bastions

For some years, I have been telling people in the Nicholls community about how markets are used to predict election results–and how they out-predict polls! Here is why markets, such as the Iowa Electronic Markets, work so well, compared to a single poll.  Just last year I wrote a blog post here on this subject, but now, the Iowa Electronic Markets are in the news (in my previous blog post I also discussed how markets could have been used to predict terrorist events, but this effort was squashed by our brilliant –not!–politicians in Washington).

Suppose you poll a very large group of potential voters about how they will vote in a few months (or days or weeks). You will get some results, but sometimes voters will not be very truthful. Some years ago, many voters who were supporting David Duke would not tell anyone, including pollsters, of their support for the former Klan leader.  Duke “under-polled” by a large margin.

The political markets are betting markets–good, old-fashioned wagers. Candidates’ “shares” get valued in the market between $0-$1, and the price reflects the market’s estimate of the candidate’s chances of success. If the bettor believes that candidate A has a better chance of winning than the candidate’s current price suggests, the bettor can buy up shares of candidate A, expecting to cash in after the votes are totaled.

A market makes forecasts much like the way the so-called “Delphi-technique” of forecasts(from Wikipedia) are made. The Delphi method takes the forecasts from experts and uses an average of middle value for the consensus.

There are several differences, though. Markets take middle values of forecasts, with each forecaster’s prediction weighted by the number of shares purchased. The more sure a forecaster gets, the more shares the forecaster buys. Forecasters select themselves instead of being picked by a researcher. Forecasters stand to gain if they make good predictions. and to lose if their predictions are lousy, and so, have a financial stake in the quality of their predictions. Traders who are especially good at forecasting, outpredicting the market, return to the market to play again. Those who lose, by being worse than the market at forecasting events, lose money and tend not to bet as much in the future, learning from their experience. The markets should just keep getting better at predicting as time goes by.

I should point out that sports betting lines and parimutuel betting odds are really determined in the same way and represent good forecasts of the outcomes of sporting events and horse races. By the same token, markets for oil and other depletable natural resources provide best forecasts of future scarcity of those resources.

While markets do better than polls, markets use information from polls, as the bettors incorporate poll information into their forecasts, and so, the polls end up being important in the process. Still, the markets pull more information together than what can be found in a single poll, and by using all information efficiently, weighing it for its reliability, markets provide the most accurate predictions of such future events.

-Morris Coats 

Georgia is in the midst of its most serious drought in decades.  But it is not alone in having trouble securing water for its people.  Florida is growing so rapidly that it is expected to also have to ration water.  And in some of our western states, such as Arizona, people growth, in both legal and illegal residents,  is coming faster that water growth.

A recent news item suggests that more than half the the states in the U.S. and many other nations face serious water shortages and may have to resort to serious measures.

The problem, and its solution, are not as difficult as it may seem.  Municipal water supplies are often controlled by municipal governments, and are usually not profit-maximizing organizations, but are instead, vote-maximizers.

Profit-maximizing organizations would have an incentive to let all who want water to pay the going price.  Water would not be given away at below costs in such a way as to gain votes, but sacrifice the future water supply, because the water in the future could fetch a high price.  Opportunity costs would have to be met.

If you ever drive through Arizona along I-10, you will notice that there are pecan orchards along the way.  If you know anything about pecans, you know that they need a lot of water, especially in the arid Arizona climate, where evaporation rates are higher than here.  Why do farmers grow pecans in Arizona?  Because they get their water for irrigation at a subsidized rate, at less than the opportunity cost of the water.  The subsidized water allows them to profitably grow pecans in the desert.  With water subsidized enough, a farmer could grow rice in the desert (rice requires a flooded field).

If the captain of a 18th century ship found that rats had eaten half of the crew’s food reserves that were expected to last until reaching the next port in 4 weeks, a responsible captain would cut rations.  Prices do that automatically, and at the same time, give those who know about the shortage an incentive to develop other food supplies.  In other words, a water shortage, if it would raise water prices, would provide an incentive for people to be creative in finding ways of developing new water supplies.

Now, some farmers in Louisiana are pumping water from the water table, depleting the water table, which has high-quality drinking water, instead of using surface sources.  The reason is that they do not face the opportunity cost of the water that they could sell in the future.  Sub-surface water is a common-property resource, but that could be changed.

The bottom line is that owners of resources are better managers of natural resources than are government bureaucrats and politicians.  Future citizens do not vote, but firms do consider about lost sales in the future because we sold things too cheaply now.

- Morris Coats