Information Markets, Administrative Decisionmaking, and Predictive Cost-Benefit Analysis

GW Law Faculty Publications & Other Works Faculty Scholarship 2004 Information Markets, Administrative Decisionmaking, and Predictive Cost-Benefit Analysis Michael B. Abramowicz George Washington University Law School, [email protected] Follow this and additional works at: https://scholarship.law.gwu.edu/faculty_publications Part of the Law Commons Recommended Citation Michael Abramowicz, Information Markets, Administrative Decisionmaking, and Predictive Cost-Benefit Analysis, 71 U. Chi. L. Rev. 933 (2004). This Article is brought to you for free and open access by the Faculty Scholarship at Scholarly Commons. It has been accepted for inclusion in GW Law Faculty Publications & Other Works by an authorized administrator of Scholarly Commons. For more information, please contact [email protected]. Information Markets, Administrative Decisionmaking, and Predictive Cost-Benefit Analysis by Michael Abramowicz∗ FutureMAP, a project of the Defense Advanced Research Projects Agency, was to involve experiments to determine whether information markets could improve Defense Department decisionmaking. Information markets are securities markets used to derive information from the prices of securities whose liquidation values are contingent on future events. The government intended to use such a market to assess the probabilities of potential political assassinations, and the indelicacy of this potential application contributed to a controversy leading to the cancellation of the program. In this Article, Professor Abramowicz assesses whether information markets in theory could be useful to administrative agencies, and it concludes that information markets could help discipline administrative agency predictions, but only if a number of technical hurdles such as the danger of manipulation can be overcome. Because the predictions of well-functioning information markets are objective, they function as a tool that exhibits many of the same virtues in predictive tasks that cost- benefit analysis offers for normative policy evaluation. Both approaches can help to overcome cognitive errors, thwart interest group manipulation, and discipline administrative agency decisionmaking. The Article suggests that the two forms of analysis might be combined to produce a “predictive cost-benefit analysis.” In such an analysis, an information market would predict the outcome of a retrospective cost- benefit analysis, to be conducted some years after the decision whether to enact a particular policy. As long as the identity of the eventual decisionmaker cannot be anticipated, predictive cost-benefit analysis estimates how an average decisionmaker would be expected to evaluate the policy. Because the predictive cost-benefit analysis assessment is not dependent on the identity of current agency officials, they cannot shade the numbers to justify policies that the officials prefer for idiosyncratic or ideological reasons. I. THE ECONOMICS OF INFORMATION MARKETS ...............................................................11 A. The Mechanics........................................................................................................12 B. Accuracy .................................................................................................................18 C. Market Design Challenges......................................................................................21 1. Conditional Markets..........................................................................................21 2. Thin Markets.....................................................................................................26 3. Subsidized Markets...........................................................................................28 II. INFORMATION MARKETS AND ADMINISTRATIVE DECISIONMAKING ..............................30 ∗ Associate Professor of Law, George Mason University. J.D., Yale Law School; B.A., Amherst College. For comments and suggestions, I thank Terrence Chorvat, Emily Frye, Robin Hanson, Shi-Ling Hsu, Stephen Parr, Dan Polsby, and Steven Schooner. Anthony Ellis provided outstanding research assistance. 1 A. The Objectivity of Information Markets.................................................................31 1. Why Objectivity Matters...................................................................................31 2. Are Information Markets Objective?................................................................39 B. Some Potential Governmental Uses for Information Markets................................51 1. Homeland Security Vulnerabilities...................................................................52 2. Solvency Regulation.........................................................................................56 3. Budget Forecasts...............................................................................................58 4. Interim Regulation ............................................................................................60 C. Institutionalizing Information Markets...................................................................62 III. PREDICTIVE COST-BENEFIT ANALYSIS AND BEYOND ....................................................66 A. The Mechanics........................................................................................................68 B. Comparisons ...........................................................................................................72 1. Normative vs. Positive Markets........................................................................72 2. Predictive vs. Traditional Cost-Benefit Analysis..............................................77 C. Comparative Benefit Analysis................................................................................86 IV. CONCLUSION..................................................................................................................87 INTRODUCTION Administrative law innovations are not ordinarily announced on the front page of the New York Times. A Defense Department experiment in government decisionmaking, however, made the front page of the Times two days in a row. The first article announced the plan for the program, 1 and the second announced that officials had responded to criticisms of it by withdrawing it even before it was to be launched later that week.2 The program, sponsored by the Defense Advanced Research Projects Agency, was to have been called FutureMAP, and its goal was to develop “market-based techniques for avoiding surprise and predicting future events.”3 The immediate application that generated controversy was the use of an information market to predict developments in the Middle East, including terrorist acts. One senator denounced the program as a “federal betting parlor on atrocities.”4 Participants in information markets in effect place bets on future events, so the description is not an inaccurate one. 1 See Carl Hulse, Pentagon Prepares a Futures Market on Terror Attacks, N.Y. TIMES, July 28, 2003, at A1. 2 See Carl Hulse, Swiftly, Plan for Terrorism Futures Market Slips into Dustbin of Ideas Without a Future, N.Y. TIMES, July 29, 2003, at A1 (A10 in later editions). 3 http://www.darpa.mil/iao/FutureMAP.htm (last visited Apr. 21, 2003) (web site no longer available). FutureMAP is an acronym for “Futures Markets Applied to Prediction.” 4 Ken Guggenheim, Pentagon Says Threat-Bet Program To Be Canceled, AP, July 29, 2003(quoting Sen. Ron Wyden). 2 The firestorm over FutureMAP mostly reflected its implications for anti-terrorism efforts. Concerns included that FutureMAP actually might encourage terrorism, 5 and politicians reasonably worried that federally sponsored wagering on whether foreign leaders might be assassinated could damage foreign relations.6 Yet there was virtually no discussion in the media of the relevance of information markets themselves for governmental decisionmaking. 7 Policymaking by governmental agencies often depends, either implicitly or explicitly, on predictions about the future. Economic policy depends on anticipation of economic conditions. Decisions whether to build prisons depend on projections of the number of prisoners. Highway appropriations depend on anticipated traffic. And on and on. Even where prediction is not central to determining whether there is a need for government action, an agency decision to enact any regulation presumably depends at least on a prediction that the regulation will have certain consequences. Predictions both about conditions that might affect government policy and about the consequences of such policy are thus central to regulation. Despite the central of prediction to policymaking, there is no provision in the Administrative Procedure Act specifying how agencies should go about making predictions, and so predictions in effect are treated like any other agency findings.8 If FutureMAP had any promise, it was not so much as an anti-terrorism tool, but as a method for systematizing administrative agency predictions, a method that might be useful in other regulatory areas even if not for terrorism. The FutureMAP debacle has provided a setback, maybe a permanent one, to anyone who might have hoped to use information markets in administrative decisionmaking. The academic question remains, however, of whether information markets would be a useful tool for government agencies to employ. That is the question this Article considers, and the answer it provides is mixed. Information markets could help constrain administrative decisionmaking and 5

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