James Surowiecki has disputed the wisdom of crowds, even though he literally wrote the book on the subject.
To
be more accurate, Surowiecki criticizes people who misapply the term,
or who simply invoke the wisdom of the crowd to justify doing stupid
things based on popularity. Under certain, explicit circumstances,
crowds can be scarily intelligent. But what are those circumstances?
First
of all, a crowd can only be wise when there is one, true answer. Crowds
are good at probabilities, math problems, and the like. For example, crowds are
great at setting odds at a race track. The crowd-chosen favorites win out over time.
But in those cases, the crowds were working on a problem which had an
objective answer. A horse was going to win the race. The crowd was
great at estimating which horse it would be, and over time, the crowd
would always prove smarter than any single expert gambler (assuming
there is such a thing).
The wisdom of crowds breaks down,
however, in instances of information cascade. If the crowd is so
smart, then how did everybody get taken in by the dot-com stock bubble?
Simple, a crowd is also a herd, and as with any herd, most people are
going to follow the group.
Surowiecki uses the example of two identical
empty restaurants next door to each other. The first customer arrives
in front of the eateries, sees them both empty and, with no data to
distinguish them, arbitrarily chooses one over the other. The next
customer arrives and sees that one restaurant has a customer and one
doesnt, and chooses the occupied restaurant under the assumption that
the first customer knew something he didnt, implying one restaurant
was better. The process repeats itself, until restaurant A overfills
while restaruant B sits empty, even though the two restaurants are
otherwise indistinguishable. All due to the random choice of the first
customer.
The dot-com bubble worked the same way. All the
investors assumed the other investors knew what they were doing-twenty
million stock speculators cant be wrong, supposedly-and they all
collectively suffered when the bubble burst. No wisdom in that crowd.
So
how is the race track different from the stock market? Both are
essentially speculative markets with wagers placed against expected
performance of a certain entity, either a company or a thoroughbred.
Well, by and large, the crowd does not collaborate at the race track.
Yes, odds are posted, but bettors generally dont confer with each
other about whom to bet on. The opposite is true of the stock market,
where collective analysis is the order of the day, and a few key
influence-peddlers coax the general investment crowd one way or the
other.
Thus, Surowiecki implicates, crowds are wise only when
each member of the crowd is working on the same problem somewhat
independently. Crowds are wise in aggregation, not collaboration.
Secondly,
race track crowds are far more diverse intellectually than the stock
market crowd, and they rely on a much wider array of indicators than
stock analysts. That is to say, most active investors are educated,
with a certain reliance on statistics and business acumen that within
itself is quite varied, but when compared against the whole of human
society is actually pretty niche.
Bettors at a race track,
however, run the gamut from math savants to the barely literate, with
bets placed as often on the name or color of a horse as the
statistictical record of its past success. How often does an investor
pick a stock based on the color of the companys logo or the catchiness
of its product jingle? Collectively, the race tracks more diverse
array of bettor insights and preferences is more accurate over time
than the comparatively homogenous set of expert stock investors,
because the varied biases for prediction factor out against each other.
Thus,
diversity, even to an absurd degree, is a healthy thing for crowds.
Darwin taught us that, too. You dont know how the environment is going
to change, so a diversity of species and genetic stock is the best
defense against the unknowable future. Apparently, its also the best
way of guessing the unknowable via an aggregate of the crowd.
