Behind neoclassicism's undiminished dominance

I am reading Yanis Varoufakis's excellent book, Economic Indeterminancy.

Today I want to share a section from that book, from which I borrowed the title of this post. It rather sadly describes the way I have observed the social aspect of theoretical (and the empirical work with close theoretical ties) economics research these days.

Neoclassicists are exceptionally open-minded people, willing to countenance any proposition, however farfetched, weird or even … leftwing. All they ask in return is that the said proposition is embedded within their three meta-axioms. This ‘openness’ is made all the more significant by the fact that, undoubtedly, any conceivable ‘story’ can be told by tinkering with neoclassicism’s first two meta-axioms (see Dasgupta, 2002). Lured by the prospect of unbounded theoretical possibility, the aspiring young economist delights in tinkering her way into the infinite vistas of potential neoclassical narratives; she even revels in sailing the oceans of indeterminacy stirred up by her tinkering. 

At some point, however, the fun must give way to publications, appointments and full induction into the profession. At that point, the lurking gatekeepers (supervisor, referees etc.) present her with a fresh condition: To be allowed into the priesthood, her models must have first achieved ‘closure’ (i.e. a restricted set of equilibria); she must, in effect, submit them to the merciless tightening of the third meta-axiom’s fist, thus tracing the r or b trajectories (see the previous section’s diagram) away from indeterminacy’s cul-de-sac. At that juncture, having already invested great energy and hope in her modelling, it takes a brave and tragic theorist to desist and call it quits. 

A tiny minority ‘close’ their models reluctantly, tucking critical comments away in their papers’ footnotes, biding their time and, once tenured, turn into resident critics. Some ‘close’ their models and steer clear of any controversy, but nonetheless manage to retain the memory of how determinacy’s imperatives whipped them back from a complex and rewarding inquiry to a paradigm devised for arid pure-exchange economies in which a sophisticated theory of agency, not to mention a left-of-centre political agenda, is as viable as a fire under a mighty waterfall (see Varoufakis, 2002, for the ‘postmodern’ aspect of this). Meanwhile, the vast majority not only leave no stone unturned to ‘close’ their models, often with moral enthusiasm, but also sweep under the emotional carpet any memory of how their models’ ‘closure’ was bought at the price of returning homo economicus to strict isolation from his brethren, of relinquishing meaningful social norms, and of losing social and historical contingency

The 'dance of the meta-axioms' is what separates economics from there social sciences.  In sociology, and particularly mathematical sociology, the problem of indeterminacy is widely accepted, and the approach to modelling social patterns of behaviour is far more diverse.

In a presentation of my signalling model (links to early presentation and pdf in this post) I was asked the question "In what way is this a model?" It seems that unless unique solutions are forthcoming, economists will back away from the 'wall of indeterminacy' to the happy place where all models have unique, of finite sets of, solutions. Never mind that, as Varoufakis explains, neoclassical models can be generated to support an 'infinite vista' of 'narratives'. That is, you can find any result you want within the meta-axioms if you are happy to tinker with assumptions, but you must follow the methodological conventions.

You can see this process play out across the discipline. I recently discussed how the 'Top young economists' are mostly playing at these games, getting sucked into the neoclassical vortex.

One can only hope that with the current period of naval taxing, and enough smart young economists entering the profession with much broader appreciations of the social phenomena economics attempts to explain, that the profession will gradually admit to these methodological limits and embrace alternatives.

Free entry assumption means zero prices

When learning about market models, perfect or otherwise, one critical assumption is that of free entry (and implied is free exit or free disposal) of new firms into a market. In fact, it is one assumption that drives the outcome of all the economic market models (including variations such as monopolistic competition), yet its exceptionally strong implications are usually glossed over.

So what does free entry really mean, and why does it matter?

The typical explanation of free entry is that in the situation where there exists a potential economic profit in a market, new firms can freely enter the market, increasing market output and reducing profits for existing firms back to zero. Any costs they incur in the process can be recovered perfectly if things go wrong. That means if a new firms buys a building or vehicle, employ some people and produce goods, but then find can’t make a profit, they can recover all their costs and try starting another business without losing a single dollar in the process.

That such as assumption obviously conflicts with behaviour in the real world is usually ignored with reference to Friedman’s ‘assumptions don’t matter’ quip. Even if, of course, the model still fails in any predictive capacity.

But taken to its logical conclusion, this simple assumption means that in any market economy with free entry all firms will be worth zero, since their profits are zero [1]. Moreover, if all markets have free entry, then all prices will be zero. 

The Twitter-verse didn’t quite understand what I meant when I said all prices will be zero, so I want to explain why this is the only logical conclusion in an economy where all markets have free entry.

First, we need to understand that the costs of production in any market for any firm are the prices set in an upstream market. That upstream market also has input costs set in an further upstream market and so on up the chain of production (and backwards through time). This is the essence of Saffra’s idea of the production of commodities by means of commodities.

The furthest upstream market is land - without a location to reside and the input of raw resources from land, no economic activity can take place. Here’s the crux of my argument. If the land market had free entry, any time the value of any piece of land became a positive non-zero amount an alternative new piece of land be instantly available to increase the stock of land and decrease all land prices back to zero [2]. 

The immediate downstream market, say for timber or some other naturally endowed product, would have a zero input cost for land and other resource inputs to growing their trees (rain, sunlight etc). The price of timber now reflects the cost of growing it, which is zero. The sawmill would have free land and free timber, and then cut free boards, and eventually the economy would produce free homes.

I’ve overlooked labour inputs, but in this free entry equilibrium all prices would be zero, which means even a zero labour wage rate would be infinitely valuable (you could buy every conceivable item with it).

Economic theory side-steps this issue by invoking a ‘normal’ rate of profit. Everyone goes and gets a normal rate, thanks very much. Any argument about the source of this magic normal rate is usually circular, and if price are zero it doesn’t matter what this rate is anyway!

As you might have noticed the world is finite, therefore not every market can be subject to free entry simultaneously, especially if they are already at the equilibrium point of using all the world’s resources!

The real world has no feature that correspond to the model. When we look at the short-list of conditions that invalidate free entry, we wonder where on Earth the whole idea came from in the first place. Even monopolistic competition invokes free entry in ‘the long run’ to push profits down to ‘normal’. 

Clearly this assumption can’t stand up and needs to be dropped if economic models of market are going to be of any use as representations of reality, and importantly, as tools to guide public policy.

One area of economics that addresses these points explicitly is real options theory. In this theory there is no free entry and exit - when a firm enters a market it can’t simply turn around and leave and recover all of its costs exactly. Moreover, firms may find it advantageous to delay entry into markets - something not possible in the orthodox models solved in a time singularity. 

fn [1]. Actually since there is another nasty assumption, that all costs embed a ‘normal’ rate of profit, a firm’s value will be proportional to its revenue. 

fn [2]. In reality of course, all land is a mini-monopoly on its location and this is an impossible scenario.

What equality-efficiency trade-off?

As my online debates with ‘well trained’ economists continue with full force I will again use this blog as an outlet to expand on arguments that can’t be made in 140 characters or less, or those that simply attract religiously-held views via comment pages.

On Facebook an otherwise innocuous comment, that it is “undeniable there is an equity-efficiency tradeoff,” really leapt off the screen at me. Why would a sophisticated economist make such a strong statement that has little to no empirical support. Could it be that this little book has had such an enduring impact on the discipline?

What is rarely taught, in the haste for economics departments across the Anglosphere to pump out energetic graduates, are the numerous built-in assumptions of the core models that lead to this apparent trade-off. Nor are alternative models presented that parcel together different, often more realistic, assumptions, and which arrive at far different conclusions.

To be more concrete, if there really is an equality-efficiency trade-off at a broad level, then there should be no single regulatory change that can increase both equality and efficiency, since if there exists such a reform, or set of reforms, it negates the entire aggregation to a macro level trade-off. Nor should you be able to simultaneous decrease efficiency and equality, as this leaves the door open for reversals of such policies.

My preferred alternative way to approach such problems is to consider the set of institutions that led to the current level of equality as a whole. Then evaluate the costs of these institutions against alternative institutions that result in more, or less, equality.

One might interject at this point to say that the shifting nature of equality is a product of technology change, education, or some other such thing. I’ll leave it to Matt Bruenig to address this point

When we talk about how economic changes, technological swings, and even education will affect the distribution of income in society, we always sort of assume away our government’s distributive policy as if it will or must remain static. But that’s not true at all. At any time we can change the huge set of policies that direct the distribution of income in society to something else. 

The last few decades of median income stagnation didn’t have to happen. Even if you say it was caused by international competition or technological change or whatever else, the point is that if we had put a different set of distributive institutions into place, we could have avoided the maldistribution of income that we have seen. It is not like the median incomes stagnated because the economy as a whole stagnated. Quite the contrary: the economy is much larger on a per capita basis now than it used to be. If we had wanted to make sure median incomes continued to rise, we could have done that. We would have just needed different distribution policy.

Let us now consider a couple of important cases in the set of reforms that, by most estimates, would increase both equality and efficiency.

First is shifting the tax base to land (and other resource monopolies). This is probably the simplest to  administer, and the one reform that would have the greatest efficiency boost and equality gains. Unfortunately it is also the one reform that, by virtue of its distributional impact, is the least palatable to the wealthy and therefore the least palatable politically.

The reason for the win-win nature of land taxes is that deadweight losses from taxation are reduced, increasing efficiency, while at the same time the tax will fall on those entities with the largest ownership claims to the natural wealth of a country, increasing economic quality.

The second case comprises any investment in public goods by government that would disproportionately benefit the poor due to their characteristics. I’m thinking here of, say investment in a fibre optic communications network to all homes, or investments in parks and community services in poorer neighbourhoods, or any number of things. These investments would then be provided free of charge or at token prices.

The policy space is vast, and economic thinking often limits it. Consider the case of gifts of land and accessible government-backed construction finance to households on low incomes. Such a scheme would provide the poorest in society an asset they can use to support themselves - to borrow against, to invest in, and use as a cushion in times of financial distress. We did it once before with the soldier resettlement programs, but for slightly different reasons.

In the case of Australia I might even suggest intervening in currency markets to keep the AUD low and foster local investment.

That’s a nice handful of policy ideas that appear to negate the apparent ubiquitous equality-efficiency trade-off. 

Why do these ideas still hold so much sway? Why do we teach that the usual case is for a trade-off, when it is equally valid to teach that the usual case that there is no trade-off? Why constrain the thinking of graduates in this way?

I can't provide a complete answer to these questions now. I can only do my part to expand the thinking of receptive readers of this blog. 

Please share this article. Tips, suggestions, comments and requests to rumplestatskin@gmail.com + follow me on Twitter @rumplestatskin

Meltdowns and Mankiw

Two classic tantrums caught my attention this week, and they are both promising signs for the future of humanity (at least in some small way).

The Australian group-think collective and former news outlet had a dummy spit over the rise of, well, competitors practising journalism. John Quiggin sums up a few hilarious take-downs, but here is another. 

The second tantrum, although not so new this week, is from the top 1%’s economic propaganda consultant N. Gregory Mankiw. It’s a rant about how Mankiw finds it ‘hard to square the rhetoric of the left with the economist’s standard framework’.

There are many responses to Mankiw’s article - here, here, here, here, here.

Together these rants reveal the current desperation of the entrenched elites in Australia and the US. Their cushy rent-seeking positions are being eaten away by a more informed new generation. Occupy Wall Street was a massive boost for those seeking greater equality and stimulated a widespread interest in the power structures that dominate corporate and political life. Any changes that stem from this I hope will be for the better, though I fear that like any group with their backs to the wall, the elites will come out swinging with the introduction of crazy laws protecting their interests. 

Change doesn’t come easy. 

I want to spend some time now also discussing why Mankiw’s thinking epitomises problems with mainstream economic analysis in general. 

When I suggested that Mankiw’s rant is fairly representative of mainstream economic thinking, I was immediately faced with this question on Twitter

Why is Mankiw's terrible attempt at philosophy representative of mainstream economic theory?

Since you can’t explain much in 140 characters or less, I figured I may as well elaborate on that point here. Which is that Mankiw sets up fictitious model worlds in which we are asked to consider the role of inequality. These worlds are meant to be representative of economic models of near perfect markets, while at the same time, they application of the model is inconsistent with its core properties (if you in equilibrium there can be no shocks, nor a rise in inequality). To be clear, this is exactly how economics is taught, which should be no surprise since Mankiw is one of the most popular economics textbook authors. 

He concludes that

It is, I believe, hard to square the rhetoric of the left with the economist’s standard framework

Which is to say that if you believe the core economic models, you can't buy into debates about inequality.

This ignores the important issue that inequality is completely unable to be understood with the core models of economics where a mystical 'representative agent' stands in for all individuals. As soon as any degree of disaggregation occurs, such that inequality can exist, we aren't in that model world of economics anymore!  

Mankiw starts by having us imagine a world of ‘perfect economic equality’. One he describes as ‘an equilibrium in which everyone earns exactly the same income’. To any economically literate reader, this reads ‘markets are complete and perfect and all are in equilibrium’. So far, he adheres to the fantasy world of the core model of economics.

Then we are to imagine that in this utopian model world an entrepreneur with an idea for a new product emerges, such as his example entrepreneurs Steve Jobs and J.K. Rowling. Through voluntary exchange, people buy this new product and these entrepreneurs get rich. So what’s wrong with that?

Nothing, so long as we forget the model!

In the model world Mankiw sets up, these entrepreneurs cannot get rich because markets are competitive and all profits are zero. They cannot sell their product for anything above its cost as consumers will substitute to any one of an infinite array of alternative goods being produced. We will simply return to the previous equilibrium.

He starts with a clear economic model, then he leaves out selected elements of it so the result suits his political agenda. 

Later in the paper, he raises the common mainstream view that there is a trade-off between equality and efficiency. This is a very common view that I see in many papers and presentations, and I almost never let a presenter get away with it.

The apparent trade-off arises in a different model world where we are already at some perfect equilibrium and wish to make a change in favour of equality. Because changes are costly, moving from this equilibrium to one with more equality has a cost.

What is hidden here is that when you profess an equality-efficiency tradeoff using this model logic, you must ignore include the costs of moving from the current equilibrium to another, but ignore the costs of maintaining the status quo equilibrium.  

Unlike in the model, in reality, the distribution of wealth is always and everywhere a product of the institutions we create. In this reality, the important question is, why are current institutions that allow the current degree of inequality so much less costly than the ones that allow less inequality? 

Later, Mankiw elaborates the foundation of his view in why inequality is justified in the section “Listening to the Left”, where he simply asserts that the rich have earned their ‘just deserts':

My own reading of the evidence is that most of the very wealthy get that way by making substantial economic contributions, not by gaming the system or taking advantage of some market failure or the political process.

Of course he thinks that. In his model world it is impossible for political processes to be gamed, therefore he simply asserts that the model outcome must be the reality! 

Given all this weaving, ducking, and model trickery, either Mankiw 1) doesn’t believe the models he has been teaching for the past two decades, or 2) he is applying them willy-nilly to support his own moral and political stance. 

I suggest a little of both.

Australia's external position. Discuss

I have written about real wealth and Australia's external position in the past; in relation to a proposal for a sovereign wealth fund and exactly what it would mean for fiscal balances, and in relation to domestic asset prices (housing).

Today I want to share a graph based on yesterday's data release of Australia's external position.  I've inverted it to represent that Australia's foreign 'investment' is on the liabilities side of the balance sheet, not the asset side.

I also wanted to share a couple of graphs that extend on earlier analysis of long term housing metrics. The point I want to make is that since housing is a non-tradable good, the expectation would be that the price of housing would increase in line with other locally produced goods.

I can produce the same 'Excess price growth' charts for both non-tradables and services indexes of the CPI. They indicate simply that Australia's external position is allowing a huge shift in relative prices - housing and other locally produced goods seems expensive simply because imported goods are so cheap.

Ultimately this shift is a policy choice, since at any point we could intervene in currency markets (given the political will) to attract more diverse local investment.

The lesson here is that any whinge about prices and incomes in Australia must look at the big picture, which has been driven to a large extend by our rather backwards attitude to foreign debt and laissez faire approach to currency markets.  Anything made locally is expensive even to Aussies. It is a long road back if we want to turn these patterns around. 

PS. I'm trying a new online graphing tool Datawrapper that I see Greg Jericho using to great effect.  Unfortunately it's not playing too nice today so only a single graph as a preview of what is to come.

Three years on: Cargo bike review

I am now a local ambassador for Dutch Cargo Bikes. If you would like to test rise this bike in Brisbane (or a three wheeler) email me at cameron@dutchcargobike.com.au  

I’ve owned a Bakfiets (long version) from Melbourne-based importers Dutch Cargo Bikes for a little over three years now. My first impressions of the bike were very generous - smooth ride, very sturdy build, lots of smiling faces as you ride.

So what do I think now after three years of daily cycling?

I think my initial thoughts were spot in. In all seriousness, it would be very difficult to find a bike built with such quality components, and one of such size and weight that still rides so comfortably and smoothly.

I don’t really know how to structure all the things I feel I should share to prospective cargo-bikers, so I’ll used the clichéd internet format of '6 things I learnt about Bakfiets'.

1. They are a second car replacement
At various times I’ve carried a new flatscreen television, 5 old bikes, a bride and groom (for a Dutch friend’s wedding), work colleagues, tables, chairs, suitcases and more. When my youngest was a newborn we used a car capsule for him strapped to the floor of the box. A Bakfiets really is an ideal tool for daycare drop-offs, supermarket trips and any number of other short commutes. It really does open up whole new opportunities for urban transport.

2. They are more comfortable than most bikes, even other ‘sit-up’ style bikes
I ride this bike with no load most of the time simply because its comfortable. I get to wear anything, carry anything, ride at night without remembering lights, ride in the rain without getting road splashes, never forget my lock. It really is a well-thought out practical machine.

I actually planned on selling the bike last year. My eldest son rides himself most of the time now. I bought a reasonably affordable sit-up bike, but after riding it for a few days decided to sell it and keep the cargo bike.

3. Your quad muscles become very powerful
When my bike was delivered and assembled at my local bike shop the first hill on my way home had me worried - how would I use this heavy bike every day! After a week I didn’t notice anymore and now when I ride a lightweight bike I just fly.

4. 3 adults and 2 children is possible
Don’t forget the rear rack is very sturdy and can easily hold an adult sitting or standing.

5. Making friends
Only once have I picked up a hitchhiker off the street for a ride. Although I am often asked for a lift by large drunk blokes in the city late at night - “Oh, you’re not a bike cab?”

Everyone wants to talk. Waiting at the lights people will wind down their car window and chat to you. You’ll get waves from people you’ve never seen before. Maybe this is off-putting for some people, but either it has stopped now in my area, or I’m used to it.

6. Resale
The big selling point for me choosing this bike was the trust that it was well made enough to maintain its value. I know that second hand bikes of this age now sell for about $2400 in Australia, and many people do ask me when I plan on selling. Add this to the low maintenance ($75 so far over three years to service components) it is actually quite an economical transport alternative. In all honesty it is probably the best value bike I've ever owned (and I've owned many bikes, cheap and high end). 

Three years on the bike feels brand new and I still enjoy the ride.

Policy and worship of prediction markets

The idea of the market as ‘information aggregator’ is, like many ideas, probably as old as humanity itself, but Friedrich Hayek is usually credited with popularising the idea in his 1945 article “The Use of Knowledge in Society”. He writes

The peculiar character of the problem of a rational economic order is determined precisely by the fact that the knowledge of the circumstances of which we must make use never exists in concentrated or integrated form but solely as the dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess.
The economic problem of society is thus not merely a problem of how to allocate "given" resources—if "given" is taken to mean given to a single mind which deliberately solves the problem set by these "data."
It is rather a problem of how to secure the best use of resources known to any of the members of society, for ends whose relative importance only these individuals know.

While I agree that information aggregation is a problem in maintaining a ‘rational economic order’, I disagree with the religious fervour that ‘markets’ are promoted the ‘solution’ to the problem of information aggregation. This is particularly the case with prediction markets, which are often seen as a type of mystical seer of the future. But if markets have an ability to aggregate information, there must exists alternative processes for information sharing, since markets can only reflect existing information and not provide new information.

A common modern view is that prediction markets are so good at information provision, or prediction, they should be widely extended to more areas of life. Here’s just one framing of the issue

Economists believe that financial markets do a good job in aggregating information in part because they provide the participants with strong incentives to form good predictions.
…
Speculative markets perform relatively well when compared with information institutions (academia, news media, experts, etc) in terms of their information aggregation and prediction accuracy when presented with the same situation or environment.
Some examples may include Florida Orange juice commodity futures which have improved on government weather forecasts (Roll, 1984), betting markets that have beaten major national opinion polls 451 out of 596 times in predicting U.S presidential election results (Forsythe, Nelson, Neumann, and Wright, 1992), and betting markets that beat out Hewlett Packard official forecasts 6 times out of 8 at predicting the computer corporation’s printer sales (Chen & Plott, 1998; Plott, 2000).
So why not incorporate such markets in areas of public choice in order to facilitate societal decision making?

To really consider this topic we must first be clear about the economic and social value of information, what we mean by aggregate, and what ‘markets’, especially prediction markets, actually do. Then we can consider when and where markets seem to be useful tools for information provision, and when and where they probably are of little value. The intention being to wrap some social and economic context around an otherwise bare, idealistic, and often skewed view of the role of markets in society.

First then to the economic and social value of information. Say, as Hayek fairly rightly assumes, that information about how to produce certain goods, where to find certain resources and so forth is known only very narrowly amongst specialists. It is almost self-evident that this knowledge is of value to production, since both having the capital equipment and knowing how to use it are inseparable ‘factors of production’.

The question then arises, what information is needed by others from these specialists in order to facilitate production and trade? Surely not everyone needs to know how to build a car, grow grain, or raise cows. The specialist need only share that information with interested parties in those markets who typically pay for such expertise. Such sharing of expertise can be provided through labour markets and other contracts directly with the individuals who hold the knowledge, but it can’t be provided by prediction markets expect under particular circumstances.

Prediction markets merely reflect the marginal participants’ willingness to gamble on a future event. In a world where the density of predictions is very high and also fairly independent (most people are predicting much the same result, they not relying on the prediction of others to form their own predictions, and the marginal gambler is somewhere near the average), we get a pretty good signal from betting or futures markets about price expectations.

Of course there are other ways to aggregate information, and many ways to improve the available information without resorting to the provision of a common signal based on the beliefs of the marginal gambler.

For example, we have some evidence that commodity futures are correlated well seasonal weather patterns. But there is no new information in the futures price that existed prior the the market being formed - it merely reflects one method for aggregating existing information held by only those participating in that market.

Society as a whole would be better off with new information, and that only comes through investment in weather monitoring and forecasting institutions and capital equipment. The supply of such is typically seen to have characteristics of a public good and is typically publicly funded.

To make my case more clearly, betting markets only provide useful information if there already exists useful information to aggregate. Imagine if we we sitting around in the 1700s and trying to figure out the depth of the Pacific Ocean. We could open betting markets, but at some point we would actually have to measure the depth to actually produce new information rather than an aggregate of beliefs

When a small number of market participants have differential abilities to control the future outcomes of the bet there are also serious problems with prediction markets. A recent survey article on the now long history of experimental testing of prediction markets say the following

Together these papers suggest that prediction markets are not universally the best choice. Rather, it is important to identify when prediction markets are a good choice. The answer depends at least in part on the extent of the robustness of these markets to insiders or manipulators.

This paper also summarised the experimental condition where there exists an ability for insiders to manipulate prices under a variety of conditions. Intrade, who extended betting to obscure outcomes, provides lessons about the ability for insiders to profit from their knowledge.

Will weapons of mass destruction be found in Iraq? Will Israel bomb Iran? The answers could alter global economics and politics—and Intrade ventured them, sometimes appearing to reflect insider information in the process. On December 13, 2003, U.S. military forces discovered Saddam Hussein in his spider hole in Tikrit. Up to that week, the Intrade contract for his capture had traded at a dismal 40 cents, indicating merely a four percent chance of his capture by the end of the year. Then, in the days before his capture became public, the contract registered unusual trade volume—driven, one can only assume, by someone who knew what was about to happen. By the time Paul Bremer said “We got him” to reporters, Intraders already knew. Anyone who bought a Saddam contract a week before had made a profit of 2,500 percent.

Do we really want to develop a whole espionage industry devoted to improving information for gamblers in prediction markets? As if there isn’t enough of this already in financial markets where actual ownership claims of tangible capital assets are at stake.

The real problem with wide adoption of prediction markets as policy guide is that incentive for those with money on the line to manipulate the outcomes. Politicians could bet anonymously on policy outcomes already decided behind closed doors. Powerful lobby groups can manipulate outcomes and gamble on their inside information. Imagine controlling insider trading is such broad prediction markets. I would suggest that prevalence of insider trading is one reason such markets have not taken off in their own right - only those with inside information would be willing to place bets, and no one would bet on the alternative outcome, given the knowledge that only insiders play these markets.

As the survey paper suggests, many true believers in prediction markets have suggested they be used as policy inputs is a wide variety of areas, from education funding to anti-terrorism. Of course the social question is whether the risk of having your intelligence agency relying on a signal so easily manipulated by the enemy is a wise choice.

We also know that surveys and opinion polling are pretty good aggregators of information as well. So why the devout attachment by the rational expectations crowd to gambling markets?

In almost every case where ‘prediction markets’ have been proposed, there exist alternatives that offer both new information a much richer set of aggregate information than single bets on prices and timing of future events.

For example, it has been proposed to me in conversation that tertiary education choice could benefit from signals about future earning by opening gambling markets on future earning of individuals studying different degrees and entering different professions. Student would then be able to use that signal to make a better decision about the choice of study and career path.

An almost costless alternative is to make publicly available individual income tax information along with main occupation. Say like Norway. Surely this would be more valuable information for a number of reasons, not just a guide to income of different occupations to aid career choices.

Other big calls are for wide implementation of ‘prediction markets’ as policy guides. 

why not let citizens bet on, rather than submit to professional opinion on, for example, which tax policy is more likely to bring prosperity?

Yeah, maybe think that one through a little more. 

The moral here is that markets don’t really aggregate information as is commonly believed - they in fact reveal the marginal beliefs of the participants in the market, or in the case of active manipulation of the market, absolutely nothing at all. All information that determines the prices already exists, and none of it is shared through prediction markets - only a single piece of information, the marginal price belief - is actually generated.