Midterms watch: The free market knows something Washington’s polling elites don’t
With Americans about to decide which party will control Congress, pollsters and political commentators are offering their final predictions. Some will be right. Others will explain afterward why voters behaved differently than expected.
There is another source of information that deserves attention: prediction markets. These markets apply a basic economic principle. People who risk their own money have an incentive to examine the facts carefully.
The same free-market process that helps determine prices throughout our economy can also help forecast an election. Washington should recognize its value before imposing restrictions that could undermine it.
The Problem with Polls
Polls can provide useful information. But asking people how they intend to vote is different from knowing who will actually cast a ballot.
Pollsters must decide whom to contact, how to weight responses and which respondents are likely voters. Even an honestly conducted survey can miss the result if those assumptions are wrong.
In an October 29 analysis, the Pew Research Center explained why this year’s midterms present particular difficulties. Turnout is uncertain, reliable polling is expensive, and inexpensive surveys vary in quality. Pew also warned that artificial intelligence cannot be a reliable substitute for interviewing real people. Pew Research Center
None of this means every unfavorable poll is biased. It means a forecast depends on the quality of the information and the assumptions used to interpret it.
Competition from another forecasting method should therefore be welcomed.
How Markets Gather Information
Prediction markets allow participants to buy and sell contracts tied to specific outcomes, including election results.
Consider a contract that pays one dollar if a candidate wins and nothing if the candidate loses. A price of 60 cents roughly indicates that traders assign the candidate a 60% chance of winning. It does not mean the candidate will receive 60% of the vote.
The economics behind this is straightforward.
No individual possesses all available information. A business owner in Pennsylvania may understand local economic conditions better than a Washington consultant. A farmer in Iowa may recognize pressures on rural voters that a national commentator overlooks.
Markets give people an opportunity to act on that knowledge. Their buying and selling help establish a price that reflects their combined judgments.
Economists call this price discovery. It is one reason a competitive market can process information more effectively than a small group of experts.
The opportunity to earn a profit encourages participants to look for mistakes.
If traders believe a candidate’s chances are better than the market price suggests, they can buy that candidate’s contracts. If enough buyers agree, the price rises. New information can change the forecast throughout the day.
A person answering a poll loses nothing by giving an inaccurate answer. A trader who repeatedly makes poor judgments can lose money. That difference matters.
There is evidence that this process works. University of Iowa researchers compared their election market’s vote-share forecasts with 964 polls covering presidential elections from 1988 through 2004. The market came closer to the eventual two-party vote split in 74% of those comparisons. ScienceDirect.
That does not mean markets always identify the winner. Nor does it establish that every modern platform outperforms every poll.
Markets can overreact, attract poorly informed traders, or have too little trading to produce dependable prices. A high probability also leaves room for upsets.
Still, those limitations justify careful interpretation, not dismissal.
Protect Competition
Sen. Elizabeth Warren and Republican Sen. John Curtis have questioned whether prediction-market platforms adequately prevent insider trading and manipulation. banking.senate.gov
Fraud should be punished. Rules protecting honest participants help markets function. Free markets depend on enforceable contracts and confidence that the rules apply equally.
But legitimate oversight should not become an excuse for restrictions that make useful markets uneconomic.
The proper question is how to preserve competition while addressing specific abuses. Government should require honest dealing and allow competing forecasting methods to demonstrate their value.
Whatever the election results, the economic lesson remains the same. Knowledge is spread among millions of people. Financial incentives encourage them to use it.
Washington does not have a monopoly on good judgment. Before politicians restrict another market, they should consider how much useful information that market provides.
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