Tuesday, May 17, 2011

Why Adam Smith Didn't Use Facebook (ETH Zurich and Wisdom of the Crowds)

One of Adam Smith's most famous phrases was originally used in the specific context of domestic vs. foreign trade. Nevertheless, here is the quote:

By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was not part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.

Regardless of whether you use the term "invisible hand" in this specific context, or in the more general context in which it is applied today, no one will argue that the actions of an individual often have ramifications far beyond the individual. What is debatable is whether the independent actions of a number of individuals provide benefits to society as a whole.

Note that the last sentence included the word "independent." This is important in understanding a recent study on the 21st century manifestation of the invisible hand. Today we call it the wisdom of crowds. And Wired notes that there are certain circumstances in which said wisdom can be corrupted:

“Although groups are initially ‘wise,’ knowledge about estimates of others narrows the diversity of opinions to such an extent that it undermines” collective wisdom, wrote researchers led by mathematician Jan Lorenz and sociologist Heiko Rahut of Switzerland’s ETH Zurich, in Proceedings of the National Academy of Sciences on May 16. “Even mild social influence can undermine the wisdom of crowd effect.”

Specifically, the test was conducted as follows:

They recruited 144 students from ETH Zurich, sitting them in isolated cubicles and asking them to guess Switzerland’s population density, the length of its border with Italy, the number of new immigrants to Zurich and how many crimes were committed in 2006.

After answering, test subjects were given a small monetary reward based on their answer’s accuracy, then asked again. This proceeded for four more rounds; and while some students didn’t learn what their peers guessed, others were told.

As testing progressed, the average answers of independent test subjects became more accurate, in keeping with the wisdom-of-crowds phenomenon. Socially influenced test subjects, however, actually became less accurate.

Now this finding is not new - one of the four requirements cited in James Surowiecki's 2004 book The Wisdom of Crowds was independence.

However, this finding is often forgotten. The mere fact that a large crowd of people is saying something is not equivalent to "the wisdom of crowds" in the Surowiecki/Lorenz/Rahut sense.

So what if Adam Smith's domestic producer DID have an 18th century version of Facebook? Then perhaps some spammer would convince the entire English populace that the Dutch tulip craze was going to return Real Soon Now - or, better still, that a second South Sea Company would emerge. After all, many of these market crashes have a social component, as people tell their family, friends, and neighbors about this wonderful opportunity - an opportunity that the person would not necessarily pursue based on independent data.

Of course it can work the other way - social connections can lead a mass of people into making a good investment also - but if Lorenz and Rahut's study can be extrapolated, more often than not these collaborative efforts fail.

What does this mean for the way we do work? Is it better to get everyone in a room to solve a problem, or is it better for everyone to stay in their own rooms and look at the variety (or non-variety) of solutions that emerge?
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