Abstract
Information markets are markets for contracts that yield payments based on the outcome of an uncertain future event, such as a presidential election. The prices in these markets provide useful information about a particular issue, such as a president's reelection probability. The purpose of this paper is to suggest how the use of information markets can improve the quality of public policy.
Our central contribution is to propose an efficient way to implement well-informed policy decisions. We do this by linking and building upon the literatures on information markets and mechanism design. Our claim is that the prices in information markets can inform the mechanism design process, thereby making previously infeasible mechanisms feasible for the policy maker. Specifically, information markets make pay-for-performance contracts viable in the policy domain. Although we focus on public sector decision making, the analysis is sufficiently general to apply to a wide range of problems in private sector and not-for-profit decision making. The framework can be applied to any situation in which a decision maker has the resources, but not the necessary information and ability, to achieve his specified objective. First, we show how it is generally possible to design contracts based on different contingencies whose prices will convey useful information on the costs and benefits of a number of policy choices, ranging from regulation to public works projects. Second, we describe one way of providing incentives for self-interested agents to implement policies that maximize net social benefits. Third, we show how information markets can be used to provide a stronger foundation for implementing a variety of government oversight mechanisms, such as a regulatory budget. We also show how legislators can use traditional budgetary controls in conjunction with information markets to exercise more effective oversight.
Finally, we identify and analyze the strengths and limitations of using information markets to help improve policy. To make the analysis concrete, we examine how the Copenhagen Consensus—which makes recommendations on spending $50 billion wisely—could have benefited from applying information markets.
We argue that there is a large scope for expanding the use of information markets. These markets could promote greater transparency in governmental decision making, provide more accurate estimates of the efficiency and distributional impacts of different policies, provide a better understanding of uncertainties, help with sensitivity analysis, offer a low-cost way of assessing new policy proposals, finance government projects and regulations with positive net benefits, allow those affected by specific policies the opportunity to hedge risk, and aid in the design of policies. Furthermore, information markets can help assess the value of additional research on the decision to undertake a project. At the same time, we suggest that there are important limits to the application of information markets. We also suggest how government could play an important role in the expansion of information markets and researchers could help in the development and assessment of these markets.