Tuesday, August 29, 2006

Prediction Markets Whup on Copyrights and Patents

I've just posted to SSRN my forthcoming paper, "Prediction Markets for Promoting the Progress of Sciences and the Useful Arts." It will appear in vol. 14 of the George Mason Law Review. You can download a pretty-to-close-to-final draft at here. The abstract:

Copyrights and patents promote only superficial progress in the sciences and useful arts. Copyright law primarily encourages entertaining works, whereas patent law mainly inspires marginal improvements in mature technologies. Neither form of intellectual property does much to encourage basic research and development. Essential progress suffers.

Prediction markets offer another way to promote the sciences and useful arts. In general, prediction markets support transactions in claims about unresolved questions of fact. A prediction market specifically designed to promote progress in the sciences and useful arts - call it a scientific prediction exchange or SPEx - would support transactions in a variety of prediction certificates, each one of which promises to pay its bearer in the event that an associated claim about science, technology, or public policy comes true. Like other, similar markets in information, a scientific prediction exchange would aggregate, measure, and share the opinions of people paid to find the truth.

Because it would reward accurate answers to factual questions, a SPEx would encourage essential discoveries about the sciences and useful arts. Researchers and developers in those fields could count on the exchange to turn their insights into profit. In contrast to copyrights or patents, therefore, a SPEx would target fundamental progress. Furthermore, and in contrast to copyrights and patents, the exchange would not impose deadweight social costs by legally restricting access to public goods. To the contrary, a scientific prediction exchange would generate a significant positive externality: Claim prices that quantify the current consensus about vital controversies.

This article measures copyright and patent law against the Constitution's call for promotion of the Progress of science and useful Arts, to find those traditional forms of intellectual property lacking. As a cure for that policy failure, it suggests scientific prediction exchanges. Given that such exchanges offer the promise of large net public and private benefits, why don't they already thrive in the United States? Because the laws written for commodity futures, securities, and gambling markets cast a pall of legal uncertainty over scientific prediction exchanges. To ease that unwarranted burden, the article explores a variety of strategies designed to guarantee the legality of scientific prediction exchanges. The article concludes with an all-too-apt illustration of how legal risks can discourage prediction markets from promoting the progress of science and the useful arts.


Thomas Lord said...

As we discussed your paper, someone suggested I forward some of my comments to you. I hope they make some sense out of their original context (the Free Software Business mailing list):

Don Marti wrote:

I think Tom Lord and Hans Reiser have both made good points that are relevant to the "why". The existing capital markets and patent system are optimized for funding inventions that are already finished from a research POV and well along in development.

Sure, that is a reasonable summary of some things I've said. (And thank you for that end-to-end check!)

I don't think that prediction markets help very much and here is why:

Prediction markets are zero-sum markets: some traders win by the exact amount that other traders lose. They are not gambling markets because skill is involved. That is to say that they are more like poker than they are like the lottery. These markets do not give a reward for discovering a new vein of gold -- they give a reward for guesstimating when the next vein of gold will be discovered. These markets do not allocate shares in the vein of gold -- they divvy up a pot of bets placed by gamblers who think they can spot when that vein will be discovered. A pair 19th century gentlemen in Atlanta could make a friendly wager that huge amounts of Gold would be found in California by 18xx and one would win, the other lose -- but neither would have any claim to the gold. They would just be reallocating their collective fortune, not investing in a speculative share of future wealth.

Specifically, prediction markets *do not allocate* any of the economic growth that results from a research success. Rather, prediction markets allocate some of the risk of investment in research. (But they perform that allocation in an odd way, see below.)

In other words, if we have a big bag of money to spend on research and we are trying to decide how to divvy it up among competing research proposals, then there is an argument made that prediction markets are the right tool to manage the allocation. What prediction markets *do not* do is provide incentive for increased investment in research. Well, mostly.

Of course, *if* it is the case that a prediction market does a significantly better job of allocating a fixed pool of research funds than other methods (say, a panel of experts operating an NSF-style bureaucracy) then, yes, the introduction of prediction markets may help to incrementally grow the size of the big bag of money to spend on research. This isn't any better, though, than just changing the NSF committee rules to get incremental gains: no new incentives to invest in research have been created; existing incentives may or may not have been slightly improved.

Even given all of that, even assuming that we really, really desire that incremental gain, it isn't clear that prediction markets are a wise idea. I suspect they would be a corrupting influence:

Prediction markets characterize research, in essence, as the activity of attempting to verify certain hypotheses -- does the question people are trading certificates in have a "yes" or a "no" answer? That is a poor metric for the value of research. For example, the Michelson-Morley experiment was worth doing even though (or perhaps because) it produced a negative result. What would be the prediction market claim for that experiment? "The aether will be measured by 1887?" "The aether will be disproven by 1887?" Why would we want a market to reward people making one of those predictions over the other? There were no serious external reasons for anyone to invest in hopes of a return from either outcome yet, as a society, profound economic growth followed from investment in simply addressing the question. Not only did M-M establish an empirical imperative that led to relativity, it had spin-offs of terms of the propagation of more generally applicable experimental techniques.

(And please don't offer the alternative predictive market question: "The hypothesis of the aether will be proved or disproved by 1887" because there was no question about that. The answer to that question was simply "yes, we know that." Prediction markets amount to a poker game for those already committed to investing in research -- they are a way to split the bill and have a little fun They are not (aside, perhaps from the fun) a way to bring new players to the table.)

In short, prediction markets imply a hopelessly reductionist view of the value of research.

To sum up:

Prediction markets allocate risk, not rewards from research and therefore create no new incentive to invest in research.

The means by which prediction markets allocate risk involves an unrealistic view of the value of research.


Towards alternatives:

We can regard the field of potentially useful consequences of performing research as an infinite supply of unexplored territory -- in principle, anyone can go and discover a new island or continent and, as side effect, identify new trade winds as they explore the ocean of truth.

Unlike physical territory, the truths discovered in the course of research are inherently non-rival -- there is little point in trading in them.

To find ways to increase research investment and direct it more intelligently we must form opinions about *process* rather than predictions about *outcomes*.

Our incentives should NOT be

I'll invest $X in research because I think outcome Y
is likely.

Our incentives should reflect:

I'll invest $X in research services from A because
I think that useful outcomes are likely given A's
systematic approach to exploration.

Externalities and transaction costs -- the ways in which research, though essentially non-rival -- does not propagate evenly in the short term -- that is the essence of where to find investment models. Which brings us back, but in a better light, to the general idea of "exclusive rights." We just ought to be more creative about what those rights entail.

If I had the start-up capital, I'd start a lab that would be funded by newsletter subscriptions and paid on-site visits. Indeed, if there are investors who would be interested in such an approach, please get in touch -- we can start quite small. I'd be happy to describe my own "systematic approach" in the field of practical, open source R&D.


Unknown said...

Kenneth Boulding once said (in effect, I am quoting from memory) "if you don't like the certainties, reward the uncertainties." Both the X-prize folks and some parts of NASA have used this thought to establish prizes for the first to provide a documented solution to a specified problem. If we want the public to participate, maybe we can remind/reinforce the point that donations to just prize funds are tax deductible ("educationsl, charitable, SCIENTIFIC" activities).
Rollie Cole, PhD, JD
Founder, Fertile Ground for Startups, Small Firms, and Nonprofits