Kaun Banega Crorepati (Indian version of Who Wants to Be a Millionaire?) is unarguably one of the most popular reality show on Indian Television. So here’s a question which has never appeared in KBC before and probably never will.
Among all the different types of life lines that Mr. Amitabh Bachchan offers to a KBC contestant, which is the most reliable one?
We’ll come back to this little later in the post. However, you can keep thinking about it while you read on.
Have you ever seen an ant at work? If you closely watch a single ant when it’s away from its other ant friends, the little fellow seems to be taking a stroll in the park with no specific purpose or sense of direction. It seems to be looking for something but its approach appears largely chaotic.
Dumb insect, isn’t it? But wait a minute. If the ant is so dumb why is there an army of scientists enamoured by the behaviour of ants?
In numerous fascinating studies, these scientists have discovered that in spite of seemingly unimpressive behaviour of a single ant, the ant colony works as a highly efficient entity for exploring and exploiting the sources of food. Somehow an ant’s individual pattern-less behaviour, when combined across several thousand ants, transforms in to a very intelligent strategy.
Doesn’t it feel very counterintuitive? I mean throwing a complex problem at a group doesn’t look like an obvious way to generate satisfactory solutions. Does it?
But recently social scientists have started to gain a greater appreciation for the problem solving abilities of the collective, the crowd. In fact, this new type of intelligence termed as Wisdom of Crowds, has opened up new ways to find solutions to hard-to-answer questions and improve on predictions. Wisdom of crowd effect says that groups can be remarkably accurate in estimating vaguely known facts.
Here’s a description of a brilliant example as seen in Michael Mauboussin’s book More Than You Know –
Victorian polymath Francis Galton was one of the first to thoroughly document this group aggregation capability. In a 1907 article, “Vox Popli,” Galton describes a contest to guess the weight of an oz at the West of England Fat Stock and Poultry Exhibition in Plymouth. He collected 787 participants who each paid a six penny fee to participate. (A small cost to deter practical joking.) According to Galton, some of the competitors were butchers and farmers, likely expert at guessing the weight. He surmised that many others, though, were guided by “Such information as they might pick up” or “by their own fancies.”
Galton calculated the median estimate – the vox populi – as well as the mean. He found that the median guess was within 0.8 percent of the correct weight, and that the man of the guesses was within 0.01 percent…Simply stated, the errors cancel out and the result is distilled information.
In his book, Wisdom of Crowds, James Suroweicki writes –
…under the right circumstances, groups are remarkably intelligent, and are often smarter than the smartest people in them. Groups do not need to be dominated by exceptionally intelligent people in order to be smart. Even if most of the people within a group are not especially well-informed or rational, it can still reach a collectively wise decision.
In later years many scientists replicated Galton’s experiment for solving complicated maze, guessing the number of jellybeans in a jar, and finding missing bombs. Every time, the wisdom of crowds produced near perfect answers. Wisdom of crowds isn’t just effective in guessing the present state but it works astonishingly well in making prediction of the future also like who is going to win the Oscars.
Social Proof Vs Wisdom of Crowds
But didn’t we learn in psychology that crowd behaviour is the cause of irrationality and social proof leads us to make wrong choices?
So let me remind you Charlie Munger’s words. He said, “To a man with hammer everything looks like a nail.”
If you swing the “social proof” hammer without understanding its scope you’d end up making wrong decisions. Being a behavioural finance enthusiast I might make the mistake of taking my belief in individual irrationality and extrapolate it by deducing that since markets are made up of individuals, markets must be irrational. But this is like saying, “We have studied ants and can show that they are bumbling and inept. Therefore, we can reason that ant colonies are bumbling and inept.”
So it appears that the mental models of social proof and wisdom of crowds are contradicting each other. Aren’t they?
One mental model talks about extraordinary delusions of crowd and other swears by the accuracy of crowd’s predictive abilities. But there has to be some nuance to this apparent contradiction. So to understand why collectives are often wise – and sometimes very unwise – we need to look under the hood at how the wisdom of crowds works.
The wisdom of crowds turns out to be an incredibly fragile phenomenon. It doesn’t take much for the smart group to become a dumb herd. Crowds tend to make accurate predictions when three conditions prevail – diversity, aggregation and incentives.
Diversity is about people having different ideas and different views of things. It reduces the collective error. Aggregation means you can bring the group’s information together. It assures that the market considers everyone’s information. Incentives are rewards for being right and penalties for being wrong that are often, but not necessarily, monetary. It helps reduce individual errors by encouraging people to participate only when they think they have an insight.
But among the three factors, diversity is the most important key to differentiate between social proof and wisdom of crowds. The diversity prediction theorem tells us that a diverse crowd will always predict more accurately than the average person in the crowd. And the moment you remove the element of diversity, a crowd’s wisdom turns into delusion.
So how does this diversity breakdown happen?
For human beings, who are inherently social and imitative, diversity is the most likely condition to fail when a crowd comes together to make a decision. When the individual choices start getting influenced by what others are doing, information cascades occurs. In other words, people begin making decisions based on the actions of other, rather than on their own private information. These cascades help explain booms, fads, fashions, and crashes.
Interestingly, the crowd doesn’t go from smart to dumb gradually. As you slowly remove diversity, nothing happens initially. Additional reductions may also have no effect. But at a certain critical point, a small incremental reduction causes the system to change qualitatively. That explains the build up of stock market bubbles and how market moves from being mostly efficient to extremely inefficient and staying that way long after the bubble has burst.
Diversity breakdown also occurs in smaller groups because in such groups loss of diversity usually stems from a dominant leader, an absence of facts, or cognitive homogeneity in the group.
Without diversity, collectives large or small can be wildly off the mark.
The real multidisciplinary thinker uses multiple ideas to think about a problem. So let’s see if we can use any other mental model to address this distinction between social proof and wisdom of crowds.
Feedback loops are a good way to understand the difference between social proof and wisdom of crowds. In a social proof, because of reinforcement caused by positive feedback loop, the outcome tends to take you to one extreme where as with diverse crowd the self correcting property of negative feedback loop brings the outcome closer to the right answer.
May be wisdom of crowds is the reason why it’s needed for a company to have an “independent” board of directors. Ironically, in most companies the board meeting resolutions are hardly an aggregate of independent opinions. If there’s once place where social proof is rampant, it’s the boardroom.
Wisdom of crowds also explains why something like Wikipedia is more accurate about facts and information than most experts in the same domain. The Wikipedia is aggregation of information generated by collective effort of diverse people. Of course there are a smaller set of curators but their work is mostly to structure the information and verify it against the referenced sources.
That way crowdsourcing is a great strategy to solve complex problems. But before you get too excited about the “wisdom of internet”, a caveat is in the order.
We live at a time when seemingly everything is available, argues John Lehrer, “but it’s more likely than ever before that we’re all reading the same thing.” He writes –
…while the Web has enabled new forms of collective action, it has also enabled new kinds of collective stupidity. Groupthink is now more widespread, as we cope with the excess of available information by outsourcing our beliefs to celebrities, pundits and Facebook friends. Instead of thinking for ourselves, we simply cite what’s already been cited.
When it comes to stock market investing there are primarily two schools of thought. The efficient market theory (EMT) says that markets are always efficient and all the publicly available information is discounted in the current market prices. People on the other side of the camp believe that markets are inefficient because of human irrationality.
Using the insight about role of diversity in crowd, we can now see that both the schools of thought are partially correct. Even though devotees of EMT argue that the prices reflect the most accurate assessments available, we know that markets are extremely fallible. However, market irrationality does not always follow from individual irrationality. You and I both might be irrationally over-confident but if you are an overconfident buyer and I am an overconfident seller, our biases may cancel out.
Markets tend to function efficiently when there is a sufficient number of diverse investors to interact. Conversely, markets tend to become fragile (panic or euphoria) when this diversity breaks down and investors act in a similar way. During market extremes the disproportionate participation of novice investors, who don’t have their own independent insights and make choices based on the observation of others, introduces groupthink and dilutes the diversity.
Investors who appreciate how and why markets are efficient will have better insight into how and why markets are inefficient.
In Decision Making
How does this mental model help us in making better decisions?
From the perspective of decision-makers, it would be valuable to request multiple independent opinions and aggregate these as the basis of their judgments.
As we have seen that the most important aspect of wisdom of crowds is the presence of diversity. So I speculate that it’s another reason why multidisciplinary approach is so effective. A multidisciplinary thinker arrives at his decisions by stitching together diverse sources of information (big ideas from varied disciplines i.e., mental models) lending credence to the importance of diversity. That’s why when you find two mental models working in different directions, they tend to act as a correction mechanism for a human mind and prevents it from building extreme opinions about a subject. That’s why a multidisciplinary way of thinking leads you to more accurate predictions.
So coming back to the question I asked you in the beginning, I think the answer must be obvious to you by now. The first life line that every KBC contestant should have used is audience poll.
Clearly, collectives cannot solve all problems. If your plumbing is in need of repair, you are better off with a plumber than an Psychologist, a Green peace volunteer, and an astrophysicist working together. But collectives are typically more valuable than experts when the problem is complex and specifiable rules cannot solve it.
The important point to remember while using wisdom of crowd is that three conditions must be in place: diversity, aggregation, and incentives. Break any one of those conditions and the crowd wisdom becomes unreliable or even worse.
As a multidisciplinary thinker you must accept that all approaches have pros and cons, there is no unique solution or unique tool to address all problems. So as a thoughtful decision maker, your prime task is to identify the nature of your problem and then consider how best to solve it.
Take care and keep learning.
Mehul Pathak says
Very insightful article, Anshul. Thanks for the great work is quoting from such diverse sources and connecting the concepts so meaningfully.
Anshul Khare says
Akhil Jain says
Wow, very well described under the three criteria of diveristy, aggregation and incentives. I used to think hard about this dilemma of social proof vs wisdom of crowds for investing too.. What do you think of potential of copy trading or twitter etc. based sentiment analysis.. i just cant buy it..
Under the point of incentives may also be the fact that stock markets are driven a lot by institutional flow much more than retail masses. Whereas in a view gathering exercise, the crowd may comprise these masses by number. The PIMCOs of the world who are correctly incentivised by billions of dollars will not be tweeting their views to be caught in a sentiment index. Rather the big investments and money flow are private and confidential so aggregation is also a big problem.
Anshul Khare says
Many thanks Akhil.
Ashish M says
Nice article Anshul.
Anshul Khare says
Mast Ram says
This article is incomplete without the mention of Abilene paradox.
Plesae do mention about “Abilene paradox” also.
Wisdom of Crowds, Social proof, Group think and Abilene paradox are 4 vertices of the same rectangle.
There is reference to first three in your article.
Anshul Khare says
I had never heard of Abilene paradox before. Thanks for bringing it up. Will read about and probably compile a post on it soon.
WISDOM OF CROWD…..
IN CASE OF STOCK MARKET INVERSE INVERSE AND INVERSE
WHEN PEOPLE AROUND US TALK TO BUY STOCK.AT PAN WALA SHOPE YOU START GETTING TIP TO BUY STOCK JUST BE CAUSTION ON PRINCIPLE OF WISDOM OF CROWD TO BE INVESTED
saurabh shankar says
Great Article Anshul :).
Its very interesting to think of markets with this lense. While markets are diverse ( people from different walks) and Prices reflect the aggregation. Its the incentives which twist it. After all most people have the incentive to make money that causes distortions.
I guess if only people had incentives of following the process and not results markets could have been truly efficient.
Your observation is right. When incentives take perverse form (extreme greed), the diversity breaks down and the wisdom of crowd turns into madness.
Great insight Anshul
Anshul Khare says