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Markets as a management tool

Ronald Coase taught us that firms arise in order to avoid the costs and complexity of decentralized market transactions. But now, highly centralized, very large firms are finding internal markets to be a useful tool, as discussed in this story in Time. Markets for contingent claims - essentially betting markets on the outcome of future events, such as sales of printers in Europe - are one example. When a company sets up an internal betting market, it allows employees to offer their views and interpretations of current information in ways that marketing committees or forecasting equations fail to capture. As a result, forecasts from betting markets are typically more accurate. Other forms of internal markets also enable companies to profit from better use of dispersed information.

In a laboratory experiment run with M.I.T.'s [Thomas] Malone, Intel used a market to make a coordination decision: which factories should produce computer chips and when. In the experiment, a centralized, strategic plan was replaced with a market in which salesmen and a plant manager traded futures contracts representing chips. The result was nearly 100% efficiency in allocating manufacturing capacity. That experiment echoed another, real-life market triumph. In 1998 oil giant BP set out to reduce company-wide greenhouse emissions 10%. Instead of issuing plant-by-plant dictums, the company let plant managers trade permits to produce emissions. Managers who could quickly get their plants into compliance and reduce emissions even further could sell their permits to other plants. BP hit its reduction target -- nine years early.

There is an emerging literature on this topic. Of course, Hayek made this point long ago, as I discuss in several of my papers on sports betting. James Surowiecki's "The Wisdom of Crowds" (discussed at the previous link), is an engaging book-length treatment of Hayek's theme. A forthcoming paper in the Journal of Economic Perspectives by Justin Wolfers and Eric Zitzewitz provides a nice introduction to "prediction markets." George Mason's Robin Hanson has been working on these markets in every sense for years, and has many original thoughts on the issue of predicting the future. Hat tip: Tyler Cowen.