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The Elections Predictor

December 30, 2011

by Edward Glaeser

Boston Globe

NEAR NEW Year’s Eve, the urge to prognosticate is harder for a columnist to resist than a glass of champagne. For politics, I look to the electronic prediction markets for a shortcut to insight. For 2012, they suggest that Mitt Romney will be the Republican nominee, Barack Obama will win the general election, and Republicans will control both the House and Senate. While centrists might welcome divided government, a closer look at these markets implies that a more extreme outcome is likely - a one-party rule.

Electronic prediction markets provide a cheap shortcut to foretelling the future, providing both the advantages and pitfalls of relying on the wisdom of crowds.

Economists at the University of Iowa started the original electronic election markets. Twelve years ago, Intrade entered and became a larger political gambling venue. These markets harken back to the pre-World War II era, when New York gamblers bet millions on the political future of Woodrow Wilson. Prediction markets can be briefly manipulated, and they suffer the same waves of erroneous group-think that can afflict any market, but their overall track record is pretty solid.

Economists Paul W. Rohde and Koleman S. Strumpf report that “in the 15 elections between 1884 and 1940, the mid-October betting favorite won 11 times (73 percent) and the underdog won only once.’’ Economists Justin Wolfers and Eric Zitzewitz find that in the presidential elections between 1988 and 2000, the average presidential vote share predicted by the Iowa markets thirty days out was less than two percentage points off, which is better than the final Gallup poll forecasts.

Both the Iowa markets and Intrade similarly depict America’s political future. After the brief Gingrich-mania that followed the earlier Perry bubble, both markets now give Mitt Romney a roughly 75 percent chance of winning the nomination. But his odds are worse in the general election as both markets give the Republican Party about a 45 percent chance of winning the presidency.

Both markets give the Republicans a greater than70 percent chance of taking the Senate, and the Iowa markets give the Republicans a roughly 75 percent chance of keeping the House. Intrade puts the odds of that event at around 69 percent. The Iowa market allows gambling on Republicans controlling both houses, and prices suggest a 60 percent chance of that event.

While Obama seems, according to these markets, likely to stay in the White House and Republicans seem likely to take Congress, the markets aren’t predicting divided government. Correlation between the contests means that the possibility of one-party rule is larger than it initially appears. If Europe pulls America into deep recession, then the Republicans could easily sweep. If the economy roars, then Democrats could take all the marbles.

If the Democrats do take both houses, which the Iowa markets give a 15 percent chance, Obama will surely remain president. If the Republicans retake the White House, then they seem likely to take both houses of Congress, which are softer targets. Taking these markets’ implied odds seriously, there is about a 60 percent chance of one-party rule.

This summers’ budget brinkmanship illustrates the downside of divided government, where both sides parade their toughness to their electoral bases by holding out to the bitter end. At best, political division will be a carefully choreographed dance that just skirts the edge of catastrophe, but at worst, we’ll go over the edge. Naturally, division also means that neither parties’ pet projects will get enacted, but moderates may prefer that outcome.

While divided government is likely to block partisan projects, it may enable unpopular but necessary reforms. The country needs serious entitlement reform, which means less spending on health and retirement benefits. But neither party seems suicidal enough to play Scrooge solo, so entitlement reform will likely require two-party participation, just like tax reform in the 1980s and welfare reform in the 1990s. Those who think America’s fiscal health needs tough medicine have good reason to hope that the prediction markets are wrong and that America gets divided government.