Nobel Prize : Digging out awardees from the History-bin.

Rarely does one get to read at some length the citation of a Nobel laureate in a daily, unless one happens to read in ‘IE’ ‘Prize for Guessing‘ that covers this year’s Nobel in economics announced yesterday. Once the brief & recent ‘history of Nobel in economics’ is sketched out in the beginning,and a suitable end is fashioned out to explain away the purpose of the article –

The three Economics Nobel laureates this year explain how politicians and administrators should take decisions when voters are poorly informed -,

it seems it is possible to fill in the middle with whatever the award committee had to say. Having said that I must confess this is the first time I have noticed the Express columnist resort to such a ploy. I therefore say in his defense that may be it is the US travel, which has choked him out of quality time needed for writing his columns. He is in USA at the moment as one discerns from his yesterday’s exertions in Denver, Colorado on a regulatory pilgrimage,where he walked into the Greenwood Village campus building of the College of Financial Planning when the institute was announcing its 100,000th graduate. While this article has useful suggestions for plugging regulatory loopholes in managing the financial intermediaries role by anticipating the disconnect between SEBI(Securities & Exchange Board of India) & IRDA(Insurance Regulatory & Development Authority), we must now return to the Nobel story.

3 individuals, 1 economists & the other 2 mathematicians, have been awarded the prize jointly for their work carried out separately in the 60s, 70s & 80s. Collectively it is called ‘Mechanism Design Theory’. It may sound a tautology at first glance, but it is a theory about how to know or forge appropriate mechanisms for predicting or influencing economic goals. What is a mechanism? One obvious example is of course :

Adam Smith’s classical metaphor of the invisible hand which refers to how the market, under ideal conditions, ensures an efficient allocation of scarce resources”,

Another would be the “Central planning“, a model now much discredited,”used in the Soviet era to make rational choices based on the mammoth data gathered from around the country relating to every conceivable parameter affecting the economy & then fed into an idealized model of equations to allocate resources“. Central planning held that given perfect information it would be possible to take informed decisions to allocate resources most efficiently. Whereas, Market supremacy implied that economic agents having equal access to information and exerting their utmost to maximize their own interests would ultimately result in an optimum equilibrium of the whole economy. Paradoxically both the models, however contrasting, have at their heart the same weakness – a set of assumptions; assumptions so stringent so as to render the models unrealistic. Recognizing this shortcoming in both deterministic & laissez faire models, Leonid Hurwicz proposed that there could be alternate allocation mechanisms. He generalized the notion of mechanisms to view them as communication systems where participants exchange messages. He further did away with the notion of symmetry and acknowledged the fact that the agents may exchange private information or give out false information or withhold information (This may resonate of Game Theory). The mechanism aggregated the results of these exchanges that were undertaken to maximize individual good to arrive at an overall outcome. This in nutshell is the story of Mechanism design theory, which was later enhanced by Myerson & Maskin through the concepts of ‘incentive compatibility’ – a state of equilibrium where every agent tells the truth – and of ‘multiple equilibriums’, where there could be more than one equilibrium & each one would have sub optimal outcomes. The new theory took apart the notions of ideal market & perfect planning and brought in its wake that of imperfect markets mediated by subcompetent regulatory environment.

Far more interesting than the theory itself, is the period when it was being conceived and developed. The period of 60s & 70s was just after the execution of Marshall plan at the end of world war II. This period saw massive intervention by governments in the working of the economies. The regulatory frameworks failed to deliver the stability and security that the people yearned for in Europe. The oil shock of the early and late 70s shook to the foundation the faith in & of the regulators. The depression of the 20s & 30s was by now a faint memory from the past. The ill effects of the government interventions were resented far more than the vagaries of the markets. The theory of mechanisms shadowed the fears & concerns of its time and tried to address them. The reverse swing of the pendulum had begun, but it was still midway between planning and markets; somewhat awkward & unsure. The boldness of Thacherism and Reaganomics was yet to take roots and its agenda of shrinking the governments & of giving free reign to markets across the Atlantic was far into the future. The theme of ‘Reagan in skirts’ or ‘Thacher in trousers’ was still preposterous.

However, in 2007, we can’t claim ignorance by concealing the benefit of almost 30 years of hindsight that we have. Today, the ascendancy of the markets is unquestioned. Bush & Blair have gone far beyond Thacher and Reagan. Public good is often held at ransom to Private wellbeing. Regulation is instinctively disliked. Planning is a bad word. Markets are to be given a free hand but only until they start interfering with private wellbeing. Therefore, I feel, the timing of the award is askew. It looks out of sync with times. Bibek Debroy has caught this dichotomy when he says,

Most recent advances in economic theory have been in information theory. There is the use of a lot of mathematics and the reaction that the economics has got drowned in the maths is understandable. This is even more the case when applications aren’t immediately obvious, unlike Stiglitz’s work, also on asymmetric information. In general, but not invariably, economics prizes have been awarded if two criteria have been satisfied — there is some fundamental contribution to economic stheory and there is a link between this advance and the broader cause of economic development. In the case of mechanism design theory, the former criterion is clearly satisfied, the latter less obviously so.“.

If there is a fundamental contribution to economics theory or not, I do not know. May be there is as Debroy says. However, the link between the theory and the current economic thinking is at best tenuous. Neither has any columnist cited an example of its practical application or use. May be its a Nobel way of having a last laugh; mocking at the ‘oversimplifying ideology’ practiced by the largest economy and greatest democracy on earth. Or may be I am mistaken. Chikarmane says that the theory in fact tells how to make decisions when,

Nonaccountability is most desirable when (a) the electorate is poorly informed about the optimal action, (b) acquiring decision-relevant information is costly, (c) feedback about the quality of decisions is slow. Therefore, technical decisions, in particular, may be best allocated to judges or appointed bureaucrats“.

He advocates its application for decision making concerning ‘123 agreement‘ by the UPA. Unluckily, Bush & Cheney anticipated both the ‘Sveriges Riksbank Prize Committee’ and Chikarmane by solid 4 years when they deicded to attack Iraq in 2003 in accordance with the criteria (a) & (b) of the theory. Four years later they are still thriving by living out the criterion (c).

My own predicament is whether the Theory is vindicated by the Bush-Cheney duo or the Bush-Cheney duo is absolved by the theory.

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3 Responses to “Nobel Prize : Digging out awardees from the History-bin.”

  1. Ed Clarke Says:

    Interesting history. Also, see Letter to Nobel Prize Committee on
    “Originality in Mechanism Design Theory”

  2. Edward Clarke Says:

    Taken from Ed Clarke’s blog.

    Letter Concerning Originality in Mechanism Design Theory

    From : Nicolaus Tideman Sent : Sunday, October 21, 2007 11:52 PM
    To : info@kva.se
    CC : edward clarke
    Subject : Originality in Mechanism Design Theory
    To : the authors of the Prize Committee’s review of Mechanism Design Theory:

    It is helpful that the Prize Committee provided such an extensive review of mechanism design theory. And yet it is disappointing that the review repeats a common mistake with respect to attribution of originality in one of the important ideas in mechanism design theory. You say (p. 7) “It thus came as a surprise when Edward Clarke (1971) and Theodore Groves (1973) showed that, if there are no income effects on the demand for public goods (technically, if the utility functions are quasi linear), then there exists a class of mechanisms in which (a) truthful revelation of one’s willingness to pay is a dominant strategy, and (b) the equilibrium level of the public good maximizes the social surplus. [fn] Footnote: The basic intuition behind the Clarke-Groves mechanism was already present in Vickrey (1961). . . .” The idea that it is possible to motivate people to report accurately the value that they would place on the provision of a public good was understood first by Edward Clarke and was published by him long before anyone else. As you say, Clarke first published his idea in Public Choice in 1971. He published a second use of the idea in Public Prices for Public Products (S. Mushkin, ed.) in 1972. I believe that you will search in vain in Groves (1973) or in Groves’s 1970 Berkeley dissertation for any indication that he had any inkling of the possibility of motivating people to report truthfully their preferences for public goods. His dissertation and his Econometrica paper were concerned strictly with incentives in teams. I believe that Groves did become aware, independently of Clarke, of the possibility of using a variation of his idea to motivate the reporting of truthful preferences about public goods. If I remember correctly, Groves told me that the possibility of adapting his idea to public goods came to his attention when a student of his, Martin Loeb, pointed out the possibility, and the two of them then coauthored a paper (1975) explaining the idea. It can be debated whether an independent discovery published four years after an initial publication deserves joint credit for an idea. But if you wish to extend such credit to Groves you should cite not his 1973 paper, but rather the 1975 paper, and extend credit to Loeb as well as Groves. As for Vickrey’s contribution, it is true that his 1961 paper shows that it is possible to motivate participants in an auction to report their valuations of an auctioned item truthfully, and this can be understood as an example of the same principle that Clarke employed for public goods and Groves employed for incentives in teams. However, I am not aware of anyone using Vickrey’s work to come to and understanding of other possible applications of the idea. Rather, as I understand it, Vickrey’s work was seen as an earlier example of the principle once its general possibilities were understood. Another independent application of the same general idea was Richard Zeckhauser’s suggestion in his 1968 Harvard dissertation that efficient incentives with respect to accidents requires that all parties to an accident be charged the full cost of the accident. This idea can also be seen to be present, obliquely, in Coase’s 1960 paper. The general principle linking all of these ideas is that the generation of efficient incentives requires that people be charged the full marginal social costs (or receive the full marginal social benefits) of their actions, whether these actions are bids in an auction, efforts to make a team more successful, actions that might result in accidents, or the reporting of valuations for a public good. When stated this way, the idea is so fundamental to economics that it is surprising that we were all so surprised by the novel applications of the idea. But we were. And this is the idea that is fundamental to mechanism design. In my view, the expression of this fundamental idea in the context of motivating people to report their preferences for public goods truthfully, as demonstrated first by Clarke, was an important breakthrough that played a key role in helping economists to understand the general principles of mechanism design. Sincerely, Nicolaus Tideman Professor of Economics Virginia Tech References: Clarke, E.H. (1971). “Multipart pricing of public goods,” Public Choice 11, pp. 17-33. Clarke, E.H. (1972). “Multipart pricing of public goods: An example,” pp. 125-30 in S. Mushkin (ed.), Public Prices for Public Products, The Urban Institute, Washington, 1972. Coase R.H. (1960). “The Problem of Social Cost,” Journal of Law and Economics 3, pp. 1-44. Groves T. (1970). “The Allocation of Resources under Uncertainty,” dissertation, University of California at Berkeley. Groves, T. (1973). “Incentives in Teams,” Econometrica 41, pp. 617-31. Groves, T. and Loeb, M. (1975). “Incentives and Public Inputs,” Journal of Public Economics 4, pp. 211-26. Vickrey, W. (1961). “Counterspeculation, Auctions, and Competitive Sealed Tenders,” The Journal of Finance 16, pp. 8-37. Zeckhauser R. (1968). “Studies in Interdependence,” dissertation, Harvard University.

  3. Ed Clarke Says:

    Thanks for the comment
    On your question about finding your blog, I simply searched “mechanism design” and blog search and found a lot of comments and interesting blogs like yours.

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