Between the Auction Theorists and the Nobel Committee, Technology Made Its Way

A handful of developments in research economics in the early 1980s created sufficient excitement to attract the attention of journalists. As the saying goes, there were sovereigns in the air.

Paul Krugman edited a conference volume on strategic trade policy built around  new ideas about economies of scale. Thomas Sargent, in “The Ends of Four Big Inflations,” suggested that the Federal Reserve Board’s battle against inflation might be less costly than was commonly thought. Paul Romer began investigating the logic of policies that might stimulate economic growth. Fynn Kydland and Edward Prescott, having already reformulated the terms by which central banking was understood, set out in “Time to Build and Aggregate Fluctuations,” to identify the driving forces behind business cycles.

And in 1982, an eight-page paper contributed by four economists who shared Stanford University connections appeared in The Journal of Economic Theory, “Rational Cooperation in the Finitely Repeated Prisoners’ Dilemma.” Interest in the evolution of cooperation had recently been stimulated by an influential paper by political scientist Robert Axelrod. The authors were concerned with the machinery by which reputations were built and preserved (or not!), Having submitted to the journal rival papers setting out ideas about the analysis of what soon would become known as sequential equilibrium, involving the application of Bayes’ rule, they were persuaded by the editor, Karl Shell, to prepare a short introduction setting out their common ground. They were quickly dubbed the Gang of Four.

Last week two members of the Gang of Four became the most recent of that cohort, most of them having begun their graduate studies in the 1970s, to be recognized by the Nobel Committee for the prize in economic sciences. Paul Milgrom and Robert Wilson were cited for their contributions to auction theory, whereupon a collective sigh of satisfaction could be heard among their friends and colleagues.  Frustration at the Swedes’ failure to act had grown so great that Milgrom’s students had resolved that, while waiting, they could compile a Wikipedia compendium as a temporary substitute for the citation they hoped to read one day.

The Committee’s paper on the scientific background to the award told the story.  Ronald Coase had advocated throughout the 1950s for government use of auctions to establish property rights for regulated public resources – such as broadcast spectrum and natural resources –  oil, gas, minerals, timber, fish,  As Committee chairman Lars Werin put it in his presentation speech, “it took some time” for Coase’s insights to sink in. William Vickrey wrote it down a pair of seminal papers describing a theory of auctions in 1961 and 1962 – then waited 35 years to share the 1996 prize with James Mirrlees for contributions to the analysis of “incentives under asymmetric information.”

Wilson, this year’s co-laureate, was learning game theory from Howard Raiffa at Harvard College  when Vickrey was writing on auctions.  When he turned in a paper on the subject at his next stop, the Harvard Business School, for an MBA, he received a failing grade because auctions were thought irrelevant to managerial decision-making. Stanford hired him a year after he obtained a Doctor of Business Administration from HBS, and he has remained there ever since, playing a role second only to Kenneth Arrow in the integration of game theory and economics. Among Wilson’s students, Alvin Roth and Bengt Holmström were previously anointed by the Swedish Academy of Sciences.

Wilson had become interested in competitive bidding in auctions where asymmetric information among bidders was the rule.  By the 1970s, he was advising governments on the design of auctions of offshore oil and gas leases, and bidders on appropriate strategies.  In 1978 his student Milgrom completed a magisterial Ph.D. thesis detailing “the seven main results of auction theory”; he went on to play a role in many of the advances of the 1980s, including, with co-author and fellow Gangster John Roberts (“Predation, Reputation, and Entry Deterrence”), the reformation of theories of industrial organization and antitrust doctrine from which Jean Tirole emerged with a Nobel Prize.  When Vickrey died, in 1996, it was to Milgrom that the Committee turned to deliver the ceremonial lecture commemorating him.

In August 1993, President Bill Clinton signed legislation granting the Federal Communications Commission authority to auction electromagnetic spectrum licenses. FCC staff had been arguing for radio spectrum auctions since 1983 when MIT-trained economist Evan Kwerel was hired away from Yale. Ten years later the FCC hired Milgrom and Wilson to design a complicated auction.  For background see Kwerel’s foreword to Putting Auction Theory to Work, Milgrom’s Churchill Lectures (Cambridge, 2004).  Or read You Say You Want a Revolution: A Story of the Information Age (Yale, 2011), by FCC Chairman Reed Hundt, who had been Vice President Al Gore’s friend since high school. In 1994 Gore exuberantly announced “the greatest auction ever” and the cell-phone era commenced. Sylvia Nasar made the event the climax of A Beautiful Mind (Simon & Schuster, 1998), her prize-winning biography of economist John Nash, since it was Nash’s highly abstract work of 45 years before that had opened the door to auction theory and all the rest – for which he was finally on his way to Stockholm to receive, with two subsequent elaborators of his insights, a Nobel Prize.

The FCC auction and many subsequent others of greater size are proof enough that the technology works. More striking still was the speed with which Google adopted a variant known as a second price auction to permit the near-instantaneous sale of advertising on its search engine, based on the appearance of a keyword in the search.  Auctions today are often all but invisible, but they govern an ever-increasing portion of modern life. And where auctions are not present, game theorists have devised countless other ways, most of them contracts, to arrange incentives to increase efficiency. Stimulated by John McMillan’s Reinventing the Bazaar: A Natural History of Markets (Norton, 2002), I set out a dozen years ago to learn more about the transformation of the old-fashioned economics of prices and quantities as the strategists introduced incentives of all sorts to the question. When the financial crisis of 2008 posed what seemed a different and much more intriguing problem, I veered off to pursue that instead. It turned out, of course, to be intimately related.

In the aftermath of last week, there was a widespread sense of jubilation. David Kreps, Wilson’s co-author on the Gang of Four, (“Reputation and Imperfect Information”), who continues to work on the wellsprings of cooperation, said Wilson’s impact on the discipline “puts him in the company of giants such as Ken Arrow and Paul Samuelson:  he is, as much as anyone, the founder of the School of Economic Theory as Engineering.” Wilson and Milgrom, along with laureates Jennifer Doudna (chemistry), and Reinhard Gentzel and Andre Ghez (both physics), will stream their lectures in December from the Swedish consulate in San Francisco.

Meanwhile economist E. Glen Weyl kicked up a row over the summer when he asserted on the website ProMarket that a complex two-sided auction to reallocate spectrum from broadcasters to mobile communications companies had produced disappointing results.  The design has produced hundreds of millions of dollars for private equity firms, he said, but failed to reallocate as much spectrum as had been hoped, and left the US at a disadvantage in a global competition to develop broadband internet. Milgrom’s firm, Auctionomics, had been the principle designer; other close associates had been involved. Weyl called for greater transparency. Milgrom responded, in a guest post on Digitopoly, a website co-edited by a former student, Joshua Gans, and Weyl replied a couple of weeks later.  Weyl, a former member of the economics department of the University of Chicago, now works for Microsoft as a political economist.  He is the author, with Eric Posner, of Radical Markets: Uprooting Capitalism and Democracy for a Just Society (Princeton, 2018).   Expect the argument about the perils of “technocracy” to continue.

Why so long a wait?   Serendipity, vicissitudes, fads and fashion surely all played a part. But who could fail to notice that Goran Hansson, secretary general of the Royal Swedish Academy of sciences began his streamed remarks announcing the prize speaking several sentences in Swedish? Or that the long citation noted that Stockholm’s 1674 Auktionsverk may be the oldest surviving auction house in the world? Economics was no part of Alfred Nobel’s will, but the Academy committee that now prepare a prize in his memory seems intent on demonstrating to its hoe audience, among others, that their Nobel program accords with the founder’s intent to recognize “discoveries and inventions of greatest benefit to all humankind.”

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