Do economists do good?
- Evan Davis | Notes on Real Life |
- 17 Oct 07, 09:24 AM
Radio 4 asked me this week to summarise the contributions of this year's Nobel Economics Prize winners in 50 seconds. It wasn't easy.
Firstly, there isn't in fact, a Nobel Prize for economics; officially, this one is called the "Sverges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel". As it takes almost 50 seconds to say that on its own, most of us refer to it as the Nobel Prize for Economics.
Secondly, the economics prize-winners never seem to make contributions that can be described simply.
This year, the Nobel notes (to be found here) cite practical examples of the three winners' work, in - for example - improving the design of insurance policies.
Big deal.
They haven't invented a cure for a disease, or brought peace to a region of the world. As usual in the Nobel season, the practical applications of the economics winners sound rather small compared to the others.
But contrary to the casual impression one might pick up, economics is useful. In the social sciences, intellectual breakthroughs are a big deal. They may not cure diseases, but they can cure muddled thinking. They may not bring peace, but they can bring clarity to regions of public and private policy.
And take this year's Nobel winners as an example. Their contribution is called mechanism design theory.
A mechanism is some kind of procedure for allocating things. Like an auction, or a vote, or a market. Society uses mechanisms to allocate things all the time - lotteries are a mechanism; dictators are another. We use some kind of mechanism for making every material decision. We use markets for allocating beans, and elections to decide on defence spending.
The issue is how to design these mechanisms to make them as efficient as possible.
This already sounds as though it is getting quite abstract.
But let me take a simple example of a mechanism. You want to divide a piece of cake between your two greedy sons, with as little fuss and argument as possible.
My mum faced this issue pretty frequently, and had a solution to the problem that was tried and tested around the world with parents through the generations. She let one of us divide the cake in two, and the other have first choice over which half of the cake to have.
This works far better than alternative mechanisms. For example, cutting the slices yourself inevitably leads to arguments about who gets the bigger slice.
Letting one son cut and choose would surely be an enticement to cut the slices unequally. You might ask him to cut them as fairly as possible, but how are you to know whether he is truly doing his best or not?
The "one-divides/other chooses" rule is perfect as it is - in economics jargon - "incentive compatible". The cutter has the perfect incentive to cut as well as possible. You don't need to ask him to do so, you know that he'll give exactly the right effort to cutting, because it is him that suffers when he doesn't.
Now, my Mum doesn't have a Nobel prize. And I suspect it was not economists who first devised the divide and choose rule.
But it raises some issues that come up all over the place in life, and which academic economics has gone long way to clarifying.
All over the place, there are issues in life where you want to ensure people reveal in their behaviour what they are really thinking; whether they are cutting the cake as equally as they can.
For example, how do you design an auction? It sounds simple, but in an efficient auction, you really want sellers and bidders not to play tactical games - you want them to make offers which honestly reflect their willingness to do a deal, not ones that try to second guess other people's bids.
Or, when you design a voting system, ideally, you want people's votes to tell us what they really feel about an issue. If I ask people whether they want 1bn more defence spending, I'd like them to tell me how much they value defence regardless of whether they think they personally will pay more tax as a result. Otherwise, the vote probably just reveals that people who don't think they'll be paying the tax, want a lot more defence.
If you are regulating the prices or profits of a monopoly utility, you'd like to know if it is as efficient as it could possibly be. But you don't know whether it is or not. And simply asking the utility is unlikely to give a very revealing answer.
In all these cases, it is possible to design mechanisms like Mum's divide and choose rule, that do their best to frame incentives for players to reveal their true thinking. And this year's economics prize-winners between them defined the problem, laid the foundations of the science, and did quite a lot of the building work on top of that foundation.
Probably the biggest value is in spotting the similarities between splitting a piece of cake and regulating a utility. Once some of the common features have been put into formal maths, the practical applications and understanding can follow.
None of those applications on their own sounds particularly grand, but taken together they amount to something. And there is no limit to the number of future issues which might be advanced using the same body of economics.
It may not sound like saving the planet, but the Nobel laureates can be reasonably satisfied their work is useful.
Jhanak
