Category: Mechanism Design

Congratulations to Paul Milgrom and Robert Wilson for winning the 2020 Economics Nobel Prize

~ cogiddo ~ Leave a comment

The 2020 Bank of Sweden Prize in Economic Sciences in Honor of Alfred Nobel was awarded today jointly to Paul Milgrom and Robert Wilson of Stanford University for their work in Auction theory. Here is the popular information document on the Nobel Prize website, complete with some really great graphics: https://www.nobelprize.org/prizes/economic-sciences/2020/popular-information/

Hearty congratulations to the winners! More from me on this blog a little later. I know a bit about auction theory and have taught parts of the theory — now I will prepare a lecture on this award to be delivered on October 23d. Details to follow.

Reaction to Katharina Pistor’s book “The Code of Capital”

~ cogiddo ~ Leave a comment

I recently read this book and decided that I will include it in the syllabus of my Economic Inequality course. A few days ago, when I indicated on Twitter my intention to write about the book in this blog, I was intending a review. However, I found good reviews online, to which my own review would have little to add. These are: a post in the Law and Political Economy blog by Sam Moyn, and this piece by Rex Nutting on MarketWatch. To these, I can add little of value from the point of view of a legal scholar, such as Sam Moyn, or a commentator on political economy, such as Rex Nutting. Instead, I will quote from the publisher’s online blurb, so you can get a quick idea what the book is about, before proceeding with my comments.

Capital is the defining feature of modern economies, yet most people have no idea where it actually comes from. What is it, exactly, that transforms mere wealth into an asset that automatically creates more wealth? The Code of Capital explains how capital is created behind closed doors in the offices of private attorneys, and why this little-known fact is one of the biggest reasons for the widening wealth gap between the holders of capital and everybody else.

In this revealing book, Katharina Pistor argues that the law selectively “codes” certain assets, endowing them with the capacity to protect and produce private wealth. With the right legal coding, any object, claim, or idea can be turned into capital—and lawyers are the keepers of the code. Pistor describes how they pick and choose among different legal systems and legal devices for the ones that best serve their clients’ needs, and how techniques that were first perfected centuries ago to code landholdings as capital are being used today to code stocks, bonds, ideas, and even expectations—assets that exist only in law.

I am intrigued by this book, in my capacity as an economist, for two main reasons.

  1. The book gives a new and insightful perspective on the nature of capital, not long after Thomas Piketty’s Capital in the Twenty-First Century, a book most certainly discussed in my course on economic inequality. One big criticism of Piketty’s concept of capital, leveled by other economists, is that it diverges from the standard use of “capital” in macroeconomic / growth theory, even though Piketty does appeal to some results from this theory in his analysis. Pistor offers in her book an intriguing definition of capital as the aggregation of a myriad strategies of highly-paid lawyers, who shop around existing legal systems to create encodings of assets into concepts that can be defended as being legal in some court of a recognized state, encodings that serve to make up assets out of “thin air” and make these assets long-lived, accumulating over time, and convertible to money when their owners desire. I am not a macroeconomist, but I am eager to see what my colleagues in that field will come up with by engaging with this definition. After all, Paul Romer’s 2018 Nobel prize was for his incorporation of ideas into growth theory, as boosting the productivity of all other inputs to production (yes, I am simplifying). Intellectual protection legal regimes matter for this for obvious reasons. Pistor essentially says that the ideas of lawyers are part of this process. She explicitly discusses how these lawyerly inventions have expanded the scope of intellectual property protection (simultaneously shrinking the public domain in the realm of ideas), but she says so much more about these lawyerly inventions that there ought to be plenty of material here for some new macroeconomic theory.
  2. The second reason this book intrigues me is that it suggests a diagnosis for the disease of ever-increasing inequality in incomes and wealth levels, with the attendant problems of social polarization, undermining of democratic systems and norms, and empowerment of more and more economic and political oligarchy. It is not the job of a law professor like Pistor to suggest to economists interested in political economy and mechanism design how to think about modeling a way forward to formulate effective social and policy responses to these trends. But she has done all such economists (and I do count myself as part of this group) a favor by her diagnosis. I hope the policy designs and suggestions from economists are not long in coming.

Difficult problems in mechanism design that are too important to get wrong

~ cogiddo ~ Leave a comment

This article by Jonathan Rauch in the Atlantic about the disintegration and paralysis of American politics, got me thinking again about how important and maddeningly difficult the problem of mechanism design is.

Don’t run away! It’s simple enough to explain what mechanism design is, even if it is hard to do it well. Mechanism design is the study of how to create rules for important human interactions that will guide the outcomes of such interactions toward desirable ends, when the people interacting follow their own perceived self-interest.

For situations in which coalition-building is not to be expected, the progress mechanism designers have made over the last few decades is palpable and has achieved results. Auctions for airwaves have raised billions of dollars of revenue; kidney exchanges have saved hundreds of lives; doctors in training are better allocated to hospitals and students to colleges and graduate programs — these are just some of the examples of cases where mechanism design had a big impact.

Politics is a quintessential realm of coalition-building. But the brand of game theory that underlies the very same mechanism design approach that has achieved the great results I just mentioned fails to model coalition-building successfully. It may be that problems like fixing US politics are inherently intractable, but it seems that the US Constitution was an inspired solution that did reasonably well for a long time, even as it is beginning to fail now.

Related to the general problem of designing well-functioning democratic political systems, we have the even harder problem of getting disparate political systems to deal with the mounting disaster of planetary environmental degradation, which threatens the entire human species (and a whole lot of other species). Mechanism design theorists simply seem incapable of modeling well such a huge problem of coalition formation. Lest you think I am just criticizing others, I count myself as one of the theorists incapable of envisioning a good approach at this time.

We have evidence, in the works of Elinor Ostrom and subsequent literature inspired by Ostrom’s work, that local solutions to the problem of the commons often develop over time and such solutions, which take the form of formal and informal rules of the game (mechanisms!), often work well to solve local pollution or resource overuse problems.

The hard problem is to develop such solutions for state-wide problems (US politics is an example) and planet-wide problems (the environment), before they destroy any semblance of civilization and the livability of planet Earth. I know there are many brilliant minds working in mechanism design, much more brilliant than mine. I hope I see progress made in modeling coalition formation and its implication for mechanisms in the coming few years, before it is too late.

Art and science, and some economics, too

~ cogiddo ~ Leave a comment

The pursuit of beauty and economic theory: friends or enemies?

I read this post on Aeon by Frank Wilczek this morning. I posted about it on Facebook but doing so did not make me stop thinking about it. I want to put some of these thoughts down here, as they relate to economic theory, what draws me to it, and whether the draw of beauty in the mathematics used in economic theory detracts from the theory’s value to society. First of all, I invite you to follow the link above and come back to read the rest of my thoughts.

Wilczek has published a book recently, A Beautiful Question: Finding Nature’s Deep Design (Google Play link, Amazon link). I have not read it to the end yet, but I hope I will over the winter break. His discussion in the Aeon post immediately made me think about the art of mathematics and how it motivates me (and many others) to do economic theory and guides our attempts to do it.

Empires built on math

In my early years studying for my doctorate, I thought of math as a collection of empire-building tools for empires of the mind (castles in the sky might be another apt name). Economic theory, heavily math-laden, becomes in this view a galaxy far, far away where each theorist builds an empire (or at least a few starships) to impose order on the universe. Once you have laid down your assumptions, you then have a solid foundation for building and you are the emperor of your theoretical creations, as long as you can write down your mathematical arguments correctly.

This view is not far from Asimov’s galactic empire fiction. Indeed, Asimov himself thought that some sort of social physics exists, and if we can discover its laws, we could predict the unfolding of societies over vast, even galactic, scales. For economics, this perspective explains at least some of the psychological attraction theorists feel towards their castles in the sky. This attraction is particularly prominent for me when I am working on general equilibrium theory, which most of the profession has left behind.

Ethereal but irrelevant?

Good question! Let me first tell a story about logic and the demise of the Hilbert program in mathematics. Then I will talk about the fragmentation of economic theory, this one brought about by the confrontation of the theory with empirical tests, such as they are (famously much harder in the social sciences than in physics).

Hilbert was a prominent German mathematician. His famous and eponymous program was an attempt to make all mathematics utterly rigorous by putting it on a formal basis and to prove within that framework that mathematics is consistent. (Perhaps the best way to understand “formalization” in this sense, besides the obvious which is that it should be totally understandable to a computer, is by thinking about something von Neumann said: “Young man, in mathematics you don’t understand things. You just get used to them.” —source)

Hilbert’s program came undone when Kurt Gödel came up with his stunning, deep, and worldview shattering (for mathematicians) Incompleteness Theorems. The gist of these theorems is that if you build all of mathematics on a finite list of axioms, then you cannot prove by using this list of axioms all true theorems of mathematics and you cannot prove that the mathematics you have founded on these axioms is consistent (contains no contradictions).

Coming as it did in 1930, this devastating development seems to be a symptom of the fragmentation of European culture, which was soon to produce a horrible war. But what does it have to do with economic theory? Well, it tells us that the theoretical castles are indeed based on air, not stone foundations.

What’s worse, that’s not all that ails theoretical empire-building in economics. While there are plenty of valid criticisms to aim at empirical research in economics, its basic import is that grand, unified economic theories perform badly. This has led to the growth of “behavioral economics”. (Once again, let me point out how silly this name is: isn’t all economics behavioral? — I prefer psychological economics). However mainstream this field has become, it does have a shattering impact on beautiful theory-building that aims at wide applicability.

We contain multitudes and that can be beautiful too!

Well, it was good enough for Walt Whitman. How about we apply it to the entire society, whose functioning is the domain of study of economic theory, broadly conceived? Does the fragmentation I just talked about make further theory development ugly?

Many social scientists have written on this issue. To me, it seems that a fragmented field of theories can still be an object of beauty in the mind of the theorist. Think of it as a kaleidoscope (a word that literally means “a device for showing beauty”). This is how I attempt to keep my motivation up when I am struggling with long, messy arguments trying to prove something in complicated mathematical models of society that invariably leave my head spinning after only a couple of hours of effort.

Another good thing to say about the fragmented collection of models that constitutes modern economic theory is that it has produced some quite literally life-saving innovations (kidney exchanges, which came from a deeply mathematical field of economic theory called mechanism design theory). A good and easily readable account is Al Roth’s recent book Who Gets What — and Why.

Some others to read on related matters

In conclusion, here are some thoughtful works to read carefully that I constantly feel guilty for not having time to read carefully enough.

Daniel Little has a website portal and a blog about what it means to do social theory, even more widely construed than the widest view of economics.

Dani Rodrik has a recently published book in which he “argues that economics can be a powerful tool that improves the world―but only when economists abandon universal theories and focus on getting the context right”, as the book description on Amazon states. Another book I have started — so I really should wrap this post up now and get back to reading, even without having convinced myself that this gigantic post is as well written as possible! Of course it’s not. But I move on anyway. Ars Longa, Vita Brevis. Or, in the original language of Hippocrates, taken from the last link:

Ὁ βίος βραχύς, ἡ δὲ τέχνη μακρή, ὁ δὲ καιρὸς ὀξύς, ἡ δὲ πεῖρα σφαλερή, ἡ δὲ κρίσις χαλεπή. In English: Life is short, and art long, opportunity fleeting, experience perilous, and decision difficult.

RIP Ronald Coase (1910–2013)

~ cogiddo ~ Leave a comment

I am late to the commemoration of Ronald Coase’s contribution to economics, on the occasion of his death yesterday at the age of 102 years. You will find a large number of online posts about this with a simple search. The New York Times publishes its obituary here. The Economist points to its article published two years ago on the occasion of Coase’s 100th birthday.

After reading a number of other posts on Coase’s legacy, I decided to offer here this fantastic piece by Kevin Bryan. I heartily recommend a careful reading of it and the links it offers. In the Toolbox for Economic Design there are several cautions against taking the “Coase Theorem” seriously. After studying Bryan’s post and the links he offers in it (especially that to McCloskey’s article), you will have a better idea why this nomenclature (Stigler’s baby, Coase proclaimed no theorems) is wrong and misleading, while Coase’s contributions to institutional economics, stemming from his 1960 article The Problem of Social Cost, are important.

Let us also not forget Coase’s 1937 (!) article The Nature of the Firm, an early and fundamental contribution to the way economists ought to view the limits of the efficacy of markets.