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13 November 2020

Why this year’s Nobel Prize marks a revolution in economic thought

For the first time in the history of economics, economists are able to monetise their own theoretical innovations. 

By Edward Nik-Khah and Philip Mirowski

The Nobel Prize committee has awarded its 2020 prize in economic sciences to Stanford professors Paul Milgrom and Robert Wilson “for improvements to auction theory and inventions of new auction formats”. In light of its 2019 prize, which was awarded to Esther Duflo and others for efforts “alleviating global poverty”, one may be forgiven for wondering what the big deal is.

But make no mistake: this year’s award is epoch-making for the economics profession. Some acquaintance with the history of economics shows why. 

Economics today is a radically different enterprise than it was for most of the 20th-century. Whereas economists were once guided by a conception of the economy as a clearly defined space governed by uniform laws, today, it is acknowledged that markets are plural, differentiated and artificial (as opposed to naturally arising), that they often work better when they are created by economists, because they can then be manipulated to produce desired outcomes. 

This year’s Nobel prize recognises some of these notions. It marks the ascendency of the field of “market design” in modern microeconomics – the branch of economics that analyses the behaviour of individual agents, such as firms or consumers. This development is of far greater importance than the creation of a new academic sub-speciality: it has fundamentally transformed what economists do.

Prior to 1980, microeconomists would advise the government on how to rectify “market failures”, that is, when the market failed to serve the public good. For example, since the market fails to take into account the environmental impact of the goods it distributes, economists may have previously suggested that the state introduce a tax on emissions to curtail pollution. This role bore some resemblance to economists’ traditional endeavour to offer “cool heads” in service of “warm hearts”, to paraphrase the 19th-century British economist Alfred Marshall. The principle guiding economists’ activities was that when markets work well, they should give the general public what they want, or, in the case of pollution, less of what they do not.

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Market designers like Milgrom and Wilson turned the traditional job of economists on its head. Instead of offering counsel to governments and making recommendations in the public interest, they designed bespoke markets for private businesses or select government entities. In order to deliver these custom-made markets – in effect, a system for organising the allocation of a specific good or service – the market designers founded specialised startup firms, produced these markets for their own profit, and claimed they “owned” the intellectual property underpinning the resulting projects.  

Many of these tailored market forms are characterised as “auctions”. As the Nobel Prize website’s “popular information” page explains, nowadays auctions are no longer confined to physical forums for selling antiques or expensive art. Since the mid-1990s, auctions have become a ubiquitous, “increasingly complicated” and usually computerised method for selling public assets – from government bonds to carbon emissions allowances to radio frequencies in what are known as “spectrum auctions” (telephone service providers, such as Vodafone in the UK and AT&T in the US, literally purchase specific frequencies on the electromagnetic spectrum in order to provide us with mobile phone coverage).

This emphasis on building bespoke markets for specific clients was reflected in a noticeable change in the language of economics. Where economists once discussed the properties of the “English” or “Dutch” auctions, or more generically, simply “the market”, they now talk of the “Milgrom Assignment Auction” or the “Hybrid Clock-Proxy Auction” – as if there were as many kinds of auction as there were auction designers, or kinds of thing to sell. The new nomenclature represented more than a newfound appreciation for their “real world” application. For the first time in the history of economics, microeconomists could monetise their own theoretical innovations, as opposed to serving as mere advisers. 

Who “demanded” this new form of economics? Here, the historical record is clear. The market designers’ biggest source of clientele came from projects seeking to privatise government assets, such as radio frequencies, or public utilities, like energy. They did not aim to serve some greater “public good”. Such markets, made to order, promised only to further the interests and goals of those who paid for them – even if at the expense of national economic performance and public welfare. 

Take, for example, the “practical application” of Milgrom and Wilson’s auction theory, featured on the Nobel Prize committee’s press release: the US Federal Communications Commission’s spectrum auctions, which sell the rights to transmit signals at specific radio frequencies. The committee’s press release suggests that the prize recipients invented a new auction format “on behalf of a seller motivated by broad societal benefit” – an idea parroted by the Wall Street Journal editorial, “Thank These Nobel Laureates for Your Cellphone.”

But this ignores the fact that the economists in question were not hired by the seller – the government, as represented by the Federal Communications Commission (FCC) – but instead by a for-profit bidder in that auction (the telecom operator Pacific Bell). Unsurprisingly, the activities undertaken by Milgrom and Wilson’s client make clear that it was less motivated by “broad societal benefit” than the promotion of auction rules that would advance its narrow business interests. Moreover, the FCC’s use of the “Milgrom-Wilson auction” encouraged the formation of shell corporations, court cases, bankruptcies and industry consolidation (for instance, the telecom behemoth AT&T has swallowed up Pacific Bell). 

Since the prize’s founding in 1968, the Nobel committee has endeavoured to burnish the virtues and munificence of the economics profession. The Nobel committee has gone to great lengths to link the award of this year’s prize to advances in game theory, which analyses how actors make decisions and act strategically in competitive situations. But this is misleading. Game theory cannot “solve” whose interests should prevail in the market: that is ultimately a political problem. The game theorist’s sophisticated mathematics can, however, obscure the wilful skewing of market rules to benefit well-heeled clients. 

Indeed, controversies bearing upon Milgrom’s activities have broken out in the last few years – and not just among historians of economics. Once again, the FCC is at the centre of a storm, in this case for its 2017 “Spectrum Incentive Auction”, which sold the rights to use spectrum bands to mobile communications companies in a fashion that may have dealt private equity firms an exorbitant cut. Confirmation of all details of the case is still pending, but the award of the prize will surely exacerbate the controversy. Nevertheless, one may safely conclude that when microeconomics is turned into a lavish source of profit, all manner of opportunities for self-dealing arise. 

By taking the longer view, then, one can appreciate what the prize is actually celebrating. In our current era of commercialised science and the defunding of universities, economists have innovated a new way for themselves to thrive. It is no accident that the best and the brightest, sometimes branding themselves “tech economists”, take jobs with Microsoft, Google, Amazon and Facebook, and so, as William Davies argued in the New Statesman in August, help to create the online platforms that will rule the 21st-century. As for our current awardees, the economist Alex Tabarrok observed with admiration that they have made so much money advising firms that the Nobel Prize money “won’t mean much” to them. Following the lead of Milgrom and Wilson, economists have at last broken free from the mere whispers in the ears of impetuous politicians.

Edward Nik-Khah is a professor of economics at Roanoke College and the author of The Knowledge We Have Lost in Information (Oxford University Press, 2017) and Philip Mirowski is a philosopher of economic thought at the University of Notre Dame and the author of Never Let A Serious Crisis Go to Waste: How Neoliberalism Survived the Financial Meltdown (Verso, 2014)

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