bbc.co.uk Navigation

notes_on_real_life

Do economists do good?

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.

2007 prize winners Leonid Hurwicz, Roger Myerson and Eric Maskin (L to R)

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.

Comments   Post your comment

  • 1.
  • At 01:29 PM on 17 Oct 2007,
  • David wrote:

Here here!

An interesting insight.

and I hope that cake was nice Evan!

  • 2.
  • At 01:36 PM on 17 Oct 2007,
  • Nick wrote:

Thanks for a clear explanation Evan, I wasn't that interested when i started reading, but i finished up wanting to know more.

  • 3.
  • At 03:22 PM on 17 Oct 2007,
  • Nick Caulfield wrote:

A book which may interest you here is "How to cut cake" by Ian Stewart who is a maths professor at Warwick University. It discusses how to extend the one cuts/one chooses fairness beyond two participants and deals with envy in a later chapter.

  • 4.
  • At 04:06 PM on 17 Oct 2007,
  • Ian wrote:

As an economist and an insurance professional I agree with your initial point that sometimes it is very difficult for people to get excited about either economics or insurance.

It is much easier re medicine where if someone has cracked the DNA code or invented a new means of treating a disease the value of the award is more clearly visible to the general public.

I also agree with your cake analogy but there is one very relevant analogy that is specific to both the works the Nobel award winners undertook and the UK economy and everyone in it. It is also highly topical.

Put simply it is insurance against flooding in the UK. In many European countries insurance policies exclude flood and the cover is picked up by the government by a variety of means.

There are a number of issues with a government backed system which the Northern Rock experience has highlighted a few. How we allocate the risk and who pays for flood cover is critical in the UK for the following reasons.

1) There are a huge number of properties built either on flood plains or in areas prone to flooding. sadly they are not all called Mill Cottage or River View. Without adequate insurance many of these properties are simply valueless as mortgage companies will not lend money without adequate protection and anyone looking to seel one will have their market severely restricted. This opens up a huge issue for property values, mortgages and Uk economic growth.

2) The government has required a huge number of new properties to be built and many of these are in marginal areas (the Thames Gateway for example). If there is no insurance cover available who will buy them?

3) If flood is taken out of the hands of the experts who have centuries of statistics to back up their valuations of cover who will price flood cover? Alistair Darling? How will these premiums be collected? Will people trust the government to administer this properly? The CSA, Passport Authority, Immigration and the NHS IT systems all give credence to those who think they might mess it up.

4) What happens to those who decide not to insure? Could the system be open to abuse via a politically motivated bail out? If I live away from any rivers and nowhere near a flood zone why should I pay when I am not at risk?

Their research may have been obscure but it affects all of our lives in major ways.

  • 5.
  • At 04:46 PM on 17 Oct 2007,
  • Scamp wrote:

Economists can do good but usually don't.

What really needs to happen is that nobody be allowed to become an economist until they are at least 55. This way they will have spent sufficient time working and living in the real world for people to take them seriously.

  • 6.
  • At 05:12 PM on 17 Oct 2007,
  • Ralph Moulang wrote:

Evan,

What a great topic! But maybe the question isn’t why did they win it, but why do you have to explain it! It seems that once again the (Memorial) Nobel Prize Ceremony has slipped by unnoticed, other than the recent exposure given to Al Gore, and only due to that poxy Mr Stewart Dimmock and his case against climate change statistics.

It is, for example, climate change, and the methods being explored in an attempt to curtail the effects thereof, that relates nicely to the work done by the 2007 Sverges Riksbank prize winners – mechanism design theory, an application of Game Theory. Another example, as many of your readers would probably remember, is the UK 3G license auction, which was one of the most successful of it’s kind, netting the government billions, all facilitated by experts in game theory – demonstrating a direct link between mathematic theory and public benefit, with economists at the helm!

Unfortunately, more often than not, those involved never achieve notoriety for their efforts. That still seems the preserve of the “celebrity”, that pillar of society! I put this down to the lack of exposure afforded to the Nobel Prize Ceremony. With the popularity and plethora of award shows, it’s strange that the “Nobel Awards” don’t receive much media interest. But then it’s probably better that way! I suppose it’s due to lack of general appeal and the fact that actors, film makers and musicians receive instantaneous criticism, whereas there is often a significant interval between the accomplishment of the achievement being recognized and the awarding of the Nobel Prize, largely due to the significance of the achievements emerging many years later, and in some cases only when applied to a difference discipline.

Popular Culture, however, is not devoid of references to Nobel Prizes and economics – the film “A Beautiful Mind” for example. But the link is tenuous: it was Russell Crow’s portrayal of a schizophrenic mathematician, not a Nobel Laureate, which earned him a BAFTA and Golden Globe. It was, however, John Nash’s brilliance, dogged determination, pursuit of excellence and his theory’s interdisciplinary application which earned him the Nobel Prize!

At a time when instantaneous gratification and media celebrity is of major importance in popular culture, the public seem to have lost the ability to recognise the effects and importance of continuous contribution, which is in essence what economics is all about: the long view.

Keep blogging

  • 7.
  • At 11:02 PM on 17 Oct 2007,
  • cedric johnson wrote:

My first class in economics dealt with 'IF'.There seems to be nothing concrete with the theory yet so much emphasis is placed on ECONOMICS throughout the world.There are many notable economists at many schools of learnings and institutions throughout the world,yet this world is washed in a state of economic depravation that,seemingly,cannot be fixed.Ask 20 economists the same question,and you will receive 35 answers and the responses will not match the question.Does anyone understand the theory by which they received the award?

  • 8.
  • At 11:35 AM on 18 Oct 2007,
  • Dan Fromm wrote:

Fine, wonderful, but this year's prize winners do operations research, not science. They've produced recipes, or perhaps recipes for making recipes. "If you want to accomplish a and the state of the world is b, do c."

This is nothing to do with human behavior and has no observable implications.

Or even Hear, Hear!

  • 10.
  • At 05:06 PM on 18 Oct 2007,
  • Josh W wrote:

In that case it could be used to save the planet, with a bit more work:
Dividing resources appropriately is free-market enthusiast’s big boast, which socialists dispute. This could lead to exact mathematical proofs about which social system is best! Does Marxism add up? How about the Washington consensus? Let’s just hope we don't come up with gloomy rules like Arrows Impossibility theorem!
Obviously a “perfect mechanism” theory can't cover everything, but so much is done in the cause of material fairness and it would be nice to know if people are right before you start implementing their theories.

  • 11.
  • At 10:25 AM on 19 Oct 2007,
  • John, Devon wrote:

Evan

The cake cutting analogy is superficially attractive but needs quite a bit of development to reflect real life more accurately.

Suppose the one doing the choosing is blindfolded and has to take the advice of the one doing the cutting as to which piece of cake is bigger, you get a much more layered (pardon the pun) situation. Is the advice the chooser is getting accurate? What are the motives of the cake cutter? Is Mother standing by to ensure fair play? Is getting the bigger slice of the cake really in the interests of the choosing party?

I could go on but you get the drift....

Or to re-phrase the old joke, "first assume a cake..."


I have often wondered what actually makes a Noteworthy Economist, apart from an economics degree (though I am not sure that is vital.)

Years ago we used to do a quick yearly interview with the Chief Economist for a large financial company to get his view on the Budget from the City's point of view.

This was early years of bug bang (sorry, big bang) and the companies offices had just been "wired for sound" as it were.

We were ushered into the new open-plan office; rows and rows of desks, each one resplendent with phone, monitor, notepad (paper variety) and Filo-Fax. The Chief, we were told, did not use a private office as he liked it on the floor.

We found his desk. The pile of paper must have been two feet deep. It completely buried the keyboard and monitor, the phone was barely visible and placed on top of the mess was a half eaten chocolate bar.

Apparently the Chief Economist was "very cerebral"

I now know what qualifies one as a notable economist, it is the ability to rationalise everyone else's life, but not your own!

  • 13.
  • At 03:39 PM on 19 Oct 2007,
  • Dan Holland wrote:

My mum also tried the same tactic as your's Evan. Unfortunately for her my brother and I both worked out that the cutter could do no better than average, and was thus at a disadvatage compared to the chooser. Cue the arguments!

  • 14.
  • At 01:35 PM on 24 Oct 2007,
  • john hoffman wrote:

A better way to use the cake to teach a lesson is to allow the same child to cut and choose this time, the other child the next time.

They learn that fairness inculcates fairness and some will even learn to cut unequally and choose the smaller when they know the other child prefers that kind of case.

The problem with economists is they assume greed is good and that everyone is greedy,

  • 15.
  • At 09:57 AM on 25 Oct 2007,
  • Ian wrote:

"Here here!"?

"Hear hear" shurely?!

Homonyms aside, an interesting piece certainly, and an introduction to the lives of those with siblings - as an only child I never faced such a cake-related dilemma and always got to lick the bowl myself!

  • 16.
  • At 12:12 AM on 31 Oct 2007,
  • JM Wong Sin Wai wrote:

The Mechanism Design Theory is interesting but it is more a mathematical than an economic theory. In fact, nowadays, economic science tends to become more an appendage of mathematics and statistics than anything else. Yet there are many domains in economics that demand to be studied and theories to be developed.
For example, the economies of the African countries south of the Sahara have been stagnating or declining over the last forty years while those of the other parts of the world have been growing. Is there a theory that can explain this and provide a solution to these African countries?
The Japanese economy were growing very rapidly at the rate of more than 10% per annum on average from 1950 to 1980; then from 1990 to the present, its growth rate had averaged less than 3% per annum. Is there a theory that can explain this change?
The Chinese economy had been stagnating or even declining from 1950 to 1978. Then, from 1980 onwards it grew rapidly and is now the fastest growing economy. Is there a theory that can explain this change of fortune?
In fact, I should say that in the field of economic growth, economic development and macroeconomics, there is no theory that can explain a situation, make reliable predictions and propose measures that can set an economic in a desired path.

  • 17.
  • At 09:36 AM on 06 Nov 2007,
  • Shahrukh Ahmed wrote:


Very interesting,

Then again it is not a two person economy where the divide and choose rule can be applied. At the end the full family should have an equal distribution of the cake which brings us back to the same sitution from where we started.

  • 18.
  • At 05:45 AM on 07 Nov 2007,
  • Mark wrote:

What people who don't regularly dip a toe into the waters of economic theory (lucky things!) may not know is the extent to which, since the 1970s, economics has focused increasingly on modelling and trying to understand HOW individuals and organisations react to information, incentives and the behavious of others. Economics is a rich subject that uses elements of mathematics and even experimental psychology to try to understand what makes us tick as economic beings, and the consequences of that behaviour.

Incentive design and compatability theory should, then, help us to design better rules to frame the institutions and behaviour we've got. That, and help us to understand in a more dispassionate, analytical way why what we THINK should happen, doesn't.

  • 19.
  • At 03:48 PM on 07 Nov 2007,
  • anysparechange wrote:

wait a minute John Hoffman. your assertion that 'the problem with economists is that they assume greed is good and that everyone is greedy' is fallacious. economists do no such thing.

economists, for the purpose of modelling consumer choice, make (usually) 3 basic simplifying assumptions and one of those is of 'non satiation'. whereby, in a simple model, it is intuitive to assume that a consumer will prefer more to less of a 'good', specifically because, by definition, it is a 'good' and if they did not, the 'good' would be a 'bad'. this simple assumption allows useful analysis of human choices when faced with a budget constraint. when these rational assumptions are removed from a model, the outcomes become counter-intuitive and thus, poor allegories of reality.

I consider economics to be the study of reality and what really occurs in the situations humans find themselves in. the modelling techniques used by economists of recreating real life situations and analysing outcomes, brought about by incentives are far reaching and have led to far more efficient mechanisms for allocation of whatever is in question.

economists labour relentlessly, to try and find improved mechanisms for a more efficient but also, fairer, allocation of goods, using such assumptions. here, the trade off between efficiency and fairness tends to raise it's troublesome head and this is why economists spend countless time creating other efficient mechanisms intended to bring about more fairness in economies.

to state that economists merely, 'think greed is good' is a patronising simplification of a discipline which through it's innovative techniques has endeavoured to improve everyone's slice of the cake, (often by magically growing the national cake!) it also likens the profession to Michael Douglas' Gordon Gecko. a cufflink wearing, lunch hating, capitalist pig stereotype, an increasingly popular figure of hate of the ignorant.

  • 20.
  • At 04:19 PM on 07 Nov 2007,
  • anysparechange wrote:

JM Wong Sin Wai,

I disagree with your last paragraph, sort of. there are numerous theories that explain huge proportions of changes in variables studied by economists. ecomonic growth, for example, is a fucntion of x, y, w, etc blah blah blah and a stochastic disturbance. it is impossible for economists to produce a perfect explanation for 100% of the variation in a given dependent variable in a human inhabited, ever changing world. this is because of the dynamic nature of the conditions we live in. physics, on the other hand, can produce such results because the variables it studies are constant in the natural world. eg, we cannot change the force of gravity, so once you've worked out the force of gravity and include it in an equation with other variables, it will be remain a constant. which will give accurate values for the other variables, in realtion to gravity.

there is no such variable within the field of economics because of the regularity of that horrible theory buster - the exogenous shock. this is why economics is called the dismal science! alos, many of the variables studied in economics are dependent upon an almost, (but not entirely), unquantifiable variable. namely, confidence. you will notice this variable is inherently human and thus unpredictable.

so, we are trying to capture reality by predicting the unpredictable! obviously, we can predict behaviour to an extent by modelling rational expectations and estimate what choices individuals will make given their options. however, conditions are always changing so I concede we cannot accurately predict what will happen and make perfect future policy recommendations all of the time but we certain have a very good idea. until of course, the next huge exogenous shock occurs.

Post a comment

Please note Name and E-mail are required.

Comments are moderated, and will not appear on this weblog until the author has approved them.

Required
Required (not displayed)
 
    

The BBC is not responsible for the content of external internet sites

BBC.co.uk