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The Nobel Prize: Milgrom and Wilson

The 2020 Nobel Prize in Economics goes to Paul Milgrom and Robert Wilson for auction theory and the improvement of auction designs. The Nobel Committee has a popular introduction and good scientific overview of auction theory. Billions of dollars of spectrum and other natural resources have been allocated using auctions designed by Milgrom and Wilson and their co-authors.

The money won’t mean much to these winners, who have made plenty of money advising firms about how to bid in the auctions that they designed. Milgrom’s firm Auctionomics advertises its service and Milgrom notes:

Milgrom has advised bidders in radio spectrum auctions, power auctions, and bankruptcy auctions. One advisee, Comcast and its consortium, SpectrumCo, followed the advice of a Milgrom’s team in FCC Auction 66 to achieve the most exceptional performance in US spectrum auction history. SpectrumCo saved nearly $1.2 billion on its spectrum license purchases compared to the prices paid by other large bidders – such as T-Mobile and Verizon – for comparable spectrum acquired at the same time in the same auction. SpectrumCo’s tactics included a $750 million jump bid – the largest in the history of US spectrum auctions and a move that prompted the FCC to change the auction rules.

You can figure that Milgrom got a percentage of those savings! Milgrom also advised Yahoo and Google, among other tech firms, on their advertising auctions.

My post Mechanism Design for Grandma written for the Hurwicz, Maskin and Myerson Nobel, has some background on auctions.

Auction theory and auction practice arose together–this is not a case of theory being rediscovered decades later by practitioners but of the demands by practitioners leading to new theory and new theory leading to new institutions. The Nobel committee notes:

In the early 1990s, an explosion of the demand for mobile communication made the U.S. federal government decide to use an auction for allocating radio-spectrum licenses among telecommunication firms. Previously, the U.S. Federal Communications Commission (FCC) had only been allowed to rely either on administrative procedures—commonly referred to as “beauty contests”—or on lotteries. These methods had notably failed in a number of complex settings, at the expense of both taxpayers and end-users…The obvious alternative is to adopt an auction to as-sign licenses. In fact, as early as in the 1950s, the 1991 Laureate Ronald H. Coase argued that the basic principle should be to allocate objects, such as broadcasting licenses, to the firms who will make the most efficient use of them, and the best way to identify these firms is to assign the objects through a competitive price mechanism (Coase, 1959).

…Following the FCC policy shift, multi-object auctions turned from an esoteric topic at the fringe of microeconomic theory to a hot research topic almost overnight.

…For the 1994 FCC auction, the final version of the newly designed auction was the Simultaneous Multiple Round Auction (SMRA)…[which] raised some $20 billion for the U.S. federal government, twice the forecasted amount. This outcome attracted considerable media attention and led other governments to set up their own auctions. The U.K. 3G spectrum auction that concluded in 2000 raised about $34 billion for the British government (Binmore and Klemperer, 2002). The SMRA auction format became the dominant design for spectrum sales worldwide, and versions of it have been used in Canada, Finland, Germany, India, Norway, Poland, Spain, Sweden, theU.K., and the U.S. These auctions have generated hundreds of billions of dollars for governments worldwide.

Perhaps the most impressive culmination of this work was the 2017 incentive auctions which “simultaneously” bought licenses from over-the air broadcast television stations and resold them to modern cellular phone bidders while respecting constraints so that over-the-air frequencies could be repackaged in ways such that they would not interfere with one another. The auction bought licenses for $10 billion, sold them for $20 billion, generating $10 billion in profit and generating an even larger increase in consumer surplus.

The first is a reverse auction that determines a price at which the remaining over-the-air broadcasters voluntarily relinquish their existing spectrum-usage rights. The second is a forward auction of the freed-up spectrum. In 2017, the reverse auction removed 14 channels from broadcast use, at a cost of $10.1 billion. The forward auction sold 70 MHz of wireless internet licenses for $19.8 billion, and created 14 MHz of surplus spectrum. The two stages of the incentive auction thus generated just below $10 billion to U.S. taxpayers, freed up considerable spectrum for future use, and presumably raised the expected surpluses of sellers as well as buyers.

These auctions also brought home that economics is now tied to computer science. The complexity of the allocation process was so high that new algorithms had to be devised. In particular, repackaging of the frequencies involved solving hundreds of thousands of graph-coloring problems, an NP-hard problem. Computer scientist Kevin Leyton-Brown was brought in to design and optimize the necessary algorithms. At the same time, Milgrom and Segal had to prove that their auction could be characterized in such a way that it could be solved in reasonable time by known algorithms.

Computer scientist Tim Roughgarden has an excellent video lecture on how implementing the incentive auction required a combination of cutting-edge economics and computer science. More generally, mechanism design in the real world, including auction design, Uber’s supply and demand mechanism, blockchains like bitcoin and many other examples, requires both economists and computer scientists to devise institutions and algorithms that incentivize socially beneficial behavior and that can also be solved in real time for real populations.

See Tyler’s post on Milgrom and on Tyler’s post on Wilson for much more, going well beyond their contributions to auction theory.

Paul Milgrom, Nobel Laureate

Most of all this is a game theory prize and an economics of information prize, including game theory and asymmetric information.  Much of the work has had applications to auctions and finance.  Basically Milgrom was the most important theorist of the 1980s, during the high point of economic theory and its influence.

Here is Milgrom’s (very useful and detailed) Wikipedia page.  Most of his career he has been associated with Stanford University, with one stint at Yale for a few years.  Here is Milgrom on scholar.google.com.  A very good choice and widely anticipated, in the best sense of that term.  Here is his YouTube presence.  Here is his home page.

Milgrom, working with Nancy Stokey, developed what is called the “no trade” theorem, namely the conditions under which market participants will not wish to trade with each other.  Obviously if someone wants to trade with you, you have to wonder — what does he/she know that I do not?  Under most reasonable assumptions, it is hard to generate a high level of trading volume, and that has remained a puzzle in theories of finance and asset pricing.  People are still working on this problem, and of course it relates to work by Nobel Laureate Robert Aumann on when people should rationally disagree with each other.

Building on this no-trade result, Milgrom wrote a seminal piece with Lawrence Glosten on bid-ask spread.  What determines bid-ask spread in securities markets?  It is the risk that the person you are trading with might know more than you do.  You will trade with them only when the price is somewhat more advantageous to you, so markets with higher degrees of asymmetric information will have higher bid-ask spreads.  This is Milgrom’s most widely cited paper and it is personally my favorite piece of his, it had a real impact on me when I read it.  You can see that the themes of common knowledge and asymmetric information, so important for the auctions work, already are rampant.

Alex will tell you more about auctions, but Milgrom working with Wilson has designed some auctions in a significant way, see Wikipedia:

Milgrom and his thesis advisor Robert B. Wilson designed the auction protocol the FCC uses to determine which phone company gets what cellular frequencies. Milgrom also led the team that designed the 2016-17 incentive auction, which was a two-sided auction to reallocate radio frequencies from TV broadcast to wireless broadband uses.

Here is Milgrom’s 277-page book on putting auction theory to practical use.  Here is his highly readable JEP survey article on auctions and bidding, for an introduction to Milgrom’s prize maybe start there?

Here is Milgrom’s main theoretical piece on auctions, dating from Econometrica 1982 and co-authored with Robert J. Weber.  it compared the revenue properties of different auctions and showed that under risk-neutrality a second-price auction would yield the highest price.  Also returning to the theme of imperfect information and bid-ask spread, it showed that an expert appraisal would make bidders more eager to bid and thus raise the expected price.  I think of Milgrom’s work as having very consistent strands.

With Bengt Holmstrom, also a Nobel winner, Milgrom wrote on principal-agent theory with multiple tasks, basically trying to explain why explicit workplace incentives and bonuses are not used more widely.  Simple linear incentives can be optimal because they do not distort the allocation of effort across tasks so much, and it turned out that the multi-task principal agent problem was quite different from the single-task problem.

People used to think that John Roberts would be a co-winner, based on the famous Milgrom and Roberts paper on entry deterrence.  Basically incumbent monopolists can signal their cost advantage by making costly choices and thereby scare away potential entrants.  And the incumbent wishes to be tough with early entrants to signal to later entrants that they better had stay away. In essence, this paper was viewed as a major rebuttal to the Chicago School economists, who had argued that predatory behavior from incumbents typically was costly, irratoinal, and would not persist.

The absence of Roberts’s name on this award indicates a nudge in the direction of auction design and away from game theory a bit — the Nobel Committee just loves mechanism design!

That said, it is worth noting that the work of Milgrom and co-authors intellectually dominated the 1980s and can be identified with the peak of influence of game theory at that period of time.  (Since then empirical economics has become more prominent in relative terms.)

Milgrom and Roberts also published a once-famous paper on supermodular games in 1990.  I’ve never read it, but I think it has something to do with the possible bounding of strategies in complex settings, but based on general principles.  This was in turn an attempt to make game theory more general.  I am not sure it succeeded.

Milgrom and Roberts also produced a well-known paper finding the possible equilibria in a signaling model of advertising.

Milgrom and Roberts also wrote a series of papers on rent-seeking and “influence activities” within firms.  It always seemed to me this was his underrated work and it deserved more attention.  Among other things, this work shows how hard it is to limit internal rent-seeking by financial incentives (which in fact can make the problem worse), and you will see this relates to Milgrom’s broader work on multi-task principal-agent problems.

Milgrom also has a famous paper with Kreps, Wilson, and Roberts, so maybe Kreps isn’t going to win either.  They show how a multi-period prisoner’s dilemma might sustain cooperating rather than “Finking” if there is asymmetric information about types and behavior.  This paper increased estimates of the stability of tit-for-tat strategies, if only because with uncertainty you might end up in a highly rewarding loop of ongoing cooperation.  This combination of authors is referred to as the “Gang of Four,” given their common interests at the time and some common ties to Stanford.  You will note it is really Milgrom (and co-authors) who put Stanford economics on the map, following on the Kenneth Arrow era (when Stanford was not quite yet a truly top department).

Not what he is famous for, but here is Milgrom’s paper with Roberts trying to rationalize some of the key features of modern manufacturing.  If nothing else, this shows the breadth of his interests and how he tries to apply game theory generally.  One question they consider is why modern manufacturing has moved so strongly in the direction of greater flexibility.

Milgrom also has a 1990 piece with North and Weingast on the medieval merchant guilds and the economics of reputation, showing his more applied side.  In essence the Law Merchant served as a multilateral reputation mechanism and enforced cooperation.  Here is a 1994 follow-up.  This work paved the way for later work by Avner Greif on related themes.

Another undervalued Milgrom piece is with Sharon Oster (mother of Emily Oster), or try this link for it.  Here is the abstract:

The Invisibility Hypothesis holds that the job skills of disadvantaged workers are not easily discovered by potential new employers, but that promotion enhances visibility and alleviates this problem. Then, at a competitive labor market equilibrium, firms profit by hiding talented disadvantaged workers in low-level jobs.Consequently, those workers are paid less on average and promoted less often than others with the same education and ability. As a result of the inefficient and discriminatory wage and promotion policies, disadvantaged workers experience lower returns to investments in human capital than other workers.

With multiple, prestigious co-authors he has written in favor of prediction markets.

He was the doctoral advisor of Susan Athey, and in Alex’s post you can read about his auction advising and the companies he has started.

His wife, Eva Meyersson Milgrom, is herself a renowned social scientist and sociologist, and he met her in 1996 while seated next to her at a Nobel Prize dinner in Stockholm.  Here is one of his papers with her (and Ravi Singh), on whether firms should share control with outsiders.  Here is the story of their courtship.

Robert B. Wilson, Nobel Laureate

Here is his home page.  He has been at Stanford Business School since 1964, and born in Geneva, Nebraska.  Here is his personal website.  Here is his Wikipedia page.  He has a doctorate in business administration from Harvard, but actually no economics Ph.D. (bravo!)  Here is the Nobel designation.

Most of all Wilson is an economic theorist, doing much of his most influential work in or around the 1980s.  He is a little hard to google (no, he did not work with Philip Glass), but here are his best-cited papers.  To be clear, he won mainly for his work in auction theory and practice, covered by Alex here.  But here is some information about the rest of his highly illustrious career.

He and David Kreps wrote a very famous paper about deterrence.  Basically an incumbent wishes to develop a reputation for being tough with potential entrants, so as to keep them out of the market.  This was one of the most influential papers of the 1980s, and it also helped to revive some of the potential intellectual case for antitrust activism.  Here is Wilson’s survey article on strategic approaches to entry deterrence.

Wilson has a famous paper with Kreps, Milgrom, and Roberts.  They show how a multi-period prisoner’s dilemma might sustain cooperating rather than “Finking” if there is asymmetric information about types and behavior.  This paper increased estimates of the stability of tit-for-tat strategies, if only because with uncertainty you might end up in a highly rewarding loop of ongoing cooperation.  This combination of authors is referred to as the “Gang of Four,” given their common interests at the time and some common ties to Stanford.

His 1982 piece with David Kreps on “sequential equilibria” was oh so influential on game theory, here is the abstract:

We propose a new criterion for equilibria of extensive games, in the spirit of Selten’s perfectness criteria. This criterion requires that players’ strategies be sequentially rational: Every decision must be part of an optimal strategy for the remainder of the game. This entails specification of players’ beliefs concerning how the game has evolved for each information set, including information sets off the equilibrium path. The properties of sequential equilibria are developed; in particular, we study the topological structure of the set of sequential equilibria. The connections with Selten’s trembling-hand perfect equilibria are given.

Here is a more readable exposition of the idea.  This was part of a major effort to figure out how people actually would play in games, and which kinds of solution concepts economists should put into their models.  I don’t think the matter ever was settled, and arguably it has been superseded by behavioral and computational and evolutionary approaches, but Wilson was part of the peak period of applying pure theory to this problem and this might have been the most important theory piece in that whole tradition.

From Wikipedia:

Wilson’s paper “The Theory of the Syndicates,”JSTOR 1909607 which was published in Econometrica in 1968 influenced a whole generation of students from economics, finance, and accounting. The paper poses a fundamental question: Under what conditions does the expected utility representation describe the behavior of a group of individuals who choose lotteries and share risk in a Pareto-optimal way?

Link here, this was a contribution to social choice theory and fed into Oliver Hart’s later work on when shareholder unanimity for a corporation would hold.  It also connects to the later Milgrom work, some of it with Wilson, on when people will agree about the value of assets.

Here is Wilson’s book on non-linear pricing: “What do phone rates, frequent flyer programs, and railroad tariffs all have in common? They are all examples of nonlinear pricing. Pricing is nonlinear when it is not strictly proportional to the quantity purchased. The Electric Power Research Institute has commissioned Robert Wilson to review the various facets of nonlinear pricing.”  Yes, he is a business school guy.  Here is his survey article on electric power pricing, a whole separate direction of his research.

Here is his 1989 law review article about Pennzoil vs. Texaco, with Robert H. Mnookin.

Wilson also did a piece with Gul and Sonnenschein, laying out the different implications of various game-theoretic conjectures for the Coase conjecture, namely the claim that a durable goods monopolist will end up having to sell at competitive prices, due to the patience of consumers and their unwillingness to buy at higher prices.

Wilson was the dissertation advisor of Alvin E. Roth, Nobel Laureate, and here the two interview each other, recommended.  Excerpt:

Wilson: As an MBA student in 1960, I wrote a class report on how to bid in an auction that got a failing grade because it was not “managerial.”

And here is an Alvin Roth blog post on the prize and the intellectual lineage.

The bottom line?  If you are a theorist, Stockholm is telling you to build up some practical applications  — at the very least pull something out of your closet and sell it on eBay!  A lot of people thought Roberts and maybe Kreps would be in on this Prize, but they are not.  The selections themselves are clearly deserving and have been “in play” for many years in the Nobel discussions.  But again, we see the committee drawing clear and distinct lines.

Let’s see what they do next year!

Are Nobel Prizes worth less these days?

It would seem so, now there are lots of them, here is one part of my Bloomberg column:

The Nobel Peace Prize this year went to the World Food Programme, part of the United Nations. Yet the Center for Global Development, a leading and highly respected think tank, ranked the winner dead last out of 40 groups as measured for effectiveness. Another study, by economists William Easterly and Tobias Pfutze in 2008, was also less than enthusiastic about the World Food Programme.

The most striking feature of the award is not that the Nobel committee might have gotten it wrong. Rather, it is that nobody seems to care. The issue has popped up on Twitter, but it is hardly a major controversy.

I also noted that the Nobel Laureates I follow on Twitter, in the aggregate, seem more temperamental than the 20-year-olds (and younger) that I follow.  Hail Martin Gurri!

And this:

The internet diminishes the impact of the prize in yet another way. Take Paul Romer, a highly deserving laureate in economics in 2018. To his credit, many of Romer’s ideas, such as charter cities, had been debated actively on the internet, in blogs and on Twitter and Medium, for at least a decade. Just about everyone who follows such things expected that Romer would win a Nobel Prize, and when he did it felt anticlimactic. In similar fashion, the choice of labor economist David Card (possibly with co-authors) also will feel anticlimactic when it comes, as it likely will.

Card with co-authors, by the way, is my prediction for tomorrow.

A Fine Theorem on RCTs and the new Nobel Laureates

In this vein, randomized trials tend to have very small sample sizes compared to observational studies. When this is combined with high “leverage” of outlier observations when multiple treatment arms are evaluated, particularly for heterogeneous effects, randomized trials often predict poorly out of sample even when unbiased (see Alwyn Young in the QJE on this point). Observational studies allow larger sample sizes, and hence often predict better even when they are biased. The theoretical assumptions of a structural model permit parameters to be estimated even more tightly, as we use a priori theory to effectively restrict the nature of economic effects.

We have thus far assumed the randomized trial is unbiased, but that is often suspect as well. Even if I randomly assign treatment, I have not necessarily randomly assigned spillovers in a balanced way, nor have I restricted untreated agents from rebalancing their effort or resources. A PhD student of ours on the market this year, Carlos Inoue, examined the effect of random allocation of a new coronary intervention in Brazilian hospitals. Following the arrival of this technology, good doctors moved to hospitals with the “randomized” technology. The estimated effect is therefore nothing like what would have been found had all hospitals adopted the intervention. This issue can be stated simply: randomizing treatment does not in practice hold all relevant covariates constant, and if your response is just “control for the covariates you worry about”, then we are back to the old setting of observational studies where we need a priori arguments about what these covariates are if we are to talk about the effects of a policy.

There is much more of interest in the post, very high quality as you might expect given the source.

Michael Kremer, Nobel laureate

To Alex’s excellent treatment I will add a short discussion of Kremer’s work on deworming (with co-authors, most of all Edward Miguel), here is one summary treatment:

Intestinal helminths—including hookworm, roundworm, whipworm, and schistosomiasis—infect more than one-quarter of the world’s population. Studies in which medical treatment is randomized at the individual level potentially doubly underestimate the benefits of treatment, missing externality benefits to the comparison group from reduced disease transmission, and therefore also underestimating benefits for the treatment group. We evaluate a Kenyan project in which school-based mass treatment with deworming drugs was randomly phased into schools, rather than to individuals, allowing estimation of overall program effects. The program reduced school absenteeism in treatment schools by one-quarter, and was far cheaper than alternative ways of boosting school participation. Deworming substantially improved health and school participation among untreated children in both treatment schools and neighboring schools, and these externalities are large enough to justify fully subsidizing treatment. Yet we do not find evidence that deworming improved academic test scores.

If you do not today have a worm, there is some chance you have Michael Kremer to thank!

With Blanchard, Kremer also has an excellent and these days somewhat neglected piece on central planning and complexity:

Under central planning, many firms relied on a single supplier for critical inputs. Transition has led to decentralized bargaining between suppliers and buyers. Under incomplete contracts or asymmetric information, bargaining may inefficiently break down, and if chains of production link many specialized producers, output will decline sharply. Mechanisms that mitigate these problems in the West, such as reputation, can only play a limited role in transition. The empirical evidence suggests that output has fallen farthest for the goods with the most complex production process, and that disorganization has been more important in the former Soviet Union than in Central Europe.

Kremer with co-authors also did excellent work on the benefits of school vouchers in Colombia.  And here is Kremer’s work on teacher incentives — incentives matter!  His early piece on wage inequality with Maskin, from 1996, was way ahead of its time.  And don’t forget his piece on peer effects and alcohol use: many college students think the others are drinking more than in fact they are, and publicizing the lower actual level of drinking can diminish alcohol abuse problems.  The Hajj has an impact on the views of its participants, and “… these results suggest that students become more empathetic with the social groups to which their roommates belong,.” link here.

And don’t forget his famous paper titled “Elephants.”  Under some assumptions, the government should buy up a large stock of ivory tusks, and dump them on the market strategically, to ruin the returns of elephant speculators at just the right time.  No one has ever worked through the issue before of how to stop speculation in such forbidden and undesirable commodities.

Michael Kremer has produced a truly amazing set of papers.

The Nobel Prize in Economic Science Goes to Banerjee, Duflo, and Kremer

The Nobel Prize goes to Abhijit Banerjee, Esther Duflo and Michael Kremer (links to home pages) for field experiments in development economics. Esther Duflo was a John Bates Clark Medal winner, a MacArthur “genius” award winner, and is now the second woman to win the economics Nobel and by far the youngest person to ever win the economics Nobel (Arrow was the previous youngest winner!). Duflo and Banerjee are married so these are also the first spouses to win the economics Nobel although not the first spouses to win Nobel prizes–there was even one member of a Nobel prize winning spouse-couple who won the Nobel prize in economics. Can you name the spouses?

Michael Kremer wrote two of my favorite papers ever. The first is Patent Buyouts which you can find in my book Entrepreneurial Economics: Bright Ideas from the Dismal Science. The idea of a patent buyout is for the government to buy a patent and rip it up, opening the idea to the public domain. How much should the government pay? To decide this they can hold an auction. Anyone can bid in the auction but the winner receives the patent only say 10% of the time–the other 90% of the time the patent is bought by the government at the market price. The value of this procedure is that 90% of the time we get all the incentive properties of the patent without any of the monopoly costs. Thus, we eliminate the innovation tradeoff. Indeed, the government can even top the market price up by say 15% in order to increase the incentive to innovate. You might think the patent buyout idea is unrealistic. But in fact, Kremer went on to pioneer an important version of the idea, the Advance Market Commitment for Vaccines which was used to guarantee a market for the pneumococcal vaccine which has now been given to some 143 million children. Bill Gates was involved with governments in supporting the project.

My second Kremer paper is Population Growth and Technological Change: One Million B.C. to 1990. An economist examining one million years of the economy! I like to say that there are two views of humanity, people are stomachs or people are brains. In the people are stomachs view, more people means more eaters, more takers, less for everyone else. In the people are brains view, more people means more brains, more ideas, more for everyone else. The people are brains view is my view and Paul Romer’s view (ideas are nonrivalrous). Kremer tests the two views. He shows that over the long run economic growth increased with population growth. People are brains.

Oh, and can I add a third Kremer paper? The O-Ring Model of Development is a great and deep paper. (MRU video on the O-ring model).

The work for which the Nobel was given is for field experiments in development economics. Kremer began this area of research with randomized trials of educational policies in Kenya. Duflo and Banerjee then deepened and broadened the use of field experiments and in 2003 established the Poverty Action Lab which has been the nexus for field experiments in development economics carried on by hundreds of researchers around the world.

Much has been learned in field experiments about what does and also doesn’t work. In Incentives Work, Dufflo, Hanna and Ryan created a successful program to monitor and reduce teacher absenteeism in India, a problem that Michael Kremer had shown in Missing in Action was very serious with some 30% of teachers not showing up on a typical day. But when they tried to institute a similar program for nurses in Putting a Band-Aid on A Corpse the program was soon undermined by local politicians and “Eighteen months after its inception, the program had become completely ineffective.” Similarly, Banerjee, Duflo, Glennerster and Kinnan find that Microfinance is ok but no miracle (sorry fellow laureate Muhammad Yunus). A frustrating lesson has been the context dependent nature of results and the difficult of finding external validity. (Lant Pritchett in a critique of the “randomistas” argues that real development is based on macro-policy rather than micro-experiment. See also Bill Easterly on the success of the Washington Consensus.)

Duflo, Kremer and Robinson study How High Are Rates of Return to Fertilizer? Evidence from Field Experiments in Kenya. This is an especially interest piece of research because they find that rates of return are very high but that farmers don’t use much fertilizer. Why not? The reasons seem to have much more to do with behavioral biases than rationality. Some interventions help:

Our findings suggest that simple interventions that affect neither the cost of, nor the payoff to, fertilizer can substantially increase fertilizer use. In particular, offering farmers the option to buy fertilizer (at the full market price, but with free delivery) immediately after the harvest leads to an increase of at least 33 percent in the proportion of farmers using fertilizer, an effect comparable to that of a 50 percent reduction in the price of fertilizer (in contrast, there is no impact on fertilizer adoption of offering free delivery at the time fertilizer is actually needed for top dressing). This finding seems inconsistent with the idea that low adoption is due to low returns or credit constraints, and suggests there may be a role for non–fully rational behavior in explaining production decisions.

This is reminiscent of people in developed countries who don’t adjust their retirement savings rates to take advantage of employer matches. (A connection to Thaler’s work).

Duflo and Banerjee have conducted many of their field experiments in India and have looked at not just conventional questions of development economics but also at politics. In 1993, India introduced a constitutional rule that said that each state had to reserve a third of all positions as chair of village councils for women. In a series of papers, Duflo studies this natural experiment which involved randomization of villages with women chairs. In Women as Policy Makers (with Chattopadhyay) she finds that female politicians change the allocation of resources towards infrastructure of relevance to women. In Powerful Women (Beaman et al.) she finds that having once had a female village leader increases the prospects of future female leaders, i.e. exposure reduces bias.

Before Banerjee became a randomistas he was a theorist. His A Simple Model of Herd Behavior is also a favorite. The essence of the model can be explained in a simple example (from the paper). Suppose there are two restaurants A and B. The prior probability is that A is slightly more likely to be a better restaurant than B but in fact B is the better restaurant. People arrive at the restaurants in sequence and as they do they get a signal of which restaurant is better and they also see what choice the person in front of them made. Suppose the first person in line gets a signal that the better restaurant is A (contrary to fact). They choose A. The second person then gets a signal that the better restaurant is B. The second person in line also sees that the first person chose A, so they now know one signal is for A and one is for B and the prior is A so the weight of the evidence is for A—the second person also chooses restaurant A. The next person in line also gets the B signal but for the same reasons they also choose A. In fact, everyone chooses A even if 99 out of 100 signals are B. We get a herd. The sequential information structure means that the information is wasted. Thus, how information is distributed can make a huge difference to what happens. A lot of lessons here for tweeting and Facebook!

Banerjee is also the author of some original and key pieces on Indian economic history, most notably History, Institutions, and Economic Performance: The Legacy of Colonial Land Tenure Systems in India (with Iyer).

Duflo’s TED Talk. Previous Duflo posts; Kremer posts; Banerjee posts on MR.

Before last year’s Nobel announcement Tyler wrote:

I’ve never once gotten it right, at least not for exact timing, so my apologies to anyone I pick (sorry Bill Baumol!). Nonetheless this year I am in for Esther Duflo and Abihijit Banerjee, possibly with Michael Kremer, for randomized control trials in development economics.

As Tyler predicted he was wrong and also right. Thus, this years win is well-timed and well-deserved. Congratulations to all.

“Two big names in European writing win literature Nobels”

I chuckled at that FT headline, fortunately the on-line version names Olga Tokarczuk and Peter Handke in its header.

Can you imagine a sports header: “Big name wins NBA most valuable player award.”  No, they would name the “big name” because that big name is in fact big.

I still think Stephen King should get one.  I didn’t enjoy trying to read Tokarczuk, though I suspect she is a very good writer in Polish.  By Handke I can recommend his Sorrow of Dreams, a memoir of his mother dying, and also a book that influenced Knausgaard.  But mostly I am find him boring, pessimistic, and nasty, perhaps consistent with his support for Milosevic and the tyranny in Serbia.  I don’t think that disqualifies him from the prize per se, but neither do I see him as an author who had to win, though he is indeed “a big name in European writing.”  The thing is, he is nothing more than that.

Here you can buy The Stand for $8.30, by the way I love Houllebecq but the new one isn’t very interesting, as sadly it reads like a parody of his earlier, superior work.  Submission remains one of the truly great novels of recent times.

Why Paul Romer won the Nobel Prize in economics

It is hard to do better than Alex’s video on Romer, pretty much definitive and Romer liked it too.  Most importantly, Romer won the Prize for seeing how the non-rival nature of ideas can boost ongoing and indeed “endogenous” economic growth.  Romer also showed mathematically that this process of growth is bounded, namely that it does not explode without limit, and that the associated mathematical models were tractable.  Previously, economists had feared that increasing returns to scale models might be impossible to work with.  See the top two links here, for the 1989 and 1990 pieces, with the third piece listed, from 1994, being Romer’s easier to read summary of the work.

David Warsh’s Knowledge and the Wealth of Nations: A Story of Economic Discovery, is the book on Romer for the ages, a truly splendid creation on both the science and the person.  Romer, by the way, is the son of Roy Romer, former Colorado governor and famous builder of airports.  I believe this later influenced Paul’s interest in the importance of economic growth.

Over time, increasing returns models are seen as less descriptive of growth than perhaps they were in the 1990s.  The growth rates of many countries have been stagnant or even falling, rather than rising.  Nonetheless, for understanding how ideas boost growth, and in cumulative fashion, Romer’s work is essential.  If you are wondering “which economist has done the most to help us explain Silicon Valley,” you would turn first to Romer.

This Prize is not a surprise at all, and it has been expected, sooner or later, for many years.  (Though I did not think it would come this year. Trump talks so much about his role in boosting economic growth, I feared the Nobel Committee would not at this point in time wish to feed into that rhetoric.  I am glad to see they did not hesitate!)

Here is Romer on Twitter.  Here is Romer on Wikipedia.  Here is Paul’s blog.  He is now at NYU, but spent much of his career at Stanford.  Previous MR coverage of Romer is quite extensive.  Here is the Prize Committee citation, excellent as always.  Here are his three podcasts with Russ Roberts.  Here is Joshua Gans on Paul.  Here is a Sebastian Mallaby profile of Romer.

Romer also in 2000 started and ran a successful business, Aplia, which revolutionized on-line education.  In the context of economics, Aplia is most notable for enabling curve-shifting exercises and the like to be done through an electronic portal.  It was later purchased by Cengage.  So like Nordhaus, Romer also has been a doer, including in the private sector.  Yet Paul once tweeted to Ben Bernanke that “Rich is over-rated.”  It is too hard to convert money into satisfaction.

Romer recently served as Chief Economist at the World Bank, with a somewhat complicated tenure.  You can find numerous articles about this in the media.

Romer has been a central figure behind the notion of “charter cities,” namely an economic region but with external or possibly foreign governance, so as to enforce the rule of law and spur economic growth.  The charter cities idea comes rather naturally out of Romer’s work on the economics of growth.  Think of Romer as asking “which is the non-rival public good which can be extended at very low cost?”, and wondering if that might be law.  Here is his famous TED talk on charter cities.  Here is an interview with Romer on charter cities.  He was originally slated to work with the Honduran government on charter cities, though he dropped out of the project in 2012.  Here is Paul’s account of what happened.

Amihai Glazer and I once wrote a comment on Romer, on his article with Barro on ski-lift pricing, which Glazer and I saw as closely connected to Buchanan’s theory of clubs.  Romer later credited this comment with inducing him to rethink what the notion of rivalry really means in economics, and leading to his two best-known pieces on economic growth; see the David Warsh book for more detail.

Like myself, Romer is an avid fan of the guitarist Clarence White, and several times we have traded favorite Clarence White videos by email.  Romer believes (correctly) that the role of Clarence White in the success of the Byrds is very much underrated, and furthermore he is a big fan of White’s early work with the Kentucky Colonels.  Here is more on Romer’s excellent taste in music, recommended.

Romer also has a well-known survey piece on the importance of human capital for economic growth; human capital of course is where new ideas come from.

Here is a short Romer piece from 2016, suggesting his own work on growth implies “conditional optimism” on climate change, but not “complacent optimism.”  This ties together his work with that of Nordhaus.

Romer is also an advocate of regularizing the spelling of the English language, so as to make it more phonetic.  He believes this would boost the rate of economic growth, and it ties in with some of his work on economic integration and growth.  If English is an easier language to learn, the global economy as a whole in effect becomes larger, and we might expect the rate of ideas generation to rise.

Here is Romer on Jupyter vs. Mathematica.  Here is Romer on corruption in Greece, he has very broad interests.  Here is Romer on TARP and banking reform.  Here is Romer’s recent critique of macroeconomics.

Romer believes (and I concur) that the word “and” is used too much in writing, and in particular scholarly writing.  From the FT:

Circulating a draft of the upcoming World Development Report, Mr Romer warned against bank staff trying to pile their own pet projects and messages into the report. The tendency, he argued, had diluted the impact of past reports and led to a proliferation of “ands”.

“Because of this type of pressure to say that our message is ‘this, and this, and this too, and that …’ the word ‘and’ has become the most frequently used word in Bank prose,” he complained in an email.

“A WDR, like a knife, has to be narrow to penetrate deeply,” he added. “To drive home the importance of focus, I’ve told the authors that I will not clear the final report if the frequency of ‘and’ exceeds 2.6%.”

I have always found Romer to be extremely pleasant and open in my interactions with him, and I am very pleased to have interviewed him (no transcript or audio available) at a summer ideas festival (Kent Presents) the year before this one.  The crowd found him very open and engaging.

William Nordhaus and why he won the Nobel Prize in economics

These are excellent Nobel Prize selections, Romer for economic growth and Nordhaus for environmental economics.  The two picks are brought together by the emphasis on wealth, the true nature of wealth, and how nations and societies fare at the macro level.  These are two highly relevant picks.  Think of Romer as having outlined the logic behind how ideas leverage productivity into ongoing spurts of growth, as for instance we have seen in Silicon Valley.  Think of Nordhaus as explaining how economic growth interacts with the value of the environment.  Here is their language:

  • 2018 Sveriges Riksbank Prize in Economic Sciences is awarded jointly to William D Nordhaus “for integrating climate change into long-run macroeconomic analysis” and Paul M Romer “for integrating technological innovations into long-run macroeconomic analysis”.

Both are Americans, and both have highly innovative but also “within the mainstream” approaches.  So this is a macro prize, but not for cycles, rather for growth and long-term economic prospects.  Here is the Prize committee citation, always well done.

Both candidates were considered heavy favorites to win the Prize, sooner or later, and these selections cannot come as a surprise.  Perhaps it is slightly surprising that they won the Prize together, though the basic logic of such a combination makes good sense.  Here are previous MR mentions of Nordhaus, you can see we have been mentioning him for years in connection with the Prize.

Here is the home page of Nordhaus.  Here is Wikipedia.  Here is scholar.google.com.  Here is Joshua Gans on Nordhaus.

Nordhaus is professor at Yale, and most of all he is known for his work on climate change models, and his connection to various concepts of “green accounting.”  To the best of my knowledge, Nordhaus started working on green accounting in 1972, when he published with James Tobin (also a Laureate) “Is Growth Obsolete?“, which raised the key question of sustainability.  Green accounting attempts to outline how environmental degradation can be measured against economic growth.  This endeavor is not so easy, however, as environmental damage can be hard to measure and furthermore gdp is a “flow” and the environment is (often, not always) best thought of as a “stock.”

Nordhaus developed (with co-authors) the Dynamic Integrated Climate-Economy Model, a pioneering effort to develop a general approach to estimating the costs of climate change.  Subsequent efforts, such as the London IPCC group, have built directly on Nordhaus’s work in this area.  The EPA still uses a variant of this model.  The model was based on earlier work by Nordhaus himself in the 1970s, and he refined it over time in a series of books and articles, culminating in several books in the 1990s.  Here is his well-cited piece, with Mendelsohn and Shaw, on how climate change will affect global agriculture.

Nordhaus also was an early advocate of a carbon tax and furthermore note that his brother Bob wrote part of the Clean Air Act, the part that gave the government the right to regulate hitherto-unmentioned pollutants in the future.  The Obama administration, in its later attempts to regulate climate, cited this provision.

I would say that much of Nordhaus’s work has its impact through being “done,” rather than through being “read.”  Few economists have read through this model, which has computer programs and spreadsheets at its core.  But virtually all economists read about the results of such models and have a general sense of how they work.  The most common criticism of such models, by the way, is simply that their results are highly sensitive to the choice of discount rate.

In recent years, Nordhaus has shifted his emphasis to the risks from climate change, for instance in his book The Climate Casino: Risk, Uncertainty, and Economics for a Growing World.  Marty Weitzman offers a good review, as does Krugman.

Assorted pieces of information on Nordhaus:

Nordhaus was briefly Provost at Yale.  He also ended up being co-author on Paul Samuelson’s famous textbook in economics.

He co-authored a recent paper arguing we are not near the economic singularity; in this area his work intersects with Romer’s quite closely.

Here is a good NYT profile of Bill Nordhaus and his brother Bob, an environmental lawyer:

Bill Nordhaus, 72, a Yale economist who is seen as a leading contender for a Nobel Prize, came up with the idea of a carbon tax and effectively invented the economics of climate change. Bob, 77, a prominent Washington energy lawyer, wrote an obscure provision in the Clean Air Act of 1970 that is now the legal basis for a landmark climate change regulation, to be unveiled by the White House next month, that could close hundreds of coal-fired power plants and define President Obama’s environmental legacy.

Bob, Bill’s brother, once said: ““Growing up in New Mexico,” he said, “you’re aware of the very fragile ecosystem.””

Perhaps my personal favorite Nordhaus paper is on the returns to innovation.  Don Boudreaux summarized it well:

In a recent NBER working paper – “Schumpeterian Profits in the American Economy: Theory and Measurement” – Yale economist William Nordhaus estimates that innovators capture a mere 2.2% of the total “surplus” from innovation. (The total surplus of innovation is, roughly speaking, the total value to society of innovation above the cost of producing innovations.) Nordhaus’s data are from the post-WWII period.

The smallness of this figure is astounding. If it is anywhere close to being an accurate estimate, the implication is that “society” pays a paltry $2.20 for every $100 worth of welfare it enjoys from innovating activities.

There again you will see a complete intersection with the ideas of Romer.  Another splendid and still-underrated paper by Nordhaus is on the economics of light.  Nordhaus argues that gdp figures understate the true extent of growth, and shows that the relative price of bringing light to humans has fallen more rapidly than gdp growth figures alone might indicate.  Check out this diagram.  Here is a BBC summary of what Nordhaus did, in other words rates of price inflation have been lower than we thought and thus rates of real gdp growth higher.

Again, you will see Nordhaus and Romer intersecting on this key idea of economic growth.

Last but not least, Nordhaus was a pioneer on the theory of the political business cycle, namely the idea that politicians deliberately manipulate the economy, using monetary and fiscal policy, so as to boost their chances of reelection.  Dare I suggest that this idea might be making a comeback?

Addendum: From Margaret Collins by email: “I’d like to call your attention to Professor Nordhaus’ longstanding association with the International Institute for Applied Systems Analysis (IIASA), the international science and policy research institution located just outside Vienna.  He worked at IIASA shortly after the institute’s creation in 1972, and his work there is closely bound to the issues the Nobel Committee cites in the award  — he was employed for a year in 1974-75, doing pioneering work on climate as part of IIASA’s Energy Program, and producing a working paper entitled “Can We Control Carbon Dioxide?”.  That was perhaps the first economics treatment of of climate change — and Nordhaus dates his work on climate as having begun there.  He has visited IIASA numerous times in the intervening years, and remains a close collaborator, particularly with Nebojsa Nakicenovic, the Institute’s Deputy Director.”

And, from the comments: “Nordhaus also helped pioneer the use of satellite imagery of night time lights as a tool for measuring economic growth, where we’ve played around with some of the publicly available tools to support various analysis.”

The Nobel Prize in Economics Goes to William Nordhaus and Paul Romer!

Two excellent choices. Nordhaus for environmental economics and Paul Romer for economic growth. I did a video for MRUniversity that goes over Paul Romer’s contributions including not only economic growth and charter cities but also his entrepreneurship in developing tools to teach economics! The video was done when MRUniversity was in the early years so it doesn’t have a lot of bells and whistles. On the other hand, Romer told me he really liked this video so this year I don’t think I need to write more!

See Tyler’s posts for more on Nordhaus and also on Romer.

Who will win the Nobel Prize in economics this year?

I’ve never once gotten it right, at least not for exact timing, so my apologies to anyone I pick (sorry Bill Baumol!).  Nonetheless this year I am in for Esther Duflo and Abihijit Banerjee, possibly with Michael Kremer, for randomized control trials in development economics.

Maybe they are too young, as Tim Harford points out, so my back-up pick remains an environmental prize for Bill Nordhaus, Partha Dasgupta, and Marty Weitzman.

What do you all predict?