Category: Economics

The Nobel Scientific Background paper is the best introduction to all of these people, and a good introduction to mechanism design in general.

As for Myerson, here is his home page.  Here is his CV.  Here is one overview.  Here is Myerson in Google Scholar.

His most cited paper is on auction design.  He laid out basic results for how to use auctions to extract revenue and elicit information about the value of the good.  These results have informed numerous privatizations and auction schemes in the last twenty-five years.

Here is a very important paper, with David Baron, on how to regulate a monopolist with unknown costs.  Strict marginal cost pricing is no longer possible.  Under some assumptions, allow the monopolist to charge a relatively high price, but design penalties to elicit an honest reporting of costs.  The key point of course is that monopolists won’t always report their costs truthfully.  This is one of the most important papers in regulatory economics in the last thirty years and it has helped disillusion many economists with a narrow ideal of marginal cost pricing.

Myerson also has important papers on how social choice theory is linked to bargaining theory, and which social choice procedures are most likely to elicit truthtelling.

I think of his "Mechanism Design with An Informed Principal" as one of his most important papers, though Google Scholar does not concur.  Let’s say that a principal knows something an agent does not and wishes to maintain that information asymmetry.  How can a principal construct the best incentive scheme for the agent?  The problem is, choosing the scheme itself may reveal information to the agent and thus eliminate the principal’s advantage.  Myerson showed what solutions to this problem have to look like.  This is a very clever problem and a very elegant paper.

Among the current research papers you will notice a strong interest in public choice and institutions, though Myerson is not usually thought of as applied, nor is that where his influence has come.  Electoral rules, corruption, and political institutions all are commanding his attention.

Here is an interview with Myerson on game theory.  Here is Myerson’s take on the core problems of social choice theory, a summary of the theoretical side of the field.

Here is Myerson on Hurwicz, which is also a very good introduction to Hurwicz.

Off the beaten track, here is Roger Myerson on Thomas Schelling’s Strategy of Conflict.  Here is Myerson’s Op-Ed draft on why America should accept limits on its military power, namely to limit deadly rivalries.  Here Myerson recommends federalism for Iraq.

In view of these difficulties, it is desirable to design mechanisms in which all equilibrium outcomes are optimal for the given goal function. The quest for this property is known as the implementation problem. Groves and Ledyard (1977) and Hurwicz and Schmeidler (1978) showed that, in certain situations, it is possible to construct mechanisms in which all Nash equilibria are Pareto optimal, while Eric Maskin (1977) gave a general characterization of Nash implementable social-choice functions. He showed that Nash implementation requires a condition now known as Maskin monotonicity (see Section 3.3 for an illustration of this property). Maskin (1977) also showed that if Maskin monotonicity and a condition called no-veto-power are both satisfied, and if there are at least three agents, then implementation in Nash equilibrium is possible.

Maskin considered Nash equilibria in games of complete information, but his results have been generalized to Bayesian Nash equilibria in games of incomplete information (see Postlewaite and Schmeidler, 1986, Palfrey and Srivastava, 1989, Mookherjee and Reichelstein, 1990, and Jackson, 1991). For example, Palfrey and Srivastava (1991) show how the double auction can be modified so as to render all equilibria incentive efficient.

Maskin’s results have also been extended in many other directions, such as virtual (or approximate) implementation (Matsushima, 1988, Abreu and Sen, 1991), implementation in renegotiation-proof equilibria (Maskin and Moore, 1999) and by way of sequential mechanisms (Moore and Repullo, 1988).  Implementation theory has played, and continues to play, an important role in several areas of economic theory, such as social choice theory (Moulin, 1994) and the theory of incomplete contracts (Maskin and Tirole, 1999).

Giuseppe Bertola writes:

Just as the Eurozone countries began to enjoy full and irreversible
economic integration, inequality increased very sharply in the EU15 and
more sharply in the 12 Eurozone countries, bringing its previous
decline to an end and reverting to the 1996 level by 2004…one finds that EMU does appear to improve economic performance (both in
terms of per capita income and in terms of unemployment) and the
intensity of international transactions (especially as regards foreign
direct investment flows).  But it also appears to be associated with
higher inequality, and with lower social spending.  Interestingly, the
inequality variation associated with EMU is fully accounted for by
changes in social policy expenditure (excluding pensions) as a share of
GDP, and in GDP and unemployment (both of which are of course likely to
be influenced by integration policies, as well as by global cyclical
and technological development).

We will of course see how far this trend goes, but it is consistent with my view that Europe will, in economic terms, become like the United States more rapidly than vice versa. 

Brad DeLong writes:

I don’t understand how any professional economist can disagree with the fact that more technology-driven inequality should call forth more social insurance in response.

I do think taxation should be progressive, but the comparative statics are tricky.  If absolute standards of living are rising, and credit constraints are being relaxed, economic failure often means no cable TV rather than starvation.  That militates in favor of less social insurance, noting on the other hand that we can afford it more as well. 

Furthermore greater productivity for the high earners can mean greater deadweight loss from the taxes and in the longer run less innovation and lower living standards (a prize to the first person who in the comments shouts "trickle down!" and accuses me of believing in discredited supply side notions; I’ll also recognize that well-spent government revenue can raise rather than lower the living standard). 

Whether "the rich would have worked virtually as hard for less" will depend on social norms.  I personally think that "shop at Barney’s slurp my sushi run a hedge fund psycho norms" — at least concentrated in a few percent of the human race — may be better for humanity than the sanity promoted by Bob Frank and Montaigne.  The thing is, part of the craziness of these people might include them not wanting to give away half or more of what they earn. 

Of course we could calm these people down altogether (or maybe not, or maybe letting them run a hedge fun is calming them down), but I’m not sure we want to. 

What about me?  I could read Epictetus all day long for free, listening to my already-purchased Indian classical music CDs and blogging for you all.  But at fifty percent marginal rates of taxation or higher, I would work considerably less at the margin.  I don’t look at a budget, to me the extra work "just don’t seem right."  Maybe it’s because I don’t play the ultimatum game like a chimpanzee.  But in any case for many people I think there is a significant notch effect at about 45-50 percent and up for the tax rate.

I might add that serious egalitarian-oriented health care reform — if indeed it succeeded — would significantly lower the case for greater progressivity of taxation.

Dani Rodrik tells us.  My whirlwind summary is pro-trade, pro-safety net, multilateral not bilateral, better procedures, pro-immigration, progressive toward poor countries, letting poor countries determine their own economic policies, and giving democracies more trade rights than non-democracies. 

I might well accept that if it were truly a package deal and truly the deal we would get.  But I don’t think multilateral institutions — a thin reed as they are — can stand that much stress or take on that much responsibility.  I also shudder to think who gets to define what a democracy is and what deals are cut to grant the higher status and how the excluded non-democracies take such a scolding.  Boosting safety nets and boosting immigration are not in every way congruent.  Most of all I wonder which of these goals are priorities.  I’ll put all of the procedural issues on the low side, as people aren’t happy with procedures no matter how good they are.  I want to start with more trade and immigration — unilaterally or bilaterally if need be — and see how much social spending we can afford without moving to European-level rates of taxation.  Most of the progressives I suspect want to start with more social spending and see how much open trade the public will then accept.  Viewed in these terms, we’re probably going to end up in very different places.

Responding to an earlier post of mine, the very smart Ian Dew-Becker emailed me the following text:

I saw you had a post up about some work I did with Bob Gordon, and I found your comments very interesting. I have a couple questions that I hope might help clarify your thoughts on the subject.

First, you seem to argue that we would expect a CEO to be paid her marginal product. As you point out, there is ample evidence that a CEO adds far more to the value of a company than she is generally paid. I’m curious, though, what you mean when you say we would expect the CEO to be paid her marginal product. Models in this literature often assume that each firm must hire one CEO. The concept of a marginal product breaks down at this point. The firm can’t hire a second CEO. There is no marginal value. It’s possible that we can look at marginal products in terms of the skill a CEO brings to the firm, but in that case, we would be mixing up marginal and average products if we were to simply look at the total contribution a CEO makes to firm output.

I think you’re correct to point out the institutional factors holding down CEO pay pre-1970. That said though, why didn’t we see CEO pay rising much faster than market cap during the 80’s in order for it to catch up to where it should be? There is a period where the pay-market cap elasticity may have been higher than 1, but it’s only for a few years in the 90’s. Looking at the full 1976-2005 sample, the relationship is nearly unitary (.935, according to Frydman and Saks). So I guess I’m surprised there is no catch up in pay.

I think you’re right to be skeptical of the Bebchuk-Grinstein results. To me, the most interesting result from Gabaix and Landier, no matter what one thinks about their model as a whole, is that the cross-section and time series may show very different patterns. So one wouldn’t necessarily expect the cross-sectional results from Bebchuk and Grinstein to predict the time-series.

One of my biggest concerns with Gabaix and Landier’s model is that it does not display decreasing returns to scale. An analogous example is Berk and Green’s model of mutual funds. They assume that if a manager all of a sudden sees the size of his fund double, he will see lower average returns. I think this is reasonable. When there are not diminishing returns, it is difficult to make models function. Gabaix and Landier are forced to do it by assuming firms never merge. That concerns me in this setting. Dixit-Stiglitz competition is often a reasonable assumption because the models using it do not actually care about firm size or mergers. In the case of CEO pay, however, firm size is clearly critical.

The question about the marginal product of a CEO is a tricky one. I can imagine the following definitions which either express marginal product or some modified version thereof:

1. How much better the highly-paid guy is than a less-well-paid substitute would be.

2. How much better the highly-paid guy is than the next best person (in stochastic terms, that is) the firm would get for that same sum.

3. How much a bit of extra pay causes the CEO to improve effort and thus performance.

4. The complex econometric definition offered by Jensen and Murphy, read pp.33-38 here.

5. Some number between the CEO’s value of leisure and how well the firm would do with no CEO at all.

None of these quite make sense in pure theory, and it is even harder to say which is the most important variable for practice.

That is the title of my piece in the new Wilson Quarterly, not on-line anytime soon and yes you should subscribe.  The piece looks at how people emotionally respond to the move from neighborhood, face-to-face competition to competition at a distance, or what I call invisible competition.  Some people will fare better in this new environment than others; for instance people who rely on adrenalin to compete will find it harder to motivate themselves in this new and more impersonal environment:

The greatest gains in this new world are likely to go to people who are methodical planners or who love the game for its own sake. Some people plot their competitive strategies far in advance. These planners–be they crazy or just highly productive–don’t need anyone breathing down their necks, and indeed they often work best alone or in very small groups. Bill Gates is a classic example. Planners’ behavior may manifest itself in very competitive forms, but their underlying psychology is often not very rivalrous at all. They are ordering their own realities, usually for their individual psychological reasons, rather than acting out of a desire to trounce the competition. Early risers will also be favored. These people enjoy being first in line, or first to use a new idea, for its own sake.

Of course many of us miss face to face competition, so we try to recreate it in trivial ways, sometimes using our children:

As the concrete manifestations of the more important contests of love and business vanish, we recreate up-close rivalry to make our lives feel more real. I suspect that this helps explain the growing appetite for televised athletics and organized sports for children as well as the vogue for reality TV series such as Survivor and American Idol, eating contests, and even spelling bees. Because children are a cheap labor supply and willing to engage in all sorts of behavior for a chance at a prize or parental approval, they often serve as the vehicle for parents who seek to live out their desire for head-to-head competition vicariously. Spelling, for example, does not interest many people (who sits around practicing?), but bees exemplify the competitive spirit in action. The challenge to spell autochthonous, panmyelopathy, or warison will bring one kid to tears and another to triumph.

Do relative status and income matter more than absolute?

If this were true, then most immigration would be from rich countries to poor countries.

One thing we could do as a country that could help reduce carbon
emissions in a relatively pain-free way would be to ease regulations
around what you’re allowed to build where.

That’s from Matt Yglesias, and I loved his take on the debates.

Addendum: Here is Virginia Postrel as well, and of course we are all wishing her the best in her struggle with breast cancer.

Here, and so far the posted numbers don’t mean anything.  Hat tip to the ever-vigilant Greg Mankiw.

An Indian entrepreneur has given a new twist to the concept of low-cost airlines. The passengers boarding his Airbus 300 in Delhi do not expect to go anywhere because it never takes off.

All they want is the chance to know what it is like to sit on a plane, listen to announcements and be waited on by stewardesses bustling up and down the aisle.

In a country where 99% of the population have never experienced air travel, the “virtual journeys” of Bahadur Chand Gupta, a retired Indian Airlines engineer, have proved a roaring success.

As on an ordinary aircraft, customers buckle themselves in and watch a safety demonstration. But when they look out of the windows, the landscape never changes. Even if “Captain” Gupta wanted to get off the ground, the plane would not go far: it only has one wing and a large part of the tail is missing.

None of that bothers Gupta as he sits at the controls in his cockpit. His regular announcements include, “We will soon be passing through a zone of turbulence” and “We are about to begin our descent into Delhi.”

“Some of my passengers have crossed the country to get on this plane,” says Gupta, who charges about £2 each for passengers taking the “journey”.

The plane has no lighting and the lavatories are out of order. The air-conditioning is powered by a generator. Even so, about 40 passengers turn up each Saturday to queue for boarding cards.

Here is the full story, via Kottke.  The crew of six includes Gupta’s wife.  Get this:

Jasmine, a young teacher, had been longing to go on a plane. “It is much more beautiful than I ever imagined,” she said.

Addendum: Here is fun commentary.

Chimps play the ultimatum game more "rationally," that is to say more in line with standard economic models, than do humans.  I’m not sure whether this says more about chimps or economists.

Thanks to Jeff Smith for the pointer.

In 2000, a world health conference in Abuja, Nigeria, set a goal: by
2005, 60 percent of African children would be sleeping under nets.  By
2005, only 3 percent were.

It turns out that handing nets out for free works much better than branding them, marketing them, and selling them, albeit at subsidized prices.  And when there are enough insecticide-laden nets in a village, mosquitoes avoid the place altogether (after the very first net, however, the mosquitoes simply move on to another nearby hut).

The sad fact is that the best insecticide-filled nets last no more than three to five years. And is this good or bad news?

…sales of malaria pills were way down.

Here is the full and fascinating story.  Eternal vigilance is the price of foreign aid, or something like that…