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Nobel predictions

I used to always predict Fama but I can’t this year.  Thomas Sargent is worthy and he has done much more than "rational expectations" but that moniker will hurt his chances for now.  Shiller is a possibility but maybe that looks like pandering to current events.  And I don’t think they will pick anyone who was on the board of A.I.G., at least not this year.

Here are my old picks.  This still wouldn’t be a bad year for Tirole, Williamson, or anyone else who worked on agency problems.  It seems those problems matter.  And there is still environmental economics.  Or the "surprising European who is undervalued by Americans" pick, a’la Maurice Allais or Trygve Haavelmo.

What do you predict?  Please tell us in the comments.

Leonid Hurwicz, Nobel Laureate

Here is Wikipedia on Hurwicz.  He is the granddaddy of the group, and the Nobel Committee sums it up nicely:

The seminal work of Leonid Hurwicz (1960,1972) marks the birth of mechanism design theory.  In Hurwicz’s formulation, a mechanism is a communication system in which participants exchange messages with each other, messages that jointly determine the outcome.  These messages may contain private information, such as an individual’s (true or pretended) willingness to pay for a public good.  The mechanism is like a machine that compiles and processes the received messages, thereby aggregating (true or false) private information provided by many agents.  Each agent strives to maximize his or her expected payoff (utility or profit), and may decide to withhold disadvantageous information or send false information (hoping to pay less for a public good, say).  This leads to the notion of “implementing” outcomes as equilibria of message games, where the mechanism defines the “rules” of the message game.  The comparison of alternative mechanisms is then cast as a comparison of the equilibria of the associated message games…

Hurwicz’s (1972) notion of incentive-compatibility can now be expressed as follows: the mechanism is incentive-compatible if it is a dominant strategy for each participant to report his private information truthfully.

In other words, no incentive scheme, no matter how clever, can get people to tell the truth.  Grove, Clarke, Tideman, and Tullock lurk in the hallways.  Note that a second price auction (let everyone bid and the winner pays the price of the next highest bid) fails in terms of Paretian optimality.  The government takes the second price bid from the winner, but what should it do with the money?  Either the government wastes resources by destroying wealth, or it redistributes that wealth in some way but then the resulting redistribution in turn feeds back into bids and we can no longer derive truth-telling as optimal (but is this really a practical problem?; my fear is that the entire incentive-compatibility literature has never gotten at the real reason why we don’t run the entire economy as a second-price auction.) 

Here is Roger Myerson’s very nice piece on Hurwicz.  Myerson ties Hurwicz to the socialist calculation debate of Mises and Hayek and also to the later work of Jean Tirole.  It is sometimes said that moral hazard problems favor capitalism, adverse selection problems favor socialism.

Hurwicz also wrote a very important paper with Kenneth Arrow on the stability of general equilibrium theory, as well as other notable theory pieces, not all on mechanism design.  Here is a list of major works, some of the early ones have pdfs attached.

Roger Myerson, Nobel Laureate

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.

Eric Maskin, Nobel Laureate

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).

Nobel Prize for iPod

I think what is most interesting about today’s Nobel prize in physics is how quickly the discovery of a new effect, giant magneto-resistance, led to real devices including the iPod.  From the totally unknown to the utterly familiar in less than twenty years.  The world really is speeding up.

The Nobel Prize Foundation has a very nice write-up of giant magneto-resistance and its applications.

Who will win the Nobel Prize in economics this year?

Greg Mankiw asks and receives many answers

One guess is William Nordhaus, for his concept of "green accounting."  An environmental prize is overdue but perhaps Nordhaus is too skeptical about stringent anti-global warming measures to get the appropriate reception in Stockholm.

Another option is Eugene Fama, both for testing CAPM for securities prices and for figuring out what is wrong with it.  You can imagine pairing his prize with either Richard Thaler (behavioral finance) or Kenneth French (Fama’s co-author on many important papers).

Or how about Oliver Williamson and/or Jean Tirole for principal-agent theory as applied to the business firm?

I would offer the prize jointly to Anne Krueger, Jagdish Bhagwati, and Gordon Tullock for their work on rent-seeking, but that is not my prediction.  Readers, what do you think?

Economist wins Nobel Peace Prize

The winner is Muhammad Yunus, economist (!) and founder of the micro-credit movement, along with his Grameen Bank.  Here is the story.  Here is his Wikipedia entry.  Here is my New York Times column on micro-credit.  Here is the best piece on what we know about micro-credit.  Here is Yunus’s book on micro-credit, which also serves as a memoir and autobiography.  It is a captivating and well-written story.

This is a wonderful choice.  The funny thing is, they never would have considered this guy for the Economics prize. 

I would write more, but a) read my column, and b) the Topalov-Kramnik sudden death speed chess tiebreakers are being played this morning, watch them live here.  Susan Polgar offers running commentary here.

Edmund Phelps — Today’s Nobel Prize in economics

Edmund Phelps.  Here is the announcement from Sweden

Here is his autobiography.  He was born in Chicago in 1933 and now teaches at Columbia.  Here is his CV, and here is another version.  Here are recent papers.  His Wikipedia entry is a short stub, but watch it grow.

Here is his summary of his research.  Here is another good summary of his workThis summary, from Sweden, is the best and most comprehensive, albeit more technical.

His main contribution is a better understanding of the Phillips curve and the dynamics of short-run unemployment and the concept of the natural rate of unemployment.  He gave the Phillips curve microfoundations and developed the "expectations-augmented Phillips curve."  As the name suggests, the level of inflationary expectations matter for how money will influence output.

Here is his memoir on developing the idea of the natural rate of unemployment.  His most influential 1960s work suggested that economies possess a natural rate of unemployment, monetary policy can reduce unemployment only temporarily (NB: in his view this is a conclusion, and should not be an axiom in economic models), monetary policy can reduce unemployment temporarily, and Keynesian economics should not treat the rate of unemployment as arbitrarily at the whim of monetary and fiscal policy.  He was also concerned with how the natural rate of employment can change over time; here is his 1997 paper on that topic.

The evolution of Phelps’s thought on how money can matter is complex.  His later work stresses monetary non-neutrality, mostly through non-rational expectations and non-synchronized wage and price setting.  His work in the 1980s focused on what the concept of rational expectations means in such complex environments.   

Do not assume that early Phelps and late Phelps are saying the same things or arguing against the same opponents.  Sometimes it is argued that he redefined macroeconomics twice.  After criticizing Keynesianism, he later turned against the "rational expectations"  point of view.  He is a complex thinker, although it can be hard to divine his "bottom line."  He fails to fit inside the "macroeconomics boxes" that have developed since the early 1980s, namely real business cycle theory vs. neo-Keynesianism.

Phelps’s work was considered revolutionary in the 1960s, though the subsequent work and influence of Milton Friedman have brought related ideas into the mainstream some time ago.

He also has done work on economic justice and how a Rawlsian maximin analysis might modify the idea of a zero rate of marginal taxation on top earners, as had been suggested by James Mirrlees.  Phelps believes that considerations of justice and distribution are important, and neglected, in economic thinking.  Once he had a piece in the Journal of Philosophy on ideas of justice in public finance.

He also wrote some well-known papers on what intergenerational justice means, the optimal accumulation of capital, and whether those allocations will prove sustainable and consistent over time.  He asks what kind of principles should govern how much capital we should leave for the next generation.  His 1961 work on capital theory formulated the notion of a "golden rule" of capital accumulation.  It asked what savings rate would maximize per capita income on an ongoing basis.  The concepts behind this work remain important for work on capital accumulation and also the sustainability of natural resource use and environmental policy.  Phelps also generated the counterintuitive result that the savings rate can be too high, and that all generations could be better off with a lower savings rate.  He does not, however, seem to think that this latter idea is policy-relevant.  The best summary of this work on capital theory is here, scroll through a bit.

Lately he has been working on the possibility of subsidies for hiring low-wage labor and Eastern European transitions.  Here is his book on wage subsidies.  Here is a more popular Phelps piece on wage subsidies.  He has also done work on the structural dynamics of economies and the underlying factors behind economic innovation.  Here is an early Phelps paper on technological diffusion; surprisingly it is his most frequently cited work according to scholar.google.com.  He looked to education and population size as key factors driving the rate of economic growth; this piece is a precursor of later work on endogenous growth theory.

Phelps also wrote a 1972 paper on statistical discrimination, one of the earliest formal economic treatments of that topic.

Here is Phelps on Project Syndicate, the link offers numerous essays on current events.  The European malaise stems from lack of dynamism.  He opposed the Bush tax cuts.  Here is Phelps on the rise of the West and the need for humane capitalism.  He has a broadly classical liberal slant but has adopted the modern liberal idea that distribution requires government intervention into labor markets and other parts of a modern economy.  He has a strong concern with the moral foundations of a free society.

Here are his cites on scholar.google.com.  4600 is a relatively low number for a Nobel Laureate.  Vernon Smith for instance has over 40,000.  In part this relatively small number reflects the older nature of Phelps’s major contributions, and that often his ideas have been absorbed but without citation.  Furthermore Phelps does not always write within the context of the most contemporary debates.

Over the last twenty years Phelps has spent a great deal of time in Europe.  In general his European influence and reputation is stronger than in the United States.

My take: It is hard to argue with this pick.  It is a good selection.  His 1960s macro work was true, important, and extremely influential.  The capital theory work endures and provides a foundation for subsequent theory.  The overall scope is impressive, and Phelps’s concerns never strayed far from the real world.

But Phelps is not an economist who has influenced my own thinking much if at all.  His major contributions were absorbed, and were standard fare, by the time I was a young’un.  For instance I drunk the same macro milk through the writings of Milton Friedman.  I find him to be a murky writer, and often he is frustrating to read and hard to pin down.  His advocates would characterize him as a "rich" thinker.

What this Prize means: The big questions still matter.  Unemployment, economic growth, labor markets, capital accumulation, fairness, discrimination, and justice across the generations are indeed worthy of economic attention.  Phelps contributed to all of those areas.   Normative questions matter.  Relevance and breadth triumph over narrow technical skill.

Addendum: The U.S. has now won six Nobel Prizes in a row, but I bet we don’t get the Peace Prize this year.

The Ig Nobel Prizes

Here is this year’s list.  Example:

Ornithology – Ivan R. Schwab, of the University of California, Davis, and the late Philip R.A. May of the University of California, Los Angeles, for exploring and explaining why woodpeckers don’t get headaches.

The funny thing is that just about all of these, even the hiccups one, represent real research.  Seriously.  Here is further background.

Poor U.S. scores in health care don’t measure Nobels and innovation

Here is my column on that topic.  Excerpt:

In real terms, spending on American biomedical research has doubled
since 1994.  By 2003, spending was up to $94.3 billion (there is no
comparable number for Europe), with 57 percent of that coming from
private industry.  The National Institutes of Health‘s current annual research budget is $28 billion.  All European Union
governments, in contrast, spent $3.7 billion in 2000, and since that
time, Europe has not narrowed the research and development gap.  America
spends more on research and development over all and on drugs in
particular, even though the United States has a smaller population than
the core European Union countries.  From 1989 to 2002, four times as
much money was invested in private biotechnology companies in America
than in Europe.

Dr. Thomas Boehm of Jerini, a biomedical
research company in Berlin, titled his article in The Journal of
Medical Marketing in 2005 “How Can We Explain the American Dominance in
Biomedical Research and Development?” (ostina.org/downloads/pdfs/bridgesvol7_BoehmArticle.pdf)
Dr. Boehm argues that the research environment in the United States,
compared with Europe, is wealthier, more competitive, more meritocratic
and more tolerant of waste and chaos.  He argues that these features
lead to more medical discoveries.  About 400,000 European researchers
are living in the United States, usually for superior financial
compensation and research facilities.

This innovation-rich environment stems from the money spent on
American health care and also from the richer and more competitive
American universities.  The American government could use its size, or
use the law, to bargain down health care prices, as many European
governments have done.  In the short run, this would save money but in
the longer run it would cost lives.

Medical innovations improve
health and life expectancy in all wealthy countries, not just in the
United States.  That is one reason American citizens do not live longer. 
Furthermore, the lucrative United States health care market enhances
research and development abroad and not just at home.

In other words, the case for national health insurance is far from clear.  In terms of other reforms, one key question is how much waste could be reformed while keeping incentives for innovation intact.  I am optimistic about the prospects for change, but this does mean that eliminating "waste" can have negative secondary consequences.

The argument has another angle, explored only briefly.  The National Institutes of Health is one of the best governmental programs we have in the United States.  Part of its success stems from its relative autonomy.  It is harder to find worthwhile governmental R&D initiatives when Congress is pulling the strings on the specific allocations.  We should do more along the lines of NIH, and lack of autonomy is one big reason why R&D programs such as synfuels did not turn out well.

And no, I don’t think the U.S. system is close to ideal:

American health care has many problems.  Health insurance is linked too
tightly to employment, and too many people cannot afford insurance.
Insurance companies put too much energy into avoiding payments.
Personal medical records are kept on paper rather than in accessible
electronic fashion.  Emergency rooms are not always well suited to serve
as last-resort health care for the poor.  Most fundamentally, the lack
of good measures of health care quality makes it hard to identify and
eliminate waste.

Nobel Prize predictions

The Economics prize will be announced October 9.  Here are speculations from last year.  Here are further plausible picks.  Gordon Tullock deserves it.  I predict Eugene Fama and Richard Thaler as deserving co-winners for their work in empirical finance.  Fama will win it for first proving (1972) and then disproving (1992) CAPM, the Capital Asset Pricing Model.  Thaler will win it for developing behavioral finance and a better account of how irrationalities manifest themselves in asset markets.  Kenneth French, a co-author of Fama’s, might be a third pick.  My greatest fear is that they pick Lars Svensson (I believe he is Norwegian, but still that is not a bad name for winning a Swedish prize), and somebody asks me to explain his work.

I believe I have never once predicted this prize correctly.  Last year I said Thomas Schelling, the co-winner with Bob Aumann, deserved the prize but might not ever get it.  What do you all think?

Addendum: Chris Masse points me to bookie odds on the Peace Prize.