The Nobel Prize in Economics, 2020

It is such a pleasure to begin a blog post on such a happy, warm and fuzzy note in 2020 – and what’s rarer is that the note is courtesy Twitter!

Milgrom and Wilson aren’t exactly household names in India – or at any rate, weren’t household names until yesterday. In fact, even within economics departments, they are unlikely to have been names that absolutely everybody is familiar with. This blog post is as much a celebration of they having won the Nobel Prize for Economics as it is an opportunity for me to learn more about their work.

But let’s begin by allowing Twitter to return to type, as it were:

This is not, to be clear, any random person on Twitter. Branko Milanovic is currently a Professor at CUNY, has worked in the World Bank, and has written some rather well received books in the recent past.

So what gives? Why such a curmudgeonly response to the highest prize that one can receive as an economist?

Twitter being what it is, Branko Milanovic was eventually goaded into answering this question himself (link here), but his response – to me! – boils down to “Pah! There are other, more important problems to think about.”

Well, maybe. But if you ask me, Milgrom and Wilson’s work is plenty important in its own right.

Let’s find out why!

Every day, auctions distribute astronomical values between buyers and sellers. This year’s Laureates, Paul Milgrom and Robert Wilson, have improved auction theory and invented new auction formats, benefitting
sellers, buyers and taxpayers around the world.

How do we decide who gets what? Should this be decided by governments without the use of markets, or should this be completely random? Should bidding wars (that is, auctions) be deployed, and if so, what might be the implications?

It is for their attempts at answering that last question, for the most part, that Milgrom and Wilson have been awarded this year’s Nobel Prize in Economics.

How did they go about answering this question? Here’s Timothy Taylor with one answer:

A useful starting point is to recognize that auctions can have a wide array of formats. Most people are used to the idea of an auction where an auctioneer presides over a room of people who call out bids, until no one is willing to call out a higher bid. But auctions don’t need to work in that way.

An “English auction” is one where the bids are ascending, until a highest bid is reached. A “Dutch auction”–which is commonly used to sell about 20 million fresh flowers per day–starts with a high bid and then declines, so that the first person to speak up wins. In an open-outcry auction, the bid are heard by everyone, but in a sealed-bid auction, the bids are private. Some auctions have only one round of bidding; others may eliminate some bidders after one round but proceed through multiple rounds. In “first-price” auctions, the winner pays what they bid; in “second-price” auctions, the winner instead pays whatever was bi by the runner up.

In some auctions the value of what is being bid on is mostly a “private value” to the bidders (the Nobel committee suggests thinking about bidding on dinner with a Nobel economist as an example, but you may prefer to substitute a celebrity of your choice), but in other cases, like bidding on an offshore oil lease, the value of the object is at least to some extent a “common value,” because any oil that is found will be sold at the global market price. In some auctions, the bidders may have detailed private information about what is being sold (say, in the case where a house is being sold but you are allowed to do your own inspection before bidding), while in other auctions the information about the object being auctioned may be mostly public.

In short, there is no single perfect auction. Instead, thinking about how auctions work means considering for any specific context how auction rules and format in that situation, given what determines the value of the auctioned objects and what what kind of information and uncertainty bidders might have.

Do read the rest of the blogpost for some very interesting examples of how auctions might go wrong – most of them excerpted from an excellent paper by Paul Klemperer.

The excellent, excellent blog A Fine Theorem ends up responding (unintentionally, to be clear) to Branko Milanovic while speaking about Milgrom and Wilson’s body of work:

When it comes to practical application, Milgrom’s work on auctions is well-known, and formed the basis of his Nobel citation. How did auctions become so “practical”? There is no question that the rise of applied auction theory, with the economist as designer, has its roots in the privatization wave of the 1990s that followed the end of the Cold War. Governments held valuable assets: water rights, resource tracts, spectrum that was proving important for new technologies like the cell phone. Who was to be given these assets, and at what price? Milgrom’s 1995 Churchill lectures formed the basis for a book, “Putting Auction Theory to Work”, which is now essential reading alongside Klemperer’s “Theory and Practice”, for theorists and practitioners alike. Where it is unique is in its focus on the practical details of running auctions.

In other words, applied auction theory helps us, as a society, decide who gets what, and on what basis. Especially with the end of the Cold War, and with the wave of liberalization and privatization that followed in many major economies the world over, applied auction theory became especially important!

Timothy Taylor again:

One useful property of auctions is that in a number of settings they can discipline the public sector to make decisions based on economic values, rather than favoritism. For example, when a city wants to sign a contract with a company that will pick up the garbage from households, companies can submit bids–rather than having a city council choose the company run by someone’s favorite uncle. When the US government wants to give companies the right to drill in certain areas for offshore oil, or wishes to allocate radio spectrum for use by phone companies, it can auction off the rights rather than handing them out to whatever company has the best behind-the-scenes lobbyists. In many countries, auctions are used to privatize selling off a formerly government-owned company.

By the way, this post – or indeed the blog posts that I have referred to so far – aren’t really indicative of just how complex this field has become today! For example, take a look at this video to understand how modern auction design is the combination of cutting edge computer science, operations research and economic theory at the same time (h/t Alex Tabarrok on MR)

MR’s other blogger, Tyler Cowen’s posts on both winners are also worth reading: here is the post on Milgrom, and here is the post on Wilson. Like the post on A Fine Theorem, both posts contain much more information about both authors than just the body of work that won them the Nobel.

For example, the story of Milgrom courting his wife:

And before I forget, also read about the “no-trade” theorem and the bid-ask spread paper – not to mention the “Chain Store” paradox and the “Gang of Four” papers. Tyler Cowen’s post, and A Fine Theorem’s post have fine summaries of all of them.

In line with Tyler Cowen’s post about Milgrom, his post about Wilson contains much more information about Wilson’s work outside of auction theory. The entire post is worth bookmarking for the treasure trove of links contained therein, but in particular, the following are particularly interesting to me:

Dynamic Games with Incomplete Information, Wilson’s survey article on Electric Power Pricing, and a (mutual) interview between Alvin E. Roth and Wilson.

Speaking of Roth (himself a Nobel Prize winner, of course), here is his blogpost about the prize – as he says, 2024’s Nobel Prize is something we should keep an eye out for!

Joshua Gans, another student of Paul Milgrom, also has a blog post on the winners, with a rather neat explanation of why Milgrom’s Wikipedia page is so lengthy:

For that conference, the attendees all contributed to complete Paul’s wikipedia page. The idea was to make sure that everything was there specifically for today. I had a goal of making it the longest page of any living economist. We overshot and it is the longest page of any economist! His contributions were so voluminous, it wasn’t hard to get to that point.

There is so much to read as a consequence of having written this blogpost! Both for myself, and for anybody who might be interested, here is a (by no means comprehensive) list:

  1. Paul Milgrom’s Wikipedia page (Joshua Gans and team are nothing if not thorough!)
  2. Robert Wilson’s Wikipedia page.
  3. How Market Design Emerged from Game Theory: A Mutual Interview
  4. Economics, Organization and Management, by Milgrom and Roberts (a textbook)
  5. The Firm as an Incentive System, by Holmstrom and Milgrom
  6. Putting Auction Theory to Work, by Paul Milgrom
  7. The Nobel Prize popular science background
  8. …and the scientific background.
  9. What Really Matters in Auction Design (by Klemperer, note!)
  10. Trillion Dollar Economists, by Robert Litan (h/t Arnold Kling)
  11. And of course, everything else I have linked to already!

And finally, just to round off the whole thing, why not end with a tweet, since we started with one? Explaining stuff as simply as possible is one of my life goals, and I wish my game was half as good as this tweet:

Congratulations to both winners!

Previous Nobel Prize entries can be found here (2019: Banerjee, Duflo and Kremer) and here (2018: Romer and Nordhaus)