Cafe Hayek: Boettke on the New Laureates

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October 16, 2007

Boettke on the New Laureates

Don Boudreaux

While I remain disappointed that the Nobel Prize in Economic Science has yet to be awarded to Gordon Tullock, Armen Alchian, Harold Demsetz, and Jagdish Bhagwati, after reading this essay (from today's Wall Street Journal) by my GMU colleague Pete Boettke I'm more impressed with yesterday's award than I was when I first heard it.

Here are the opening paragraphs:

Yesterday Leonid Hurwicz, Eric Maskin and Roger Myerson won the Nobel Prize in Economic Science for their pioneering work in the field of "mechanism design." Strangely, some have used this occasion to disparage free-market economics. But the truth is the deserving recipients owe a direct debt to free-market thinkers who came before them.

Mechanism design is an area of economic research that focuses on how institutional structures can be manipulated by changing the rules of the game in order to produce socially optimal results. The best intentions for the public good will go astray if the institutional arrangements are not consistent with the self-interest of decision makers.

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Comments

But did Hurwicz say if he thought Hayek and Mises were right?

Posted by: Sheldon Richman | Oct 16, 2007 7:26:59 AM

While it was before my time, and I don't know the specifics of the situation, it still seems a bit odd that Tullock didn't get to share the 1986 prize with Buchanan.

Posted by: Tom | Oct 16, 2007 8:12:32 AM

Sheldon,

Good question and you know the answer ... Hurwicz said Hayek got half right, Lange got the other half right. But that is besides the point, I believe. He framed the debate such that we don't have to talk past one another because the focus is on incentives and information. Now we can quibble about the meaning of incentives and information in these models, and I think we can, but mechanism design theory did move the discussion.

In fact, if you look at my original post, I say that Younger Austrians (and economists in general) should explore the ways in which the Hurwicz et al response to Hayek's challenge ultimately fail to come to grips with the full implications of Hayek's challenge (i.e., the epistemic turn in econmic analysis).

See http://austrianeconomists.typepad.com/weblog/2007/10/hayek-and-hurwi.html

Pete

Posted by: Peter Boettke | Oct 16, 2007 9:15:35 AM

Don, Peter, Russ,
someone,
How exactly will, or does, this mechanism design theory help the individual at the bottom level.

Is it something I can read, think about, and use to improve my immediate life?

Posted by: vidyohs | Oct 16, 2007 9:42:05 AM

Strangely, some have used this occasion to disparage free-market economics.

Strangely? Surely not.

Leftist support their blood-soaked totalitarian regimes, turning a blind eye to the destruction left in the wake of such regimes regardless of the evidence. In fact, destruction and murder is seen by them as necessary and perfectly excusable to achieve their goal utopian society. Since the cannot convince others that socialism is better on the strength of the evidence, they must regularly simply disparage any system that allows liberty. Anyone who doesn't "get it", the "reason", is just a moron. In fact, they regard humanity as a whole to be retarded Cretans in bad need of guidance from those whom they consider more worthy - themselves.

Note how they disparage the prosperity resulting from free market policies in places like the United States and Ireland. By redefining poverty, they claim that poverty has increased in both places. In reality, true poverty exists in neither place anymore and relative poverty can't be eradicated by definition. Absolute poverty exists predominantly in places where there is no free market system - usually in countries which have installed the very same totalitarian socialist system these people favour.

Socialists disparaging the free market system is neither surprising nor strange. Lying, cheating, stealing and disparaging the primary characteristics of socialists.

Posted by: Methinks | Oct 16, 2007 3:35:50 PM

I am always leary of anyone who talks about "optimal results". Optimal by whose standards? What a free market is supposed to achieve is everyone pursuing their own individual goals and having a good chance of achieving them. "socially optimal results" sounds too much like someone trying to determine what everyone else's goals should be, in fact setting the same goals and values for everyone and choosing the means to reach them.

Posted by: SaulOhio | Oct 16, 2007 7:49:50 PM

Don, Peter, Russ,
anyone,
Can I assume from the silence that I am not going to get an answer to my question?

What does this Mechanism Design Theory mean to me down here on the street. Is it something I should take the time to read and understand, will it help me in my day to day efforts to make more money than I need for the day's expenses? Of what use is it to me?

I am like SaulOhio in that when I hear talk of "institutions" coupled in any way with the word "economics" I begin to get an itch between my shoulderblades.

In my world capitalism is something that happens because of me.

In my world economics is something that happens because of me.

People can theorize about capitalism and economics all day long and dream up long involved explanations for what I already know begins and ends with me each morning.
Okay, I'll admit that it begins and ends with not just me, but myself and people just like me.

I think that if you screw with me as an individual at any point then you screw with capitalism and economics, in a way that is not good.

I am not looking for an argument or picking a fight, I'd really like to know what it should, or could, mean to me when I get up and get dressed to go out and create wealth in the morning.

You see, I am ignorant of the study of economics. I just know that if I get up in the morning and go create wealth serving people in some way, I will wind up in evening with enough profit to provide for my needs and probably with a surplus for tomorrow.

I also know that the one single entity that is most likely to try and screw with me and derail that, is government.

Does one need Mechanism Design Theory to operate in my world, will it help me to operate better?

Posted by: vidyohs | Oct 16, 2007 8:59:05 PM

Vid,

Vide this.

In the Globe and Mail interview published this morning, the author was happy that she found someone who actually applies this stuff in the real world on a regular basis. I apply mechanism design theory every day in my work with clients, i.e., in your world, although its necessarily invisible to you.

Posted by: M. Hodak | Oct 16, 2007 11:11:16 PM

Vidyohs:

To expand on what M. Hodak said, mechanism design is only relevant if you are able to influence the structure of institutions. The most the average person will benefit from this will be in setting up agreements with roommates or family (e.g. so the kids actually do their chores, etc.)

Posted by: vidyohs | Oct 17, 2007 4:34:19 AM

Someone is posting for me now? I was not awake and at my computer at 4:34:19Am.

Vidyohs:

Posted by: vidyohs | Oct 17, 2007 4:34:19 AM

Posted by: vidyohs | Oct 17, 2007 6:45:48 AM

M.Hodak,
I appreciate the time you took to try and clear up this mechanism design theory for me.

I looked at the link to your own blog and your explanation there made me understand that I really need to get ahold of something that explains the MDT in layman's terms, if such an explanation exists.

In other words by reading your generous response, and that of whoever posted as 'vidyohs' at 4:34:19AM, I find myself with many more questions, Not the least of which, premature as it may be, is why.

Why a MDT? Marc, do you know of a work that explains this MDT in layman's terms or at least gives an overview that I don't need 4 years of economic study to understand? If so could you provide me with the title and author? Or, is this so new that such a work does not yet exist?

In my present field I deal with men and women who subject themselves to the fact of legal arbitration, either voluntarily or at the order of a judge, on a regular basis. I also frequently work with those who are arbitrators, and I will make a point of asking them if they have heard of MDT and if they use it at all.

Posted by: vidyohs | Oct 17, 2007 10:06:46 AM

vidyohs,

Thanks for asking the same questions I had. From what little I've read (including M. Hodak's fine blog entry), it seems to me, an engineer/law student, and decidedly not an economist, that probably the earliest example of MDT in practice that many would be familiar with is King Solomon's offer to cut the baby in half. I think the time-honored parental tactic of allowing one child to cut the pie/cake/whatever and the other to have first choice of the two pieces is also a simple, familiar example of MDT.

As for why, if I'm right in my nascent understanding of it, the purpose seems to be getting the incentives right (right meaning leading the actors to behave as the rulemaker desires). In that sense, I think it rests on the same solid foundation as ordinary trade (the main difference being that in a voluntary exchange, each actor also acts as rulemaker, by altering what he's willing to give up to get the other to give him what he desires, as opposed to a third-party rulemaker).

M. Hodak wants his managers to agree on a price with a minimum of transaction costs.

Solomon wants the true mother of the baby to distinguish herself from the pretender.

The mother wants her children to have roughly equal pieces of pie, but perhaps more importantly, wants them to enjoy it without endless whining about fairness and who got the bigger piece.

Each one devises rules that give the actors incentives to work toward the rulemaker's goal while pursuing his or her own interests. If I'm off base, I hope someone more familiar with MDT will show me where, but if I'm not, it makes sense to me and may not be the bugaboo it seems at first glance.

Posted by: Billy | Oct 18, 2007 1:06:55 AM

Billy,

I see you were on the same wave length. I didn't go any deeper into my questions because I didn't want to appear to be argumentive.

My question of why was because I know, and your citeing the example of Solomon was perfect, that knowledge of motivation and incentive is not a new subject. So, there has to be more to it than meets our eyes at this point. Or, maybe not.

I worked in a very large institution for 21 years, and that institution was only a part of an even larger institution. I can tell you from experience that getting all those institutions to work together in harmony is a task to set at God's feet because mere mortals aren't going to make it happen.

For instance institutions are really just a collection of people supposedly working together for a common goal (even this aspect is not always true), and in government the institutions are all supposedly working to further a common goal (this is even less true in fact).

Institution A sees institution B as a competitor in many fields, the people of institution A are indoctrinated with the attitude that institution B is to be stymied in any subtle way possible so that institution A always appears to be the golden cog in the wheel. (Happens routinely)

When someone talks of motivating institutions I get that itchy feeling between my shoulders because I know that what they are ultimately talking about is maybe thousands of people, all individuals, and all with unique need for motivation and incentives. I don't see how one MDT is going to convert into a "one size fits all" workable plan.

If this MDT can explain the whys of that and then be practically applied to eliminate the conflicts between institutions then truly we have become God like.

Which is why I'd like to get my hands on at least an overview of the MDT to see at least what they got the Nobel prize for.

On the personal level, your example of Mom laying out the rules for dividing the pie was exact. We, the people, know how to motivate and provide incentives without a design theory and have pre-recorded history. I thought of it differently, I am 66 and come from the age when it was still okay to wear your MDT in your belt loops and to use it to motivate kids to do their chores and act like decent human beings. My dad did and he didn't have to resort to applying that MDT very often because it was very effective.

Yes, we have developed a nation full of people who forget that fear is one of the best motivators/incentives in the world. (this is a huge topic and worth expounding on but I won't unless motivated to do so)

Now to M. Hodak's managers. My immediate thought was "managers" is the key to his analogy. The word manager means custodian/user and not owner. Since his manager A was being compelled to transfer property to manager B without open bidding or outside buying, that implies they both perform for the same owner.

This makes the transfer a "paper transfer" as far as the dollar figure to be attached is concerned. In other words it is arbitrary. The owner surely knows the true value, and if not he would be pretty stupid to have to be told by an outside consultant to go get an appraiser when this is something anyone would know. To me the arbitrary dollar figure to be placed on the "sale" might be a figure best designed to extract all of the allowable tax writoff benefits, otherwise......?

I just don't want to come across as picking on M.Hodak or even the hosts of this blog. They are so very far ahead of me in the field of economics. But, I do have experience in business and have common sense, so sometimes I have to wonder "why". and I am too lazy and strapped for time to invest in 4 years of college to get that answser.

Posted by: vidyohs | Oct 18, 2007 7:25:45 AM

It looks to me like you've nailed MDT's raison d'etre right here. You can't really do much to change the selfish motivations of institutions or those inside them. You can, however, recognize those motivations and craft rules that take advantage of them to make the people and institutions work for the common good (however you as the rulemaker have defined that). I think that's MDT in a nutshell, though again, I'm just a non-economist fascinated by the topics that come up here.

Posted by: Billy | Oct 18, 2007 3:08:59 PM

I guess I'll have to remain the cynic about crafting rules that will ever alter the institutional culture that I saw in government.

I don't think I am too far off base by being cynical about the same for corporate institutional culture as well.

Posted by: vidyohs | Oct 18, 2007 5:42:28 PM

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