The work of Economics Nobel winners has been tested in public policy with success

This year’s Sveriges Riksbank Prize in Economic Sciences, also known as the Economics Nobel, conforms to the Swedish Academy’s tradition of recognising work in the areas of game theory and behavioural economics — a field largely devoted to welfare-maximising price discovery in imperfect markets where ‘rational’ economic agents are influenced by each other’s actions in a host of intriguing ways. Hence, an auction design of a public good such as spectrum would aim at arriving at a price that maximises both consumer utility over time and government revenues. Stanford University economists Paul Milgrom and Robert Wilson have been awarded this year’s Nobel in economics for designing auction formats for goods and services for which there are no traditional markets — such as radio frequencies and carbon credits. The duo notably ‘designed’ an auction for spectrum allocation in the US in 1994, which was regarded as successful and was tried out in Europe.

Wilson developed a theory for auction of objects of “common value”, a value that is “uncertain to begin with but is eventually the same for everyone”, to quote the Nobel committee’s press release, such as radio frequency. He shows why rational bidders place their bids below their best estimate of common value — they are afraid of the winners’ curse, of paying too much and losing out. Milgrom generalises the auction theory to look at “private values” which can vary from bidder to bidder (such as an art auction). He concludes that sellers realise a higher revenue “when bidders learn more about each other’s estimated values during bidding”. With auctions being used to sell “complex objects” such as landing slots, shares and radio frequency, sophistication in auction design has become an imperative.

In the Indian context, the Supreme Court said in 2012 that natural resources should be allocated through auction rather than on ‘first come first served’ basis. While it can broadly be said that the latter is open to sheer theft of public goods, the auction system in India or elsewhere has some way to go in terms of being transparent and achieving optimal outcomes. Spectrum auctions in India have helped plug government deficits, but their impact on consumer welfare and competitiveness is uncertain. In the US, the Federal Communications Commission, in 2017, conducted a two-sided auction, with Milgrom as one of the designers, to transfer spectrum from TV broadcasters to mobile companies, attracting a controversy over how speculators in spectrum among the broadcasters supposedly benefited in the process. The auction design needs to be transparent, while the ‘designers’ need to be accountable to the public at large. There is also the question of whether an auction design in one country, with a particular set of institutions, can be mechanically transplanted on to another. The tussle between ‘markets’ and ‘institutions’ shall remain an eternal one in economic theory.