Market Design: The Policy Uses of Theory

Abstract

Herbert Stein, advisor to presidents, noted that “most of the economics that is usable for advising on public policy is about at the level of the introductory undergraduate course. ” My subject is the remainder of usable economics: the part that is not elementary. Frontier theory has been put to good use in some recent policy-making. Asymmetric information and strategic behavior, the core of modern micro-theory, are highlighted by the financial scandals of 2001-02. The misdeeds of WorldCom and Enron would have been averted if shareholders could see what managers were up to. Even before the scandals broke, Congressman Paul Kanjorski called for disclosure rules “to end the problems of asymmetric information. ” The jargon has spread. A novel set in Wall Street is aptly entitled Moral Hazard. High executive pay, said the Bismarck Tribune, signifies principal-agent problems. The bidders for Britain’s mobile telecoms licenses, said the Times, fell to the winner’s curse. Promises that deregulation would cut electricity prices, said the Australian, were cheap talk. Game theory crops up often— though a headline in the Jerusalem Post hints it may not last intact: “Zero-Sum Game Has Only Losers.”1 New lingo is not all that theory offers policy. The economist as engineer (Alvin Roth, 2002) is exemplified by the design of government auctions and of mechanisms for assigning ownership (Sections I and II). The limits of theory are illustrated by China’