66 Finance & economics The EconomistOctober 17th 2020
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n 1991 alvin roth, who in 2012 would share the Nobel prize for
economics, was asked how the discipline might change over the
century to come. “In the long term”, he wrote, “the real test of our
success will be not merely how well we understand the general
principles which govern economic interactions, but how well we
can bring this knowledge to bear on practical questions of micro-
economic engineering.” Sweden’s Royal Academy of Science
seems to agree. On October 12th it gave this year’s Nobel prize to
Paul Milgrom and Robert Wilson, both of Stanford University, for
their work on auction theory and design. Their work epitomises
economics as engineering.
Auctions are an ancient mechanism for selling valuable com-
modities, from fine art to a fisherman’s catch. A few, simple forms
of auction have been dominant over time. In an English auction,
ascending bids are made until a winner remains; in the Dutch vari-
ety, a high opening price is set and is reduced until a bidder is
found. Yet as their use has expanded, auctions have become more
complex, and economists have taken a keener interest. In the
1960s William Vickrey, who shared the Nobel in 1996, developed
what became known as auction theory. He assessed bidders’ opti-
mal strategies and studied the revenue and efficiency properties of
different auction formats. But Vickrey concentrated on a relatively
narrow set of cases, in which each bidder’s valuation of the good
being sold is unrelated to those of the other bidders. In practice,
however, what one person believes an auctioned item to be worth
often depends on the valuations of other bidders or the seller. Each
may have private information about its value, clues to which are
revealed in the course of the auction.
Mr Wilson began analysing such cases in the 1960s. He first
tackled scenarios where the item for sale has a “common value”—a
value that is uncertain beforehand but, in the end, is the same for
everyone. An example might be a plot of land with oil beneath it,
where participants may have different estimations of its value,
perhaps because each has varying estimates of the quantity of oil.
In such cases, the winner often discovers that the information oth-
ers had about the common value led them to make lower bids. This
may mean that the winner overestimated the worth of the item
and paid too much, a phenomenon known as the winner’s curse.Mr Wilson’s work in this vein laid the groundwork for the anal-
ysis of yet more complex scenarios, which take both bidders’ un-
ique private valuations and estimates of an item’s common value
into consideration. The value of an oilfield, for instance, might de-
pend on both the quantity of oil in the ground and how cheaply
each bidder can extract it. Mr Milgrom (whose doctoral thesis was
supervised by Mr Wilson) derived a number of important lessons
from his analyses. Auction structures that elicit more private in-
formation from bidders—such as English auctions, where every
participant observes who bids what and who drops out—reduce
the winner’s curse problem compared with formats where very lit-
tle private information is divulged. In some cases, it may be in the
seller’s interest to provide bidders with more information about
the item under the hammer.
Much like Mr Roth, who helped design market mechanisms to
match sick patients with kidney donors, Messrs Milgrom and Wil-
son put the knowledge gained from their theoretical work to prac-
tical use. Before the early 1990s, America’s government used un-
wieldy methods to allocate portions of the radio spectrum to
interested telecoms companies. Bidders either explained why
they deserved a slice of spectrum more than others (and spent vast
sums of money on lobbying), or were allocated slices through lot-
teries. Neither led to an efficient allocation. In 1993 Congress al-
lowed the Federal Communications Commission to use auctions
instead. Yet it was not clear how these might work. Bidders had
wildly varying assessments of how slices of spectrum might be
used, and the value of one piece of spectrum often depended criti-
cally on what other parts an owner also controlled. The laureates
worked with another economist, Preston McAfee, now at Google,
to invent a new format, known as the “simultaneous multiple-
round auction” (smra). Participants may bid on all items in a num-
ber of rounds, after each of which some information about bids
and prices is revealed to the bidders. When first used in 1994, smra
raised $617m for an American government that had previously
earned almost nothing from its distributions of spectrum rights.
smra-style auctions are now used routinely in many countries
and in contexts other than spectrum sales—in selling electricity,
for instance. Questions of distribution have continued to motivate
the prizewinners’ research and led to the development of other
specialised auction formats. Messrs Milgrom and Wilson became
the embodiment of the economist as engineer, using theory to de-
vise a solution to a practical problem. It is an approach Sweden’s
Royal Academy of Science seems to admire. This year’s award is the
third since 2007 to honour “mechanism design”, or the use of eco-
nomic principles to design markets to solve real-world problems.The economist’s lot
The pursuit of economics as a form of engineering means that
Messrs Milgrom and Wilson are more enmeshed in the real world
than the typical academic. Both have consulted for regulators and
firms. Mr Milgrom advised Time Warner and Comcast on their par-
ticipation in radio-spectrum auctions in 2006; his efforts helped
save his clients more than $1bn. In 2009 he co-founded a firm, Auc-
tionomics, that provides consulting services to those looking to
operate and to bid in auctions (many of the sort designed by the
prizewinners).
It is a different sort of work from that which many aspiring
scholars imagine themselves to be pursuing. But the rewards the
laureates have reaped in academia and beyond certainly advertise
the power wielded by economic engineers. 7Free exchange Winning bids
The Nobel prize for economics rewards advances in auction theory