When planning succeeds

Posted: 16 October 2012 in Uncategorized
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Yesterday, I made the argument that the 2012 Nobel Prize in Economics can be interpreted as an award for the design of nonmarkets, that is, for mechanisms that can be used when markets fail.

Arindrajit Dube would appear to agree:

The use of the word “market” in describing exchanges of every sort has become ubiquitous, even in cases where there is no actual price that helps clear the market or channel information. Perhaps due to this slippage, an interesting fact about the work receiving the award has been largely ignored. The concrete applications that are discussed as ways of “improving the performance of many markets”–such as matching residents to hospitals, matching donors to organs, and students to schools–are not really “markets.” At least not if we think of markets as institutions where prices help clear supply and demand. Instead, they involve non-market interactions, where the matches are actually formed by centralized exchanges. In these situations, decentralized and uncoordinated matching can produce unstable and inefficient matches, and gains are possible from centralization of some sort. Sometimes the price may not exist because of legal restrictions, but in other cases the participants may voluntarily forego using prices, as it might conflict with other objectives. This is exactly where the Gale-Shapley algorithm can be useful in implementing a “stable” allocation: an allocation where no pair-wise trades exist which can make both parties better off, which is one notion of optimality. In other words, this and similar algorithms can help implement … gasp! … economic planning. . .

A final note. A popular view today is that it is not possible to implement an efficient allocation using planning because people don’t have the incentives to reveal their true preferences to begin with, which makes this whole exercise rather pointless. A variant of this position was originally articulated by Austrian economists, including Ludwig von Mises, during the so called “socialist calculation” debate of the early 20th century. And in many cases this criticism rings true. However, it does not follow that the truthful revelation problem is ubiquitous. For example, it is interesting to note that Alvin Roth and Elliott Peranson show (both theoretically and empirically) that when implementing optimal matching, this problem may be smaller than one might imagine: when each applicant only interviews a small number of positions overall, the gains from strategic manipulation of preferences are small. This, too, has important implications for the “socialist calculation” debate, as it suggests that for a range of cases, a centralized exchange implementing planning without using prices can (and indeed does) implement relatively efficient allocations. And it can do so without having distributional effects such as rationing kidneys out of the reach of the 99 percent by using prices to allocate organs.

So when asked by our students and friends “what was the ‘Nobel’ all about?” we could do a lot worse than by answering “economic planning.”

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