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Photo: Andrew Brodhead/ AP
Photo: Andrew Brodhead/ AP

Auctions can maximize more than just money

This year’s economics Nobel Prize has been awarded to the duo who reshaped how scarce stuff is best sold. Their auction models could even be used to serve larger public purposes

It was 2:15am at Stanford University in California, US. An elderly figure was caught on security cameras walking over to a neighbour’s house, closely followed by a woman. The man rang the door bell and knocked on the door several times, before saying: “You’ve won the Nobel Prize. And so they’re trying to reach you, but they cannot. They don’t seem to have a number for you." The response seemed to suggest disbelief. “Yeah, I have? Wow!" In the old days, before video clips attained virality, such original footage could have been auctioned. But the concept of scarcity has changed, so have auctions, and few can explain why and how better than the two men involved in the exchange. The man seen knocking was Robert Wilson, 83, an economics professor at Stanford, while the surprised voice was that of Paul Milgrom, 72, also an academic at the same university. On Monday, they were jointly awarded this year’s Nobel Prize in economics for sharpening auction theory and coming up with new formats for auctions. The Royal Swedish Academy of Sciences observed that their work had been of benefit to sellers, buyers and taxpayers around the world. The two have worked closely in their careers, and Wilson was Milgrom’s doctoral thesis advisor.

The award signifies top-level recognition of the duo’s pioneering research, which has multiple real-world applications, especially for the tricky business of resource allocation that has grown frightfully complex over the years. In a typical auction, the seller’s prime motivation is to maximize gains, and bidders are vulnerable to the so-called “winner’s curse", by which bidding rivalry tends to push what’s under the hammer beyond its actual worth. But buyers, aware of this problem, also modify their bids accordingly. Wilson’s work put this aversion to over-paying under a lens and developed a theory on auctions of stuff for which a “common value" could be estimated, something that is uncertain at the outset but eventually deemed to be the same for everyone. A rational bidder, he argued, would seek to underbid his or her estimate of common value. Milgrom posited that “private values" differed from one bidder to another, and that an auction format in which buyers knew more about one another’s estimates would yield more for the seller. One of their auction designs was famously used in the US to allot telecom spectrum back in 1994, raising a neat $617 million, instead of the trifles obtained on previous occasions. This model has since been adopted globally. Broadly, their ideas have reshaped how the world allocates stuff ranging from online advertising to airport landing slots, not to speak of scarce resources—the principal point of economics as a discipline. Yet, their most striking work was on auctions that do not necessarily aim to raise as much money as possible, but maximize other variables such as overall market efficiency and public welfare that depend on what’s on the block. Their formats for hawking inter-related things simultaneously—say, an entire set-up for vaccine delivery—have been a big help.

As a country where the allotment of resources like mineral blocks and airwaves often gets mired in controversy, India may have much to learn from modern auction designs. Spectrum, for example, is ideally allotted not in a way that best enriches the government, but makes the most of telecom services as an economic catalyst. Likewise, our central bank could consider tweaking how it goes about auctioning government bonds, its last few outings having fared poorly. After all, what organs of the state put up for bidding is almost always meant to serve a larger public purpose.

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