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Bradley in DC
10-16-2007, 06:32 AM
http://online.wsj.com/article/SB119249811353060179.html?mod=opinion

A Market Nobel
By PETER BOETTKE
October 16, 2007; Page A21

Yesterday Leonid Hurwicz, Eric Maskin and Roger Myerson won the Nobel Prize in Economic Science for their pioneering work in the field of "mechanism design." Strangely, some have used this occasion to disparage free-market economics. But the truth is the deserving recipients owe a direct debt to free-market thinkers who came before them.

Mechanism design is an area of economic research that focuses on how institutional structures can be manipulated by changing the rules of the game in order to produce socially optimal results. The best intentions for the public good will go astray if the institutional arrangements are not consistent with the self-interest of decision makers.

Mr. Myerson's work on how to design auctions to elicit information about the value of the good being auctioned -- and how to maximize the revenue extracted from the auction -- has informed numerous privatizations of publicly owned assets over the past quarter-century. Mr. Maskin also contributed to auction theory, and applied the idea of mechanism design to assess political institutions such as voting systems.

Mechanism design theory was established to try to address the main challenge posed by Ludwig von Mises and F.A. Hayek. It all starts with Mr. Hurwicz's response to Hayek's famous paper, "The Use of Knowledge in Society (http://www.econlib.org/Library/Essays/hykKnw1.html)." In the 1930s and '40s, Hayek was embroiled in the "socialist calculation debate." Mises, Hayek's mentor in Vienna, had raised the challenge in his book "Socialism," and before that in an article, that without having the means of production in private hands, the economic system will not create the incentives or the information to properly decide between the alternative uses of scarce resources. Without the production process of the market economy, socially desirable outcomes will be impossible to achieve.

In the mid-1930s, Hayek published Mises's essay in English in his book, "Collectivist Economic Planning." From there the discussion moved to the U.K. and the U.S. Hayek summarized the fundamental challenge that advocates of socialism needed to come to grips with. Hayek's argument, a refinement of Mises, basically stated that the economic problem society faced was not how to allocate given resources, but rather how to mobilize and utilize the knowledge dispersed throughout the economy.

Hayek argued that mathematical modeling, which relied on a set of given assumptions, had obscured the fundamental problem. These questions were not being probed since they were assumed away in the mathematical models of market socialism presented by Oskar Lange and, later, Abba Lerner. Milton Friedman, when he reviewed Lerner's "Economics of Control," stated that it was as if economic analysis of policy was being conducted in a vacuum. Lange actually argued that questions of bureaucratic incentives did not belong in economics and were best left to other disciplines such as psychology and sociology.

Leonid Hurwicz, in his classic papers "On the Concept and Possibility of Informational Decentralization" (1969), "On Informationally Decentralized Systems" (1972), and "The Design of Mechanisms for Resource Allocation" (1973), embraced Hayek's challenge. He developed mechanism-design theory to test the logic of the Mises-Hayek contention that socialism could not possibly mobilize the dispersed knowledge in society in a way that would permit rational economic calculation for the alternative uses of scarce resources. Mises and Hayek argued that replacing the invisible hand of the market with the guided one of government would not work. Mr. Hurwicz wanted to see if they were right, and under what conditions one could say they were wrong.

Those efforts are at the foundation of the field that was honored by the Nobel Prize committee. To function properly, any economic system must, as Hayek pointed out, structure incentives so that the dispersed and sometimes conflicting knowledge in society is mobilized to realize the gains from exchange and innovation.

Last year Mr. Myerson acknowledged his own debt to Mr. Hurwicz -- and thus Hayek -- in "Fundamental Theory of Institutions: A Lecture in Honor of Leo Hurwicz." The incentive-compatibility issue has highlighted the problems of moral hazard and adverse selection (perverse behavior due to incentives caused by rules that are supposed protect us and selection problems due to imperfect information). Mr. Hurwicz helped repair a mid-20th century neglect of institutions in economic analysis.

While we celebrate the brilliance of Messrs. Hurwicz, Maskin and Myerson, we should also remember that Hayek's challenge provided their inspiration. Hayek concluded that the private-property rights that come with the rule of law, freedom of contract, and freedom of association is still the one mechanism design that mobilizes and utilizes the dispersed information in an economy. Furthermore, it does so in a way that tends to capture the gains from trade and innovation so that wealth is continually created and humanity is made better off.

Mr. Boettke is a professor of economics at George Mason University and the Mercatus Center.

noxagol
10-16-2007, 06:41 AM
Hurrah for free-market capitalism.