Economics and Economists
Copyright 2001 LMH News
Vol. 7, Michaelmas 2001, pp. 6.
Economics and economists seem to be constantly in the news these days, sometimes for good reasons and sometimes for bad reasons. Partly due to Gordon Brown's pervasive influence on British policy-making, economists now probably have a greater influence on public policy than at any time since the days of John Maynard Keyes. In some ways, the influence of Ed Balls at the Treasury is possibly even greater than that of Keynes in his heyday.
But is this resurgent influence a good thing or a bad thing? Well, as the new economics fellow at LMH, I'm hardly likely to argue for the latter! But I can give one really good example of why the contribution of economics to public life is very important: the third generation (3G) mobile phone spectrum auction last year. The auction was designed by a team of British-based economists, including Professor Paul Klemperer, a fellow at Nuffield College, Oxford (his website contains more information on auctions).
Although initial estimates of the amount that could be raised were modest (around two billion pounds), the auction actually raised over twenty-two billion pounds. That's about four hundred pounds for every man, woman and child in the country; or, as Ken Binmore of University College London (the co-designer of the auction) said, enough to pay for all the Research Councils, forever.
This success was never assured, however. Of the six mobile phone auctions in Europe last year, only the UK and German ones were a success. And the German authorities were actually quite lucky. The Swiss, Netherlands, Austrian and Italian auctions were all disastrous; in the case of Switzerland, the auction raised only one-thirtieth of the revenue per capita achieved in the UK.
The first principle to running an auction is that you need to have more bidders than items to be auctioned. There's not much point in putting that Monet you found in your attic up for auction if there's only going to be one bidder. This is mistake that the UK government made in 1991 when it auctioned the ITV regional franchises. Central TV won the Midlands franchise with a bid of £2000 because it knew there were no rival bidders.
Strangely, this was exactly the mistake that the Netherlands made last year. In the UK 3G auction, there were five licences and four existing incumbent firms, which gave plenty of scope for new firms to enter to industry. In the Netherlands, there were five licences and five incumbents. Since the incumbents knew a lot more about their prospects than any potential entrants, only one new firm, Versatel, actually thought about entering the bidding. Even at that stage, all might have been well, but for the fact that one of the incumbents sent Versatel a threatening letter and Versatel immediately dropped out of the auction. The Netherlands auction raised a mere third of the revenue per capita that the UK auction did.
Even when you have more bidders than licences, it is still possible for collusion among firms to frustrate the auction. Although the German auctioned ended successfully (raising 98% of the UK revenues per capita) there was some interesting behaviour among the players. For example, Vodafone-Mannesman ended a number of bids with the digit "6", which is widely believed to have signalled its preference to end the auction quickly with six remaining bidders. In several recent US mobile phone auctions, companies have ended their bids with digits corresponding to the dialling codes of the areas that they really wanted to win!
Traditionally, economics has been defined as the study of how society produces, distributes and consumes scarce resources. While this is still true, it is a little dull. In fact, economists like to think that they mostly study human behaviour, especially where economic agents (be they firms, consumers, governments or international speculators) interact on a repeated basis. While economics can't explain everything, it is always worth bearing in mind that 'people respond to incentives' and much of economics is the study of those incentives.
You can email me at Gavin.Cameron@economics.ox.ac.uk
Last updated: 2 June 2004.
