Reforming governments should take note of the theory of "mechanism design"—work on which recently won three economists the Nobelby Ken Binmore / November 25, 2007 / Leave a comment
Published in November 2007 issue of Prospect Magazine
In mid-October, the Nobel prize for economics was awarded to Leo Hurwicz, Eric Maskin and Roger Myerson for their work on mechanism design. Newspaper economics correspondents made what they could of this news, but obviously had only the vaguest idea of what mechanism design is.
Mechanism design is too important to get this kind of treatment. The philosophy behind the theory represents a genuine “third way” that ought to inform the reforming efforts of any government of whatever stripe.
The basic idea of mechanism design is simple. It is obvious that in any organisation, decisions should be made by whoever happens to have the necessary expertise. The people at the head of the tree will almost never have the command of detail or the local knowledge needed to make good decisions at the coalface. So an efficient organisation will decentralise authority to the most appropriate level.
The problem is that the guys lower down the pecking order are unlikely to have the same motives as the guys at the top. As David Hume put it: “In constraining any system of government… every man ought to be supposed a knave and to have no other end, in all his actions, than private interest.” He didn’t mean by this that everybody is corrupt; only that people will find excuses to look after themselves rather than the interests of their organisation, unless someone keeps an eye on them.
There are two traditional ways of dealing with this problem. The first is to rely on market incentives to generate efficient outcomes. Margaret Thatcher was dimly aiming at this solution when she introduced so-called internal markets into the NHS in 1990. But the idea that free markets are necessarily efficient is a myth. Perfectly competitive markets are efficient, and we should exploit this fact when appropriate. But very few markets are perfectly competitive. Among other requirements, a perfectly competitive market needs a very large number of buyers and sellers and…