Ethos Issue 6, Jul 2009
Auctions, Market Experiments
and Public Policy
A discussion with Professors Vernon L. Smith,
Stephen Rassenti and Bart Wilson
Singapore’s Certificate of Entitlement
system (for car ownership) and
government land sales also go through
auctions. Are there other public policy
areas where auctions can be used to
maximise consumer benefit?
Stephen Rassenti: Bus routes or bus
lines can be auctioned to bus companies
that are willing to serve the routes.
In today’s world, you have a perfectly expressive language in auctions where
bidders can come and tell you what
they’re willing to pay. You don’t have to
worry that some routes won’t get served
and try to pre-package them. This need
not happen.
In the same way that companies
pay to serve a route, they can be paid
to serve one. Instead of setting the
price at a positive number, you can set
it at a negative number and subsidise
companies to serve a route. In these
auctions, you can let companies express
their willingness to buy a whole package
of routes that they would be interested
in serving and pay you a particular price,
because they would clearly be interested
in servicing adjacent territories.
Smith: You can run the auction without
much information, because the relevant
knowledge resides with the companies.
For the design of the auction, you
have to make sure that the rights, the
alternatives and the modes of choice
enable companies to express their
diverse preferences.
Rassenti: The same is true with respect
to spectrum licenses, which have been
auctioned all over the world in prepackaged
format. In such auctions, the
spectrum bandwidths and regions are
always stated, but it is possible to conduct
these auctions without pre-stating these.
You can let the buyers express how much
bandwidth and which regions they need.
Many of the buyers don’t need what is
pre-packaged. Sometimes they need a
little bit less; and those that need a little
bit more may have to end up buying two
licenses, and be stuck with something
that is not worth much to him. Why
should regulators make those decisions?
Why not just let buyers bid for what
they need? The environment becomes
very complicated, but sometimes a more
complicated message space will create
more efficient allocation, making it
easier for the participants to express
their preferences clearly. Otherwise,
the regulator may have to be quite
strategic or manipulative during the
auction process.
Another area of opportunity for
auctions is airport landing rights. In
the US, airports are required by law
to charge landing fees that reflect
the costs of building and running
the airports. But the Department of
Transportation has figured that, under
existing law, they can allow the airports
more flexibility when pricing, as long
as they don’t charge more than the
overall costs. There are different kinds
of auctions that can be used for landing
and takeoff rights. It can be a real-time
auction where the pilots do the bidding
while the airplanes are circling. They
can be assisted in their decisions by the information management systems that
they have access to.
Right now, landing rights are still
being pre-allocated. There is a prohibition
on trading of airport landing rights for
cash in the US. The only thing you can
do is to exchange something in return
for something else. Also, rights are not
the only bottleneck. US airports fund
airport improvements by selling the gate
rights to those airlines that provided the
funding for the airport improvements.
And so now, for example, even if an
airplane can land at an airport, it may
not be able to find a gate to dock at,
while there are empty gates that only
airline partners have access to. So there
are opportunities to use auctions to
enhance the efficiency of the system.
How have governments responded to
the use of experimental economics
in understanding policy problems?
Has it influenced their policy
design, for example, in the way they
structure their markets with their
privatisation exercises?
Smith: You get the most receptive
environment when people are facing a
genuine problem with their current way
of doing things and they are looking for
a different way. One good example is
the evolution of the market for sulphur
and nitrogen dioxide in the Los Angeles
Basin. A colleague, David Porter, who is
with Chapman University, was involved
with its design. They devised a system
and allocated rights to pollute. The idea
was to tighten the standards and let
people trade the permits. But they didn’t
have any trading mechanism.
Intermediaries formed and they
knew more about both sides of the
market than the buyers and sellers.
This led to a situation where the market
was competitive and disorganised. The
intermediaries made huge arbitrage
profits buying and reselling the permits.
The companies were outraged and they
thought that there ought to be a better
way to do it.
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