Ethos Issue 6, Jul 2009
Auctions, Market Experiments
and Public Policy
A discussion with Professors Vernon L. Smith,
Stephen Rassenti and Bart Wilson
John Ledyard, Dave Porter, and
Mark Olson from Caltech went to the
laboratory to create a trading system
for these permits. This was a complex
market because there were two kinds
of pollutants. Some people only traded
in one, some in the other and others in
both. There is also a distinction between
coastal and inland permits because
of prevailing winds onshore. If you’re
located on the coast, you also need to have permits inland but if you’re inland,
you don’t need coastal permits. So there
are constraints. You need to buy enough
permits to support your emissions until
you get your act together to install
cleaner equipment. So basically people
buy and sell these permits in blocks.
How do you get them to fit together?
That’s where the combinatorial auctions
came in.
In that market, they did a range of
laboratory experiments before they
actually implemented policies and they
had the cooperation of the industry
players and the government.
Rassenti: Having a real necessity is an
important point. Reforms in the power
industry in the United States are slow
to come by because people are still well
off doing things the inefficient way. In
Australia, where Vernon and I went to do
consultancies in the 1990s, Australians
were complaining that they were paying
twice as much for energy as people
in the United States. They wanted to
renovate their energy industry and the
way it was organised to become more
competitive. Many in the industry took
part in the experiments simulating the
new structure before they did something
in Australia.
Smith: At that time, each Australian
state owned its own generator which
generated electricity for its own needs.
The National Grid Management Council
wanted to create a national electricity
market. It was fine if the states wanted to
retain ownership of the generators but
they had to compete to supply electricity
in the national market. So a lot of those
assets are still publicly owned but they
are disciplined by the market.
The experiments involved a lot of
participants from both sides of the
market—buyers, sellers and the national
grid. People were asking questions
and debating. Back then, it was really
a pretty radical idea to trade energy
on a network, on high voltage grid in
real time. People buying and selling,
and disciplined by the constraints on
the grid.
The experiments provided a marvellous
practical means for overcoming some
of the market resistance to this radical
new system. It was like having a wind
tunnel before implementing policies.
This discussion was excerpted from an
interview conducted by Donald Low, Head of the Centre for Public Economics and
Associate Fellow at the Centre for Governance
and Leadership, Civil Service College, when
Professor Smith and his associates were in
Singapore in March 2008, during which they
delivered a lecture and conducted a two-day
workshop on experimental economics.
Vernon L. Smith is a Professor of Economics
and Law and a research scholar in the
Economic Science Institute at Chapman
University, California. He has authored and
co-authored over 300 articles and books
on capital theory, finance, natural resource
economics and experimental economics.
Cambridge University Press published
his Papers in Experimental Economics in
1991, and a second collection, Bargaining
and Market Behaviour in 2000. In 2008,
they published Rationality in Economics:
Constructivist and Ecological Forms.
Professor Smith received the Nobel Prize
in Economics in 2002 for his work in
experimental economics and continues
work in the study of market performance,
the design of market-based management
systems, and in researching the property right
foundations of specialisation and exchange.
Stephen Rassenti is a Professor of
Economics and Mathematics and Director of
the Economic Science Institute at Chapman
University. His research interests are in
economic systems design, experimental
economics and organisational design
and he has consulted frequently with
corporations and governments on the design
of auction systems for efficient distribution
of public resources such as electric power
and communications spectra. Professor
Rassenti is currently working on a project
that examines a competitive alternative to
government controlled drug testing.
Bart Wilson is a Professor of Economics and
Law at Chapman University and the Donald
P. Kennedy Endowed Chair in Economics
and Law. Prior to this, he was an Associate
Professor at George Mason University in the
Department of Economics, with affiliation in
the School of Law. Professor Wilson’s broad
fields of specialty are industrial organisation,
experimental economics, and econometrics.
He is currently pursuing research on the
foundations of exchange and specialisation
and the origins of property rights systems
that support exchange. His other research
programmes apply the experimental method
to topics in e-commerce, electric power
deregulation and antitrust.
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