Modern Times

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It may be, as has been said, that the twin twentieth-century golden ages of economic theory are over; that an epoch of design, applied work and big data is at hand; that network theory has yet to deliver a truly social economics. Before excitement about the new day takes over, though, there is some unfinished business to attend to. To an economic journalist growing up in the 1980s, three developments in particular stood out.  New Trade theory, New Growth theory and something called the Gang of Four, which was shorthand for a series of transformative advances in game theory taking place mainly in California. So far only the New Trade literature has been recognized with a Nobel Prize, to Paul Krugman, in 2008.

Last week, three of the four gang members – David Kreps, Paul Milgrom and Robert Wilson, all of Stanford University – shared the National Academy of Sciences’ Carty Award, given every two years since 1932 to recognize some noteworthy accomplishment among the various fields within the academy, often having to do with the relationship of theory to practice. Early winners included presidential science czar Vannevar Bush, molecular biologist James D. Watson, and mathematical statistician David Freedman. This was the first time the prize was given in the field of economics.

All three recipients are members of the Science Academy. Any of them, perhaps each, in some combination or another, eventually may find his way to Stockholm. But that’s not the most interesting thing. Omitted from the award, though not from the brief account accompanying it, was the fourth member of the group, John Roberts, also of Stanford. And thereupon hangs a story – by a thread. (Roberts, Kreps, and Wilson teach in Stanford’s Graduate School of Business; only Milgrom works in the Economics Department.)

The “Gang of Four” appellation stems from the decision by the authors to publish a note together in the Journal of Economic Theory in the summer of 1982 explaining the basic idea that underlay a flurry of work they were publishing separately, in various combinations. “Rational Cooperation in Finitely Repeated Prisoners’ Dilemma” explained in general terms how cooperation could emerge in the classic situation where screw-your-buddy “defecting” or “finking” behavior had been thought to be the inevitable rule. It wasn’t, though, if whatever differential information was taken into account, possessed by one or both players concerning the other’ options, motivation or behavior.

The same journal issue contained two articles showing how the idea could be applied to well-known problems of industrial organization: “Reputation and Imperfect Information,” by Wilson and Kreps; and “Predation, Reputation, and Entry Deterrence,” by Milgrom and Roberts. Members of the group published four other important papers that memorable year: “Sequential Equilibria” (Kreps and Wilson); “A Theory of Auctions and Competitive Bidding” (Milgrom and Weber); “Limit Pricing and Entry under Incomplete Information: An Equilibrium Analysis” (Milgrom and Roberts); and “Information, Trade, and Common Knowledge” (Milgrom and Nancy Stokey). Years later, Eric Rasmussen, of the University of Indiana, wrote in his Readings in Games and Information, “A new tool makes for a rush of new applications, and such moments are not common.”

All had stemmed from an electrifying series of meetings at Stanford’s Institute for Mathematical Studies of the Social Sciences the one or two summers before. When former students gathered in 2010 to celebrate his career, Roberts told a conference reporter, “It was one of the most exciting times in economics that I ever observed or could ever have imagined. Traditional wisdom was being turned on its head every day.” Those Stanford summers have long seemed to me to be the really interesting story.  Defenders of traditional general equilibrium theory –  Frank Hahn and Franklin Fisher in particular – resisted the new developments for a time, giving up only after epic arguments took place. “Thank God for John,” Milgrom recalled in 2010. “He said, ‘No, we’re on to something. Let’s stick with it.’ And we did.” Strategic considerations and cognitive science finally entered economics in those years, with many practical consequences. (Kreps’s lucid 1997 account of the transition can be read online for free.) Ten years ago I set out to tell that story. I gave up, partly because I was too impatient a writer to convey the subtle reasoning involved, mainly because the financial crisis decisively changed the landscape of the times. The story of the Gang of Four will have to wait for young historians of economics.

The panel of members that made the National Academy award, presumably all of them economists, may have been eager to conform to a rule made long ago by the statutes of the Nobel Foundation – no more than three persons can share an award.  Perhaps the logic of the prize itself dictated the result. John J. Carty was American Telephone and Telegraph’s chief engineer.  Whatever their reasoning, the choice of three led to the making of something of a hash in the citation.

Kreps and Wilson provided a framework, known as sequential equilibrium, for modeling dynamic effects in economics. All three of the award winners, together with other collaborators and in particular D. John Roberts, employed these techniques to model and study reputation and collusion, both of which have broad applications in macroeconomics, industrial organization, and labor economics.

Later, the entire modern telecommunications industry arose out of an auction format developed by Milgrom and Wilson, along with Preston McAfee, for the 1994 radio spectrum auctions by the Federal Communications Commission. The simultaneous ascending auction format, in which each bidder can bid for multiple licenses over a series of rounds so long as it remains “sufficiently active,” has since been used around the world to allocate hundreds of billions of dollars’ worth of wireless licenses. Variations of the format have also been applied to numerous other industries, including electricity markets and various commodity markets.

In fact, Milgrom and Wilson have worked together, mainly to advance auctions in theory and practice; Kreps and Wilson between them have done foundational work in pure theory, of choice and financial markets, by Kreps; of nonlinear pricing and the foundations of dynamic equilibria, by Wilson.

Roberts, meanwhile, pursued a third dimension, writing an influential textbook with Milgrom, Economics, Organization and Management (1992); training future economists (his students include Susan Athey, Andrew Postlewaite, Kyle Bagwell, and Nicholas Bloom); teaching MBAs; and advising corporations, large and small.  With Robert Gibbons, he edited The Handbook of Organizational Economics (Princeton, 2013).  The next year, Jean Tirole, of Toulouse University, was recognized with a Nobel Prize for “his analysis of market power and regulation” – an avalanche of papers stemming from his 1988 book, The Theory of Industrial Organization.  Roberts, who grew up in Winnipeg, Manitoba, a cheerful man of great equanimity, evinces few regrets.

The point is that prizes give a highly imperfect picture of how things happen in economics. For that you need journalists, or historians operating on the future’s trailing edge. Indeed, in The Knowledge We Have Lost in Information: The History of Information in Economics, (Oxford, 2017), Philip Mirowski and Edward Nik-Khah tell a version of these developments, on a broad canvas, from a very different perspective. But that is a story for another day. It would have been better, I think, if the National Academy had named all four members of the gang and let the Swedes sort it out.  When the political scientists got their chance to name a winner, in 2004, they chose Elinor Ostrom. And look what happened to her