“Ha!” exclaimed my nephew, Paul, during our weekly visit to the swimming pool. “I read in the newspaper that the Dutch economy grew by 3.4% in the last quarter.” I replied: “Quite spectacular, isn’t it, in particular because economists like Robert Gordon recently predicted that developed countries could at best achieve a long-run growth rate of around 0.5%.” “Hmph, you economists seem to have a hard time getting anything right,” said Paul bluntly, “you didn’t even see the last financial crisis coming.” “Not so fast Paul!” Paul swam breezily ahead of me. He shouted back: “Before you catch up with me, make sure you can give me three examples of where economists have made a meaningful contribution to society.”
He had me by the balls. The first things that came to mind didn’t seem to work at all. “The insight that incentives matter” and “a deep understanding of the appropriate use of statistical models” seemed rather abstract and perhaps even trivial. “Some economists did foresee the financial crisis” sounded too much like hindsight wisdom. The chlorinated water also did not really help to defog my mind. Neither did the lack of Internet resources in the middle of the swimming pool. For a short while, I even started to doubt whether we teach anything at all useful to our economics students.
But then I recalled Dani Rodrik’s book, Economics Rules, which I had read recently. Rodrik writes about the strengths and weaknesses of economics and expresses what he finds useful in the economic methods. Of course, I did not have the book at my disposal in the swimming pool, but I vividly recalled a couple of quite convincing examples of economists successfully changing the world by applying economic ideas to public problems. The first example is ‘Bretton Woods.’ At the end of World War II, delegates of all 44 allied nations gathered at the Bretton Woods Conference. Guided by John Maynard Keynes, “the towering English giant of the profession,” as Rodrik writes, a new system of monetary management was established. The Bretton Woods system obliged each country to tie its currency to gold in order to maintain a virtually constant exchange rate. The system proved extremely successful in that it “unleashed an era of unprecedented economic growth and stability for advanced market economics […].”
Another beautiful example is the use of “game theory […] to set up auctions of airwaves for telecommunications.” As early as the 1950s, Nobel Prize laureate Ronald Coase advocated the use of auctions to allocate scare airwaves. It took a while, but in 1994 airwaves auctions became a reality in the US. Since then, thousands of licenses have been assigned in this way in the US, opening new markets for mobile telecommunications and raising over tens of billions of dollars in the process. Around the year 2000, many European countries followed by auctioning third-generation mobile phone (3G) licenses, raising more than €100 billion. Game theorists like Paul Milgrom, Robert Wilson, and Paul Klemperer have greatly influenced the design of the spectrum auctions.
I had almost caught up with Paul when a third example occurred to me. In 2012, Alvin Roth and Lloyd Shapley won the Nobel Prize in economics for “for the theory of stable allocations and the practice of market design.” In the Dutch TV show De Wereld Draait Door, VU economist Pieter Gautier discussed a potential application of the Nobel Laureate’s ideas that was closer to home. He argued that the insights developed by Roth and Shapley could be used to improve the way pupils were assigned to high schools in Amsterdam. In Amsterdam, around 8,000 pupils enter high school every year. The problem is that some schools are overly popular so that not all pupils can enter their most preferred school. In the old allocation system, the pupils could only choose one school. If the school of their choice was oversubscribed, some pupils were rejected. These pupils could choose another school, but only one that still had seats available. The pupils and their parents were quite dissatisfied with the system and some found ways to ‘game’ it by strategically signing up for their second or third choice school. So, the city of Amsterdam quite happily picked up Gautier’s suggestion and invited a number of Amsterdam-based economists to propose alternatives to its allocation system. In 2015 Amsterdam implemented a new system based on the work of the Nobel Prize laureates. Although there were some complaints, overall the new system was considered an improvement over the old one and the city decided to retain it for the next couple of years.
I sped up and gave Paul the three examples. He was easily convinced, which made me proud in that even for a layman the value added by economics might not be too hard to appreciate.
When we drove home from the swimming pool, I thanked Paul for our inspiring conversations, not only at the pool, but also while watching football, during our family weekend, and in the pub. They helped me quite a bit in shaping my columns for Rostra Economica, of which this is, unfortunately, the last one.