The Economics of Truth

By MATT PHILLIPS
October 15, 2007 1:39 p.m.

Three American economists won the Nobel Prize for work that centers on how mechanisms such as markets and auctions can get people to admit how much something is worth to them.

Americans Leonid Hurwicz, Eric S. Maskin and Roger B. Myerson were awarded the Nobel prize in economics Monday for their study of "mechanism design." An abstract branch of economics that employs daunting formulas and heroic feats of mathematics, mechanism design is decidedly clear-eyed in its approach understanding always-less-than-perfect circumstances of economic exchanges. One way to understand the "mechanisms" these distinguished dismal scientists study is to think about an auction for, say, a Picasso painting. It's a pretty efficient way of getting people to admit -- by bidding -- how much they value the painting. And according to Tyler Cowen, a professor of economics at George Mason University and well-known economics blogger, essentially, these economists use math to analyze and describe that process of "trying to get people to tell the truth or reveal information." Jeffrey Ely, an economics professor at Northwestern University who works in the field, explains mechanism design as a sort of reverse engineering of game theory, a field in which people try to understand how individual incentives and structural rules interact and result in certain behaviors. But instead of just understanding the rules of existing systems, mechanism design focuses on designing them in such as way that a certain outcome is achieved. "They developed the basic tools for thinking about institutions in this way," Mr. Ely said of today's award winners.

Alvin Roth is a professor of economics at Harvard University who has used some of the theories pioneered by today's Nobel award winners to help design programs such as the process by which medical students are placed in residency programs at hospitals. "You might say that before modern game theory, economists looked at markets and other economic institutions sort of the way botanists look at plants, as naturally occurring mysteries to be studied," Mr. Roth wrote in an email. "Mechanism design takes seriously that markets are built by people, and starts to ask what we can do with them, what we can't, and how best to go about it." As such, their work has applications in a wide range of fields, from regulatory policies such as the Federal Communications Commission's somewhat abstract auctions of bandwidth on the wireless spectrum, to the residency-placement system devised Mr. Roth, to the kidney-donation swaps highlighted in today's Wall Street Journal. And, more generally, the economists' theories can be used as a framework to help identify when markets, auctions or other mechanisms -- such as matching programs -- might be better -- or ill -- suited for providing a specific outcome.

At 90 years old, Mr. Hurwicz is the oldest Nobel winner ever, according to the academy. Mr. Maskin, 56 years old, is professor at the Institute for Advanced Study at Princeton, N.J.; and Mr. Myerson, 56, is a professor at the University of Chicago. The award is officially known as the Nobel Memorial Prize in Economic Sciences. It isn't one of the original Nobel Prizes, but was created in 1968 by the Swedish central bank in Alfred Nobel's memory. Nobel Prize winners receive $1.5 million, a gold medal and a diploma from the Swedish king on Dec. 10, the anniversary of Nobel's death in 1896.

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Stocks Fall on Citigroup's Profit
Stocks declined Monday as investors scrutinized a sharp drop in profit at Citigroup and news that a fund will be established to help boost liquidity in the credit markets. The Dow Jones Industrial Average, the S&P 500-stock index the Nasdaq Composite Index were all down more than a half a percent. Crude-oil prices hit a record high Monday, with the November light-crude contract adding $1.40 to $85.09 a barrel, amid tensions between Turkey and Iraq and a tight global supply situation. Bonds fell, with the 10-year Treasury note and the 30-year note both down. The dollar weakened slightly against the yen and the euro. Asian indexes mostly rose. European shares held steady.

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Citigroup Net Income Plunges 57%
Citigroup said its third-quarter profits slumped 57%, depressed by mortgage defaults and this summer's credit scare, and executives were lukewarm about the bank's immediate prospects. New York-based Citigroup, the largest U.S. bank by market value, reported net income of $2.38 billion, or 47 cents a share, down from $5.51 billion, or $1.10 a share, a year earlier. Revenue rose 6% to $22.7 billion from $21.4 billion. The results were slightly better than what Citigroup had forecast in an Oct. 1 profit warning, but the company on Monday didn't repeat reassuring remarks from two weeks ago that the profit environment appears to be returning to normal. Its shares were off more than 2% in midday trading.

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Buyout Group Looks to Exit SLM Deal
The group that agreed to buy SLM Corp. is seeking court backing to pull out of the $25 billion deal that has been in jeopardy for months, saying the agreement's terms can't be met. The declaration was made in court papers as the group answers SLM's suit to force the buyout's completion or payment of a $900 million breakup fee. The group -- consisting of private-equity firm J.C. Flowers, Bank of America and J.P. Morgan Chase -- claim the combination of weaker credit markets and new federal law involving the student-lending industry represent a material adverse effect. That means the group would have no obligation to complete the deal under the previously agreed-to terms.

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China's Growth Tops Hu's Agenda
In a major speech to open the Communist Party's twice-a-decade National Congress, Chinese leader Hu Jintao said economic growth must remain the party's "central task." China's per-capita gross domestic product, a broad measure of the nation's prosperity, has nearly doubled over the past five years, and was just over $2,000 in 2006. Mr. Hu said the government's goal is to double that figure again by 2020, and "basically eliminate" absolute poverty. Mr. Hu is embarking on his second five-year term engaged, and as he keeps the government's focus on fast economic growth, he is also promising to deliver a more equitable society and a better natural environment.

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AOL to Cut Another 2,000 Jobs
AOL plans to eliminate 2,000 jobs as the Time Warner unit continues a broad overhaul and plots its place within the media giant. The layoffs are slated to begin Tuesday and will affect about one-fifth of AOL's global work force, AOL Chief Executive Randy Falco said in an internal memo. The reduction comes on top of 5,000 positions cut last fall and follow plans to move AOL's headquarters to New York from Dulles, Va.

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Presidential Campaign Reports Trickle In
In detailed filings with the Federal Election Commission Republican Rudy Giuliani reported spending $13 million between July and September, his biggest spending quarter yet as he positioned himself as his party's presidential front-runner. Mr. Giuliani raised $11.4 million during the quarter, with about $10 million of it available to spend on his contest for the Republican nomination, according to a report filed Monday with the election commission. His campaign listed a total of $16.6 million cash on hand, $11.6 million available for the primaries. All presidential candidates were required to file their third-quarter reports by midnight tonight.

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Rice Visits Mideast
In one of her most forceful statements yet on the Middle East conflict, Secretary of State Condoleezza Rice said Monday the time has come for establishing a Palestinian state and that it's in the interest of the U.S. to do so. "Frankly, it's time for the establishment of a Palestinian state … I wanted to say in my own voice to be able to say to as many people as possible that the United States sees the establishment of a Palestinian state and a two-state solution as absolutely essential for the future, not just of Palestinians and Israelis but also for the Middle East and indeed to American interests," she said after a meeting with Palestinian President Mahmoud Abbas. "That's really a message that I think only I can deliver," Ms. Rice said, defining Palestinian statehood as a U.S. interest.

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GM Details Funding Plans For UAW Health Trust
General Motors said it expects to transfer $16 billion from its internal health-care trusts, in addition to a $2.5 billion cash infusion, to a new United Auto Workers trust in order to fund a new independent voluntary employees' beneficiary association, or VEBA. The auto maker and the union reached a labor agreement earlier this month following a short strike. Meanwhile, UAW President Ron Gettelfinger said Monday that a council of union local heads and other union leaders gave an "overwhelming recommendation" in favor of the contract hammered out last week Chrysler. He added he hopes to get two thirds of the UAW workers at Chrysler plants to approve the contract in ratification votes expected to take place in the next few weeks.

--The Associated Press contributed to this report.

Write to Matt Phillips at matt.phillips@wsj.com


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