Thursday, July 2, 2015

Interview with Al Roth: Market Design When Prices Aren't Sufficient

Douglas Clement offers another characteristically excellent interview in The Region magazine published by the Federal Reserve Bank of Minneapolis, this one with Al Roth (June 2015 issue, pp. 14-25). Roth, of course, was a co-winner of the 2012 Nobel prize in economics (with Lloyd S. Shapley) for his work on market design. The interview ranges over Roth's work in many areas, including programs run by cities in which parents chose schools for their children, matching medical residents and hospitals, and matching kidney donors and recipients. The whole interview is very readable, but here are a few comments that jumped out at me.

On what makes a matching market different from a market where price is sufficient for buyers and sellers to agree to a transaction:

God makes wheat, but the Chicago Board of Trade makes #2 hard red winter wheat. It has a lot less variance than wheat. You know what you’re going to get and, therefore, you don’t have to care who you’re buying it from. You don’t have to inspect it. But before wheat was commodified, you had to have someone look at the wheat to see what you were buying. Similarly, before coffee was commodified in Ethiopia, you needed a man in Addis Ababa tasting the coffee; now you don’t.
In those markets, you can make an offer to the entire market. I want #2 hard red winter wheat from whomever; it doesn’t matter who I get it from.
But, of course, labor markets aren’t like that, and many other markets aren’t like that—because you care not just about the price, but also about who you’re dealing with. What that means is, if everyone has a different price—if dealing with you is so nice that I’m willing to pay a higher price rather than deal with someone else—there’s no longer a small-dimensional vector of prices that organizes the market, like a price for each kind of wheat.
Instead, it’s personalized prices, maybe doubly personalized prices. How much will Google pay me to work for them? How much would I need to take their offer, rather than a different salary from Facebook?
The space of prices is larger, so even if you tried to organize the market entirely through prices, you would need to see many, many more prices than you do in the market for coal, where you only need a price per ton for each grade of coal.
There isn’t a sharp line between matching markets and commodity markets. I think there is sort of a continuum. There are markets where price does all the work: the New York Stock Exchange, for instance. Its job is to define at any moment the price at which supply equals demand for each of a bunch of financial commodities. The labor market is very personal, but price also matters a lot, so it’s somewhere in the middle of the continuum. For school choice and kidney exchange, we don’t let prices work at all. And lots of markets fall somewhere between kidney exchange and the market for wheat.
What used to happen in matching medical residents to hospitals before a formal process was set up--and how matching market can unravel: 
In 1900, when you graduated from medical school, you looked for a job. We’re talking about graduating in June and looking for a job that starts around July. By 1930, those jobs were being filled by Christmastime (before graduation) rather than June. Medical journals from the 1930s say, “We’re now hiring our new interns without knowing their class rank and other important information we might get by waiting until they graduate. We can live with that, but let’s not go any earlier.”
But, of course, it’s hard to stop people from competing simply by asking them not to do so. By 1940, hospitals were hiring people two years before graduation. That was very inefficient. Everyone understood it was very inefficient. Hospitals couldn’t tell who the good students were two years before graduation, and the students couldn’t really know what jobs they wanted. They didn’t yet have much experience with different medical specialties. ... 
Around 1945, the medical schools intervened and managed to control the dates at which contracts were signed for post-graduation employment. The medical schools are a third party: They’re not the doctors, they’re not the hospitals, so they weren’t suffering from the competitive self-control problem that kept forcing hiring earlier. By not releasing transcripts, not releasing letters of reference, they managed to get control of the date and move it back into the senior year of medical school. That prevented unraveling, but then they had terrible exploding offer problems—job offers that were retracted if not accepted quickly. ...
Fortunately, that problem has now been solved in the medical residency market, but it’s happening right now with law clerks. So this isn’t an ancient problem; it’s still very present in other markets. ... Federal judges have tried over and over again, maybe a dozen times in the last 30 years, to deal with unraveling in the market for law clerks. They develop rules that they then cheat on. Right now, they’re in a period of no rules. They just abandoned their most recent set of rules because everyone was cheating. So they’re back to making very early exploding offers. If you’re a law student who is going to get an offer of a clerkship, it will come sometime well before you graduate, and it will be earlier this year than it was last year. ...

[I]t’ll probably be in your second year. Some judge will make you an offer, and you will most often accept it on the spot because that’s part of the deal for getting the interview. So you won’t get to consider a lot of offers. ... This unraveling process, this process of making offers earlier and earlier, turns out to be common to many markets.
On what made the University of Pittsburgh, as well as other departments, a supportive place for a researcher: 
The mathematician Alfréd Rényi is said to have said that a mathematician is a machine for turning coffee into theorems. Maybe economists turn decaf into models.
There were lots of people to talk to at Pittsburgh. It was a fruitful time. And it was a very good department. I think a lot of what makes a department a good place to work is that when you’re onto something you’re excited about and you walk out the door of your office and tell one of your colleagues about it, he’s excited to hear about it, too. He says “That’s great. Let’s go have a cup of coffee, and you can tell me about it.” So there’s the positive reinforcement you get just from having people think, “Isn’t that great you’re excited about something. You’re thinking about something interesting.” It makes places fun to work.
Here at Stanford, I try to organize regular coffees—I did this at Harvard and I do it here—regular coffees with students interested in different things. We have a Tuesday morning coffee for experimental economics and a Thursday morning coffee for market design. I think that a lot of intellectual interaction arises out of social interaction. You have to be talking to people before you’re talking about work.