This year’s Nobel economists have transplanted theory into good practice

I AM about to start teaching one of my favourite classes. I provide students with background reading and ask a simple question: how should we allocate kidneys? This year the course will be particularly relevant. Yesterday, we heard that Lloyd Shapley and Alvin Roth shared the 2012 Sveriges Riksbank Prize (the Nobel Prize in Economics). Both had fascinating insights on allocating kidneys, an emotionally charged subject.

Kidney allocation is a complex and pressing issue. There are around 7,000 people in the UK who need a new kidney, but tragically fewer than 3,000 operations are conducted annually. My class helps students understand alternative allocation mechanisms. We talk about the pros and cons of relying on personal networks, a centrally-managed list of donors, or indeed an actual market.

Shapley was interested in exactly this kind of market – one where two sides of an exchange need to be matched. He developed an algorithm that resulted in non-arbitrary and stable outcomes. Roth built on this theoretical work to solve real word problems, like matching students with schools. This is the exciting field known as market design and it blends together game theory and experimental economics.

But these aren’t really markets – kidneys aren’t bought or sold. Instead people who are willing to donate their kidney to a friend or relative, but who are not a suitable match, can exchange their commitment with someone who is. Genuine markets require private ownership and trading, but many applications of market design occur when property rights are ill-defined (like mobile network licensing or pollution permits). These are networks that – depending on your view – either draw upon important market-like mechanisms, or get in the way of real markets developing.

There is a danger of market design conceit, where bright economists become overconfident about their ability to improve upon potential market outcomes. The most important function of markets is the way the price mechanism conveys information. But, if goods aren’t actually traded, you get only an approximation of a price at best.

As is often the case, the pioneers of market design are humble about the limits. Roth has also made significant contributions to the topic of so-called “repugnant” markets – the extent to which cultural factors can act as a constraint.

Few economists actually advocate an open market in kidneys. But I am always intrigued by how many students leave my class recognising that a more market orientated approach to kidney donation would result in fewer organ patients dying, but how this also generates a great deal of uneasiness. “How many people are you willing to let die to avoid feeling icky?” I ask.

I finish the class by saying that there is only one country in the world with a market in kidneys. And there is also only one country that has no waiting list. You won’t be surprised to learn that it’s the same country. But you may be surprised to learn that it’s Iran.

Regardless of one’s own views on the matter, Roth and Shapley are deserving winners.

Anthony J. Evans is associate professor of economics at ESCP Europe Business School. Email Twitter: @anthonyjevans