The Experimental Economist

Nobel laureate Vernon Smith takes markets places they've never been before.

Nick Gillespie & Michael W. Lynch from the October 2002 issue

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But the main problem is that inability to interrupt demand. You're talking about an industry in which the way they think about their problem and the way the regulators think about the problem is that all demand has to be served all the time. No one should ever lose their lights, and a fair price is a constant price over time. You always meet all demand. Well, it's impossible. You can't always meet all demand. You can't meet it in storms. You can't meet it when supplies are tight.

A big barrier to change is the local electric wires, which are franchise monopolies. For nearly 100 years, companies have been tying in the sale of energy with the wires. There's no reason the provider of the wires has to be the provider of the energy. Do you remember when Ma Bell wouldn't let you connect any telephone unless she produced it? They argued that they had to protect the "integrity" of the network: We just can't let anyone go in and connect whatever they want! It's silly. Why would anyone produce a telephone that wasn't compatible with the system?

That's all changed for phone service providers, but not for companies in the electric power industry. They're saying, "Why should we give access to our wires to alternative energy providers, especially ones who want to put in an interrupt device?"

What we need is a system where entrepreneurial types can come in and compete and try out different things, including the demand-interrupt system. Some will lose money and go broke. Some will hit it big. That's what's happening in telephones, and it's not happening in electric power. It won't happen until those barriers are removed.

Reason: What are other areas where experimental economics is playing a role?

Smith: We're doing work on creating a market for the exchange of landing and takeoff slots at airports. In normal circumstances, those rights have been fully allocated among the airlines at a given airport. But let's say a bad weather front moves in, so there's a ground delay. They've been doing maybe 60 landings and takeoffs per hour, but now they've got to reduce that to 30. What airports tend to do is just stretch out the existing schedule, which leads to cancellations and other problems. What you need is a market mechanism so that the flights that have higher priority get out. What would be a higher priority? Bigger planes, probably, but also full planes and planes with a lot of passengers who have connecting flights.

Suppose we're talking about planes leaving LaGuardia in New York. If a plane's going to Los Angeles, it's probably the final destination for a lot of the passengers. Planes going to Chicago or Dallas probably have a lot passengers who are catching connecting flights. Maybe those flights should have a higher takeoff priority in bad weather. In any case, you need a market mechanism where the airlines can compensate one another-and their passengers-to cancel their flights and trade takeoff slots.

Such a system doesn't exist now. First, the airlines have to be convinced that's the way to go. Then the Federal Aviation Administration has to cooperate. And you really need Congress to approve this, since it gave the original allocation of slots. The danger is that Congress will say, "Wait a minute, we don't like this because they're buying and selling these slots. We gave them to you, and now they're making money by reselling them."

Another area for experimental economics has to with NASA. We worked on the Cassini mission [which in 1997 sent 800 pounds of scientific instruments on a small spacecraft to Saturn to conduct experiments]. We used a trading system to allocate the resources that each separate experiment got to use on board.

Each experiment used three basic elements: energy, mass, and volume. The idea was to come up with the most efficient use of these three resources. We allocated a set amount for each resource. Participants were given tokens that were essentially money that they could trade among themselves. When the bidding started, the price of mass started out very high relative to volume and energy. Then people started to conserve it and, by the end, it collapsed. The price of mass collapsed!

That was the first space mission that came in without a big cost overrun. But they never did that sort of market allocation again. Why? Because there's lot of people that like things the way they are. They can run the current system and they don't care about waste. NASA's space station is now about $5 billion over budget. We've proposed selling enough space on that station to earn $5 billion. I don't know whether there's a market for that, but why not take a look at it?

We met with someone in the White House and there was some interest in it, but it takes a political entrepreneur to change that sort of thing, and it's very risky. If it doesn't work, you're going to get all the blame. If it does work, then everybody's going to claim to have been behind it.

Reason: You started out life as a socialist but now call yourself a libertarian. What do you mean by that?

Smith: For me, libertarianism is tied to a certain set of recognitions: that all organizations have the problem of decentralized information, that decentralized mechanisms are the best way to organize that information to produce good outcomes, and that the best results come when the individual is free to make his or her own tradeoffs while aggregating information. That's true whether we're talking about politics or economics or even social interaction. The best systems maximize the freedom of the individual, subject to the constraint of others in the system.

I was born and grew up in Wichita, Kansas. My parents were socialists and our friends were socialists. We were supporters of the Socialist Party. My mother's first vote when she was 21 was cast for Eugene V. Debs, when he was in jail for opposing the First World War. My mother's father was an engineer on the Missouri Pacific Railroad. He was a great lover of Debs, who had organized the railroad workers. My mother ran for state treasurer on the Socialist Party ticket in Kansas more times than I can count. My first vote was cast for [Socialist] Norman Thomas in 1948, when I was 21. The two votes that I've felt the most comfortable about casting were for Norman Thomas in 1948 and [Libertarian Party candidate] Ed Clark in 1980.