The Nobel Prize Winner Who Created a Better Auction: A Conversation With Paul Milgrom

The Nobel Prize winner who created a better auction, Paul Milgrom, is the author of “A Theory of Incentives in Auctions.” In his paper, he describes how auctions are used to allocate resources and that they can be designed to maximize efficiency.

Paul Milgrom is a Nobel Prize Winner who created a better auction. He has been in the field for over 30 years and he is also known for his work on the theory of auctions.

For over three decades, Stanford University economics professor Paul Milgrom has been at the vanguard of auction theory, researching auction design and bidder behavior.

When the US government authorized the first radio spectrum auction to cellular carriers in 1993, it faced the difficult job of allocating the licenses to a fledgling sector.

Prof. Milgrom and his Stanford mentor, Robert Wilson, worked together to create a new kind of auction that provided all of the licenses at once at low rates, making it simpler for businesses looking to purchase numerous licenses to evaluate the possible costs right once, eliminating pricing uncertainty. The work helped the duo win the Nobel Prize in Economic Sciences in 2020.

Prof. Milgrom co-founded the consulting firm Auctionomics Inc. in 2009 and has advised governments all around the globe on how to create auctions that suit their requirements. When the Federal Communications Commission sought assistance in 2011 developing a plan to purchase and auction airwaves it had given away to local TV stations more than half a century before, it went to Prof. Milgrom.

As a consequence, another new design was developed, this time using two interdependent auctions: First, the FCC purchased broadcasters’ licenses in a reverse auction, which reduced costs until the agency had the airwaves it required at the lowest feasible cost. The Federal Communications Commission then reconfigured the airwaves to make room for transmissions and auctioned them off to cellular operators.

The sale produced almost $10 billion in revenue for US taxpayers after paying for the television licenses. The FCC has generated more than $207.5 billion in airwave auctions since 1994. The most recent auction for airwaves that will be utilized with 5G wireless technology began on October 5.

Prof. Milgrom was recently interviewed by the Wall Street Journal. The following are edited extracts.

WSJ: How did you go from your birth in Detroit to receiving the world’s most prestigious economic prize?

PROF. MILGROM: I liked math and went to the University of Michigan to get my bachelor’s degree in mathematics. I then worked as an actuary for a few years since that was the only job I could find.

I became dissatisfied with my job as an actuary and enrolled in Stanford’s M.B.A. program, hoping to get an M.B.A. While working as an actuary, I published a few of papers on improved methods to examine specific issues. When I first arrived at Stanford, I would also tell instructors that their approaches to technical issues weren’t the best. “You’re in the wrong program; you should be in the Ph.D. program,” they told me, “because this is not what M.B.A.s do.”

WSJ: You’re most well-known for your work on the FCC’s auctions. Why is it so difficult to sell wireless licenses? Is it possible to sell them on eBay?

PROF. MILGROM: If you just have one item to sell, eBay or sealed bids or anything like is a straightforward solution. And they’re generally quite effective. However, in this instance, we had businesses with business strategies that necessitated the use of several licenses. They didn’t want to purchase a few licenses for Chicago and Detroit and then be unable to transport passengers from Los Angeles to New York.

Bob and I devised a plan in which you collect pricing information on all of the licenses before committing to any of them. So you start looking into how much licenses will cost in New York and Los Angeles before committing to purchase and pay a certain sum in Chicago.

WSJ: Has the auction design altered since the first one in 1994?

PROF. MILGROM: For a variety of reasons, it has developed. They utilized this in Europe, where they sold licenses covering an entire nation to a tiny number of bidders, and they discovered that all of the information we provided to bidders was being used to rig pricing. They’d split the market at low prices, then cease bidding against one another. As a result, the Europeans developed auctions in such a manner that the quantity of information given was decreased.

And the scope has widened. Rather of having individuals bid on them individually, they changed the regulations such that the auctioneer sets the price and then asks, “OK, how many licenses of this kind do you require at this price?” The auctioneer then increases the price and re-posts the call if there is an excess of demand.

So there have been evolutions that are compatible with the original design, or with the original design’s economics, but they make it operate quicker and with less collusion susceptibility.

WSJ: You devised arguably the most complex auction ever, including the purchase of television airwaves throughout the nation and their reorganization for sale to cellular carriers. Some skeptics questioned if it could be done. How did you become engaged in the project and how did you approach the design?

PROF. MILGROM: They approached me and said they wanted to collaborate with me since no one else knew how to do it and they believed I may be able to. I told them I couldn’t handle it on my own. It was too difficult, but I could assemble a squad. They recruited me in 2011, even before the law was approved.

“The bidding cannot be difficult,” I replied. It must be straightforward. Second, it must be adaptable, because whatever we propose will be altered. It will go through the political process, there will be lobbyists, and there must be excellent bones in this thing so that when we make changes, it will still stand.”

It was strong, I’m pleased to say. Even though we were unable to address some of the issues that arose, we were able to make the necessary adjustments and develop algorithms to ensure that the auction went well. During the auction, we had to solve maybe 10,000 of these issues, and we only failed on around 100 of them.

Paul Milgrom, on the left, and Robert Wilson, on the right, pose with their Nobel prizes.

Reuters/Elena Zhukova/Nobel Prize Outreach

WSJ: So, what does the future hold for complicated auctions like these? Where will these concepts be implemented?

PROF. MILGROM: We believe that water rights will be essential. I don’t have a design in mind for that yet, since defining precisely what rights farmers have to their water, groundwater, surface water, and how surface water recharges the earth is a major part of the issue. If you take too much groundwater and the building collapses, you may permanently damage it, and it will never replenish.

How do you build marketplaces that are both profitable and sustainable in terms of water use? To make it work, we had to alter the rights in the radio spectrum, and we’ll probably have to do the same in the water markets. When we come up with a design, it will need to have strong bones because it will be altered, and political interests will push us to make modifications, just as they did with radio spectrum.

Mr. Gryta is a New York-based correspondent for The Wall Street Journal. [email protected] is his email address.

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