Prize It All!

Prizes and Design of Economic Incentives

One of the most profoundly informative books that I read last year was Fermat’s Last Theorem by Simon Singh. In short, the book takes the reader through a historical account of the three century search for the definite answer to a puzzle that the French amateur mathematician Pierre de Fermat posed. It also bears very interesting mathematical and scientific detail regarding the history of the search for the solution to the problem posed by an amateur mathematician. Notwithstanding the glorious history of science in general and mathematics, this problem was at one time regarded as completely intractable. Then an unhappy set of circumstances led to a late night encounter of Fermat's Last Theorem after which Paul Wolfskehl dedicated an enduring prize fund that acted as a supplementary incentive towards proof of the theorem. There was a surge of interest and the crunching and thinking began again to find this solution. Finally, the prize was taken apart by prof. Andrew Wiles who was not as moved by the financial expectation but by the obsession from mid teens. Without the intention to disparage prof. wiles intentions and declarations, no doubt the primacy of the problem was kept alive by the added incentive of a substantial prize of 100,000 German Marks. Fermat’s last theorem ceased to be a puzzle in 1995 when the solution by Professor Andrew Wiles was accepted.

Many economists now know that the proper design of economic incentives would concentrate mind power and ensure that a distributed and democratic search for a solution to a well defined problem is undertaken. This idea is not overly complicated because it involves an approximation of a market conditions by allowing for competition towards the claim of a sufficiently large prize and allows for knowledge to be built around different findings. Writing in the New York Times, David Leonhardt supports the view that innovation can be hastened with sufficient offer of prize money and reminds readers that the idea of navigation by longitudes was itself discovered by a watch maker partly responding to the incentive of the £20,000 prize. More recently, the X prize of US$ 10 million was a competitive challenge for researchers and thinkers to design a vehicle and ensure the first private space flight. The challenge that was thrown in 1996 but the prize was claimed after eight years. For such a highly technical feat, this was a stellar achievement over an acceptably short time at a comparatively low cost.

Recalling an earlier post on this blog about Sir Richard Branson’s undertaking to invest up to US$ 3 billion on the quest for an alternative fuel source, this blogger stated that the use of a prize would be far efficient and would almost certainly inspire a dedicated and cost-effective solution. Other public problems that should be pursued in the same manner are probably a vaccine or cure for HIV/Aids on the one hand and the cures for other costly diseases such as malaria and cancer. Prizes are an adequate approximation of markets that would ensure that only real solutions are paid for in addition to democratizing the search. A number of firms are also using this approximation of markets to harness brain power in the solution of business problems. Why shouldn’t Richard Branson take the example?

Related Readings
Freakonomics Blog

Netflix Prize

Madeleine Albright Takes on High Finance

Madeleine Albright Takes on High Finance

That fund managers design complicated instruments and execute huge trades and transactions cannot be denied. This leads this blogger to respect the conventional view that management of a hedge fund requires very highly specialized skills and capabilities. Daniel Gross of Slate magazine reports that there is a definite tendency for high profile individuals from the public sector to establish or earn appointments to hedge funds while totally bereft of prior investment experience. While Prof. Larry summers has also been appointed as a part time manager of a separate hedge fund, the entry of individuals with experience in the public service and no financial training is worthy of examination.

The Albright Capital Management not only bears the name of Madam Secretary Madeleine Albright but has put together up to US$ 329 million in seed money courtesy of a Dutch pension institution. Granted that this fund will be managed in consultation with experienced financial gurus, I am led to question whether Madeleine Albright underestimates the skills in running of such a fund. Among the large portfolio of skills that Madeleine Albright has proven to have are high level diplomacy, an understanding of political formations, the trajectory of failed states, serious authorship in addition to being a distinguished professor in her craft. The relevance of this explicit set of talents to running a hedge fund are not immediately apparent to this blogger.

However, that may well be the wrong question because all that hedge fund management may require is unquestioned intelligence which enables a diplomat to convince a pension fund to place US$ 329 of seed money in a newly registered hedge fund bearing the name of a person who has no trading experience, training in economics or finance. That is real diplomacy. I posit that it may well be that high finance is not as much about unintelligible financial models as hedge fund managers make it but about the command of markets and the economic principles that govern them. No doubt that ACM will have more clients due to the reputation of its principal, but whether it will register superior returns is an issue for future blogs.

Guangzhou City Bans Motorbikes

For a person who has not visited mainland China yet, I imagine that motorcycles would disproportionately account for the transportation needs of Chinese citizens in the cities. This claim finds confirmation in admittedly dated data showing that the proportion of motorcycles among registered vehicles grew from 23.4% in 1987 to 63.2% in 2001. China’s export success is also driven by significant exports of motorcycles and this is considered an intermediate step towards the manufacture and assembly of automobiles.

New York Times reports the curious fact therefore that Guangzhou, one of the most successful of China’s export cities has announced a ban on motorcycles and motorized bicycles. The main reason for the ban is that these forms of motorized transportation are contributing to crime and insecurity. This strikes me as a very casual approach to crafting public policy for a city that has seen this level of unprecedented growth. Migrant workers, whose low incomes are partly responsible for the China’s export capability, are most likely going to be adversely affected. The preferable approach would have been to concentrate on reducing crimes by catching criminals as opposed to the blunt instrument of attacking motorbikes because purse snatchers happen to ride on them. Credit though to the city it opted to offer modest cash in exchange for surrender of the motorcycles. This is a dangerous and ill-informed mixture of social and economic policies. Apart from generating a huge scrap yard, I am certain that this policy is wrong-headed. I will keep an eye on its effects.

Quote of the Day

"The most difficult lesson for the economist in business to learn is that it is easy to be too rational for one's own good." John Kay

Thinking about Energy with Newsweek Magazine

Newsweek Magazine’s Special Edition for December 2006 to February 2007 is dedicated to energy and is appropriately titled as “Breaking Out”, where the energy boom will lead us. It was interesting reading during the Christmas and New Year Holidays. Among its outstanding articles are those authored by Daniel Yergin, Fareed Zakaria, Gordon Brown and Mathew Simmons. Richard Branson of Virgin Group elucidates his vision of an airline operator exploring a US$ 3 billion investment in a green future. Of the interviews, Vinod Khosla, the venture capitalist presents his extremely perceptive views on the possibility of niche markets for alternative fuels from biomaterials.

A number of articles also present fascinating but contrarian views. Of these, the stand out piece is the interview with the Nobel laureate Dudley Herschbach. He presents the possibility that petroleum could be non-biological in origin and thereby confronts the conventional view that it is undeniably a fossil fuel. He narrates the outcome of the suggestive experiment conducted with a diamond anvil that recreates the intense pressure of the earth’s plates which produced methane. Separately, Kurt Eichenwald highlights Enron’s corporate and financial innovations such as weather derivatives and long-term energy contracts that have been adopted by other unrelated firms with some success. The moral of the story: “…often, even a corporate corpse carries a wallet.”

It is obvious from the publication that the search for an alternative or supplementary energy source in underway and that some of the ideas that are featured in the publication will be big winners in the lab and subsequently in the markets too. The challenge to human ingenuity and market reliability is posed here. We look out for the results. Five Stars for the editors.

My disappointment comes from the fact that for a very comprehensive review of ongoing research and cutting-edge ideas regarding the trajectories of energy research, investment and petroleum industry growth, I did not encounter any opinions or mention of the bold claims by the technology solutions firm Steorn and which formed an earlier post on this blog. I may have to adjust the odds below the 5% that I allowed then.