AIPIS 106 – Alvin E. Roth, Who Gets What – and Why: The New Economics of Matchmaking and Market Design

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It's my pleasure to welcome Alvin E. Roth to the show. He is a Craig and Susan McGaugh professor of Economics at Stanford University and the Gund professor of Economics and Business Administration Emeritus at Harvard University. He's winner of the Nobel Memorial Prize in Economic Sciences and author of a fantastic book that I just had the pleasure of getting through about three weeks ago entitled who Gets what? And the New Economics of Matchmaking and Market Design. Alvin, welcome. How are you?

I'm well, thank you. I'm glad to be here.

It's good to have you on the show and I just want to tell my listeners that you are doing something awesome as we're recording. You have one of those treadmill desks. I think that's just great that you do that. I've many times considered getting one of those.

I enjoy it. It saves my back.

Yeah, yeah. Keeps you in shape too. That's great. Well, you know, what is market design and the economics of matchmaking?

Well, market design is an ancient human activity, but it's a new thing for economists to think about. People have been making markets, designing marketplaces since before the beginning of agriculture. When you look at the distribution of stone tools around the world, they're thousands of miles from where they were quarried and made. And that's evidence that our prehistoric ancestors knew something about the benefits of trade. And of course, today, when we see lots of new marketplaces on the Internet, from Google as a marketplace for ads, to Airbnb as a marketplace for rooms and Uber as a market for taxi rides, we see markets being created all the time. So one of the things that economists are now turning to is trying to understand what makes some markets work well and what makes some markets work badly.

In a certain sense. Economists have studied markets for a long time, but entrepreneurs build marketplaces. And so the questions are, what are the connections? What do marketplaces have to do to accomplish, to make markets work well? And that's what market design is about.

You know, market design, it kind of implies central planning. Is that a necessary component of it, or is it something that just takes place in the free market or which way works better? What are your thoughts about that?

So I think markets and central planning are very different. Central planners try to decide who should get what should be the outcomes. Market designers, makers of marketplaces, try to create a venue, a place where people can come together and figure out through markets how to aggregate the necessary information to determine who gets what. So the New York Stock Exchange is a central location, but it's not a place that central planning goes on. Lots of people come to that central location, and every day they determine the price from minute to minute of all the stocks traded on the exchange. But there isn't central planning going on. There's a market. Marketplaces can have central locations without being central planning. And free markets are markets that have rules that allow them to work freely. Again, think about the New York Stock Exchange. It has lots of rules. It opens at a certain time each day. Those are rules set by the proprietors. Some of the rules are laws. You can go to jail for trading on insider information, but together, the rules of a marketplace constitute its design. And what makes a market work well or doesn't has to do with how those rules work, how they interact with the interests of the participants in the market, and whether they allow them to get together in an efficient way to deal with the congestion that results when a lot of people get together in a market. And does it make it safe for them to reveal the parts of their information that they need to reveal to get what they want?

You talk a lot in the book about organ donation and kidneys and so forth, and I want to dive into that. But since so many of our listeners are interested in investing and real estate investing, especially you mentioned the New York Stock Exchange, of course, you know, do you have any just sort of general, broad thoughts on the real estate market?

Well, the real estate market is an unusual one. I've never been involved in commercial real estate, but of course I've bought and sold homes. And I continue to be surprised by the.

Large role that realtors play in the residential real estate market and how that has survived the growth of The Internet and the much easier access to information about homes that, that the Internet brings to us.

And by the way, that surprises me too. So, yeah, go ahead.

So.

You know, the many markets are, many markets that we think of are commodity markets, but real estate markets aren't commodity markets. You can't just say, I want a house of a certain square footage at a certain price. Each house is different. So real estate is a matching market. You make offers on particular houses. And a lot of what I talk about in the book has some bearing on that because I make the distinction between commodity markets and matching markets where you care who you're matched with. If an offer is turned down, you have to formulate a different offer as opposed to when you're trying to buy shares in AT&T. You can put out an offer and no one accepts it for a while. You can still have that offer to the whole market because you don't care which shares of AT&T you buy. You just care how many and the price. But, but most markets are, or many markets are different than that. And real estate is certainly one of them. And of course, you can start when you're offering to sell a house, for example, you can offer to sell it to the whole market. When you're thinking about buying a house, you can survey as much of the market as you can manage. But once you make an offer now, you're engaged in a negotiation, and while you're engaged in that negotiation, other houses that you're interested in might go off the market. They might be sold. And if you're a seller, while you're negotiating.

Other buyers might go off the market. So the timing matters. And this is something that I talk about as congestion. The reason offers on houses have strict time limits on them is because time isn't free.

If your offer isn't going to be accepted, you'd like to be able to make. Be free to make another offer somewhere else. So a lot of the rules of the real estate market have to do with ways of dealing with this congestion. You know, what does, what contingent offers look like and how are they structured and all of those things.

Alvin, you know, when you talk about the surprise that, you know, the realtor market has survived the Internet, as travel agents really haven't, and so many of these other intermediaries or so many of these other parties have been disintermediated by the Internet, but the real estate community has oddly survived. And I attribute that to the fact that the real estate business is so fragmented that it's not an Exact commodity. You know, two houses, one right next to each other, across the street from each other may be very different. And also, you know, maybe the concern that people have about buying such a high ticket item on their own, you know, it's not like an airline ticket or a ticket to a concert or some of these other things, you know, thought more thoughts about that.

Well, I think the surprising thing is not that you need intermediaries and help in buying expensive things like houses. What surprises me is that now that you can take a virtual tour on the Internet and things like that, that they aren't that the real estate contracts have stayed so similar to what they were before the Internet with a percentage of the sales price being what the realtor gets. You know, lawyers, high priced lawyers bill by the hour. So if what you needed was help in the closing, you could imagine that.

That you just deal with lawyers or there are Realtors like Redfin who give you back some rebate, some of the commission. I'm surprised there hasn't been more competition.

But see why like red, that's interesting about Redfin. You know, Redfin has been around for a long time now. They've got great technology, it's very well funded company, or at least it was. I haven't kept up with them lately, but they've hardly made a dent in the market. You know, I just, you don't see Redfin much of anywhere.

Right. So I think you have to give realtors a lot of credit for keeping this monopoly in contracting. And part of it has to do with the form of the contract. If you come to a house that is being shown by a realtor, then the contract says that the realtor will get the full fee, 5%, 6% of the sales price, regardless of whether you come with a realtor or not. So to the extent that realtors do make things easier, they do provide some services. You might as well have a realtor.

Not having a realtor won't let you get the house cheaper. So I think that's part of what makes realtors still so ubiquitous. And again what surprises me is not that realtors still exist, they perform important services, but that they are paid so much compared to say the lawyers who help you close the deal.

I agree. You know, and that's, you know, that's just sort of that, that concept of the 6%, it just sort of, it's been around through so many inflationary cycles and now the prices of the real estate are so much more expensive and those fees are pretty high. But you know, it's kind of interesting, too, because I remember at one of my real estate conferences many years ago, one of the speakers that was hired to speak was Larry King. And oddly, he had some interesting insights into the real estate market. And he said, you know, would it. Wouldn't everybody be okay with lower commissions if there were fewer real estate agents out there and there was less competition and you could do higher volume? See, to me, that would make a more efficient market. Real estate people spend massive amounts of their time and money on the marketing aspect, which really isn't. You know, that's not the business of serving customers a little. A little bit of it is, admittedly, but, you know, most of that is. It's kind of fluff. You know, it's not actually practicing the trade. You know, they're really. I've said, when I've spoken to real estate groups and trained them, I said, you know, you should probably consider yourself a marketing professional who happens to have a real estate license. It seems kind of backwards to me, but also seems true.

Well, I think the perspective of a Realtor, an individual agent, is different from the. From the perspective of someone who operates an agency. But I have to admit, this is a market that I. I don't understand very well. I would have predicted that Realtors would either their fees would drop or as a percentage of the house sales, or that their presence would decrease with the fact that they no longer have a monopoly on the multiple listing service, that you can sign onto that from your computer and find out a lot about houses and see pictures. And we've certainly seen Zillow and truly and all these sites that increase information a lot. So I think it's something. I find it surprising. It's not something I've looked into deeply, but I find it surprising that Realtors still have the presence that they have in the residential real estate market.

And I've got to agree with you, Alvin. I do, too. It's quite interesting the way that has all worked out. And really, a lot of those tools, by making that information accessible to the consumer, have really made their job easier because the consumer goes and does a lot of the work. You know, where at first the Realtors were intimidated. Oh, my gosh, you know, the Internet's gonna take over our business. But really, I think the way it's actually worked out is it's made their job a lot easier. So it's kind of counterintuitive there. But talk to us about the world, the fascinating world of organ donation, if you would, and, you know, matchmaking and market design there, you know, what if, God forbid, someone listening needs a kidney or something one day? What happens?

Well, let me take a step back before I do that to just continue the discussion about the difference between commodity markets and matching markets. Commodity markets, only the price matters. And when you're buying shares of AT&T on the New York Stock Exchange, you don't care who you're buying from or which shares you're buying. But as we've already discussed in the real estate market, of course you care which house you're buying. That's a giant deal. So you can't just make an offer to the whole market. And in many of these markets that are matching markets, even when prices play the very important role that they play in real estate, they don't necessarily determine who gets what. An example I like to give is college admissions, where Stanford University doesn't choose its entering class by raising the tuition until just enough students want to come, until supply equals demand. It's expensive to go to Stanford, but lots of students would like to come. And so there's these whole other market institutions of applications and interviews and admissions and essays and all of that. And similarly with, with labor markets, you can't just decide you want to work for Google, you have to be hired. So matching markets are markets where you can't just get what you want. You can't just choose what you want. You also have to be chosen. And you can't just choose what you want, even if you can afford it. So prices don't determine who gets what, although they can be important. But there are matching markets where we don't allow prices to play any role at all. And organ transplant is one of them. It's against the law in the United States to buy or sell a kidney for transplantation, for example. So partly as a consequence of that, we have a great shortage of organs. There are 100,000 people in the United States waiting on a waiting list for a deceased donor kidney. When you register for your driver's license, there's a good chance that in most states you ask, would you like to be on the deceased donor registry? And if you check that box, then that paves the way. If you die in a sort of special way that makes your organs possible to donate, it paves the way to do that. But there aren't enough of those organs. We do about 11,000 deceased donor transplants a year, and there are a hundred thousand people waiting. So thousands of people die each year.

While waiting, and that is a terrible thing. So should it be Different, I mean, should we be allowed to pay? Should there be a market with which the actual money. I know many people find that distasteful in the US Although, as you said, I believe in the book, it's not that way in every country.

It's that way in almost every country. The exception, the one country in the world that has an explicitly legal market for kidneys for money, where you can buy and sell kidneys is, strangely enough, the Islamic Republic of Iran. But everywhere else in the world it's illegal, although there are lots of black markets. So that's something worth talking about. I devote a chapter to what I call repugnant transactions. But let me continue for a minute about kidneys. Because the special thing about kidneys that makes all of this an issue is that healthy people have two kidneys and can remain healthy with one. So if there was someone you loved who was dying of kidney failure, you could perhaps donate a kidney to them.

I know. I have a friend who did just that. She donated one to her father.

Absolutely. But sometimes you're healthy enough to give someone a kidney, but you can't give a kidney to your father because there's a mismatch of some sort. Kidneys have to be matched. And so what has happened in the United States and my economist colleagues and I have had a role in helping organize it, is that there's a kind of non monetary matching market for kidneys now called kidney exchange. And supposing your friend wanted to give a kidney to her father and is healthy enough to give a kidney, but her father can't take her kidney for some reason, which happens often. And suppose you're in the same situation, there's someone you want to give a kidney to, but your patient can't take your kidney, then a kidney exchange would happen. If it was possible for you to give a kidney to her father and for her to give a kidney to your patient. And that way two people would get compatible kidneys that would work for them, two transplants would be possible that wouldn't have otherwise been possible, and two lives would be saved. So kidney exchange has in the last 10 years, become a standard form of transplantation in the United States, and it's spreading around the world. So that's a kind of matching market where we don't let money serve any role at all. But exchange is what's going on. So it's clearly the kind of thing economists are supposed to study. And so that's been a big success, but it's been a big success in a war that we're losing. That is.

Some thousands of transplants have been done because of kidney exchange, but there still aren't enough kidneys. The question you ask about, should it be possible to compensate kidneys? Is a lively one. But as I said, it's not just against the law in the United States. It's against the law almost everywhere. As an economist, I feel that we don't understand that well enough. I've spent some time thinking about what I call repugnant transactions. So a transaction is repugnant if some people want to engage in it and other people think they shouldn't, even though it's not obvious that they come to harm themselves when the transaction takes place. And so kidney sales are a good example of that. There are clearly people who would like to buy kidneys. There are people who would like to sell them. And as a result, there are black markets that, like many markets that are illegal. It's hard to stamp out the market if people want to trade.

But we have laws against it. When you look into this, you see that there are lots of repugnant transactions and they change over time, and they're different in different places. I think they're well worth studying. I'm in California right now, and in California you can buy the whole supply chain of a baby. You can buy sperm and you can buy eggs, and you can have a surrogate artificially inseminated and carry the baby to term, and you can pay the surrogate. In New York, you can do the same things, but it's not legal to pay the surrogate.

I love how you call that the whole supply chain of a baby.

Yeah, yeah.

Interesting to hear it referred to that way.

Well, it's a novel thing, and I mention it that way partly to indicate that not everyone thinks that's a good way to describe having a baby. In Britain, I was just in England. I returned on Monday.

It's not legal to pay surrogates. It's legal to go through that process I just described, but you can't pay the surrogate. So, of course, there's very little surrogacy in England. And we have fertility tourists coming to California from England. And there are many more fertility tourists going to places like India and Thailand where surrogacy is cheaper, but also less well, less well organized. And so every now and then, bad things happen. And so you think about a market that's going up like that, that in some places they make it illegal, and in other places they make it legal, but with few rules to.

Prevent bad things. From happening. And when you talk about bad things happening, what you're talking about is a surrogacy agency, say, could go bankrupt while pregnancies are underway. So now the question is, what happens then? Maybe not all the pregnant women will be paid what their contracts call for. And so how will that end? So you could see that could be.

Resolved through reserve requirements like insurance companies have, right?

Absolutely. So now you're talking about or maybe.

An insurance policy that would insure against bankruptcy, right?

Exactly. So now you're talking about how to regulate the market. What rules should we impose on companies that perform surrogacy brokerage so that bad things won't happen? And that's the beginning of market design. You know, you say, are we going to allow a market? If we're going to allow it, what rules should it operate under? What should its rules be so that it doesn't have bad outcomes that we would regret?

That's what market design is about, allowing markets to work well, providing rules that allow them to work well if we think they should be allowed to work. There are lots of illegal markets like narcotic drugs and non narcotic drugs. So in the United States, the states are now starting to experiment with legalizing marijuana. So Colorado and Oregon, and there are places, this is where you don't have to say, I get headaches. Can I qualify for medical marijuana as one does in California? And we'll see how that goes. A giant experiment, if you like, in repugnant transactions has been going on around the world and in the United States in the last 10 or 20 years involving same sex marriage. That's a transaction that some people would like to engage in. They would like to marry each other, and other people don't think they should be allowed to. And in the United States, we went from no state allowing same sex marriage before.

2004 when Massachusetts legalized it, to all states now being, you know, having to allow same sex marriage, because the Supreme Court just made a decision on that. So these are things that can change fast when they change and are different in different parts of the world and continue to divide Americans. So, you know, when you ask me, should kidneys, should it be allowed to compensate kidney donors, that's a question that's.

Subject to a lot of discussion. I don't know how it will go. When you see something that's against the law everywhere in the world, there's a good reason to think it may stay against the law for a while.

Well, you know, it's interesting, Alvin, that you bring up the same sex marriage thing. Because, you know, my thought about that was, regardless of my own personal feelings on the issue, I don't see why the government should be allowed to get involved in whether or not someone's allowed to make a contract. I mean, I, you know, I probably, you know, do 2, 300 contracts a year in all my different businesses and so forth. Maybe even more, I really don't know. But it seems like I'm signing one a day almost. So, you know, why would the government be allowed to interfere in that? But I guess you're right. You know, the government, government interferes in all sorts of contracts. It won't let you do a kidney contract. It won't let you engage in a contract for the world's oldest profession. Of course, I'm talking about prostitution. So the government interferes constantly in contracts, Right?

Well, the government also supports contracts. If you and I sign a real estate contract and later I don't fulfill the terms of it, you can sue me in court. The courts are part of the government. So you say governments interfere with contracts, but they also give property rights. If I want to sell you my house, the question of, is it my house? Is normally something we resolve by looking at the title, which is registered in the county courthouse.

So a lot of what governments do is support contracts and markets, and they support them by regulating them. That is, judges will decide whether. When you and I have a contract dispute, there's an agency of the government that decides which of us is correct and what the remedy should be. And that's what makes contracts safe. And in general markets, one of the things marketplaces have to do is make transactions safe.

So government plays lots of role and often we think of it as interfering, but it's hard to think of which contracts you could. Of the hundreds of contracts you engage in each year, which would be safe to do if they weren't backed up by the legal system.

Oh, you'd have a bunch of vigilantes, would be terrible. It'd be anarchy. It would not be good. The, you know, a primary role of government is to have a court system and to enforce contracts. But the problem, I'm saying, is that some contracts aren't enforceable because they're not legal to enter into.

No, that's, that's right. That's where we talk often about repugnant transactions. Yes, right.

Yeah, fascinating. Well, you know, just kind of in to start wrapping this up here. You know, what, what is the sort of takeaway that the listeners should have, Alvin? What is the, you know, Is there anything kind of actionable here? Or is this just something to be aware of and know about? Or how can people apply this to their lives?

Okay, well.

Let me answer that two part. First of all, some of it is something to know about. I mean, one way to read my book is that it's sort of a field guide to markets. And you start noticing how markets work. And that gives you an awareness of them that is often actionable, but doesn't have to be. And of course, we're entering a political season where there's going to be a lot of discussion about what are free markets. And you and I have already touched on that. An analogy I like is a wheel that can rotate freely. If you have a wheel that can rotate freely, it's not in a vacuum, it's on an axle, it has well oiled bearings, and that's why it can rotate freely. And what we've just been discussing when we talk about contracts and property rights and rules and regulations, is that to work freely, markets need rules that allow them to let competition happen and to make transactions safe. So when our politicians talk about free markets, they often do it without saying what they mean. And they often seem to think it has to do with the number of rules and regulations. I think it's better to talk about what rules and regulations do. Markets need to work well and different markets need different rules. Now, in terms of actionable things.

One of the things I talk about is that many markets are congested a marketplace, once it succeeds in making a market thick, there are lots of transactions to think about and they're hard to evaluate in the time that you might have all sorts of strategies crop up in different markets. And I talk about at some length about signaling. One of the things I say, for instance, is if you know a student who's applying to colleges and they visit a college campus, they should be sure to sign the guest book at the admissions office. Because many, many colleges have so many applications that they can't easily give all of them careful consideration. And they have to think not just about who they like, who they think would be a successful student, but who likes them enough that they would succeed in recruiting them if they make them an offer of admission. And so they look for signals. And because it's so easy nowadays to submit many college applications, getting an application is not a strong signal of interest anymore. But.

Coming to visit the campus, you can't easily visit two dozen campuses, even if you can make two dozen applications. So colleges look for signals of interest like that, just as on dating markets, signals of interest are important. You know, one of the things I talk about in the book is how in many Internet dating sites, women with attractive photographs get many more email contacts than they can really process.

That was fascinating. Since I'm single, my ears perked up when I. You know, it's just I was talking to a friend about match.com and the other dating sites last night. It really doesn't work very well, at least for men, because it's so imbalanced. And every guy in the world is emailing the attractive women, and, you know, they can't sift through all the emails. It's ridiculous.

So a market design innovation that some friends of mine did on an experimental basis with a dating site is they gave everyone two virtual roses that they could send each day in their email. So you could send as many emails as you wanted, but only two of them could have roses attached. What that meant is if you got an email from someone with a rose attached, it might be worth looking at because they weren't sending off 1,000 of those. And what they found, Muriel Nitaly and Sue Lee, when they did this experiment, was that emails with roses attached led to a lot more contacts, subsequent contacts, than emails without. And so that's a little like visiting the. The college campus of a place that you're applying to or writing a persuasive cover letter when you're applying for a job. That shows that you're not applying to all the jobs that you found on Monster.com, but rather that you know what this company does and have an idea of what job you could do for them. So sending signals is important, not just in markets. That's what peacocks have big tails in order to show that they're healthy and can escape from foxes, even though they have healthy tails. And there are two kinds of messages that you send in a congested market. One kind of message is.

I'm interesting. You should be interested in me. I'm talented. I have a desirable property, whatever. So when you're applying to college, for example, that's the kind of message you send with your high school grades and your extracurricular activities. Look at me and what I've accomplished at the ripe old age of 18. But there's another kind of signal you send, which is, not only should you be interested in me, but I'm interested in you. So if you respond, if you try to make a match with me, you might have a chance of succeeding. I might be worth talking to. And that's the different kind of message you send by visiting the college campus, by sending a rose, by sending a carefully worded email that shows that you've read the profile of the woman you're sending your email to. In congested markets, you have to send both kinds of signals. I'm interested in you and you should be interested in me.

Very interesting. Good stuff. Well, Alvin, give out your website people where they can find out more. You've got some great blog articles. You've got one that's talking about assisted suicide and the different organ donation laws, how they vary state by state. Fascinating stuff.

Well, if people search on Google for market design, they'll find my blog or if they search on my name, Alvin Roth. And of course the book is called who Gets what And the New Economics of Matchmaking and Market Design.

I would highly recommend that book to anybody who's interested in this concept. And it just applies to every area of our life, pretty much every day of our lives. So understanding the way markets work, very, very important. Alvin E. Roth, thank you so much for joining us.

Thank you.

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