Recent developments in economic theory and in experimental economics have profoundly changed the way that economists can contribute to the design and implementation of economic policy. As a result, economics has become intensely practical and relevant in domains that were previously undreamt of.

Economic thought is usually broken up into microeconomics and macroeconomics, though at a fundamental level there is only one discipline. The developments with which we are concerned are in the foundational areas of microeconomics. Microeconomics has traditionally dealt with private and public decision making in a world of scarcity, and with the social institutions that have arisen in this environment. Principally, this has meant markets. Economists have a good understanding of why it is that sometimes markets work well (the “invisible hand”), producing outcomes that are in some sense socially optimal, and that sometimes they do not work well at all (market failure). Recent advances take us well beyond the classical study of markets, and provide a powerful way of understanding many non-market institutions.

We now understand that information, especially asymmetric information, is fundamental in shaping economic institutions. Informational constraints are as pervasive as resource constraints, and we now have good tools with which to understand them. With this insight has come a great expansion in the depth and the extent of the domain to which economists can contribute. In particular, the limits to markets, and the nature of many non-market institutions, have become much clearer.

Decision theory, game theory, information economics, and experimental economics have all matured (as has been recognised in a string of Nobel Prizes: John Harsanyi, John Nash, Reinhard Selten, James Mirrlees, William Vickrey, George Akerlof, Michael Spence, Joseph Stiglitz, Vernon Smith). This maturity brings with it an opportunity to contribute in new ways to policy design.

We have known since the work of John Harsanyi that many social institutions, including markets, firms, and regulatory arrangements, may fruitfully be modelled as Bayesian games of incomplete information. With this realisation comes the insight that designing institutions means choosing the games that people will play. Theory and experiment work hand in hand in this process. By placing real decision makers in a controlled laboratory environment, where they make real decisions with significant financial consequences, we can check whether theory and reality match up, and we can test and fine-tune policy designs in a low cost, low risk setting. The use of theory and experiments working together in this way has become known as Economic Design (a term popularised by Alvin Roth in a well known paper The Economist as Engineer: Game Theory, Experimentation, and Computation as Tools for Design Economics , Econometrica 2002).

The partnership between economic theorists, experimental economists and practical policy professionals has proved very fruitful. The cycle of diagnosis, analysis, design, laboratory validation and fine tuning, has provided a practical path to the design of innovative, custom-made policy instruments. As is often the case with economics, the discipline and commitment to clear thinking that are inherent in this methodology are one of the reasons for its success. Applications range from multi-billion dollar communication spectrum auctions, the design of electricity markets, the design of emissions markets to reduce pollution, and the allocation of London bus routes, to the allocation of airport landing slots and the matching of medical interns to hospitals. In Australia, the recent “Bush Tender” biodiversity procurement auctions are changing the way we think about environmental policy. 

Three areas need to be developed if we are to reap the maximum benefit from this new approach. The first is training and scholarship in modern economic theory. This is already an area of relative strength, on which we wish to build. The Australasian Economic Theory Workshop, which has met annually for the last twenty five years, provides a national focus. The second is to develop the area of experimental economics. Although there are a number of individual experimental economists who are active in Australasia, and there are excellent international linkages, there is a need to consolidate and develop this area. The third is to develop the linkages between theorists, experimentalists, policy experts, and other disciplines (for example, engineering, ecology, hydrology). The Network will be active in developing the discipline in all three of these areas.