0:33 Intro. [Recording date: June 29, 2015.] Russ: Now, early in your book you give some examples of markets that struggle to reach the outcome that we might hope they achieve, often because they don't use prices to clear the market; there may be legal restrictions. But sometimes there are inherent aspects to the market which you call 'thinness' or other problems. What are some of the examples of markets that you've studied and what are their problems? Guest: Well, let me start by mentioning that a lot of the markets that I study are matching markets, in which prices alone don't clear the market. But there are other institutions to help clear them. So, labor markets are like these--they are among the markets that I've studied. And in labor markets, as in other matching markets, you can't just choose what you want. You also have to be chosen. So, labor markets have all these other institutions about applications and interviews and offers and acceptances. And sometimes those are used for competitive purposes in various ways. So, for example, right now if you knew someone who was just graduating this month from a prestigious law school and was going to take his first job as a clerk for an appellate judge, there's a good chance he would have gotten that job two years ago, when he was a beginning second-year law student. And he would have gotten that job with an exploding offer--which meant that he had to say yes or no when the offer came, before he could find out what other offers might be coming. Russ: A very short deadline to respond. Guest: Very short deadline. Russ: That's the exploding part: it's going to disappear. Guest: Exactly. And so that's a market that doesn't work the way we normally think a well-functioning market should work, where you can consider lots of alternatives. But it's one of the ways that judges compete with each other. And that's a market where the judges can't compete on price because Congress sets the wage for clerks. But it turns out that other markets work that way, too. When private equity firms are trying to hire young investment bankers, they do the very same thing. When law firms which pay salaries very freely, try to hire new associates, they do the same thing--often with competition through summer associateships while people are in law school. So that new lawyers in general will often, as they go to their jobs after finishing three years of law school, have been committed to those jobs for years. Russ: And the challenge here--it's a congestion problem, that--what do you want to call it? natural, unnatural--it's the nature of education: everybody's hitting the market at the same time. Guest: So, one problem with congested markets is that it might be hard to deal with all the transactions that you have to consider when they all come on the market at the same time. And that's one of the things that--for instance, the clearinghouse for new doctors tries to address. That's a market that went through problems being 'thick'--problems with people not being able to consider many offers simultaneously. And then it went to problems with congestion. And today many doctors get their offers through a computerized clearinghouse that allows them to decide in advance, once they've learned all about the jobs, the wages and conditions, which ones they would like first, second, third. And then it automates the process of offers and rejections so that the preferences of doctors over all the jobs and of employers over all the doctors are taken into account. Russ: And another example which I hope we'll get to would be school choice--assigning students to a grade school, a kindergarten, a high school, etc., in say New York or Boston, two markets you've been involved in. Guest: Right. So that's a market where we don't allow prices to do any work at all. When we are giving out places in public schools we want them all to be free and we don't want wealthier parents-- Russ: Speak for yourself. But yeah, okay. That's the way it is. Guest: We in society. We organize schools so that you can't pay to get your child into a better kindergarten. Or you can't easily pay. Or, of course, there's a whole private school market operating alongside the [?] of school markets. Russ: But it works in a somewhat similar way. It has the same challenges in that they all start around the same time. Right? And they don't use price exactly to allocate--they don't sell their spots to the highest bidder. They have other goals besides maximizing revenue. Guest: Absolutely. And in general matching markets don't use price to equate supply and demand. So, Google doesn't hire workers by lowering the wage until just enough engineers want to work at Google. Google has a very desirable job; lots of people would like to have it. But you can't just choose it if you like the wage. You have to be hired. Russ: And as I like to point out, that's true of the NBA (National Basketball Association) also. For those of us who have certain other deficiencies [?] some of us can't work for Google; some of us aren't tall enough, athletic enough to work for the Boston Celtics. Guest: Right. But that is a different kind of problem: the market might clear without me working for the Boston Celtics. Russ: It does. More or less. Guest: But think about universities: Stanford doesn't set tuition so that supply equals demand. It's expensive to go to Stanford, but a lot of people would like to come at the current tuition. And so there are all these other institutions: applications and admissions. And so Stanford--college admissions--is a matching market. Money is important; prices play a role; but you can't just choose what you want, even if you can afford it.

6:18 Russ: One of the things I struggled with when I was reading your book and thinking about your work is that this issue is pervasive in the sense that quality matters. Besides price, in any market. So, talk about how--when I was raised as an economist, the approach that tried to deal with this was hedonics--Sherwin Rosen's work--trying to figure out how do we deal with competition when price isn't the only thing that matters: we also care about quality? Is that all that we are talking about here or is there something subtler going on besides the fact that there's a certain minimum quality to get into Stanford. Because they really don't just care about that, either. That's not--it's not just, 'Well, they don't just care about the money. They care about quality.' It's something other than money-and-quality. It's a subtler thing going on with the matching. So, talk about that. Guest: In matching markets you care who you are matched with. And there's something impersonal about buying things in a commodity market. When you go on the New York Stock Exchange to buy shares from some company, you don't care who you are buying them from. You don't worry that, whether they took good care of the shares. And they don't worry that you'll take good care of them. But when you admit someone to your college, you are building a class. You are thinking of that individual as a person. When you hire someone, you are hiring an individual. And if the offer you make to hire someone is rejected, then you have to find someone else to make the offer to. The offers are made personally, not to the market. Not to the whole market. Russ: And I guess the other way to think about it is that quality here is so multi-dimensional it's not really meaningful to talk about it as, maybe as a dimensional problem. We don't just say, 'Well, you've got to get to a certain score on these 10 attributes.' There's--I guess the way I think about it is the marriage market. You don't just say, 'Well, I want my spouse to have these characteristics, x, y, and z; and as soon as it gets above a 17, it'll be fine.' There's something subtler going on. Guest: That's exactly right. I'm glad to--this changes my priors on whether you are happily married. You can't just choose your spouse. You also have to be chosen. And you choose an individual. And it's hard to turn that into a commodity. Incidentally, it's hard to turn commodities into commodities. The way I talk about it in the book, I say, 'God made wheat. But the Chicago Board of Trade made No. 2 Hard Red Winter Wheat.' And Number 2 Hard Red Winter Wheat is a commodity sufficiently specified that you no longer need to know who you are buying it from. Russ: And of course--and I really enjoyed that part of the book, by the way--and of course, even though there's some gray areas--I find it fascinating that people in general, when they want to sell their house, they want to sell, in that case they just want to sell it for the most money. They care about whether the loan is going to go through to the buyer. They might care about the speed with which they sell the house, obviously. But once the house is sold, they are going to sell to the highest bidder once those other attributes are taken care of. And yet, emotionally, some people don't like the idea of certain kind of people living in their house, who might not take care of it. It just--we have emotional baggage with lots of transactions, once we get past wheat. It seems to me. Guest: That may be one of the reasons for the persistence of realtors as intermediaries. Russ: Correct. Guest: Which I think is actually a little hard to explain. But that's right. You might like not like to know that the person buying your house looked at your kitchen and said, 'Well, this will have to go.' Russ: Yeah. Of course. Guest: After you carefully chose all the countertops. Russ: No, I think there's no doubt about it. That when you do a renovation in your house, some kind of renovation or addition, you are reassured that the person is going to take care of it. There's some kind of aesthetic there. And art to the house-re-doing that you care about. That's the way it is. Guest: Well, and you might sell for not the most money if the person who offered the most money was planning to scrape the house and build an entirely different house. Russ: Correct. Guest: Compared to someone who was offering almost as much money but who loved your house and thought that the yellow walls in the living room were perfect. Russ: And of course at some price that becomes untenable and you'll sell it anyway to someone who is going to tear it down.

10:32 Russ: So, let's talk--I want to take--you've done a wide range of work and much of it is in the book. I want to take a couple of examples and contrast the problems that are involved and also the market design that you used to deal with those problems. So, we're going to start with kidneys--which is a matching problem of one kind. Then we'll move on to a different kind of matching problem, which is the problem with assigning students to schools, in, say, a public school system. So let's start with kidneys. This is a rather--I found it quite moving, actually, because there are very few times when an economist--first of all there's very few times when an economist makes a difference in the real world, to start with; but to make a difference in the real world and save a life. It's one thing: I give Julian Simon a lot of credit: de improved the allocation of airplane seats by letting people, letting people over airlines to overbook and then volunteer to give up their seats. That was efficient, good for everybody, more or less. But this is better. So your research has helped save people's lives and transform their lives. So, let's talk about the basic problem with kidney matching and some of the different stages that the market design went through to cope with that. Guest: Well, end-stage renal disease--kidney failure--is a deadly disease. But you can be kept awhile, for some years, on kidney dialysis. However, the best cure, the treatment of choice, is transplantation. And right now we have 100,000 people on the waiting list for deceased-donor kidneys in the United States. So, one way to get a kidney plant is from someone who has died while on a ventilator and who wished to make a donation. And their kidney can save your life. But we only do about 11,000 of those transplants a year, because that's all the viable kidneys that we recover. Russ: In that case, there's a waiting list. And they just go down the list? When a person dies on that ventilator, they go down the list till they find a medical match? Guest: Yes. With some more complications. The lists are regional, so they are differently long in different parts of the country. And there are some priorities. For children, for example, they are higher on the waiting list than people who have been waiting the same amount of time for adults. There are some other priorities as well. But there are only 11,000 deceased donor kidneys available for transplantation in the United States. So, the waiting list is very long. And people die while waiting. Thousands of people die each year while waiting. There's another way to get a kidney transplant, and that's because healthy people have two kidneys, and can remain healthy with one. And so if you are healthy enough to donate a kidney, you could save the life of someone you love who needed a kidney by giving them one of yours. But sometimes you are healthy enough to give a kidney but you can't give a kidney to the person you love because your kidney isn't compatible with them. There are a bunch of medical criteria that go into making sure that your kidney will work in someone else's body. And if you are incompatible, then loosely speaking you just can't give them a kidney. And what they used to do was send you home. They'd say, 'Thank you very much. Your offer is a generous one. Now go home.' But there are other incompatible patient-donor pairs in the same situation. So, you might want to give a kidney to someone you love, and I might want to give a kidney to someone I love; and neither of us can do that. But it might be that my kidney is compatible with your patient, and your kidney would work for my patient. And so that opens up a possibility of exchange. Incidentally, this is a market into which we don't allow money to work at all. It's against the law to buy and sell kidneys for transplant, just about everywhere in the world. Except the Islamic Republic of Iran, where there is a legal cash market for kidneys. Russ: Yeah. You didn't mention how their market is working. Has anybody studied that, by the way? Guest: There have been some studies of it. It's not a happy market, in the sense that a lot of the donor/sellers who agree to be interviewed in studies ask for anonymity. So it's legal, but it hasn't become respectable. Russ: Interesting. So, back to our world. Let's stick with the United States. What changed? What did someone come up with to make it better? Guest: So there started to be some kidney exchanges which were exchanges between incompatible patient-donor pairs. Economists didn't invent this. But when the first one happened in the United States--it happened at the Rhode Island Hospital in New England--and over the next 4, 5 years there were another 4, 5 among the 14 transplant centers of New England. And what my economist colleagues and I did was start to think about how to organize this on a large scale. It's now a standard form of transplantation in the United States. And we thought about how to get it going: how to make the market thick, first. How to assemble data bases of patient-donor pairs with the information that you needed to see when exchanges were possible. How to arrange larger exchanges than just between two pairs. Because sometimes that double coincidence of wants doesn't happen--the kidney that we need isn't the one you have, even though the one you have, even though you have a kidney that you need. Russ: So you need a third pair. Guest: So you need a third pair, for example; and that eases finding that double coincidence. And then, over time, we've started to make great use of chains of transplants started by non-[?]active donors. Those turn out to be very useful, because we don't have to do all the surgeries in a chain simultaneously; and that sometimes lets chains form that have [?] more transplants in them. Which means when you take a photograph of all the people involved, there will be 60 people in the photograph--30 nephrectomies, 30 kidney removals, and 30 transplants--30 kidney installations. So, kidney exchange is now well accepted in the United States, and is growing around the world. But I should say though I could tell you about victory after victory, it's in a war that we're losing. That there are more people waiting for kidneys today than there used to be. That's partly good news. Part of that good news has to do with the reduction in traffic fatalities, for instance. That was one source of diseased donors. But it's partly bad news. There's an epidemic of diabetes that often leads to kidney failure. Russ: Right. We have 11,000 deceased-donor kidneys; and we pick up another 6 [6,000--Econlib Ed.] from the chains? Is the number 17? Guest: Well, we pick up a number--we pick up 6000 additional living donors-- Russ: Per year-- Guest: In a year. Not at all, all for kidney exchange. Many of them are you love someone and want to direct someone a kidney-- Russ: [?] Guest: Incidentally, those numbers mean that we more have more living donors in the United States than we had deceased donors. Even though we have 11,000 deceased-donor transplants and only 6,000 live-donor transplants. Because deceased donors give two kidneys. Russ: Oh. Good point.

18:12 Russ: You point out in the book--we started off, there was a simultaneity as the economics comes in rather directly. The original pairs were simultaneous. So, all four people would be on the operating table roughly on the same time. A person would donate a kidney; they would race out to take that to the other pair. The other pair, one of those two would donate a kidney and they would race that, to bring it to the first person, this donee, the person who needs a kidney. You talk about the unease with which hospitals felt about non-simultaneous donations. There's an incentive problem. What is it? Guest: The National Organ Transplant Act, the law that says that you can't buy a kidney, actually says you can't give valuable consideration for a kidney. And one way to think about that is you can't write a contract for a kidney. So there isn't a contract that's legally enforceable in the United States that says 'We--' one incompatible patient-donor pair, 'we give you a kidney today and you give us a kidney tomorrow.' And so the reason we do those exchanges simultaneously is if on Day 1, Pair 1 donates a kidney to Pair 2, and on Day 2, Pair 2 fails to reciprocate, Pair 1 would be really harmed. They would have had a surgery that didn't help them, and they would no longer have a kidney to participate in future kidney exchanges. So, to prevent that from ever happening, those pairwise exchanges are virtually always done simultaneously. Which means that you need four operating rooms and four surgical teams to do the two nephrectomies and two transplants. So that limits how many transplants you can do. But we now have an increasing number of non-directed[?] donors. And when you have a non-directed donor, you can do the transplants in a chain. It doesn't have to loop back to the non-directed donor, because a non-directed donor is someone who wants to give a kidney without having a particular recipient in mind. So you can now organize a chain where a non-directed donor gives to some patient-donor pair that the donor in that pair then gives to another pair. And so forth. And as I said, those chains are sometimes very long. And the reason you can do those non-simultaneously, which is what allows the chains to be long--so you can solve the logistical problem of many simultaneous surgeries--the reason those don't have to be done simultaneously is each pair gets a kidney before they give one. So, if a chain is broken, it's disappointing; but it's not a tragedy for the people who didn't get a scheduled kidney. Because they still have a kidney. They can participate in future exchange. In the next week or whenever we do another kidney exchange. So, maybe soon. And that cuts the cost of a broken link, which allowed us to explore the benefits of long chains. And this was actually something proposed by my economist colleagues and myself along with some surgical colleagues. But the surgeon who first took the leap and first did a non-simultaneous chain was Mike Rees, who heads an alliance called the Alliance for Paired Donation. Which is one of the original organizations that organizes kidney exchange and that we helped organize these kinds of chains. Russ: So, you write in the book, the part I found very moving, is you were in the operating room or in the theatre, for one of these--early ones? Or-- Guest: Yeah. I think the one that I wrote about happened in 2007. So that's quite early. Russ: And what was that like? Guest: Well, I was--I'm not a doctor. Russ: Well, you have a Ph.D., though. Guest: I'm not a medical doctor. Russ: I like to say--my running joke is, when people ask me if I'm a doctor, I say, 'Yeah, but not the kind that helps people.' But you actually are the kind of Ph.D. that kind of helps people. So, carry on. Guest: Well, so medical doctors draw appropriately a big distinction between M.D.s and Ph.Ds. Russ: Oh, yes, they do. No doubt. Guest: And in fact, when I visited this surgery, I was introduced to the surgeon by the nurse who was organizing the OR [Operating Room] as Dr. Roth. And then, as the surgery went on, they were explaining to me in great detail what they were doing. And she came over to me, 'Dr. Roth,' she said, 'Do you have a Ph.D.?' And I said, 'Yes, I do.' And she said, 'I could tell from the way they were talking to you that you were not an M.D.' And she changed the log, in which, when they had said 'Dr. Roth,' she must have written 'Alvin Roth, M.D.' Russ: That's very funny. Guest: So, I was a little concerned actually, with how I would react to the OR. So I skipped breakfast. But that turned out to not be necessary, because it was really very interesting and not all that anatomical. My wife is a human factors engineer and watches a lot of surgeries, and she says it's a little bit like cooking: they have their work field very narrowly defined and they are working in it. And there's flesh, but it doesn't seem like a person. Russ: Yeah. None of it's recognizable. I guess. Guest: So the surgery I visited was in Cincinnati, Ohio, and the donors had traveled, so the living donor was right in the next OR to the person who was getting the transplant. And her patient, and his donor, were in Toledo, Ohio, where Mike Rees was. And in Cincinnati, where I was, Steve Woodle[?] was the surgeon I was accompanying. They first anaesthetized the patients and did the initial incisions. And then Steve got on his cell phone, and said, 'We're ready in Cincinnati. Are you ready in Toledo?' And the answer was, 'Yes, we're ready in Toledo.' And then the surgeries went ahead. The kidney was removed--which is the point of no return. And transplanted very quickly in this operating room that was just steps away. And at the same time, those things happened in Toledo, Ohio. Russ: How long does the surgery take, by the way? Just a side note? Guest: Good question. Russ: Roughly. Guest: I don't know the answer to it, but what I did notice is that they started two clocks when they took out the kidney. And the first clock was stopped when the kidney came out of the ice bucket--when it was no longer on ice. And the second clock was stopped when blood began to flow--when the kidney was oxygenated again in the patient. And I think we are talking about less than an hour for the second clock. Because the kidney didn't travel. Nowadays, the kidneys more often travel. And so you have some hours of what is called 'cold ischemia' time on ice. But apparently that doesn't harm the operation of the kidney. Russ: Incredible.

25:05 Russ: Now, there's one line in your book that I couldn't help think about and you didn't expand on, so I'm going to expand on it here. You mention in passing that some hospitals were uneasy with some of these arrangements; they were afraid they might lose some control that they currently have over their kidney donors, and when we move to a more national market, and as economists, we tend to think bigger markets are better--thicker, more choice, more ability to satisfy and prove things--but there was some pushback from doctors and hospitals, who, correctly, for whatever it's worth, receive revenue from these processes. And I thought it was interesting: You didn't talk about it there. Many of us--I'm not one of them so much because I am an economist maybe or for whatever reason--many people are uncomfortable with the monetary aspect of this kind of transaction and want to get the money out of it. Don't want it to have a monetary aspect. But we have no problem with paying the doctors, paying the hospital. They make enormous sums of money and they are very skilled. I think that's great. But it's interesting that our repugnance, which is something we're talking about, mainly toward the end of the interview--our repugnance stops at the side-door of the person--where the incision is made. Outside of that, eh? Sure, get rich. You find that interesting? Guest: So, it is interesting. But that may not be the right way to look at it in order to diagnose these repugnant transactions, which are transactions that some people would like to make but other people don't think they should be allowed to. So, it's possible that some people find it repugnant that surgeons get paid a lot of money. But I think most of us, as you say, would prefer to be operated on by surgeons who do that professionally rather than do it in their spare time after doing whatever they have to do to earn a living. I think that much of the repugnance about buying and selling kidneys comes from the concern that somehow this will disadvantage poor and vulnerable donors. And that there may be aspects of monetary exchange in markets that can be coercive or exploitative. And it's those concerns that lead to laws against buying and selling kidneys. Which, incidentally are around the world, so as a social science phenomenon--this is something much more uniformly legislated against than other complicated transactions that people often feel uneasy about and that are illegal in some places, like commercial surrogacy, for example. Russ: For pregnancy. Guest: Right. Russ: So, I don't know. I think the model would be though not a doctor doing it as a side project; but we don't say, 'Well, medicine's too important to be left to the profit motive.' Well, some of it we do. But surgery, we say, 'Well,' we could say, 'I don't want my surgeon to be in it for the money. So I'm going to cap surgeons' salaries. It's going to be a profession. I'm going to cap them at $100,000 a year. That's plenty. And then the people who come into it will be the ones who care the most.' Now, most people would say, 'Well, yeah, I think maybe I don't want those who care the most, but maybe are the most skilled--it's just interesting. We don't draw the line there.' Guest: It is. So, I think the question of what kind of social support markets get is an important one that economists have understudied, because markets require social support. So, letting--well, we are seeing something like this now with Uber and taxi services. We used to be content with municipal monopolies on taxi services that were enforced by local regulations, and now Uber has come into the market, sort of trampling on those regulations. Russ: Yeah. Guest: And is--however things end up in the steady state, has forever changed the taxi market. Russ: Yeah. Guest: So, it'll be interesting to see how that plays out. But we seem to tolerate Uber breaking the rules because there was something unsatisfactory about the way the taxi market was-- Russ: Well, some of us do.

29:23 Russ: I just want to raise one other issue with respect to the surgeons and repugnance. Which is, in the case of college athletes and here we are on the campus of Stanford University, which is a dominant force in many college athletic competitions; also tries to maintain high standards in the classroom, which makes it a little unusual, which is a handful of universities who try to do that--I don't know how widespread it is; who knows?--but a lot of people suggest that a college athlete as an amateur is a sham. That college athletes make a lot of money for the institutions and that they should be compensated--maybe not all of them; maybe not all at the same rate. There's a lot of different discussions. But what I always find interesting is that the coaches are always against this. And you can hear them on Sports Talk Radio: they'll say, 'Oh, that's a terrible thing. It would ruin the whole thing.' Of course, they're the beneficiaries, because the competition spills over into their salaries. And so even though there is this repugnance on the part of--I certainly conceded there's repugnance on the part of the general public of possibly, about a kidney market, which they may not fully understand all the ramifications of, but emotionally it may trouble them--doctors, they maybe have some vested interest in seeing this persist. What are your thoughts on that? More generally, you've had a lot of contact with great surgeons. Do they have any thoughts on this that are different than the general public? Guest: So, I think there's some merit to the idea to the idea that people like getting their raw materials for free. Doctors wouldn't be the only ones. But the surgeons I talk to, that's not at the front of their minds. It possibly could play a role Russ: Even [?] Guest: But often what doctors have in the front of their minds is the idea that they should do no harm. And what they are a bit worried about is if the person they are operating to remove a kidney, the healthy person on whom they are doing a surgery, is not there for the right reasons, that they may somehow have been exploited. Now, this is a confused and confusing idea, that economists have not yet come to grips with in a way that let's us discuss this intelligently with medical ethicists, say. Because by and large, when you say to an economist, 'Can I make someone worse off by offering them money?' you think--economists, our first reaction is, 'No.' Russ: As long as it's not coerced. Guest: As long as it's not coerced. But of course as we start to think that people may not be perfectly rational you could at least speculate that if you offer me a lot of money, I might do less due diligence than I otherwise would have, if I hadn't been dazzled by the sum you offered me. And that I might make a decision that I would not have made if I would have had more time to think about it. Even given the amount of money that I might somehow be rushed into it. So if we are going to think about markets for kidneys, we'll want to regulate them very carefully. We'll want to make sure that there is lots of informed consent. Russ: Maybe a waiting period. But I've actually heard people argue that we should discourage the kind of donation you talked about originally, a few minutes ago--not originally but a few minutes ago. The kind of donation where it's just open ended. That, obviously, that's a person who has got maybe some emotional trouble. They should receive counseling. I don't know. My first thought is that's a gloriously generous thing to do and we should encourage it, not slow it down. But obviously [?] Guest: Well, in fact, that's certainly a concern. So, if you were to present yourself as a potential living kidney donor, whether for someone you loved or us an undirected donor, you would go through a battery of tests, not merely physiological but also trying to ascertain both your mental health and your state of mind. Because one of the things they worry about is you might be being coerced in some way. Russ: By the recipient. Guest: Yeah. Family dynamics. If your brother needs a kidney and your mom thinks you should give a kidney to your brother, you might be coerced. Russ: Sort of. Guest: Well, if you might not want to give a kidney, and one of the things that goes on, not often mentioned, but one of the things that goes on in the evaluation process of donors were if you were to say to the people evaluating you, 'Well, you know, really, I never liked my brother; he used to beat me up; and I really don't want to give him a kidney but it would be a terrible breach with my mom if I didn't,' they will report that your kidney is incompatible. That it's not suitable. So, they'll give you an out, and take it upon themselves to do that. So, that's a complicated set of decisions, too. Russ: Yeah. Yeah, that's fascinating.

34:19 Russ: Let's move on to school choice. Because I think it's a slightly different case. And when we're done with both these examples, I want to start thinking about some of the allocative and welfare implications of these different models. So, talk about the problem where parents have to say a preference for schools for their kids. Seem pretty straightforward. What's the big deal? You just list the ones that you want your kids to go to. You pick your first choice, your second choice, your third choice; and then you assign people to those schools. Why did that system originally not work very well? Guest: Okay. So, let me take a step back and think about marketplaces in general. And the way I talk about them in the book is to serve the market well, marketplaces have to help make the market thick, they have to deal with-- Russ: Thick? Meaning? [?] Guest: Lots of people together. Which isn't a problem for municipal school districts. There's lots of [?] to go to high school. Then they have to deal with congestion. That's going to be a big deal for some of these school districts. That is, how to process all the decisions that have to be made when the market is thick. And then, they have to make the marketplace safe to transact in. And what that can involve, one of the forms of safety, is it's safe to indicate what you want. Because if you can't try to get what you want, then it's going to be very hard for you to get it. And that came up in a number of school districts. Russ: You wouldn't think it--I mean, what could be unsafe? Guest: Well, so let me tell you about that. Russ: Yeah. Guest: So, in New York City (NYC), where they had a big congestion problem, they also had a safety problem when they first approached us. The way you used to applied to schools in NYC was you would fill out a form: First choice, second choice, third choice. Those forms would be xeroxed and sent to the schools. And that was your application to the schools. Then the schools would make various decisions and they'd process these in the mails, and waited for responses. And that was a congestion problem that was a big problem. But the safety problem was that the schools didn't just get your application. They saw your rank order list. And they could see: 'Oh, look at that! You're applying to me, and I'm your second choice.' And school principals could, and did sometimes, decide on a policy that said, 'So many children are applying to our school that we will only admit children who list us as their first choice.' What that meant, of course, was that if you didn't get your first choice, you might lose the opportunity to go to many other schools that you would like to go to as your second or third or fourth choice, because you had only a list: One school as your first choice. Russ: And they'd get filled up. Guest: A timing issue. So they'd get filled up with first choices. So, a school that might have accepted you if you had listed them as your first choice, would be filled with people who had listed them as their first choice before you could get to them, if you were rejected by your first choice. So it was no longer safe for you to put down as your first choice the school that you simply happen to like first. Because maybe that one was hard to get in to. And then maybe you would have this big risk of not getting into a school that you could get into if you listed it first. Russ: So you needed to be strategic. In that world. Guest: You needed to be very strategic. And your first choice became not a question about what school do you like best, but a question about what's the best school that you think you could get into if you list it as your first choice? Which is a very different question. Russ: Correct. So, what did you do to improve on that? Guest: Well, so, for NYC and then subsequently for other school districts-- Russ: And this, we should add, is an innovation of course. In the old days you couldn't choose your school at all. You were just stuck with your neighborhood. So that's where this problem came from. Guest: That's right. But NYC already had school choice. Boston already had school choice. Many American cities now have school choice, partly because when we send children to schools in their neighborhood, children who live in poor neighborhoods are often condemned to go to poor schools. And the idea is if they, if school choice can take place then it makes the schools that aren't working well smaller that makes them easier to fix or to close or to co-locate in the same building with schools that are doing better, and makes it easier to handle the problem of schools that aren't educating students well. Which, of course, are often ones that parents don't want their children to go to. So, what we did in New York and subsequently elsewhere is we helped them build a computerized clearinghouse that uses a deferred acceptance algorithm with children proposing. That's a mouthful. But it has the effect that it's safe--it makes it safe to list what your true first choice, what your true second choice, what your true third choice. And the way it does this is, if you, when you use a different acceptance algorithm, if you don't get your first choice, you get your second choice, with just the same probability that you would have gotten it had you listed it as your first choice. And similarly, if you don't get your second choice, now your chance of getting your third choice is just the same as it would have been if you had listed it as your first choice.

39:14 Russ: And it does that by taking that original power away from the Principal to sift through those and cherry-pick the students that listed them first, say, or so basically what you are doing is, you are marrying off students with school. You are saying--so can you give us a little more of the flavor of how that happens inside of the algorithm? Guest: I can. But first, let me say that what we did, when you say we stopped the Principals from cherry picking--that part has to do with no longer allowing principals to see the rank order lists of students. So, they are no longer getting your xeroxed rank-order lists. They are just be told-- Russ: You are interested-- Guest: Joe applied to you. Russ: Right. Guest: And that prevents them right there from saying, 'On my rank order list, I will only rank order students who have listed me first.' Because they no longer know who listed them first. Russ: So, how do I--if I'm a--a more basic question: Do schools rank students? Guest: So, in NYC, they do. But in Boston, for example, they don't. So in NYC, many schools--not all--the Principal has the right to rank students. And they tend to rank them in somewhat broad classes. But, they are concerned with things like reading score and math grades and things like that. Which they have. In NYC what we organized was school choice for high schools. In a number of other cities--in Boston, in New Orleans, in Denver--we've helped organize school choice for all grades. But in New York City, because it's with high schools, the students who are applying, if they've been in the New York City public school system, they have a long record. The principals know a lot about them. So, of course they can have preferences over them. In many cities, the principals have no preferences. They don't play a role in admissions. Instead, the school district gives priority to students based on factors like, do they have an older sibling who attends the same school? Do they live near the school? Things like that. And often at the end there are random lottery numbers that are used as tie breakers. So, let me tell you actually about how Boston used to organize its school system. This was studied by my colleagues, [?] Atila Abdulkadiroglu. And Atila has gone on to be one of the giants of school choice. What Boston did was they had these priorities for schools, and they asked you for your first choice, your second choice, your third choice. And then they tried to give as many families as possible their first choice. Russ: Seems like a good idea. Guest: It seems like a great idea. And when some school had more people applying to that school as their first choice than it had capacity, then they used these priorities, these tie breakers: first we let in the kids who have older siblings; then we let in some of the kids who live nearby; then we use the lottery numbers. So, that was unsafe--that made it unsafe to tell Boston schools which was your first choice, because if you failed to get your first choice, your second choice might now be filled with people who had listed it as their first choice. Even though your child had an older sibling who went to that school. Russ: Too late. Guest: You'd lost your priority by not listing it was your first choice. So you had to be very careful; and maybe you said, 'Although we'd like our child to go to an all-day kindergarten, let's send him to the school where his older brother goes because we can get into that school and that will be pretty convenient even though not our first choice.' So, it looked to them as if a lot of people were getting their first choices. But in fact, people were adjusting what they claimed was their first choice. Russ: It's a fantastic example of how data can be misleading or misinterpreted without taking account of the incentives. Guest: So, the way it works now in Boston and in New York is you have some set of choices of schools--in Boston they've recently changed what choices people have depending on where they live. But you have some set of choices; you submit first, second, third choice schools. In New York, the schools submit preferences, first, second, third choice kids. In Boston they just have these priorities for each school. And then what happens is the algorithm goes through and it has each child apply to his first choice school, and the school looks at all its applications, and sometimes children are ineligible to apply to a school, they are not accepted; but if they can accept everyone, then they don't reject anyone yet. They don't accept anyone immediately, but they don't reject anyone yet. And if there are too many applications, then they reject all the ones that are over capacity, after ordering them in priority order; and they don't reject--they hold onto the applications from the ones they haven't rejected. So this is called a 'deferred acceptance algorithm' because acceptances only come at the end of the algorithm. So, what happens next is that the students who were rejected from their first choice apply to their second choice. And the schools now look at all the applications they have--all the ones left over that they didn't reject from last period and the new ones--and they order them in priority order without paying attention to when they applied. So if your child has an older sibling at the school to which you now apply as your second choice, you'll go right to the top of the list, because that's the top priority. And so you won't have lost your chance of going to that school. And the school may have to reject some other people, because there are new people at the top of the list. And those people apply to their next choice school that they haven't yet applied to. And the schools again order everyone in priority order without paying attention to when they applied in the algorithm--this is all happening at the same time. And that continues until no one makes any new applications. At which point the schools accept the children whose offers they haven't rejected, whose applications they haven't rejected. And that's the deferred acceptance algorithm.

45:18 Russ: So, this is rather remarkable. I assume that when it was first proposed, there were bureaucrats who didn't like it, for a whole bunch of reasons. But it must have taken some time to get parents to trust it. Because you can say--maybe at the time, I don't know whether you were at Pittsburgh or Harvard or Stanford-- Guest: I was at Harvard at that time. Russ: Okay. Which is good--kind of. It's like saying, 'I know this sounds complicated but it's going to be okay for you to tell the truth. I think you should have before and you didn't. But it's going to be okay because a Harvard professor says it's going to be fine.' Were there political issues like that that came up? Guest: There were certainly political issues. We spent a lot of time explaining it; we went to public meetings. Russ: Must have been challenging. Guest: And I think the school districts were interested for different reasons. In New York, I think the big attraction was not merely the safety but the fact that it dealt with congestion. In New York, they have almost 90,000 kids going into 9th grade each year. And they had been handling this process through the mails. So, after the schools made their admissions decisions they would forward them to the Department of Education which would send out letters to about 17,000 students who had multiple admissions saying you were admitted to three high schools; choose the one you want and get back to us. And when they got back to them, they would be able to make a new offer, things like that. They only had time for three letters; and they left about 30,000 students unmatched, right before the beginning of school. And those students had to be administratively assigned to schools over which they hadn't expressed any preferences at all. So, it was a very congested process. Russ: Really unpleasant. People were very happy-- Guest: So they were glad to have it computerized and work fast, have the preferences asked far in advance so you didn't have to wait for the mails to go back and forth. So that was, I think, a big advantage. And the first year in New York that they used this computerized algorithm that we helped them build, instead of having 30,000 unassigned students who had to be administratively assigned, they only had 3000. So it was a big improvement. But then, one reason why it's a successful system is that it does have these good incentive properties. And indeed, in New York City, where principals have a very active role in school choice, principals had been contriving to hold places off the market--not reveal their full capacity, saying that some classrooms were under renovation and things like that. And then they would discover new places just around the time that school was about to start. And they would admit students in what was called 'over the counter.' So there were other ways to get into schools than to go through the official process. But as this new process started to work--and it had good incentives for families and for school principals--those places started to come back into the system, as principals saw that it was working very well and that you couldn't get students you preferred by withholding the places. So, that actually effectively increased the number of good school places that could be allocated in New York. And in Boston, there was a somewhat similar effect. Although school choice is a very political issue that cities tamper with a little bit--tinker with, is the word I want--year by year. Because loosely speaking school choice divides cities into two political parties: the people who live near good schools are the walk-to-school party, and the people who live near bad schools are the school-choice party. And the question is how to allocate the legitimate concerns and interests of these people. And the various school districts that we've worked with often adjust those things year to year based on what happened in the previous year and which kids are [?].

49:19 Russ: Let's turn to some of the broader issues that these kind of methods bring up. I found myself thinking a lot while I was reading your book about how such markets might allocate spaces or matches if prices were used. And, we understand there are issues about prices we might be uncomfortable with. As you say, sometimes poor people might be disadvantaged; we usually respond to that as economists by saying, 'Let's give people vouchers.' In this case, a lot of people do, literally, give people vouchers to help them compete, say, for spaces in private schools. But what's missing, it seems to me, and I'm curious--you did not talk about this in the book: Historically in the economics literature--'historically' meaning, I guess it depends how far you want to go back--but people talk about the role that prices play as signals. They signal quality; they signal shortages; they signal surpluses. When we are in these markets where design, an algorithm like we're talking about, is substituting for prices, what do we lose? I see what we get: We often get an improvement over a situation without prices. But if we'd gone to a market with prices--and maybe some adjustments of a different kind--how different might the allocation be? Have you thought about this much? Guest: Absolutely. And remember, there are lots of markets--with public schools, we don't allow prices to play any role at all. Nor do we with kidneys. But for college admissions, prices play a big role. Colleges adjust their tuition very freely. However, they don't adjust the tuition so that supply equals demand. Russ: Correct. Guest: So, in matching markets prices work differently than in commodity markets, and that's one of the things that the book is about. And other kinds of signals have to be sent, not just price signals. But let me point out that market design is important even in getting price signals to do the work that they should be doing in commodity markets. So, I have a student at the U. of Chicago, a former student named Eric Budish, who has been studying high speed trading, algorithmic trading in financial markets. And lots of money is spent on making data flow very fast between the New York Stock Exchange and the Chicago Mercantile Exchange. So, billions of dollars a year have been spent on very fast transmission lines. Because both of those markets, the New York Stock Exchange and the Chicago Mercantile Exchange, are run by, are designed to run by continuous double auctions. Which means that the first person to take a trade, gets it. And right now, the time for a price signal to from New York to Chicago is about 8 milliseconds. And it takes you hundreds of milliseconds to blink your eyes. And as a result, competition by speed has to some extent displaced competition by price. Because the markets become very thin at the millisecond level. Even markets that have hundreds of trades a minute for things like Standard and Poor's 500 [S&P 500] bundles, when you look at millisecond by millisecond, many milliseconds [?]-- Russ: [?] Guest: with trades. And what Eric and his colleagues have proposed is that it might restore some price competition rather than speed competition to have call-markets once a second, for example, so that all the bids and asks that accumulated in a whole second would be accumulated and traded at the price at which supply equaled demand. And that would give the trades to the person who offered the best price rather than to the one who came at the earliest millisecond. So, so, thinking about how markets work doesn't necessarily interfere with competition by price, to send price signals. Because playing by the rules and doing things that are allowed with the current market, people are substituting one kind of competition for another.

53:31 Russ: Let me come back to the school example, though. Because I think--I just realized something I hadn't thought of before. Normally, we would say that price signals would send information about what are the better schools than others. Right? We would say, in theory, private schools, for example, that have the best quality can charge more than private schools that have lower quality. In theory, that could be the entire education market. We don't have that. We have this whole sector called the public sector with no prices. And that, as a result, we all know, there are schools that persist that are awful. In the walk-to-school world, for sure. And even in the world that you are talking about with public school choice. Because they still stick kids in the end in some of the schools that are less desirable. It won't be [?] their full choice. What daunts on me though is that we could use the votes that people give in their preferences about closing schools. We just choose not to, so much. So the market has a brutal calculus, which says: You don't cover your costs; after a while you are not going to make it. The public sector, that cost can be mitigated through taxation. But, if we chose to we could use those preferences that people give to close bad schools. And we just-- Guest: No, no, no. Well, now that there are a number of schools that have a system of school choice that make it safe for families to reveal their true preferences, they are starting to use them. So, schools that no one wants to go to as their first choice, that sign that they may not be such a good school. And before, when it wasn't safe to put down your true first choice, that there might not be any schools like that. It might be that if you didn't get the bad school in your neighborhood, you'd get a bad school far from your neighborhood. Russ: Right. Guest: And so you would-- Russ: Your sister never went to. Guest: Right. So you would say that the bad school in your neighborhood was your first choice. But now, certainly in New York City I know that that's, that kind of preference information has played a role in the decision to close some schools. Russ: Yeah. I guess that's some encouragement. It's slightly embarrassing that we seem to not have an episode of EconTalk without mentioning Uber. And you already mentioned it. So: there are a lot of very creative things going on in markets right now that worked there 10 years ago--Airbnb, Uber. These are essentially private matching algorithms. You mentioned some possibilities that might be on the horizon. Do you want to speculate a little bit about what might be coming? For example, you mentioned, that if you are out of your house during the day, your WiFi is currently congested, and there's some paperwork involved in trying to rent out your WiFi while you are gone. Are there others you can talking about? May be involved? Sorry to [?] Guest: No, no. Right. I think that's a good one, I did mention in the book. There's a company called BandwidthX[?] that's trying to make a market for the unused WiFi, that you should be able to access on your cellphone. The idea, the attraction of this for your cellphone provider, is that it would help smooth out when they need to build new microwave towers. And things like that. So it would make their capital costs more bearable. And of course the individual handshake, as you drive through a city and WiFi connections flicker on and off is not something you can negotiate with your phone, but it's something that Comcast can negotiate with AT&T. And other providers. And BandwidthX proposes to facilitate that marketplace. Because its costs might be different at different times of day. When you are home using your WiFi, you might not want to make it available for me driving by in my car or walking by with my cellphone. So that's one kind of market that we might see more of. Another one that I think I mention is restaurant reservations. Right now, restaurants, fancy restaurants that might take a long time for you to get a reservation, charge you for your meal but not for your reservation. And that creates some congestion in that market. When you buy a ticket for a hard-to-get Broadway show, if you later can't go to the show--you bought the ticket two months in advance and now a wedding has come up--you can give your ticket to someone else or sell it. But you can't do that with a restaurant reservation. And some restaurants are starting to think that maybe it would facilitate their market to change the way they give reservations, possibly charging separately for the reservation than for the meal. Or possibly just making the whole package transferable. So I think we're beginning to see some exploration of that. Russ: What's fascinating to me is that I'm sure a lot of restaurants would be uneasy about that: reputationally they might struggle with it. Of course, if it's a high-demand restaurant maybe people would be thrilled to at least get a reservation of any kind.