In a recent article published by McKinsey & Company, economist Robert E. Litan toots his own horn, or at least toots the horn of his chosen profession of economics, and author of Trillion Dollar Economists: How Economists and Their Ideas have Transformed Business.
In his article, Litan points out the importance of “the ideas of economists. Not forecasts or models or the dry parade of graphs and equations found in the typical introductory textbook, but rather economists’ insights and ideas, which sometimes have an enormous impact on the evolution of industries and also have been put to use in very practical and profitable ways by real companies.”
Research by economists led to transportation deregulation
The deregulation of the transportation industry in the 1970s and early 1980s enabled highly efficient and flexible systems to be developed by UPS and others, and paved the way Internet retailers like Amazon who came along two decades later.
The deregulation of prices and of entry into the transportation industry—especially interstate cargo air traffic and trucking in the mid to late 1970s—is a big deal in retrospect, but its importance was not obvious at the time.
Litan argues that the starting point for the push to deregulate transportation was the congressional hearings held by the late Senator Edward Kennedy. The hearings featured cutting-edge economic research that pointed to big price cuts from dismantling price and entry controls in the airline industry. New president Jimmy Carter joined forces with Kennedy and his colleagues to push forward with deregulation. To get the ball rolling, Carter appointed two well-known economists, the late Alfred Kahn and Elizabeth Bailey, to the Civil Aeronautics Board (agency with regulatory authority over the airline industry).
The airline industry was finally deregulated in 1978.
The trucking industry was next, just two years later. Litan notes: “Trucking deregulation came in 1980, with the help of some heavy pushing along the way by the Interstate Commerce Commission, headed by another highly regarded economist whom Carter had appointed as chairman:Darius Gaskins. The bottom line is that neither deregulation success would have been possible without many years of prior economic research and, most likely, without articulate economists such as Kahn, Bailey, Gaskins, and the economists they appointed to key regulatory positions.”
Validating the idea of auctions as the basis of a market economy
Economists also have had a impact on the evolution of the Internet through their theories about auctions. Almost a century ago, the concept of how prices are set in a market economy was compared to an auctioneer. The auctioneer in effect continuously undertakes auctions for all commodities to set the current price.
Litan highlights that auctions played a role in the rise of mobile telephony, and are now deeply intertwined with the Internet and ecommerce. Of note, economist Ronald Coase first suggested auctioning segments of the electromagnetic spectrum back in the late 1950s, an idea that eventually became reality in the 1990s.
Moreover, auctions are a key part of the business model of numerous ecommerce firms, in particular Priceline and Google.
Priceline was founded by Jay Walker, who studied economics at Cornell. When the commercial possibilities of the Internet started to become obvious, Walker and partners brainstrormed “name your own price travel, basically reversing the usual travel purchasing experience where companies set prices and consumers choose to pay or not.
Litan points to a clever wrinkle that made Priceline uniquely successful: “Walker’s clever innovation was to require consumers to pay the price they bid if the airlines and hotels on Priceline decided to accept it. That condition made travelers think hard about their bids and induced them to make serious offers.”
Finally, Litan discusses Google as a firm founded on auction-related principles. He notes that the tech titan produces most of its revenue through an auction-based system of selling ads. This auction system was developed by two software engineers, but tested and approved by Google’s chief economist, Hal Varian, who served as the first dean of the School of Information at the University of California at Berkeley.