Volume-04 ISSN: 2455-3085 (Online) Issue-06 RESEARCH REVIEW International Journal of Multidisciplinary June-2019 www.rrjournals.com[UGC Listed Journal] The mechanism design theory: Policy and regulatory design for developing countries ( India) Shubhra Suman MA (Economics), Delhi School of Economics, Delhi University, Delhi ARTICLE DETAILS ABSTRACT Article History Developing countries like India are faced with the problem of accelerating the rate of Published Online: 04 June 2019 development while grappling with resource constraints, structural imbalances and many socio-economic problems like poverty and illiteracy. The current research in Economic Keywords Theory has tended to address the specific problems of developing countries. There are Mechanism design , public policy, conflicting social preferences like equality and parity, ethical behaviour, honesty, motivation development, India. for good government which may be in conflict with private goals and self-interest. In such a scenario the planner is faced with conditions of maximising social welfare in face of hidden motive or information. Mechanism theory in conjugation with development in technology, provides a means of finding optimal solutions to such constrained situations. Due to this it has great applicability to countries like India. This article throws light on some aspects of mechanism design and its policy implications providing a basis for its widespread use in current economic situation. 1. Introduction decision problem, such as the allocation of work in a team, the Mechanism design or implementation theory is a allocation of spectrum for mobile telephony or funding for relatively new field of economics which has been gaining public schools; A measure of quality to evaluate any candidate importance lately. Its beginnings are traced to the 1960s solution, for example efficiency, profits or social welfare; A when Leonid Hurwicz considered a very policy-oriented description of the resources – informational or otherwise – problem - that when information is wide spread among many held by the participants. A mechanism specifies the set of people but the planning authority or planner may not have messages that participants can use to transmit information access to the same then how should a decision be reached in and the decision that will be taken conditional on the order to maximise social benefits? It is essentially a normative messages that are sent. Once a mechanism is in place, concept aimed at achieving certain objectives similar to participants effectively “play a game” where they send enhancement of societal welfare. In 2007, the messages (e.g., a bid in an auction) as a function of their SverigesRiksbank prize (Nobel Prize in Economic Sciences) information. The goal is to find a mechanism with an was awarded to Leonid Hurwicz, Eric Maskin, and Roger equilibrium decision outcome (sometimes required to be Myerson for their fundamental contributions to mechanism unique) that is best according to the given measure of quality. design theory. The strength of mechanism design lies in its generality: any It is the ‘engineering’ aspect of economics where the procedure, market-based or not, can be evaluated within a ‘mechanisms’ or ‘institutions’ or ‘processes’ are designed to unified framework (Legros& Cantillon, 2007). achieve social objectives. It has a wide array of applications Game theory and mechanism design (often called from designing voting mechanisms to auction design. reverse game theory) have played a significant role in a large Interestingly Mechanism Design is also called ‘reverse game number of spheres of matching markets with socially theory’ as it deals with cases of information asymmetry. important applications such as competitive matching of According to Hurwicz, in order to resolve any solution the colleges with students and hospitals with interns, leading to planner should take into account the incentives of self- maximization of social welfare. They have also saved precious interested agents, i.e., the people on whose information the human lives through better and faster matching of kidneys and decision relies must find it in their interest to reveal that human organs(Narhari, 2014). information. This was a revolutionary idea at the time and found many takers mainly in context of market forms- 2. Theory of mechanism design socialism vs capitalism. Hurwicz’s analysis pointed out that Mechanism design deals with information asymmetry, lack of proper individual incentive was a major weakness of which can be compared to ‘games of incomplete information’ the socialist market system, while in case of capitalism there i.e. where all the parties do not have full information. Such was no proper alignment between individual incentives and games may consists of two broad forms of games viz. games social incentives. Maskin and Myerson developed the theory of ‘hidden information’ and games of ‘hidden action’. ‘Hidden further in the 1970s and 1980s by expanding on the ideas of information’ arises in cases where one party has superior Nash Equilibrium along with Implementation Theory and information or has information that the other does not have Auction Designs respectively. access to. The case of sale of second-hand cars is an In its current form, mechanism design theory provides a example of hidden information as the seller (owner of the car), general framework to study any collective decision problem. A knows more about the performance/condition of the car than mechanism design problem has three key inputs: A collective the buyer. Various similar hidden information scenarios arise RRIJM 2015, All Rights Reserved 1777 | P a g e Volume-04, Issue-06,June-2019 RESEARCH REVIEW International Journal of Multidisciplinary in society everyday. For example, a prospective employee First, the beneficiaries may understate the amount they knows more about her own capabilities than the employer, the are willing to pay (i.e. under-report their true benefits). This is insured is better aware of her health condition than the done to ‘free ride’ since the project will benefit them anyway insurer, bidders are better aware of their own values for the even if they pay less. Second, there are those who will be auctioned item than the auctioneer, the voters are better adversely affected by the bridge and need to be aware of their own preference than the government, etc. compensated. These may include not only workers but people When a company is hiring a person, the company has less who lose land or access to a good view, etc. An appropriate information compared to the person about his abilities and mechanism must address these problems and ensure that the motivation. outcome is such that the welfare is enhanced. ‘Hidden action’ arises when one party (generally called Secondly, there are various ways (mechanisms) by which the ‘principal’) is not able to observe the actions of the other the transfer of resources can be done. The government can party (usually called ‘agent’). Thus, the government may not give it out on a ‘first come first served basis ’(e.g. this was be able to observe when a tax official accepts a bribe, the done in the allocation of 2G spectrum in India). Alternatively, insurer may not be able to observe whether the insured takes the prospective parties can be asked to make presentations reasonable precautions, the employer may not know when the as to how they would use the resources and their capabilities. employee is lax, etc. The hidden actions of the ‘agents’ The empowered committee would subsequently make a adversely affects the ‘principal’. choice. Another method is to ‘auction ’the resource to the In either form of information asymmetry, there are highest bidder. The auctioning design can be of various types essentially two parties — one with complete information and (e.g. open auction, Dutch sealed bids). the other with guesses or beliefs which can be updated as the How to chose between different mechanisms is the game proceeds meaning experience is gained. The task of the question. The answer depends on the objective of the party with less information is to separate out the different government (e.g. social objective or maximising economic types or to work out different responses from each type so welfare). This means the resource (e.g. spectrum) must go to that the objectives may be achieved, knowing that directly the party which values it the most. This is because economic asking the other party will not ensure true and honest welfare is defined as the difference between the ‘willingness to answers. Thus, the critical elements involved are ‘information’, pay’ and the ‘cost to society’. Hence, the resource should go ‘types’ with their preferences, beliefs about types and the to the party which is willing to pay the highest or values the various ‘messages’ that each type would give (i.e. strategies) resource the most. under different game settings. A desirable mechanism is one in which the outcome of Mechanism design, in the strict sense of the term, will the game meets the social objective. The outcome (or have one ‘mechanism designer ’who sets up the game (often outcomes in some cases) is an equilibrium result of the called ‘regulator ’or the ‘institution’) with ‘structures and rules ’ incomplete information game or mechanism, designed and put by which a number of parties play the game. The ‘mechanism in place by the designer. This equilibrium outcome may be a designer ’will have certain goals or objectives but unlike in the dominant strategy equilibrium in the sense that the players examples considered above, she is herself not an actual have a strategy (action) which is clearly more beneficial to ‘player’. The mechanism designer has a menu of them than other strategies (actions). games/mechanisms to choose from, or will go about designing one, if no such mechanism is readily available. In other words, 4. Applicability to developing countries she examines the outcomes of the various ‘games ’and In many developing nations, however, there is a lack of chooses the one (or designs one) which will have outcomes information regarding underlying matters—whether that be the that matches with her objective (i.e.