At age 72, Stanford University professor Paul Milgrom won the 2020 Nobel Prize in Economics “for improvements to auction theory and inventions of new auction formats.” While that might sound esoteric and abstract, Milgrom’s work has changed the world.
In a crowning achievement, he and his company, Auctionomics, designed the broadcast incentive auction run by the FCC between 2016 and 2017. The auction resulted in dozens of broadcasters – which collectively owned more than a thousand television stations – selling their rights to certain electromagnetic spectrum frequencies to wireless companies. With these rights, the companies could use the purchased radio spectrum to transmit digital information, primarily data for smartphones.
Wireless companies ended up paying about $19.8 billion, most of which went to broadcasters. The U.S. Treasury also took a sizable cut, about $7 billion. Overall, the auction was a massive success. All parties – the buyers, the sellers, the federal government, and the American people, benefitted.
After the spectrum auction, which also garnered him an Emmy award in September, Milgrom could have just settled down, Dr. Silvia Console Battilana, told Freethink. Console Battilana, an economist and entrepreneur, co-founded Auctionomics with Milgrom back in 2008. Auctionomics utilizes complex mathematics and software algorithms to design auction-based markets, along with a variety of other services.
“I would probably just go on a yacht for the rest of my life,” she said, laughing.
Instead, Milgrom resolved to “solve one more big problem in the world,” she recalled.
Their new mission? Easing water scarcity — and conflict — in an increasingly drought-stricken world. He thinks auctions and market design could provide the solution.
A Water Mess in the American West
Water scarcity is a global problem. According to the United Nations, roughly half of the world’s population experiences severe water scarcity for at least part of the year. As humanity grows and the climate changes, the situation is likely to worsen, potentially triggering conflicts, economic hardship, and famine.
Milgrom isn’t so bright-eyed to think he can fix every instance of water scarcity around the globe, but he’s not setting his aspirations low either. Auctionomics first aims to set up a water market in the American West to upend the competitive, water-guzzling status quo and incentivize more efficient use.
Water rights in the American West may be politely referred to as a “hodgepodge” and perhaps more accurately a “shitshow.”
The American West is a dry place – in many areas, outright inhospitable to humans. Nonetheless, it’s home to a thriving and thirsty agricultural sector, along with tens of millions of people. Cities and farms across the region are broadly nourished by the Colorado River Basin. But the “lifeblood of the American West” has been wracked by a mega-drought lasting 23 years. In 2021, the river’s largest reservoirs — Lake Mead and Lake Powell — fell to critically low levels. They recovered this year after a wet winter, but still technically remain in a shortage condition. Over the ensuing decades, experts worry that overexploitation and climate change could cause the Colorado River and other vital bodies of water in the Western US to dry up.
Water rights in the American West, some dating back to the 19th century, may be politely referred to as a “hodgepodge” and perhaps more accurately a “shitshow.” Some rules are straightforwardly wasteful. In some cases, rights-holders must use all of the water they are allotted every year, whether they need it or not, or else their allocation will be cut going forward. Numerous states and stakeholders with conflicting interests are involved, and even though all are aware that they need to cut back on water use, none wants to be shorted relative to the others. Often, if you want to sell some of your water allocation, you first have to show that downstream users won’t be harmed, which is often impossible to prove. The situation is rife with legal dissension. The Colorado River may be sluggish, but lawsuits over its remaining water flow freely.
“Water rights to divert surface flows specify a location, a season, a point of diversion, and a particular use,” Milgrom and his PhD student Billy Ferguson wrote in a NBER working paper published in December 2023. “Specifying details like those limits externalities [negative effects on third parties] from changing uses, but also makes beneficial changes harder.”
To Milgrom, Console Battilana, and Auctionomics, water scarcity in the American West looks similar to the spectrum problem they previously solved. In both settings, rights and rules are antiquated, while a vital and valuable commodity is being mismanaged. Thus, a similar playbook to ease water scarcity in the Colorado River Basin might just work — if the stakeholders can be convinced the new system will work for them.
First, the federal government, in cooperation with state authorities, would need to establish new water rights. They’d be based on how much water is consumed (actually taken out of the system), rather than merely diverted. (For example, when irrigating fields, some water flows back into the basin and remains in the system.) Furthermore, allocations will adjust based on yearly precipitation, helping to prevent overdrawing in drought years. Satellite imaging, paired with sophisticated hydrological models, now make it possible to continuously evaluate consumptive water use at little cost, Milgrom and Ferguson argue.
Trading Up
To encourage adoption of these new rights, they propose a voluntary one-time auction – likely overseen by the federal government or a collective body of state governments – in which current rights holders get paid to convert their legacy rights to new ones. Again, this would be completely voluntary. If stakeholders are happier with their current water rights than what they’d get in the auction and the new system, they can keep it. At the same time, new water rights would be sold to qualified bidders – cities, for example. A large chunk of the revenue would go to legacy holders who converted their original rights. All holders of the new rights would then be free to trade their seasonal water allocations in a market. Stakeholders who elected to keep their older rights would not be allowed to join the market.
As Console Battilana told Freethink, Auctiononomics would perform all of the complex ground work, designing easy-to-use software to allow stakeholders to participate in the initial auction and then subsequently trade their water allocations as needed. Stakeholders could buy water from others when they need more or sell their own when they’ve been frugal.
“Can you put all the complexity under the hood like a Ferrari so that you just look at it and it’s beautiful on the front end and all the complexity and the math is on the back end? That’s what we’re the world experts at doing, and that’s what we did in the [FCC] incentive auction – where we had television station owners that needed a very easy interface… Same thing here,” Console Battilana explained.
With a new market established, liquidity will come to an ironically illiquid market. Efficient water use would be encouraged as stakeholders have an incentive to save water each year so they can sell the balance. This would drive investment and innovation in water-saving technologies. Such a market would likely also drive water prices down, owing to better allocations and increased efficiency.
“Once the farmers have a right attached to this water, where they’re allowed to flip parts of it, then they’re incentivized to use new technologies. Then all the venture capitalists will invest in water use technologies. Then the whole ecosystem will go to a more efficient use of water,” Console Battilana argues.
“We know we can design the market way better, but obviously there’s often a lot of friction.”
Silvia Console Battilana
Milgrom, Console Battilana, and Auctionomics are already engaging with states and stakeholders to make this water market in the American West a reality.
“We have conversations. The issue is that several states have to agree. California seems to be the key,” Console Battilana said. “We know we can design the market way better, but obviously there’s often a lot of friction, a lot of interests at stake from the people who benefit from the inefficiencies of the market.”
Some stakeholders are understandably concerned that a water market would worsen inequities. That’s something that can be accounted for when designing a market from scratch, the economists argue. Auctionomics can set up rules and build guardrails into the system. Speculators would be banned, for example, and the rights of disadvantaged communities would be protected by rules built into the system. The antiquated status quo doesn’t do that, they point out, and instead it hinders progress on conserving water.
With so much complexity and numerous entrenched interests, Console Battilana thinks that it might take the system going over the edge – a massive drought-caused water shortage, for example – before change is possible.
“It will only happen when it’s a complete crisis and there’s gridlock due to lawsuits because they were asked to reduce [water use].”
Beyond water
In a world increasingly defined by big data, where ubiquitous technology is making more things measurable than ever before, Auctionomics’ market design services may increasingly be called upon.
Though most laypersons don’t realize it, custom-designed “markets” already govern many key services – these algorithms are in internet advertising, dating apps, ride-hailing, and even organ donation.
“The key thing to create a market that doesn’t exist yet is to define the items in a way where you can compare what you want and what I want,” Console Battilana explained.
She sees rapid algorithm-run auctions being necessary for a host of emerging industries: permitting drone deliveries, as companies will need to bid for space in “invisible highways in the sky.” Markets will also need to be created for cloud computing, so users of large language models can purchase computing power on-demand. Autonomous vehicle companies might also compete in a marketplace for the most efficient travel routes.
In a world increasingly overflowing with information, the market for creating and maintaining markets is only going to grow. Console Battilana thinks Auctionomics can also help here, incubating startups focused on specific industries.
“I’ve always been passionate about connecting people that want to do change to enable them to do change,” she told Freethink. “I want to be the super-connector to solve all of the market design problems in the world.”
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