How much for a kidney?

The first successful kidney transplant occurred in 1954 at a hospital in Boston. It happened when Ronald Herrick donated a kidney to his twin brother Richard, who was dying of kidney failure.

For a kidney transplant to be successful, donors and recipients have to “match”. Simply wanting to donate a kidney to a loved one is not enough. Your blood types and tissues all need to be in synch. Over half a century later, and despite great advances in the procedure, the waiting list for a kidney transplant is many tens of thousands long.

The list would be even longer if it weren’t for Harvard economist Alvin Roth, who won the Nobel Prize in economics for his work in helping to design a nationwide kidney market.

Under the right circumstances, markets can be a tremendously effective mechanism for efficiently allocating resources around the economy. And on this front, some markets are certainly more efficient than others. Market failures — such as the concentration of market power, the presence of externalities, or information that is either missing or hidden — can all result in either too little or too much being produced.

Efficiency however, is just one criteria against which we can assess market performance. Indeed, markets provide more than just a means of exchange. They provide advice on about what to produce, where to invest, what to study, where to buy a house and how to spend your weekend. They ensure that consumers have choice and that products are available when and where consumers want to buy them. They regulate behaviour and reveal where the good coffee is, and which accountant to trust.

A well-functioning market provides the following services to the economy.

·        Price discovery — markets help to uncover value. Ultimately, the value of a good or service is only worth what someone is willing to pay. As buyers and sellers haggle they reveal information about their willingness to pay and the costs of production. Economic value and prices emerge as a result, and this allows us to make all kinds of decisions.

·        Signalling — when prices rise, this sends a message to suppliers that more of a product is needed. Suppliers make investments, new firms appear, and additional workers are employed in order to meet this demand. Signals work their way up and down supply chains, and throughout labour and capital markets. Then, “as if by an invisible hand”, the economy responds by shifting more activity to producing that product, at the expense of others.

·        Prediction — prices embody intelligence and knowledge about the future. In commodity markets for example, the current price of say iron ore or coal, embodies a consensus of expectations about where the market is headed. Should new intelligence arise, the market will make an assessment and adjust the price accordingly.

·        Mutually beneficial exchange — markets help to ensure that those who value products the most are the ones that receive them. When two parties voluntarily engage in a trade, they do this because one party values the product more than the other. When an exchange occurs, both parties are better off — even if the gains from trade are lopsided. Markets help to ensure resources get to the “right” people, and can do this without needing to know all the information.

·        Value creation – the competition and innovation promoted by markets results in a never-ending process of value creation. Firms compete for market share by either offering products that better meet customer needs, or by lowering costs. Innovation and productivity follow as a result, with consumers the big winners.

The extent to which a market conducts these functions give us an insight into its performance. Sometimes markets fail, not because of the presence of market failures, but because they’ve been designed poorly. Well-functioning markets depend on a number of detailed formal and informal rules. These rules govern how agents in the market behave and consequently the outcomes that result.

Squeezing more investment and innovation out of the economy might be more an exercise in writing better rules, than an exercise in incentives and directives.

Post script: The really interesting thing about Roth’s kidney market was that it didn’t involve prices. It’s illegal to sell organs in the US. Rather, Roth’s kidney market was an elaborate match-making service that paired chains of donors with compatible strangers. Through the kidney market, the number of “kidney-paired donation transplants” went from 2 in the year 2000, to about 600 today.