Promoter of industrial organization
The 2014 Nobel Prize in Economics was awarded to Jean Tirole of the University of Toulouse in France “for his analysis of market power and regulation”.
Tirole did his undergraduate studies in engineering and mathematics from the Ecole Polytechnique and the Université Paris Dauphine in 1976. In 1978 he obtained a doctorate specializing in decision mathematics from Dauphine and in 1981 he completed his doctorate in economics from MIT, USA. After his doctorate, Tirole worked as a researcher at the École Nationale des Ponts et Chaussées in Paris until 1984, after which he joined MIT as a faculty member. He remained at MIT until 1992 then returned to France and taught at various universities. In 2011, he founded the Toulouse School of Economics.
In this article, we will review Tirole’s main works and how they helped shape public policies.
main works of Tirole
Tirole is known for his work on the regulation of monopolies. He worried about negative externalities and socially suboptimal outcomes when a few firms controlled the market. He noted that such monopoly power has led companies to make supernatural profits, or inefficient companies blocking the free entry of more efficient companies, thus leading to market failures. He used game theory models to design regulatory mechanisms for monopoly industries.
Tirole was one of the main contributors to the field known as industrial organization. As Tirole had pointed out, French economists Cournot and Dupuit had pointed out the socially sub-optimal results of oligopolies.
However, the mainstream economy, particularly the Chicago school, has always had a skeptical view of regulation, despite anti-trust initiatives in the United States (the Sherman Act and the breakup of giant Bell Telecommunications into baby Bells). ). To quote Tirole from his Nobel lecture:
The theory of industrial organization has proven to be a very useful tool for reflecting on one of the major issues facing our economies. He shaped antitrust law and regulation. Recognizing that industries are different from each other and therefore one size does not fit all, she patiently built a body of knowledge that has helped regulators better understand market power and the effects of policy interventions, and companies to formulate their strategies. Industrial organization has come a long way, but a lot of work remains to be done. One particularly gratifying aspect is that the field of industrial organization is currently booming, with many young top researchers producing exciting work. Making this world a better one is the first mission of the economist. I think that the entire community of researchers in industrial organization has largely contributed to this mission. On behalf of this community, I was touched, honored and grateful to receive the 2014 Sveriges Riksbank Prize in Economics in Memory of Alfred Nobel.
Tirole was responding, in a sense, to critics from the Chicago school who argued that there was no theoretical framework for antitrust or regulatory policies. Tirole was not satisfied with the “per-se” rules (which allow or prohibit anti-competitive behavior) or the “one size fits all” approach which recommended price caps to monopolies. This approach improved efficiency but could not control the super normal benefits. To quote his Nobel lecture further:
Economists have therefore advocated a case-by-case or “rule of reason” approach to antitrust, far from rigid rules “in themselves” (which mechanically authorize or prohibit certain behaviors, ranging from price fixing agreements to the maintenance of prices. resale price). However, the pragmatic message of economists comes with a double social responsibility. First, economists must provide a rigorous analysis of how markets work, taking into account both the specifics of particular industries and what regulators know and do not know; this last point calls for “information light” policies, ie policies that do not require information that will probably not be available to regulators. Second, economists must participate in the political debate. The financial crisis, the main ingredients of which could be found in academic journals, is one example. But of course the responsibility here goes both ways. Policymakers and the media must also be prepared to listen to economists.
Building on previous work on the regulation of monopolies and oligopolies, Tirole used game theory and work on industrial organization to present a general theory of corporate market power and regulation. With this theory, a framework for analyzing issues such as antitrust, monopoly regulation, and pricing became available. Tirole looked at the ways in which companies reacted to regulations and the strategies of other companies. He suggested possible action by regulatory agencies to control oligopoly collusion and control monopoly practices that harm consumers.
Tirole also suggested that companies should cooperate on non-tariff issues such as technology sharing, which led him to come up with the platform theory. A platform is nothing more than a matching device to connect the seller and the consumer. These platforms are prevalent in two-sided markets such as video games, software, newspaper readers and advertisers, card payments, social media, etc. Tirole proposed a model of platform competition with two-sided markets and examined the determinants of price and profit allocation. in different contexts such as monopoly, oligopoly, etc. In this context, Tirole also examined the vertical restraints which limit competition. This occurs when an upstream company (e.g. a manufacturer) supplies downstream retail units and restricts supply in such a way as to keep profits high. Tirole found that while vertical restraints can limit competition, they also encourage innovation. Competition law must therefore balance these two considerations. Tirole’s main point was that desirable competition policies will vary from market to market.
Tirole worked with Jean-Jacques Lamont and suggested a way around the asymmetric information problem that regulators face – because they don’t know the cost structure of monopolies and the production techniques they use. The regulator faces the problem of offering sufficient compensation for a monopoly’s output to be useful, while avoiding supernormal profits. In 1986, they suggested that a company could be offered a menu of contracts with different pay structures. Doing this will lead the producer to choose the right contract, mainly out of self-interest. A high-cost producer, who cannot lower costs, will choose a contract with high remuneration and a producer with better control over his costs will choose a contract with lower remuneration. This will allow the regulator to push powerful companies to be more efficient, while being attentive to the interests of consumers and allowing its competitors to survive. This theory has been adapted to study a number of industries such as banking, social media, and telecommunications, where there is a tendency to form monopolies and oligopolies. These results were published in their 1993 book titled “A Theory of Incentives in Procurement and Regulation”.
Tirole’s publications include over 200 articles and several books, including the college-level textbook ‘Game theory’ (1991), co-authored with Drew Fudenberg, “The theory of corporate finance” (2006), and “Internal and external liquidity” (2011), co-authored with Bengt Holmström.
Tirole’s work has helped shape regulatory and competition policies around the world, particularly in sectors such as telecommunications and banking, where there is a propensity for the emergence of monopolies. His theory of economic platforms has also provided a framework for analyzing the behavior of companies in social media, search engines, video games, e-commerce, etc. Tirole’s work has taught us to look at each market differently and, accordingly, to design different regulatory and competition policies for different markets.
The author is an IAS Officer, working as Senior Resident Commissioner, Government of West Bengal. The opinions expressed are personal.