Proponent of business organisation
The Nobel Prize in Economics for 2014 was awarded to Jean Tirole by the University of Toulouse in France “for his analysis of market power and regulation”.
Tirole completed his bachelor’s degree in engineering and mathematics at the Ecole Polytechnique and the Universite Paris Dauphine in 1976. In 1978 he received his doctorate in decision-making mathematics from Dauphine and in 1981 he received his doctorate in economics from MIT, USA. After receiving his doctorate, Tirole worked as a research assistant at the École Nationale des Ponts et Chaussées in Paris until 1984, after which he moved to MIT as a faculty member. He stayed at MIT until 1992 and then returned to France and taught at various universities. In 2011 he founded the Toulouse School of Economics.
In this article we will review the main works by Tirole and their contribution to guiding public policy.
Major works by Tirole
Tirole is known for his work on the regulation of monopolies. He was concerned about negative externalities and socially suboptimal results when some firms controlled the market. He found that such monopoly power resulted in companies outperforming profits or inefficient firms blocking the free entry of more efficient firms, leading to market failure. He used game theory models to design regulatory mechanisms for monopoly industries.
Tirole was one of the leading contributors in what came to be known as the industrial organization. As Tirole had emphasized, the French economists Cournot and Dupuit had pointed out the socially suboptimal results of oligopolies.
However, mainstream economics, especially the Chicago School, have always been skeptical of regulation, regardless of antitrust initiatives in the US (the Sherman Act and the dissolution of the giant Bell Telecommunications in Baby Bells). To quote Tirole from his Nobel Lecture:
Industrial organization theory has proven to be a very useful tool for reflecting on one of the greatest challenges facing our economies. It has shaped antitrust law and regulation. Recognizing that industries are different from one another and that one size fits all, it has patiently built a store of knowledge that has helped regulators better understand market power and the effects of political interference, and has helped companies formulate their strategies . Industrial organization has come a long way, but much remains to be done. It is particularly gratifying that the field of industrial organization is currently flourishing and that many young top researchers are delivering exciting work. Making this world a better world is the economist’s first mission. I believe that the entire research community of the Industry Organization contributed significantly to this mission. On behalf of this community, I felt humble, honored and grateful that I was awarded the Swedish Riksbank Prize for Economics in 2014 in memory of Alfred Nobel.
Tirole responded in a way to criticism from the Chicago School, which argued that there was no theoretical framework for antitrust or regulatory policy. Tirole was not satisfied with the “per se” rules (which either allow or forbid anti-competitive behavior) or the “one size fits all” approach, which recommended price caps to the monopolies. While this approach improved efficiency, it failed to control above-average profits. To quote further from his Nobel Lecture:
Accordingly, economists have advocated a case-by-case or “rule of reason” approach to antitrust law, away from rigid “per se” rules (which mechanically either allow or prohibit certain types of behavior, from price fixing to fixed prices in resale). However, the pragmatic message from economists goes hand in hand with a twofold social responsibility. First, economists need to offer a thorough 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 requires an “information light” policy, that is, a policy that does not require information that is unlikely to be available to regulators. Second, economists need to participate in the political debate. An example of this is the financial crisis, the main parts of which can be found in scientific journals. But of course the responsibility goes in both directions here. Politicians and the media must also be ready to listen to economists.
Building on previous work on the regulation of monopolies and oligopolies, Tirole presented a general theory of the market power of companies and regulation based on game theory and the work on industrial organization. This theory provided a framework for analyzing issues such as antitrust law, monopoly regulation, and pricing. Tirole examined how companies reacted to regulations and strategies of other companies. He suggested possible action by regulators to control collusion by oligopolies and review monopoly practices that harm consumers.
Tirole also suggested that companies should work together on non-pricing issues like sharing technology, which led him to propose the theory of platforms. A platform is nothing more than a suitable device to connect sellers and consumers. Such platforms are widely used in two-sided markets like video games, software, readers and advertisers in newspapers, card payments, social media, etc. Tirole proposed a model of platform competition with bilateral markets and examined determinants of price distribution and profit under different framework conditions such as monopoly, oligopoly etc. In this context, Tirole also considered vertical restraints of competition. This happens when an upstream company (e.g. a manufacturer) supplies downstream retail units and limits supply in order to generate high profits. Tirole found that while vertical restraints limit competition, they also encourage innovation. Competition law should therefore weigh 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 to circumvent the problem of asymmetrical information to the regulators – since they do not know the cost structure of the monopolies and the production techniques they use. The regulatory authority is faced with the problem of offering compensation that is sufficient for the production of a monopoly in order to avoid above-average profits at the same time. In 1986 they proposed offering a company a series of contracts with different compensation structures. This leads the manufacturer to choose the right contract, mostly out of self-interest. An expensive producer who cannot cut costs will choose a high-paying contract, and a producer with more control over its costs will choose a lower-paying contract. This will allow the regulator to push powerful companies to be more efficient, while keeping consumers’ interests in mind and allowing their competitors to survive. This theory has been adapted to study a number of industries such as banking, social media, and telecommunications, which tend to form monopolies and oligopolies. These results were published in her 1993 book entitled A Theory of Incentives in Procurement and Regulation.
Tirole’s publications include more than 200 articles and several books, including the textbook “Game Theory” (1991), “The Theory of Corporate Finance” (2006) and “Inside and Outside Liquidity”, co-authored with Drew Fudenberg. (2011), written together 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 monopolies are tending to emerge. His economic platforms theory also provided a framework to analyze company behavior on social media, search engines, video games, e-commerce, etc. Tirole’s work taught us to look at every market differently and accordingly different regulatory and competition policies for different markets.
The author is an IAS official and serves as the Principal Resident Commissioner for the Government of West Bengal. Views expressed are personal.