Noble Corner – Jean Tirole – Contributions by Jacques Crémer

Around noon, 13th of October 2014:  The news spread rapidly throughout the Toulouse School of Economics:   Jean Tirole had been awarded the Nobel Prize in Economics! The initial shock from such great news was followed by enthusiasm, happiness, pride, admiration. Students were so ecstatic they congratulated each other as if they had won the Nobel Prize themselves. Cocktail parties and other events were organized to celebrate this remarkable achievement. TSE alumni organized their own celebrations to honor Jean all over the world. The whole city of Toulouse was talking about it and our friends outside TSE were constantly asking us about Jean and his economic theories. We all feel like being part of it. Our team, excited as it is, decided with great pleasure to change the structure of this issue and dedicates this column to Jean. But, what can we write about Jean?

We all know how humble, polite, smiling, hardworking, efficient and smart he is. We all have been taught economics from his papers and his books. So we decided to let the experts talk about him: we invited some of his colleagues, co-authors and former students to share with us their personal memories and feelings regarding Jean. At the same time, we asked Jacques Cremer to write a longer article about his economic contributions (or any other synonym because Jean is repeated far too many times) (a quite challenging task) with his own unique style of writing. Despite the strict deadline and their busy schedule, all of them accept to contribute with pleasure. The list of people participating in this column is non-exhaustive. We hope you will find this column enjoyable and informative. Jean, our warm congratulations! You made us (again) very proud.

Jacques Crémer (IDEI and TSE)

On Monday 13th October the Nobel committee announced that Jean Tirole had won the prize. On Tuesday 21st October, we found ourselves, by coincidence, on the same plane going to London. Jean was all excited because an hour and a half of flight gave him the chance to get back to … working on papers! His enormous output is the fruit of an exceptional intelligence, but also of a deep love for research. We are extremely lucky that he is our colleague in Toulouse; both thankful to Jean-Jacques Laffont for convincing him to settle in the “pink city” in 1991 and very proud that Jean has found the environment sufficiently to his liking that he has decided to stay since. I arrived in Toulouse one year before Jean, and it is presumably because I am one of his most senior (this is a polite way of saying oldest) colleagues that the editors of The TSEconomist have asked me to summarize the contributions which earned him the Nobel Prize. This is a mixed blessing: there is the fun of describing this great body of work, but also the impossible challenge (I have been given 1800 words) to do justice to three or four books and dozens of article.  The Nobel Prize committee summary of the work takes up fifty four very dense pages! It is often said that the Nobel Prize is given for one discovery; in his case it has been given for reinventing a field of economics. As the committee so justly puts it, “Tirole’s overall scientific contribution is greater than the sum of his individual contributions. He has created a unified framework for IO theory and regulation, founded on a rigorous analysis of strategic behavior and information economics.” Most economists would agree that his contributions can be usefully classified in three subgroups which we will now turn to.  The first group of contributions was the result of Jean’s ability to take advantage of the state of Industrial Organization – the study of the way in which the strategies of firms and consumers shape individual markets – and of the development of new tools in economic theory at the time at which he was beginning his career. Up to the beginning of the 1980s, Industrial Organization (IO) had been dominated by the search for general laws of competition which would extend across different industries. At the same time, game theory, which had started as a minor field at the intersection of mathematics and economics, had come into its own and was beginning to make its influence felt all over economics. Jean realized that it provided a unified language for studying the strategies of firms at a finer level. For instance, with his friend and graduate school colleague Drew Fudenberg, they explained the mechanics of the way investment by a monopolist can influence, or even deter, future entry. They showed that the incumbent would sometimes want to overinvest, and sometimes to underinvest. But the importance of Jean’s contributions to these developments by this and other articles pales compared to his classic book The Theory of Industrial Organization (MIT Press, 1988).  There, he revisited the different aspects of the field and showed how a careful game theoretical analysis shed light on many issues. It provided a summary of what was known and highlighted what remained to be done. When you tackle the book, you are struck by the simplicity and the elegance of the writing. As you go further, you are struck by the depth of the economic intuition. As he was still writing The Theory of Industrial Organization, Jean began working with Jean-Jacques Laffont on the second line of work, which won him his Nobel Prize. In 1982, David Baron and Roger Myerson had published “Regulating a monopolist with unknown costs” which showed how the theory of asymmetric information, which was in full development at that time, provided useful insight on the regulation of a natural monopoly by a regulator. However, Baron and Myerson stopped far short of providing guidelines for actual regulation. Starting with their 1986 article, “Using Cost Observation to Regulate Firms” and culminating in their 1993 book A Theory of Incentives in Procurement and Regulation, Jean-Jacques and Jean tackled this task. They went much farther than exploring the fundamental tradeoff between efficiency and leaving rents to the regulated firm – they extended the analysis to study multi-product firms, the regulation of quality, the dynamics of contracts, the policy of the regulator when it has limited commitment power and, pushing further, they explored issues of institutional design: for instance, they showed how governments can limit the impact of regulatory capture through appropriate regulatory institutions. It is fair to say that the Laffont- Tirole agenda totally  changed the way in which economists think about regulation. They also showed how this could be done in practice through research on specific sectors, in particular the telecommunications sector (see their 2001 Competition in Telecommunications). (Jean-Jacques actually spent lots of time in the last years of his life applying this approach to the problems of developing countries.) Finally, at the beginning of the 2000s Jean developed, along with Jean-Charles Rochet (who has since left Toulouse for Zurich) the theory of twosided markets. This work was linked to the contacts that the IDEI (Institut d’Economie Industrielle) had with Visa, frustrated by the “market-by-market” approach of industry supervisors – leading them to accuse Visa of charging excessively high prices in one market (namely, overcharging merchants) and predatory low prices in another market (namely, undercharging consumers). Thinking through the fundamentals of the industry, Jean and Jean-Charles highlighted the role of “two-sided” network effects: consumers are more willing to carry a card if more merchants accept them, and, conversely, merchants are more willing to join the network when more consumers carry a card. Other examples of “two-sided markets” include operating system software (end users and developers of programs or apps) and media (content and readers/viewers). This “two-sidedness” drastically affects the strategies of firms who need to take into account both the direct and indirect consequences of changes in prices. For Visa, for instance, lowering the price charged to consumers increases the number of consumers, as it would for any good, but also the number of merchants who join the network,  as new merchants are attracted by the new consumers. As a result, it can be desirable to subsidize one side of the market (the too often used, but very striking, example of nightclubs provides a vivid illustration: both the club and men gain from the fact that women are often subsidized through a reduced price at entry). Most importantly for public policy, two-sidedness also changes the “socially optimal” prices – subsidizing is also what a social planner would do. The analysis of two sided markets has had profound consequences for the analysis of firms’ strategies – it is the basic conceptual framework for many courses in business schools – but also for competition policy, especially as it applies to the Internet and information technology. Jean’s work has not only opened a new strand of literature, but it has also helped put the policy debate on better tracks. This is the reason why Joaquín Almunia, the EU commissioner in charge of competition policy, reacted to the prize by stating “We owe Jean Tirole so much,” adding that his work “has been central to the economic analysis underpinning many of our instruments in competition policy and beyond”. The editors of The TSEconomist have asked me to “write an article about the work of Jean on the analysis of market power and regulation, for which he was awarded the Nobel Prize.” I hope that they will forgive me for a few addenda. First, Jean’s contributions extend far beyond the domains for which he was recognized by the Nobel committee. He has been a leader in economic theory, in finance, in banking regulations and so on and so on. To give an idea of the breadth of his work, he has been one of the leading contributors to the rapidly developing field of “economics and psychology” – and he has read enormous  amounts of psychology! Second, and most importantly, Jean has not only written papers. He has contributed to the public debate under many forms, most prominently as a member of the French “Conseil d’Analyse Economique”. He has also played a – I want to say the – crucial role in the development of the TSE. It is sometimes difficult to remember that TSE in its current form was created in 2007! Jean was the linchpin of the design of the new institution, and the driving force of its development. He was director for a couple of years at the start, and has since been its president – definitely not an honorary title! He has also imagined and created the TSE’s sister institution, the Institute for Advanced Studies in Toulouse (IAST), which supports research in social sciences other than economics. Finally, and I know that Jean will scold me for writing this, he is extremely generous with his time – one of my graduate students sent a copy of his paper to Jean, received it back completely covered with comments and told me how thankful he was. The development of the TSE has cost him many sleepless nights and hours away from his research. And finally, as Tyler Cowen put it in his blog Marginal Revolution, “Jean Tirole is renowned as an excellent teacher and a very nice person.” The students who edit The TSEconomist know and are better judges than I am of the ‘excellent teacher’ part. I know about the ‘very nice’, but everyone else in the profession will also be a witness to this fact. Since the announcement, I have spoken to many colleagues from other universities around the world and have been struck by how well liked he is and how personally happy they are for him.