The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel was awarded this year to French economist Jean Tirole for his “analysis of market power and regulation.” This is a good thing for economics, and for us. The validation and publicity that the Nobel name carries may bring some sense into our regulatory world.
There are many different kinds of market regulation and it can get complicated very quickly. One thing is clear, however: the regulation of markets eventually falls into the arms of politics and its less-attractive companion, political influence.
The underlying reason for this is that the goals and methods of regulation are not hearty or clear enough to endure the trip to the real world.
Jean Tirole is changing that by providing a better understanding of how businesses work in markets where they have just one, two, or a few competitors. Economists call this “imperfect competition” and, generally, it is the reason why government regulation is necessary in the first place. If there are a large number of competitors consumers’ interest will be looked after by market forces.
Tirole works in an area of economics called “Industrial Organization,” which, in terms of news media and public attention has been almost an academic shadow specialty in a field dominated by forecasting and other financial market concerns.
Industrial organization theory deals with how markets really work. Markets are not often perfectly competitive, but usually have a small number of competitors — an oligopoly in economists’ lingo. While a considerable amount of theoretical work had been done on oligopoly — spurred in no small way by the interest in how prices for oil and gasoline were determined — very little has been done to match regulatory goals to the “situation on the ground” in the industries themselves. Professor Tirole’s Nobel award may change all that.
While the underlying concept of Jean Tirole’s work is easily understood, his analysis is not. When you discover that the Nobel committee’s explanatory summary took 58 pages you get an idea of the problem. Those pages are not likely going to be the basis for a Broadway production of “Tirole: The Musical.”
Part of the complexity is that Tirole’s theoretical approach involves game theory, which requires an understanding of mathematics that doesn’t come easy for most of us mortals. The purpose of this, though, is to provide a sound theoretical foundation for the regulatory solutions he discovers. He succeeded in this, which is, of course, why the prize was awarded.
In addition to the foundation his theory provides, the complexity provides regulators assistance in recognizing that oligopolies and other imperfectly competitive markets tend to be individualistic. The oil and gasoline business is different from the silicon chip business and neither is quite like the insurance or banking business. Each of them has a structure and driving forces sufficiently different to make a single, one-size-fits-all, regulation ineffective. We need regulations, and laws, which are tailored to fit goals for specific industries if we expect to get the results we want.
It takes a while for ideas in economic theory to be absorbed in the U.S., especially if they originate somewhere else, like France. And while Wall Street’s collapse gave a burst of energy to government meddling and regulating, there have no big changes in oligopolistic markets themselves. If anything, through consolidations they have become more entrenched and more powerful in our economy. Professor Tirole’s work explained why, but few were listening.
Government regulatory efforts that take legal action against firms with excessive market power tend to end in darkness and despair. In one Justice Department lawsuit against IBM, for example, after a trial that lasted six years the suit was declared to be “without merit” and tossed out of court.
Part of the problem is the wording of the regulatory laws, whose origins date back to the Teddy Roosevelt era. Professor Tirole’s work may be helpful in bringing the legal structure up to date.
The Nobel laureate’s analysis does not cover the political reality of drafting regulations, though, and that is a world unto itself. As soon as Congress schedules hearings for drafting new regulations for an industry, it is like announcing a lobbyists’ convention. Industry representatives also parse every phrase and sentence of proposed regulatory language and insist, often very effectively, on changes that favor their interests.
As a result of gaps in economic theory the U.S. experience with market and industry regulations has been generally more successful with monopolies than oligopolies. Jean Tirole’s work will help immensely with the theory side of the problem, but it is up to us to solve the political influence side, which, come to think of it, ruins a lot of things in government.
James McCusker is a Bothell economist, educator and consultant. He also writes a column for The Herald Business Journal.
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