Meet the economics Nobel laureate who explains net neutrality and app stores

A natural monopoly bearing the true social cost of its decisions without optimal regulation? Don’t make me laugh.
A natural monopoly bearing the true social cost of its decisions without optimal regulation? Don’t make me laugh.
Image: Reuters/Fred Lancelot
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Jean Tirole, today’s big economics prize-winner, has built a career examining some of the thorniest problems of the modern economy.

In countries—indeed, in most of the world—where it is assumed that market competition generates the most prosperity, there are still markets that allow monopolies or near-monopolies: communications and transportation networks, military materiel, natural resources. Governments need strategies to regulate monopolistic behavior and prevent dominant companies from jacking up prices on everyone, but they also need to avoid forcing prices so low as to make the business unsustainable.

They need, in effect, to simulate competition without having all the information to do so, the Achilles’ heel of central planning.

Tirole and his collaborators have for decades been using game theory to understand this problem, and it is for this work that he was awarded the Nobel prize in economics.* Antitrust issues are returning to importance in economic discussion, as the digital economy seems to lend itself to monopolistic practices (or allegations thereof), whether it was Microsoft in the nineties or Google today.

Lately, Tirole has been focused on “platform markets” that bring together two different parties—payment networks that join merchants and customers, Apple’s iOS ecosystem for developers and users, internet service providers connecting content-providers with internet surfers, or Uber’s car service bringing together drivers and riders. That makes Tirole’s work a timely pick by the committee.

What to do about platform markets. Two decades ago, Tirole explained why Netflix is always complaining about Comcast. Indeed, there is a case to be made that Americans are arguing about net neutrality because the US didn’t adopt Tirole’s optimal strategy to regulate companies like internet service providers.

Currently, deregulated internet providers set their own prices for connecting to competing networks, and the largest networks are accused of setting their prices too high, causing bottlenecks; these companies say they need to cover the costs of building their network. Tirole gives us a formula for regulators to set prices in response to demand that would, theoretically, incentivize investment without killing competition.

How to fight regulatory capture. The financial crisis brought public attention to the problem of regulatory capture, when public agents wind up serving private interests they are supervising, either because of implicit or explicit bribes, or simply bad culture. Tirole’s work has observed, somewhat ironically, that regulators are less likely to be captured if their framework doesn’t set up powerful incentives for supervised firms to cut the their costs, since that reduces the company’s interest in corrupting the regulator.

But Tirole has also found he had to adjust his model of regulatory behavior to account for the fact that some regulators are public spirited and not completely self-interested, an interesting case of behavioral economics creeping into his worldview.

Why is there open-source software? Tirole has examined patent markets, and that led to an interesting explanation for why open-source software exists and is so valuable, since traditional economics would suggest that protecting innovations with a patent is the best option for self-interested programmer. Not only has open-source software thrived, it has become commercially important. Tirole found that this probably results from the fact that signaling expertise and ability is more important to success for software developers than the monetary returns of owning a patent. But the Nobel committee notes that there might be room to complicate this model with a sprinkle of altruism, too.

*Yes, we’re aware it is, technically, the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.