2014 Nobel prize winner Jean Tirole on market failure

Jean Tirole is one of the most influential economists of our time. He has made important theoretical research contributions in a number of areas, but most of all he has clarified how to understand and regulate industries with a few powerful firms.Many industries are dominated by a small number of large firms or a single monopoly. Left unregulated, such markets often produce socially undesirable results—prices higher than those motivated by costs, or unproductive firms that survive by blocking the entry of new and more productive ones.From the mid-1980s and onwards, Jean Tirole has breathed new life into research on such market failures.

His analysis of firms with market power provides a unified theory with a strong bearing on central policy questions: how should the government deal with mergers or cartels, and how should it regulate monopolies?

Before Tirole, researchers and policymakers sought general principles for all industries. They advocated simple policy rules, such as capping prices for monopolists and prohibiting cooperation between competitors, while permitting cooperation between firms with different positions in the value chain. Tirole showed theoretically that such rules may work well in certain conditions, but do more harm than good in others. Price caps can provide dominant firms with strong motives to reduce costs—a good thing for society—but may also permit excessive profits—a bad thing for society.

Cooperation on price setting within a market is usually harmful, but cooperation regarding patent pools can benefit everyone. The merger of a firm and its supplier may encourage innovation, but may also distort competition.The best regulation or competition policy should therefore be carefully adapted to every industry’s specific conditions. In a series of articles and books, Jean Tirole has presented a general framework for designing such policies and applied it to a number of industries, ranging from telecommunications to banking. Drawing on these new insights, governments can better encourage powerful firms to become more productive and, at the same time, prevent them from harming competitors and customers.”

Unlike some previous recipients, such as Robert Engle and Clive Granger in 2003 or Lars Peter Hansen in 2013, who won the prize for developing new econometric methods few laymen can easily understand, Mr Tirole’s research has direct relevance to current policy issues. Most notably, his ideas of how to regulate industries dominated by a single large firm are helping to produce strategies for how to prevent Google from using its vast market share in the internet-search business to behave as a monopoly. And as we argued back in March, Mr Tirole’s theories can also help us understand the impact on markets of disruptive forces such as Uber, a taxi app that matches customers and drivers. 

http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2014/press.html