Jean Tirole Awarded 2014 Nobel Prize in Economics

Jean Tirole, a professor at the Toulouse School of Economics, is the recipient of the 2014 Sveriges Riksbank prize in economic sciences in memory of Alfred Nobel. Tirole is chairman of the board of the Jean-Jacques Laffont Foundation at the Toulouse School of Economics, and scientific director of the Industrial Economics Institute in Toulouse. The announcement of the award by the Royal Swedish Academy of Sciences stated “Jean Tirole is one of the most influential economists of our time; he has made important 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. Tirole is awarded this year’s prize for his analysis of market power and regulation.” His analysis of firms with market power provides a unified theory with a strong bearing on central policy questions such as how governments should deal with mergers or cartels, and how to regulate monopolies.

A question that is always relevant for public policy is which activities should be conducted as public services and which should be left to private firms. Many governments have opened up public monopolies to private stakeholders. This has applied not only to industries such as railways, highways, water, and telecommunications, but also to the provision of education and healthcare. The experiences resulting from these privatizations have been mixed and it has often been more difficult than anticipated to get private firms to behave in the public interest. There are two main difficulties. First, many markets are dominated by a few firms that influence prices, volumes and quality. Traditional economic theory does not deal with this case, known as oligopoly; instead it presupposes either a monopoly or conditions of perfect competition. The second difficulty is that regulatory authority generally lacks information about firms’ costs and the quality of the goods and services they deliver; this lack of knowledge often provides regulated firms with a natural strategic advantage in controlling markets.

In a series of books and articles, Jean Tirole has presented a general framework for designing regulatory policies and applied it to a number of industries including banking and telecommunications. Although written twenty years ago, Tirole’s book (with co-author Mathias Dewatripont) The Prudential Regulation of Banks applies modern economic theory to prudential regulation of banks. The authors tackle the key problem of providing the right incentives to management in banks by looking at how external intervention by holders of equity or debt affects managerial incentives and how that intervention might ideally be implemented. Observing that the main concern of the regulation of intermediaries is solvency and the relation between equity, debt, and asset riskiness, Tirole and Dewatripont provide detailed research findings on the institutional background of the banking industry and develop a case for regulation, to include performing the monitoring functions of screening, auditing, covenant writing, and intervention that dispersed depositors are unable to perform. The authors develop a model of the capital structure of banks and show how optimal regulation can be achieved using capital adequacy requirements and external intervention when necessary. Their regulatory system is designed to insulate bank management from macroeconomic shocks.

Another major work by Jean Tirole is his 2002 book Financial Crises, Liquidity, and the International Monetary System. Major banking and currency crises in recent decades have fundamentally altered the traditional views of free and unrestricted capital flows and capital account liberalization. Tirole analyzes the various crises and the proposed reforms of the international monetary system and emphasizes that a proper identification of market failures is essential to reformulating the mission of The International Monetary Fund. He adapts the basic principles of corporate governance, liquidity provision, and risk management to the specific requirements of country borrowing; he revisits commonly-advocated policies and considers how multilateral organizations can help debtor countries reap enhanced benefits while liberalizing their capital accounts.

Jean Tirole’s award of the 2014 Nobel Prize in economics, together with the success of Thomas Piketty’s book Capital in the Twenty-first Century (featured in the November 2014 edition of Commentary) has put the French economics profession in the international spotlight. France is noted for its world leadership in philosophy, literature, art, fine wine, cuisine and haute couture; economics is now added to that list of accomplishments. When the International Monetary Fund recently listed the world’s twenty-five best young economists, seven were French. According to Research Papers in Economics (RePEc) that undertakes bibliographic and citation analysis and prepares ranking lists of both citing and cited research papers, Jean Tirole ranks among the most influential economists in the world today. The RePEc rankings of university economics departments for excellence include both the Paris School of Economics (where Piketty is a professor) and the Toulouse School of Economics (where Tirole is a professor) among the highest-rated universities.