David R. Henderson  

Henderson on Tirole

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But they do not commit the mistake of thinking that regulators are necessarily better than firms in setting prices. Consider the recent issue of interchange fees (IF) in payment-card associations like Visa and MasterCard. Many regulators have advocated government regulation of such fees. But in 2003, Messrs. Rochet and Tirole wrote that "given the [economics] profession's current state of knowledge, there is no reason to believe that the IFs chosen by an association are systematically too high or too low, as compared with socially optimal levels." In other words: Back off. Interestingly, the article from which I'm quoting was not among the 159 articles referenced by the Nobel Committee.
This is my favorite paragraph from my piece, "The Economic Nuances of the Latest Nobel Laureate," published in print today, and electronically last night, in the Wall Street Journal.

Here's my second favorite:

From the late 1960s to the early 1980s, the field of industrial organization was dominated by the Chicago School, where four of the major players were the late George Stigler (who was awarded the Nobel in 1982), his colleagues Sam Peltzman and the late Yale Brozen, and UCLA economist Harold Demsetz. They argued that even though most industries do not fit the economists' model of "perfect competition" in which no firm has the power to set a price, the real world was plenty competitive. Firms compete by cutting costs, by cutting price and by innovating. These economists' understanding of the ubiquity of competition led them to be skeptical about much of antitrust law and most government regulation.

Some background. Every Columbus Day (apologies to co-blogger Bryan Caplan), I set my alarm for 4:00 a.m. and get up and watch the live announcement of the Nobel Prize winner. Then I think through his/her (don't forget Ostrom) work and look at the materials the Nobel Committee has on its site. I decide by 4:45 a.m. whether I know enough to write a piece for the Journal and have it to them by 11:00 a.m. Usually the answer is yes.

This year, it was harder. The Nobel guy making the presentation emphasized Jean Tirole's work on reining in large firms. A friend who noticed that I was on Facebook messaged me to say that if I was doing the piece this year, he had some thoughts to share on on Tirole's work in which Tirole comes off as a central planner. After reading both Tyler Cowen's and Alex Tabarrok's excellent posts on Tirole, I decided that I didn't know enough about Tirole to write the piece. Here's how I decide: the bar for me to write a negative piece is higher than the bar for me to write a positive piece. If I'm criticizing someone on "his day," I'd better know the work pretty thoroughly. That's why I didn't write the piece on Amartya Sen when he won. I had never been impressed by his work, and my piece would have been very critical; but I thought I might have left something positive and important out.

I called Alex and discussed the idea, and told him that if he wanted, I would bow out and recommend him. Alex didn't feel comfortable enough either. I then called my editor at the Journal and told him my thinking. His thinking was similar to mine: if you're going to say it was a bad pick, you had better really know the work.

Two minutes after I called my Journal editor, Alex sent me a 2003 article by Tirole and Jean-Charles Rochet that turned around my thinking on Tirole. It's the one I quote in my Journal piece. I looked back at everything I had seen that morning and realized that it was the Nobel Committee, with its emphasis on reining in big business, that had colored my view of Tirole. That wasn't fair to Tirole. But it also gave me my angle: contrast Tirole's cautiousness with the Committee's aggressiveness. I e-mailed the two Journal editors I was dealing with, titling the e-mail "HALT." I made my case. The Journal accepted.

By 9:30 a.m., I had the piece done and sent it to Alex Tabarrok and Lynne Kiesling for comments. Alex had two suggestions, one of which I used, and Lynne liked it. I also sent it to the friend who had seen Tirole as a central planner. We had talked on the phone while I was writing and he was starting to realize that he hadn't been reading Tirole directly but, instead, had read people who ran with Tirole and used it to advocate aggressive regulation. I pruned it a little and sent it to the Journal at 10:30 a.m.

The Journal got the edit to me by 1:00 p.m. with some changes and queries that were easy to deal with. Just before approving, I heard from the friend who had thought Tirole advocated aggressively regulating IFs. He had run my idea by a colleague who knew Tirole's work better. His colleague confirmed my view: people were using Tirole's work to advocate aggressive regulation, but Tirole was much more cautious. I approved the article.


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COMMENTS (7 to date)

I didn't know much of Tirole's work either, but of what I did, I concluded that 1. he's remarkably broad in his interests, and 2. he's definitely a 'two-handed' economist. I.e., he's very cautious about recommending any policy, given the competing incentives in play most of the time.

Then, I really had to laugh when, just after France's Prime Minister Manuel Valls was taking his victory lap over the 'French-bashers', Tirole himself came out as all Margaret Thatcher (France is going to run out of money with its current level of government spending). Headline:

Economics Nobel laureate tells France to 'downsize the state'
David R. Henderson writes:

Wow, Patrick! That’s fantastic! It fits a piece that Alex Tabarrok sent me this a.m. that Tirole wrote in 2007. This will be a whole new blog post. Thanks.

Tom West writes:

Here's how I decide: the bar for me to write a negative piece is higher than the bar for me to write a positive piece.

Yet another reason why I enjoy your writings.

"given the [economics] profession's current state of knowledge, there is no reason to believe that the IFs chosen by an association are systematically too high or too low, as compared with socially optimal levels."

Ah, "socially optimal".

I'd say that's the whole kettle of fish right there. The difficulty with economics (and with sciences that have economic policy implications like climate science) is that

(1) it's hard for individuals to divorce the science from their personal ethos and
(2) it's hard for outside observers to believe that individuals are divorcing their science from their personal beliefs.

Todd Moodey writes:

David--

Thanks for the really interesting peak into your thought process. Since it's Nobel season, I thought you might hazard a guess as to why Armen Alchian never won the prize? I believe Hayek's theory was that he didn't publish enough.

BTW, I count my incredibly unlikely encounter with the Alchian and Allen textbook, then know as Exchange and Production, in an intro Micro course at Cornell (of all places) as one of the great blessings of my adult life!

Thanks,

Todd

David R. Henderson writes:

You’re welcome, Todd Moodey.
I said this in my talk at Armen’s memorial: I think he published enough--look at Coase. But he was a little too shy and didn’t brag enough. Also, if he had glad-handed a little over in Stockholm in his early 70s, that would have helped. But see my two points earlier: shy and not braggy.
Thanks, Tom West.

Dallas writes:

Prof. Henderson

I very much enjoyed your piece, but was wondering if you could elaborate on the differences between the older Chicago approach and more recent theory in IO (as illustrated by, say, Tirole's textbook).

You mention that Stigler et al saw the economy as more competitive, but that is an empirical proposition and Tirole is more of a theorist. In term of theory, it seems like the older generation relied much more on intuition (like Demsetz). So introducing game theory wouldn't be a dramatic shift, just a way to make their arguments more formal. Do you disagree?

andy writes:

I am about half through the Nobel 50 page article and so far my impression is: regulating these things is something between hard and impossible. It seems to me that if somebody proposed to provide some state-payed service, I would almost point him to this and ask: are you sure you can do that?

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