David R. Henderson  

Tirole on Economics for the Common Good

Origins of the Entitlement Nig... Some comments on tax incidence...


In 2014, French economist Jean Tirole, chairman of the Toulouse School of Economics and the Institute for Advanced Study in Toulouse, won the Nobel Prize in Economics. Although he is well known within the increasingly technical economics profession, Tirole is not well known to non-economists. This 500-plus-page tome is an effort to change that. Written for a general audience, it covers a wide range of issues, including those on which he has published professionally and those on which he has not but still has much to say. The topics include the effects of free trade, French unemployment, the role of the state, financial bubbles, the Greek economic crisis, and regulation of industries.

It's hard to generalize about Tirole's views. On the one hand, he understands the powerful role of incentives, understands why free trade is good for a country, thinks through the unintended consequences of legislation and regulation, and understands that the political system is filled with perverse incentives. On the other hand, he favors some highly intrusive regulations in the labor market, has too much confidence in the ability of economists and governments to improve on free markets, misunderstands how to judge the tightness or looseness of monetary policy, misstates the nature of externalities, and doesn't seem to understand adverse selection in insurance markets.

These are the opening two paragraphs from David R. Henderson, "A Mixed Bag," Regulation, Winter 2017/2018. His book is titled Economics for the Common Good. Here's the whole review. (Scroll way down, almost to the end.)

Three paragraphs on some of my favorite parts of the book:

To illustrate how thinking about incentives and unintended consequences can help inform good policy, Tirole considers a hypothetical case in which a nongovernmental organization (NGO) "confiscates ivory from traffickers who kill endangered elephants for their tusks." The NGO can either destroy the ivory or sell it. Tirole points out that most people would advocate destroying the ivory. But he urges the reader to think further. Destroying the ivory means that the supply of ivory is lower than otherwise, making the price higher than otherwise. How does a higher price affect the incentives of poachers? That's right: it causes them to kill more elephants. Another example, which many economics professors use in class, is the perverse effects of price ceilings. Not only do they cause shortages, but also, as a result of these shortages, people line up to purchase the scarce provisions and thus waste time in queues. The time spent in queues wipes out the financial gain to consumers from the lower price, while also hurting the suppliers. No one wins and wealth is destroyed.

Tirole, like most economists, is strongly pro-free trade. He argues that French consumers gain from freer trade in two ways: free trade exposes French monopolies and oligopolies to competition; and goods imported from low-wage countries are cheaper. On the former, Tirole notes, "Renault and Peugeot-Citroen sharply increased their efficiency" in response to car imports from Japan. He estimates that the monthly gain from free trade per French household is between 100 and 300 Euros. That translates to an annual gain per household ranging from $1,400 to $4,200.

Incidentally, when economists refer to economics as "the dismal science," they almost always get the origin of that term wrong. Tirole gets it right. He explains that Thomas Carlyle, in an 1849 publication calling for bringing back slavery, called economics the dismal science because the economists of the time strongly opposed slavery. The economists who dominated in 1849, although Tirole doesn't mention this, were strongly pro-free market.

I wrote the Wall Street Journal piece on him, published the day after he won.

COMMENTS (4 to date)
Jon Murphy writes:

It sounds like an interesting book. I'll have to add it to my list!

Jacob Egner writes:

Wow, very interesting:

Incidentally, when economists refer to economics as "the dismal science," they almost always get the origin of that term wrong. Tirole gets it right. He explains that Thomas Carlyle, in an 1849 publication calling for bringing back slavery, called economics the dismal science because the economists of the time strongly opposed slavery.

That essay is "Occasional Discourse on the Negro Question" and you can find the full text here.

Such an ill-founded insult to economics. I hope as people learn the origin of the insult, they'll tend to abandon it.

Michael Makovi writes:

Sounds like an interesting book. I'm going to go buy it. And it looks like there's a lot more to be said. For example, I quote your review:

"His solution is to charge employers who fire employees an amount reflecting the cost that the unemployment insurance system imposes on French taxpayers. This would probably work better than the current system, but..."

Actually, his solution sounds like it could have some horribly perverse consequences. It's one thing to charge an employer for firing a competent and reliable employee who simply isn't needed anymore. From the perspective of someone who support unemployment insurance, that isn't a perverse outcome.

But what about incompetent and unreliable employees? If an employee is fired because they come to work late and don't adhere to the dress code, then the employer will be penalized. This will make employers even more reluctant to hire those with low educations and little work experience. Restrictions on firing employees already make it harder for the lowest tier of workers to get hired. Penalizing employers for firing employees would only make it harder for the worst-off members of society.

Michael Makovi writes:

. . . on the other hand, if employers pay a penalty for firing employees, then the employer will simply reduce wages by the actuarially-estimated appropriate amount. In essence, employers would collect insurance premiums from their workers (deducted from wages), and if the worker is fired, the employer would pay the government the insurance payout, and the government would turn around and pay the worker.

So it's really just a roundabout way of having the employer and employee negotiate unemployment insurance between the two of them. The government becomes almost superfluous in this arrangement. So it would certainly internalize costs by making workers aware of what unemployment insurance really costs them. On the other hand, this might make it politically unpopular. The whole point of politics is to give people "free" benefits whose costs are hidden. Tirole's scheme would make the costs clear to workers, which is good economics but poor politics.

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