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Theoretical Pragmatism

And this year the Nobel Prize for economics goes to: Jean Tirole, Professor of Economics at the University of Toulouse in France. The award of a Nobel Prize is a bit of a junket, which is not to say Jean Tirole doesn’t warrant one. But the award often reflects not some objective criterion of contribution to human knowledge (which, incidentally, is the fundamental criterion for a Ph.D) but a fashion in political economy. The composition of the selection committee usually determines which fashion. For several years during the period of financial boom, the prize went to economists focused on explaining why markets were always correct. In 2014 there is clearly a crisis of confidence in grand economic theories given the Great Recession and the highly pragmatic mode of recovery called Quantitative Easing (QE). As Ben Bernanke, ex-Chairman of the US Federal Reserve, recently joked, QE “works in practice, but it doesn’t work in theory”.

Therefore, appropriately, the prize this year went to a theoretical pragmatist. In his multitude of papers, many co-authored with his late colleague Jean-Jacque Laffont, Jean Tirole gave mathematical exactitude to common sense propositions. The key point was that industries that exhibit tendencies towards monopoly, and which therefore alert the need for regulation, are never more similar than they are different. In other words, that dreadfully hackneyed expression “one size does not fit all” applies. The underlying truth of this arises from the simple fact that those who best understand the differences between the industries are not regulators but those directly involved in running the companies concerned. But this poses a problem for society. As Adam Smith famously remarked, a caucus of business people are more likely to promote their own interests than those of society. Only a bland belief that the interests of companies is indistinguishable from the collective interest of society can ignore this problem.

The mainstream economic argument concerning monopolies consists of two propositions: that markets dominated by monopolies will price higher and produce lower than competitive markets; monopoly profits will attract new entrants who will eventually undermine these monopolies – in essence, this is the argument of the dominant Chicago School. Only market failure will prevent this process from occurring, and therefore only market failure justifies regulatory intervention on any significant scale. Add rapid technological change to these arguments and we arrive at the inevitable conclusion that the subject of regulation, for example, monopoly profits or alternatively market share, is ephemeral. That doesn’t mean that there are never prolonged periods when the issues remain the same, it just means those periods are being foreshortened. That in turn implies regulation must be nimble, which is not the strong card of most governments.

Jean Tirole devoted his scholarship to examining ways to make regulation smarter by understanding how the behaviour of regulated companies undergo major shifts in light of technological and competitive changes that force them to change their business models. A much cited example in the ICT field is the shift from high subscription charges to low or free subscriptions and a greater emphasis upon value-added services, advertising revenues and the monetization of market data. Price and profit caps make little sense in such a business environment. On the other hand, the way personal data is used raises many additional regulatory concerns. As Viktor Mayer-Schönberger, Professor of Internet Governance and Regulation at the Oxford Internet Institute pointed out, as we move into an era of the Internet-of-Things in which personal data will be collected through a ubiquity of channels, it will no longer be feasible to identify individual personal data for purposes of obtaining permission to use it. Personal data protection legislation is quite new, but it is already becoming outdated. The academic work of Jean Tirole tells us that what works today, doesn’t necessarily work tomorrow, not least because regulated companies can game the system, so regulators need to find a modus operandi that makes their interventions relevant.

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