The news that this year’s Nobel memorial prize in economics has gone to Jean Tirole is absolutely excellent, a really well-deserved award. I’m not going to compete with the swift and thorough summary already put out by Tyler Cowen. But I do want to add one comment just in case there are people out there thinking, why on earth has the prize gone to an economist who does theoretical, highly mathematical work – isn’t that yet another sign of how remote from the real world the whole discipline of economics has become? No economist who knows Tirole’s work will think so, and I’m sure there will be general delight about his selection, but maybe there are others who might make this mistake.

This is of course a common complaint about economics. It’s only partly true, and therefore partly false. There are for sure some economists who rely too much on basically very simple mathematics to gussy up economic analysis that doesn’t really need any equations. However, often economic thinking about the messy, complicated real world gets to a point at which the inter-relationships between variables are so knotty that mathematics is better able than words to keep track of them. The results are sometimes surprising.

Jean Tirole’s mathematics is of this kind. For example, in the work I know on two-sided markets (those where a platform stands between buyers and sellers), competition and market power look very different than they do in conventional markets like those for clothes or haircuts – so the conclusions competition authorities should draw from pricing on one side of the market might be very different from the usual ones. As the Scientific Background paper says:

“Tirole’s models have sharpened policy analysis. Focusing on the fundamental
features that generate a divergence between private and public interests, Tirole has
managed to characterize the optimal regulation of specific industries. Often, his rigorous
thinking has overturned previous conventional wisdom. For example, he successfully challenged the once prevalent view that monopoly power in one market cannot be profitably leveraged into another market by vertical integration. As a result, competition authorities have become more alert to the potential dangers posed by vertical integration and restraints. More generally, Tirole has shown how the justifications for public intervention frequently boil down to problems of information asymmetries and credible commitments. These general lessons — together with a catalogue of specific applications — form a robust foundation for policy analysis.”

His research has built the fundamental methods for the applied study of actual markets characterised by information asymmetries, moral hazard, lock-in, the exercise of power – features that are all too prevalent in the real world of business. It has huge practical relevance to regulators, including in the financial sector, and competition authorities. As Tyler points out, Tirole has also written on intrinsic motivation versus financial incentives.

The example of his work emphasises a broader point, which is that appropriate mathematics is essential in economics. And as Tony Yates recently pointed out, the maths needed as economics – thank goodness – gets ever closer to the real world is likely to get harder and harder. Say, if the subject takes more seriously non-linear dynamic systems, or strategic interactions between firms with different degrees of market power in a network market. Having said that, I always like F.Y.Edgeworth’s advice to regard mathematics as a kind of intellectual scaffolding, essential for the construction process, but preferably to be removed at the end.

[amazon_image id=”B00MF1FVTC” link=”true” target=”_blank” size=”medium” ]The Theory Of Industrial Organization by TIROLE JEAN (1988) Paperback[/amazon_image]