There are trade-offs in regulation. In five words, that is the wisdom which won Jean Tirole his Nobel Prize in economics. The insights of the scientific director of the Industrial Economics Institute at the University of Toulouse in France are valuable. But his modelling techniques subtract more than they add.
The Nobel committee's summary of Tirole's work reads like a policy conclusion drawn from the three-plus decades of research: "The best regulation or competition policy," it writes, should "be carefully adapted to every industry's specific conditions".
In blunt terms, that means that all theories are severely limited. Take the new fashion in utility regulation in the 1980s. At one time, suppliers' charging mechanisms were linked to their costs. But that led utility companies to increase costs in order to justify higher tariffs. That, in turn, led to preference among economists for fixed prices. These, it was thought, gave suppliers an incentive to control costs. Consumers would ultimately benefit from lower rates in subsequent rounds of regulation.
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The prizewinner's mathematical models are valiant attempts to provide order in this confusing world. Many economists are impressed, especially by his use of game theory. However, outsiders find more value in his intuitions, such as those concerning the dangers of paying high bonuses to bosses in industries where performance is hard to measure.
Tirole's reliance on the conventional economic assumption that people behave rationally and selfishly is also flawed. People are much more complicated. They are sometimes selfish, but they usually have at least a vague desire to help society. Good regulation relies on, and tries to encourage, the goodwill of both supervisor and supervised.
Tirole might not have won the Nobel if he eschewed the theoretical maths and simplistic psychology. But he might have given economics more insights.
