Jean Tirole throws his head back and laughs. “You’re kidding!” he exclaims. I’m not kidding, I insist. It’s true. I explain to him, once again, that when proposals for regulatory price caps on energy bills are floated, politicians and respectable commentators in Britain tend to start discussing Marxism. Tirole’s incredulity is significant. The 64-year-old Frenchman won the Nobel memorial prize in economics in 2014 for his pioneering theoretical work on how utilities ought to be regulated. Tirole is a global authority on the subject, his research influencing regulators the world over. And he knows there is nothing Marxist or communist about restricting the prices a privatised natural monopoly such as energy can charge customers. “Price caps were introduced initially to deregulate,” he explains, citing the caps imposed by the Thatcher government on what British Telecom could charge after privatisation in 1984. Allowing the newly private BT to jack up prices when there was no competition would have ripped off captive customers and destroyed the social legitimacy of the whole project. “I can’t believe that price caps would be seen as a communist plot or something like that,” he says, shaking his head at the primitive nature of our national debate. The key challenge for regulators, as Tirole explains it, is in designing caps so that they are fair to consumers and yet do not discourage private sector investment in the field. It’s not an area in which lectures about the failure of the Soviet Union are particularly relevant. Yet, as I interview Tirole, who is in London to promote his new book Economics for the Common Good, it gradually becomes clear that I’m not going to get any specific answers to the pressing economic questions of contemporary UK politics. Is Theresa May justified in pushing through a cap on energy prices? What about Jeremy Corbyn’s proposals to nationalise the electricity system, the water companies and the trains? Tirole refuses to be drawn. Why? Tirole cites something he calls “Nobel prize syndrome”, or the tendency for winners of the biggest prize in the discipline to dispense their economic prescriptions without doing their homework. Since he hasn’t researched the specific details of the UK sectors in question – analysing the degree of monopoly power of firms, the historical context, the likely behaviour of consumers, etc – he won’t commit. “I really think we should be more humble and not talk about things about which we have an opinion but we have nothing special to say,” he explains. “[The pressure is] stronger when you have the Nobel prize because people believe you know everything!” Nevertheless, he does caution Labour against regarding national ownership as a magic bullet solution to frustrations with the performance of a privatised utility. “I’m not a big fan of privatisation but nationalisation can also be even worse,” he explains. “The issue is that [nationalised] firms tend to be overstaffed very quickly because politicians find it easy to create jobs at the expense of the consumer or the taxpayer. I don’t think the role of the state is to be a producer or a job provider. I think the role of the state nowadays needs to be a strong regulator, defining the rules of the game.” Tirole has been based at France’s respected Toulouse School of Economics for a quarter of a century. But like many of France’s top economists, such as Thomas Piketty, he studied in America. Tirole received his doctorate from the mighty Massachusetts Institute of Technology in 1981 and spent seven years researching there. Ambivalent as he might be about the merits of public ownership, one thing Tirole is insistent on is the imperative for the state to give people good information to make certain markets work. He is scathing about the idea, promoted by libertarians, that the best thing governments can generally do is simply get out of the way. “I found it totally outrageous when some American politicians during and prior to the financial crisis said we should not give financial information to people,” he says. “My goodness! You have to tell them about the risk of teaser rates, about what happens if interest rates go up. They don’t have PhDs in economics. Even if you have a PhD in economics you may not even know if you should switch supplier!” He says that competition authorities everywhere need to pay much more attention to the insights of behavioural economics and the limits of our cognitive capabilities, citing the work of this year’s Nobel economics laureate Richard Thaler. “When you offer 500 pension plans to consumers we are unable to choose. I think there are too many options. You need to standardise things so you can compare offers,” he says. The vast majority of winners of the Nobel Memorial Prize in Economics since it was established in 1969 have been American. Britain comes second. But France’s performance is respectable. Tirole is the third Frenchman to have been recognised by the Swedish committee, following Gerard Debreu and Maurice Allais in the 1980s. What, I inquire, does he make of the striking recent critique from President Emmanuel Macron of “postmodernism”, the theory developed by French philosophers Jean Baudrillard and Jacques Derrida in the mid-20th century that everything is relative and there is no such thing as objective truth. “The worst thing that could have happened to [French] democracy” is how Macron described it in an interview with a German magazine. Tirole shuffles a little uncomfortably on his sofa and says he doesn’t want to get into “academic conflicts”. But it’s clear where his views lie in this debate. “Economics is an inexact science. We have to be humble. But the idea that everything is cultural I think is completely wrong” he says. While he stresses that competent economists always take culture and social norms into consideration, that doesn’t mean everything is relative and one cannot say anything definitive about the world. “Otherwise I would not want my salary to be paid by the French taxpayer,” he says. “I think that would be a shame. We [economists] need to be useful to society.” ‘Economics for the Common Good’ is published by Princeton University Press
This article was originally published in The Independent on 16/11/17 FULL TRANSCRIPT:
UK polls show high public support for bringing things like water, rail and electricity back into public ownership. Labour’s manifesto pledges to renationalise them. Regardless of whether that’s a good idea or not, does this level of public dissatisfaction enable us to say privatisation in these industries has been a failure?
Let me just say, I’m not an expert on British matters. Is it a failure of privatisation or is it a failure of regulation? That’s really the issue. We need to design good regulations. It’s not easy because by definition those are by and large monopolies. You can introduce a bit of competition here and there, but you really need to design good incentives and because they are monopolies you cannot easily benchmark. You can do that across regions, but even that is difficult. You have to be aware of pitfalls of regulation. So for example, if you try to give what we call “high-powered incentive schemes”….so you try to encourage a firm to reduce cost, then you know there’s a danger that quality won’t be very good because to reduce costs you can reduce quality. That’s the easy way to reduce costs. But of course that’s not the right way. If you try to incentivise firms to be more efficient you also have to more carefully monitor quality. And we have seen that a little bit on the railroad industry. You have to make sure there is enough maintenance of the track etc. We had that in the UK actually with British Telecom [after privatisation in 1984]. Things like that we have to be aware of. Just [to] deregulate for the sake of deregulation is bad. It’s not an easy exercise and sometimes you’re going to leave some rents on the table. That has to be accepted….I’m not a big fan of privatisation but nationalisation can also be even worse. The issue is that [nationalised] firms tend to be overstaffed very quickly because politicians find it easy to create jobs at the expense of the consumer or the taxpayer. That’s my main worry. I’m not saying privatisation is wonderful. It’s still a monopoly. It’s very hard to regulate. You may not get quality of service or right prices. But the same is true for nationalisation. You still have a monopoly and on top of that you have this soft budget constraint in that you can overstaff the firm. We have seen that all over the world – it’s not a British problem. You use a firm to create jobs and try to get some more votes. In the end it’s going to create a very expensive firm. I’m not against nationalisation by ideology. If a bank fails you may say we’ll nationalise the bank as long as we’ll privatise it again in two to three years, which is what the Scandinavians did in their [banking] crisis. That’s fine. I’m not an ideologue. But I don’t think the role of the state is to be a producer or a job provider. I think the role of the state nowadays needs to be a strong regulator, defining the rules of the game. It’s not very good at producing stuff.
One of the sources of the public discontent with privatisation is a legitimacy problem of private profits from what were traditionally non-profit sectors. What about the idea of non-profit companies running these services?
You still need the governance – you don’t want this firm to be without control. You need someone who is going to hold the managers accountable. I’m the chairman of a foundation, a not-for-profit, the Jean-Jacques Laffont Foundation. We could spend the money and waste the money. So it’s very important that we have a board of directors. Out of the 15 directors 13 are outsiders. They check what we’re doing and they’re also monitored by the French accounting office. We need to be checked.
But what about something like the Bank of England, which has operational independence? What about a not-for-profit water company that has a mandate for investment and good quality service and a fair deal for customers but how you achieve that we leave in your hands…
You could have that. But you could also have that at the level of the regulator, if you have an independent regulatory agency who is going to basically resist political pressure and industry pressure.
But that still has the profit motive for the company…
That’s right. But the profit motive when regulated well. I don’t see anything wrong with that. If you have a regulator that is checking on you, making sure that you are delivering quality and not overcharging, not cheating on the consumer, then the profit motive is not that bad. In the US public utilities in the seventies were private – and by the way they were not functioning that well. In Europe we had nationalised public enterprises – which were not functioning that well [either], except in France we had EDF, which for various reasons, did a decent job. But once we had the introduction of competition that became a little bit harder to think about because you had this tension between a state being a regulator and the state being an owner. That was difficult. We don’t have that much experience, expect in development or education, with foundations and schools…You could have non-profit, but you still need the governance structure. Who is going to oversee that entity? If you have a strong sense of mission that may occur in healthcare, in NGOs for example, that can be fine. But you cannot just rely on people being nice and doing the right thing. What I’m sure of is that you need a strong independent regulator. Independent central banks are not completely independent. People think Janet Yellen can do anything she wants, or Mario Draghi can do anything he wants. But there are constraints. And if they repeatedly did wrong things they would be kicked out. Even if they do the right thing they might be kicked out! That’s another issue.
One of the debates we have in the UK is that nationalisation would be expropriation and would create such a legal morass that it would be impossible…
Banks are different because banks when they are nationalised are valueless. Of course there are still court proceedings and the like and the shareholders will argue it’s not completely valueless. But it’s easier. It’s more difficult [for other companies]. Which value do you take? Do you take the share value? But of course that depends on expectation of nationalisation. The book value? But is that a good measure of the investments that have been made? And so on. It’s just very difficult to find the right price to nationalise.
Is that an insurmountable barrier?
No. Think about “eminent domain”. It’s a case where you want to build a highway or a railroad and you confiscate somehow…and then there is some court proceedings saying is that fair or not? You could [do that]…it’s a bit harder. For real estate you have the value of land, you look at comparable houses, comparable pieces of land. It’s harder here because you have monopolies! There’s no traded prices. You can expect a more conflictual processes. Again I’m not a big fan of nationalisations. Not on principle – there’s nothing wrong with the public being involved. I’m very concerned with the firm being used for purposes which are not very good purposes – creating jobs which are not needed. Overstaffing is a big concern. We cannot afford that anymore. A period of high growth and high wealth is fine – you can have some slack. We are in a period of low growth and high debt [so] spending a lot of money and taxing consumers and taxpayers [is dangerous]…
So would you say to Labour that the answer to public discontent about privatised industries is to focus on the regulatory architecture?
Yes, definitely. And make sure you have the right people, that you don’t have political appointees. Sometimes you do. You get top people. We know that central banks are able to attract top people. If you screen enough and you focus on expertise rather than political friendship – there is always this tendency because Congress and Parliament always tries to get their friends appointed. That’s bad.
In the UK context the concern is less that the regulators are bad people, but that the regulators and competition authorities are toothless and they don’t take enough consideration enough of ordinary people’s behavioural biases…
The same exists in France. It’s part of the duty of governments to actually inform consumers. It’s true with electricity, it’s true with elections, it’s true of everything. Our world is very complex, there’s a lot of information we don’t have, we don’t process. We have behavioural biases. People need a choice, but they also need help with the choice. We have to pay attention not to give too much power to the Government in those choices. But having a little bit of advice from experts…explaining the trade-offs – not saying you should go for the incumbent or the entrant…but at least giving them some elements to think about those issues is very important. We have to explain what the risk is [such as] “watch out, there are teaser rates”. I found it totally outrageous when some American politicians during and prior to the financial crisis said we should not give financial information to people. But my goodness! You have to tell them about subprime, about the risk of teaser rates, about what happens if interest rates go up…if you don’t inform them…they don’t have Phds in economics…even if they have Phds in economics you may not even know if you should switch supplier! You need help. Same thing when you offer 500 pension plans to consumers. We are unable to choose. I think there are too many options. You need to standardise things so you can compare offers. It’s not about comparing the options. It’s trying to make things comparable. I don’t have time to compare different offers – there’s just no way.
But given people aren’t behaving in the way the designers of the market would like them to act, is it then legitimate to protect those people who are being financially penalised through price caps? The UK government is doing this through an electricity cap for people on standard variable tariffs.
In France you have the right to come back to the incumbent [electricity supplier] if you are not satisfied. Which is a strange option because it says you can always try and come back. If the price goes up you can always come back to a regulated tariff…
Labour also wants to have a French-style rent increase cap…
It would be better actually to index on market conditions. You move into an apartment which is very costly, you have children in school…and you don’t want your landlord to tell you after six months that by the way it’s twice as expensive. Capping the rent between different leases doesn’t make sense, because you don’t want rent control. Rent control is bad. But within a lease, you have to protect the person who rents. Because otherwise you have hold ups. And the question of course is: how do you do it? The best thing of course is to index it to something, but something which is objective somehow. In France you are protected. And I think it’s fine. But of course there are cases where it’s hard to find the right cap. So for example in electricity, we know the wholesale price is supposed to reflect scarcity if there is not too much market power (sometimes there is). And if you put a price cap you are going introduce more scarcity mainly for the peak supply. That’s a big issue – sometimes there is not enough peak capacity. If you cap at a very low level the rate, you won’t have such [investment] plans. In France people have kept the cap because they think there is a lot of market power. [It] has been proved that there’s market power in those peak periods. But then you create shortage. So what is done is that you introduce capacity markets. You require suppliers of electricity to sell you the electricity to show they have capacity so that they can cover peaks. Price caps are useful to constrain market power so the first question is: is there market power? In the [residential] rent stuff there might be a hold-up once you have moved into a flat. And also in electricity market during very scarce supply periods. Then the question is: what level do you want to put the price cap, knowing that it will have bad consequences? It will curb market power but could cause a shortage of capacity.
So a well-designed cap is not a bad thing?
That’s right. But we face that everywhere. Let me give you the example of the credit card market. In [previous] times if you use your credit card to shop you’ll be using it at the same price as if you use cash – there was no surcharge, simply because American Express of Visa or Mastercard would tell you you’re not allowed to surcharge if you’re a merchant. Then the regulator said no, the merchant should be allowed to surcharge because they pay a fee, maybe 3 per cent for Amex or Paypal, and they should be allowed to pass through that to the consumer. But of course you have an interesting pattern in the UK, Australia and some other places in the US too is that most merchants didn’t actually surcharge but some surcharged a huge amount. You know the cases where you pay £10 or £15 once you have booked Ryanair or something…What regulators are trying to do now is cap the surcharges. And the question is what level you pick. The proposals right now are mainly a cap – 3 per cent less something – actually we have a paper in Toulouse saying it’s too lenient in that case. But that shows the difficulty…
Do you about Booking.com stuff? It shows why finding a cap is difficult. If you are a hotel, Booking says you have to accept the condition of “price parity” or “most favoured nation”. If you buy from Booking as a consumer you have to pay the same price as on the website of the hotel or Expedia. But look at a situation where all hotels are on Booking and you are sure as a consumer to get the lowest price on Booking. You as a consumer are never going to look anywhere else because all hotels are on Booking and you’re never going to get a cheaper price anyway. Then Booking can go to the hotel and say “look, my customers are unique customers. You are not going to reach them unless you accept 20-25 per cent [commission]”. Huge market power. And the by the way the market power doesn’t come from dominance in the reservation system because Booking.com has only 20 per cent of reservations. It could have 2 per cent – it doesn’t matter! As long as it has unique customers it can ask any price. The decision in relation to Booking.com in France and Germany was not to go for a price cap because what would it be? 8 per cent? 14 per cent? Nobody had a clue actually. With a credit card we basically designed the rule to tell you what the price cap should be. At least you have principles for thinking through the price cap. Whereas in the case of Booking the economists haven’t done their homework. We don’t even know where to start. We certainly think 25 per cent is too big. But is that 8 per cent? 14 per cent? What was decided was something else saying you could get a lower price. In France you can get a lower price on the website of the hotel. Which creates also some problems – the danger then is that the consumer goes on the website of Booking, finds the hotel he or she wants, and then goes to the hotel directly and then Booking gets no reward, which is not fair either. In the case of Booking the decision was not to go for a price cap because we didn’t know how to calibrate the price cap. We had different remedies. They [price caps] can be a good thing. But if they’re poorly calibrated they can have bad effects.
We have a very primitive debate in the UK. Whenever anyone says “price cap” we hear “Marxism” or “slippery slope to communism”….
You’re kidding! I thought price caps were introduced initially to deregulate to some extent. So for British Telecom, to get a pricing structure which was closer to what was more economically oriented. I can’t believe that price caps would be “communist” plot or something like that…
So how do you regulate giant internet companies – Amazon, Google – with huge market power? You don’t seem to reach any conclusion in your book…
Economists haven’t quite done their homework. You have to think much more about those things because they are the new economy. We are going to get those network effects which are very powerful. You will have superstar firms making big profits. The question is: what do you do with these firms? Somehow you want to make these firms contestable, which is a jargon for saying if someone is more efficient in some market niche then you want his firm to be able to enter, which may be difficult if Google bundles the various services. It’s going to be hard to compete against a zero price service. So you have to be very careful that entrants can enter in a particular market segment. And by the way they all do that. If you think about Google itself it started small. Amazon started selling online books. Think about Uber. I cannot predict, but my guess is that Uber is not entering the taxi market, I mean the current taxi market. But in five years from now, or ten years from now, there won’t be any taxis any more, at least not with drivers. Uber is trying to enter a niche and then expand. They all do that. You cannot enter every market at the same time. It’s too risky, too complicated, too costly. You start with one and build out.
What about them buying competitors. Should this be allowed by regulators?
This is a complicated area. What’s happening is those firms are buying future competitors. At the same time it’s pretty hard for the anti-trust authorities. Given those a young firms and you don’t know where they are going and you don’t have any data. Are they future competitors? We don’t even know. The principle is easy. If you want to merge with someone who’s going to compete with you in the future? No. But the practice is harder. And that’s one of the things we need to think through. But the anti-trust authorities don’t have an easy job. The idea you need some total concentration [measurement] makes no sense. A start-up has zero sales, or very small sales! Then there are lots of specific issues. We talk about Booking.com…I give some insight about the anti-trust, but we need much more work. In Toulouse we have developed this theory of two-sided markets, the economics of platforms. We have been saying for a long time, when you do anti-trust don’t look at one side of the market. You have to look at the two sides, otherwise it makes no sense. Many of those platforms they charge zero to one side of the market – you get a great deal for your credit card or your search engine – it’s wonderful. You’re selling your data. And then they charge huge prices to advertisers and to merchants and so on. On one side of the market you’re a pure monopolist and the other side you’re preying on your competitors because you’re charging zero prices. It’s just a completely wrong picture. The anti-trust authorities also have to adapt to the new economy. We are a bit ahead of the anti-trust authorities but we are behind what’s going on. We have to work harder.
Do you have much contact with regulatory authorities? Do they consult you, because you are obviously an authority on it…
To be honest I’m pretty involved in the policy debate, but on other issues. The labour market and climate change issues. A bit in competition policy issues…Also I’m pretty involved in banking policy. But there’s only so much time. Fortunately there’s a number of very highly qualified economists in competition authorities who actually who have read that stuff [of mine]. So for example what we said on “patent pools” has been adopted in the European Union. And the same thing for credit cards. But I haven’t played any role…The ideas are maybe used, but just because you have some bright people in those authorities! I’m not in Brussels.
Would you like to see regulators taking more account of behavioural economics?
No question. I’m a big fan of behavioural economics. Also I recognise the threat it may pose, you know. We have to be careful. It’s in its infancy. Economists have been working on it for 20 years. But it’s not a mainstream thing.
President Emmanuel Macron recently criticised “post-modernism” and its influence on France. Would you agree with that?
I don’t want to get into academic conflicts. I’m a strong believer that there should be a back and forth between theory and empirical work, connection with the facts. And theory’s important as well. You have to be explicit what your assumptions are, what your logical reasoning is, and so on and so forth. This is the scientific method. Economics is an inexact science. We have to be humble. But we also have a methodology that we have to claim. And that’s very important. And the idea that everything is cultural I think is completely wrong! Because then everything is qualitative and you cannot say anything. That doesn’t mean that culture plays no role, which is a different thing. Social norms, culture – we are studying that in economics, of course, they’re important. The people who stress those things, of course they’re not completely wrong. But we should not go all the way and say that everything is relative and therefore you cannot say anything. Otherwise I would not want my salary to be paid by the French taxpayer! I think that would be a shame. If there was not a minimum of consensus and knowledge at any point of time, which evolves of course, how could I justify my salary? We need to be useful to society.
Do you feel that you’re successfully resisting what you describe as ‘Nobel prize syndrome’?
I try not to get into politics and areas in which I’m not competent – there are many areas in which I’m not competent. There’s always a grey zone – where do you stop? You have some common sense, you have stuff from your colleagues, you have some knowledge. It’s always tempting to go beyond. I cannot say I never go beyond where I should stop. I’m mindful of the temptation – I try to resist. I really think we should be humbler and not talk about things about which we have an opinion but we have nothing special to say. It’s stronger when you have the Nobel prize because people believe you know everything!