'Theoretical' Nobel economics explain WHY the tech industry's such a damned mess

Regulation's not a dirty word

Worstall on Wednesday Jean Tirole was this year's Nobel Laureate in Economics* and what the prize was awarded (in part) for should interest people around here. Tirole's work has often been about how this tech industry of ours works and what the hell anyone should be doing to try and regulate it – if, indeed, it should be regulated at all.

This is rather amusingly different from last year's economics prize, which went to three people explaining the Efficient Markets Hypothesis: one stating that it worked, the other that it didn't and the third providing the deep mathematics to show that both were correct.

This year the prize goes to something useful in the real world, rather like Elinor Ostrom's prize a couple of years back, where she explained how, in the real world rather than on paper, people could solve common problems through voluntary cooperation.

Tirole's work has largely been in industrial organisation: how do firms organise themselves and interact? Much of this has been about what happens when we don't interact, as we usually don't have those perfect markets so beloved of the simpler economic models.

When is a monopoly actually exercising its economic power? How are oligopolistic firms (ie, two or a handful of dominant firms) competing or carving up the market between them and what should we do about it if we don't like what they're doing?

Tirole's biggest finding is that the correct answer is, as the correct answer so often is in economics, “it depends”. We need to look at the details of that specific market and see how changing regulation and oversight would actually impact upon current behaviour, before we can decide what, if anything, should be done.

The standard answer of “regulate the bastards” doesn't particularly work as regulators all too often end up protecting the industry they're supposed to be regulating (“regulatory capture” in the jargon, or when we apply it to political ministers, we say they've “gone native”. They end up representing their department to the cabinet, rather than being the cabinet regulating the mnistry).

More specifically about the tech world, Tirole has done a lot of work on “platform markets”. The simplest example of this is perhaps Facebook: it's free to us the consumers because we're the product being sold to the advertisers. Facebook is a platform that gives us something we want (social media) but the economic driver being that it collects a billion of us, with lots of lovely data, that can be sold to advertisers. The economics of such platforms are subtly different from those of regular producers of something because there's two entirely different sets of customers to placate.

A major paper on this point was written before Facebook even existed but we can see the same point being made through the examples used:

Two-sided (or more generally multi-sided) markets are roughly defined as markets in which one or several platforms enable interactions between end-users, and try to get the two (or multiple) sides “on board” by appropriately charging each side. That is, platforms court each side while attempting to make, or at least not lose, money overall.

Examples of two-sided markets readily come to mind. Videogame platforms, such as Atari, Nintendo, Sega, Sony Play Station, and Microsoft X-Box, need to attract gamers in order to convince game developers to design or port games to their platform, and need games in order to induce gamers to buy and use their videogame console.

Software producers court both users and application developers, client and server sides, or readers and writers. Portals, TV networks and newspapers compete for advertisers as well as “eyeballs”. And payment card systems need to attract both merchants and cardholders.

There are many other two-sided markets of interest, only a few of which will be mentioned in this overview.

This is, I hope you'll agree, an area of study of great interest to all of us in the tech business. Tirole's specific interest isn't just in describing such two sided markets: it's in trying to work out how or whether they should be regulated. It is, for example, obvious that Google has a dominant position in European search. But is that the same as a monopoly? And even if it is is this something that we should try to regulate: and if the answer is yes, then just how should we regulate it?

The point being that precisely because this is a two sided market then the economics of what is welfare enhancing isn't immediately obvious.

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