One Great Idea From Jean Tirole, the Nobel Economist

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Jean Tirole, the French economist who won this year’s Nobel economics prize, has so many ideas that it takes a 52-page scientific paper just to list them, with the authors apologizing that “it is hard to do justice to his immense body of work in a few introductory paragraphs.” One of his contributions that’s relatively easy to explain, however, gives a taste of what he has done—and continues to do, since at age 61 he remains in the prime of his fertile career.

The government worries mainly about “horizontal” mergers in which one company buys another that does the same thing. But there’s also risk in vertical combinations. A monopolist in one part of the production chain—say, a computer operating system—might be able to extend its market power to neighboring links on the chain.

The Chicago School of antitrust economics, personified by the likes of failed Supreme Court nominee Robert Bork, argued in the 1970s and 1980s that attempts to extend a monopoly “vertically” would be irrational because a company could get all the benefits of its market power without merging with one of its customers or suppliers. The Chicago School’s theory was so influential that it caused the Justice Department. to remove “vertical integration” from the things to watch out for in its official merger guidelines.

Tirole was among a group of economists who showed, using game theory, that it was in fact possible to make a bigger profit by extending a monopoly to higher and lower links on the production chain. One example would be a company with a patent on a cost-reducing innovation. Selling it to everyone might benefit the public. But the patent holder could make a greater profit by selling the patented invention exclusively to just one customer, which would then be able to underprice its competitors and capture the market. The patent holder might ultimately need to buy its customer, Tirole said.

The downside of that is less competition and possibly higher prices. The upside is that vertical combinations can encourage innovation. “Competition law therefore has to weigh these two considerations against each other,” the Nobel committee wrote in its general-interest explanation of the prize.

“Tirole’s analysis of vertical contractual relationships quickly gained academic acceptance, and it has contributed to a significant revision of competition policy, especially in the U.S.,” the scientific paper explains.

I spoke today with Lawrence J. White, who helped develop the original Justice Department horizontal merger guidelines as chief economist of its Antitrust Division under President Reagan in 1982 and 1983. “This is a well-deserved award,” says White, who is a professor of economics at New York University’s Stern School of Business.

The theories of Tirole and others probably influenced antitrust regulators to put conditions on Comcast’s acquisition of NBC Universal, White says. Comcast (CMCSA), which had market power as a signal carrier, extended its influence by buying an important content provider. The 2011 deal approved by the Federal Communications Commission and the Justice Department required Comcast to give up management control of the Hulu online-video service that NBC shared with Fox (FOXA) and ABC (DIS) and set conditions for Comcast to share NBC programming with online rivals and traditional competitors such as Dish Network (DISH) and DirecTV (DTV), as reported by Bloomberg.

Read more: One Great Idea From Jean Tirole, the Nobel Economist

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