Jean Tirole’s Contributions to the Economics of Innovation

The Nobel prize that Jean Tirole obtained last year was the reward for a remarkable set of contributions to economics. The readers of the TNIT newsletter may not realize that for the general public in France, Jean is better known for his contributions, in collaboration with Olivier Blanchard, now chief economist to the International Monetary Fund, to the public debate on reforms of the labor market! The Nobel prize committee rewarded him for his work on Industrial Organization, the study of the structure of industries, where as they put it “Tirole’s overall scientific contribution is greater than the sum of his individual contributions”. But Jean has also contributed to economic theory, the regulation of banks, finance, the theory of organizations of firms, the theory of financial bubbles, economics and psychology and many other fields.

Jean was born and brought up in Troyes, a provincial town of about 60,000 inhabitants a bit more than 100 miles to the south east of Paris. He studied in Paris at the Ecole Polytechnique from which he graduated in 1976, and then entered the French public service by becoming an engineer in the ministry of transportation. At the same time as he was studying at the Ecole des Ponts et Chaussées, the school that prepares the top civil servants of the Ministry, he obtained a doctorate in Applied Mathematics, but had already begun working in economics. He went to MIT in 1978 and obtained his PhD in 1981. For the next three years, he was a researcher in Paris and crossed the Atlantic again to become Professor at MIT up to the beginning of the 1990s where he settled in Toulouse, where he not only continued to produce an amazing flow of top level research, but where he also has taken major administrative responsibilities.

There are three major strands of his work that led Jean to the highest honor that can be bestowed to an economist. First, during his days as a graduate student, he realized that game theory, which had just graduated from being a fringe field of study to a fundamental element of mainstream economics, could provide the intellectual structure for the study of the strategies of firms. The list of his articles on the topic, including some with his graduate school friend Drew Fudenberg, is impressive, but even more impressive is his classic book The Theory of Industrial Organization, published five years only after he obtained his PhD. It provided at the same time a structure for understanding the field as it stood at that point and a roadmap for future developments. It is still a much used reference.

Whereas the first set of contributions studied the behavior of unfettered markets, the second focused on the intervention of governments to regulate industries. Spurred by the debate around the regulation of “natural monopolies” which raged in the 1980s, Jean, in collaboration with Jean-Jacques Laffont, used the new theories of information economics to explore the way in which regulators should provide incentives for the firms under their purview - Electricité de France and France Télécom (now Orange) were among the sponsors of Jean and Jean-Jacques’ work in Toulouse. This work has revolutionized the way in which regulation is done the world over.

Finally, in the first years of the 21st century, along with Jean-Charles Rochet then professor in Toulouse, Jean was the major contributor to the development of the theory of two-sided market, which has revolutionized the study of platforms, and which forms the underlying intellectual framework for much of the research discussed in the TNIT Newsletter.

Although the work for which the Nobel committee rewarded Jean is theoretical, it is grounded in a determination to understand the real world and a dialogue with policy makers. Let us give two examples: Laffont and Tirole applied the insights of their theoretical work to write a primer on the regulation of the Telecommunications industry; the work on two sided market was inspired by a study of the payment card industry.

In recent years, Jean has turned some (he does lots of other things!) of his attention to another important aspect of industrial organization: the study of innovation. This represents both a new field of study for him, but also a new methodology: in this work, done in collaboration with Josh Lerner, he not only developed the theory, but also tested it.

This research on innovation has focused on the growth of new organizational structures to promote the development and diffusion of ideas. Perhaps the most intriguing of these new models is open source, which seems very unlike what most economists expect. Private firms usually pay their workers, direct and manage their efforts, and control the output and intellectual property thus created. In an open-source project, however, a body of original material is made publicly available for others to use, under certain conditions. Many of the contributors, individuals or firms, to open source projects are unpaid. Indeed, contributions are made under licenses that often restrict the ability of contributors to make money on their own contributions. Open source projects are often loosely structured, with contributors free to pursue whatever area they feel most interesting. Despite these unusual features, recent years have seen a dramatic rise of open source projects.

Jean’s work on open source has focused on two questions. The first has been the understanding the motivation of individual contributors. Lerner and Tirole¹ argue that the standard framework of labor economics can be adapted to capture activity in the open source environment. Even if there are no short-run monetary returns from working on open source projects, they argue that participation can have important signaling benefits in the long-run. The paper highlights the importance of programmers’ desire to signal their quality - e.g., the desire to impress prospective employers and financiers, as well as obtain peer recognition - as a spur to contributions to open source projects. The presence of these signaling incentives will lead to more success for open source projects where contributions are more visible to the relevant audience (such as peers or employers) and where the talent of the contributor is better discerned from their contributions. The empirical evidence, particularly the survey work of Hann² et al., is largely consistent with the belief that individual contributors to open source projects do ultimately benefit financially from their participating in these projects.

A second area is the legal rules under which open source projects operate. The licenses differ tremendously in the extent to which they enable licensors and contributors to profit from the code that is contributed. Lerner and Tirole³ argue that permissive licenses, where the user retains the ability to use the code as he sees fit, will be more common in cases where projects have strong appeal to the community of open source contributors - for instance, when contributors stand to benefit considerably from signaling incentives or when the licensors are well-trusted. The evidence is largely consistent with these suggestions.

But many of the issues posed by open source are not unique to this setting. Open source can be seen as at the end of a spectrum of technology sharing institutions. Many of these other institutions, such as patent pools and standard setting bodies, have encountered similar conflicts.

To cite one example, how “open” a standard is can critically affect its evolution. The rapidity with which the standard is adopted and the incentives to innovate may be shaped by this decision. For instance, the Internet today runs on a non-proprietary architecture largely because the Internet Engineering Task Force had in its early years a strict policy of only incorporating technology where the developer agreed to license it on “reasonable and non-discriminatory” (RAND) terms. Had the SSO had a more permissive policy (as indeed they adopted in the mid-1990s), the development of the Internet may have been very different⁴.

In a recent paper, Lerner and Tirole⁵ (2014) examine the challenges that occur when there are multiple routes to solve a given technological problem. Each one of these may be equally viable, but often a standards body will choose only one avenue. After the decision is made, however, the chosen patent becomes a “standard-essential patent (SEP),” and the patent owner can ask for a high royalty even when other patents could have offered comparable value, had the technology been morphed differently.

Standard setting bodies must therefore regulate the licensing of the patents chosen to be part of the standard. To restrain firms from taking advantage of the essentiality of their patents, standards bodies commonly require firms to commit in advance to license their patents on fair, reasonable and non-discriminatory (FRAND) terms. The problem with this approach is that FRAND commitments are very ambiguous; what exactly is a fair and reasonable rate? The substantial ambiguities associated with FRAND commitments have resulted in dozens of enormously expensive litigations. This paper proposes an alternative approach for addressing these issues, which we term structured price commitments. Requiring price commitments is theoretically appealing, rather risk-free, and, we think, definitely worth experimenting with.

More about Jean Tirole:

• Jean Tirole Nobel Prize Videos on YouTube
• Jean’s Co-Authors Congratulate Him on YouTube
• TSE Magazine: “The Economist, the Market and the Nobel Prize” Special Issue

More information:

• Jean Tirole faculty page at Toulouse School of Economics
• Jacques Crémer faculty page at Toulouse School of Economics
• Josh Lerner’s faculty page at Harvard Business School

Footnotes:

1/ Lerner, J. and Tirole, J. (2002), Some Simple Economics of Open Source. Journal of Industrial Economics, 50: 197–234. doi: 10.1111/1467-6451.00174.
2/ Hann, Il-Horn; Roberts, Jeff; Slaughter, Sandra; and Fielding, Roy (2002), “Economic Incentives for Participating in Open Source Software Projects,” ICIS 2002 Proceedings. Paper 33.http://aisel.aisnet.org/icis2002/3.
3/ Josh Lerner and Jean Tirole (2005), “The Scope of Open Source Licensing” Journal of Law, Economics and Organization 21 (1): 20-56 doi:10.1093/jleo/ewi002.
4/ Bradner, Scott (1999). “The Internet Engineering Task Force” in Open Sources: Voices from the Open Source Revolution DiBona, Chris, and Sam Ockman, eds., O’Reilly Media, Inc., 47-52.
5/ Josh Lerner and Jean Tirole, “Standard Essential Patents,” Journal of Political Economy, forthcoming.

The preceding is re-published on TAP with permission by its authors, Professor Jacques Crémer and Professor Josh Lerner, and by the Toulouse Network for Information Technology (TNIT). “Jean Tirole’s Contributions to the Economics of Innovation” was originally published in TNIT’s December 2015 newsletter.