When Jean Tirole won the Nobel Prize in Economics, he suddenly found himself being stopped in the street by strangers and asked to comment on current events far from his own research. His transformation from academic economist to public intellectual prompted him to reflect more deeply on the role economists and their discipline play in society. The result is Economics for the Common Good, a passionate manifesto for a world in which economics can help us improve the shared lot of societies and humanity as a whole. To show how, Tirole shares his insights on a broad range of questions affecting our everyday lives and the future of our society, including global warming, unemployment, the post-2008 global financial order, the euro crisis, the digital revolution, innovation, and the proper balance between the free market and regulation. Compelling and accessible, Economics for the Common Good sets a new agenda for the role of economics in society.
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Do You Like Economics?
If you are not an economist by training or profession you might be intrigued by economics (otherwise you wouldn't be reading this book), but you do not necessarily like it. You probably find economic discourse abstruse, even counterintuitive. In this chapter I would like to explain why that is, describe a few cognitive biases that sometimes play tricks on us when we think about economic questions, and propose some ways of spreading an understanding of economics more widely.
Economics concerns all of us in our everyday lives; it is not just for experts. Once we look beyond appearances, and identify and overcome the initial obstacles, it is also accessible and fascinating.
What Prevents Our Understanding Economics
Psychologists and philosophers have long examined the factors that shape our beliefs. Numerous cognitive biases work to our advantage (which no doubt explains why they exist) but they also occasionally mislead us. We will encounter these biases throughout this book, and see how they affect our understanding of economic phenomena and our view of society. In short, what we see – or want to see – and reality are different.
We Believe What We Want to Believe, and We See What We Want to See
We often believe what we want to believe, rather than what the evidence points to. Thinkers as diverse as Plato, Adam Smith, and the great nineteenth-century American psychologist William James have all pointed out that the way we form and revise our beliefs serves to confirm the image we want to have, both of ourselves and of the world around us. When these beliefs are aggregated, they determine a country's economic, social, scientific, and geopolitical policies.
Not only are we subject to cognitive biases, we also frequently seek out things that reinforce them. We interpret facts through the prism of our beliefs; we read the newspapers and seek the company of people who will confirm us in those beliefs; and thus we stick obstinately to these beliefs, whether or not they are correct. When Dan Kahan, a professor of law at Yale University, confronted Americans who voted Democrat with scientific proof of the anthropogenic factor (the influence of human beings on global warming), he observed that they were more convinced than ever of the necessity of taking action against climate change. When Republicans were confronted with the same data, many of them were confirmed in their skepticism. Even more astonishing, this was not a matter of education or intelligence: statistically, the refusal to face up to the evidence was at least as firmly anchored in Republicans who had advanced degrees as it was in less well-educated Republicans. No one is immune to this phenomenon.
The desire to reassure ourselves about our future also plays an important role in our understanding of economic (and more generally, scientific) phenomena. We do not want to hear that the battle against global warming will be expensive. Hence the popularity in political debate of the idea of "green growth." The name suggests that in environmental matters we can have our cake and eat it too. But if it is really so easy, why hasn't it already been implemented?
We like to think that accidents and illnesses only afflict others, not ourselves or those close to us. This can lead to harmful behavior, such as driving carelessly or not looking after our health (though this is not entirely negative since worrying less improves our quality of life). In the same way, we do not want to believe the possibility that an explosion of public debt might endanger the survival of our social safety net – or at least we want to believe that someone else will foot the bill.
We all dream of a world in which the law would not have to encourage or constrain people to behave virtuously, a world in which companies would voluntarily stop polluting and avoiding their taxes, in which people would drive carefully even without police officers around. That is why movie directors (and not only of Hollywood movies) invent endings that meet our expectations. These happy endings confirm our belief that we live in a fair world where virtue wins out over vice (what the sociologist Melvin Lerner called "belief in a just world").
When populist parties on both the right and the left promote the vision of an economy free of difficult choices, anything that questions this sugarcoated fairytale is perceived at best as scaremongering, at worst as lies put about by global warming fanatics, austerity ideologues, or other enemies of humanity. The insistence on reality rather than fairytale is one reason why economics is often called "the dismal science."
What We See and What We Don't See
First Impressions and Heuristics
The teaching of economics is usually based on the theory of rational choice. To describe the behavior of an individual, economists start by describing his or her objectives. Whether the individual is selfish or altruistic, seeking profit or social recognition, or has some other ambition, in every case he or she is assumed to act as far as possible in his or her own interest. This hypothesis is sometimes applied too strongly, and not only because an individual does not always have the necessary information to make a good choice. As the victim of cognitive biases, this agent is also likely to make a mistake when evaluating the best way to attain an objective. Humans are subject to many biases in reasoning or perception. These biases do not invalidate the theory that rationality defines the choices that individuals ought to make to act in their best interest (normative choices), but they explain why we don't necessarily make those choices.
We will make use of the notion of heuristics, as described by Daniel Kahneman, a psychologist who won the Nobel prize in economics in 2002. Heuristics are rules of thumb for thinking, shortcuts to an answer to a question. They are often very useful because they allow us to make decisions quickly (if we are face-to-face with a tiger, we don't have time to calculate the optimal response), but heuristics can also mislead. They channel emotion, which can be a reliable guide but can also be very ill-advised.
For example, we are more likely to remember situations in which our activity has been interrupted. Thinking "the telephone always rings when I'm in the shower" is clearly a trick played by our memories. The call that interrupted the shower remains imprinted on our memories, unlike the calls that did not. Similarly, we are afraid of airplane crashes and terrorist attacks because they are covered at length in newspapers; we forget that car accidents and "ordinary" murders kill many more people than these fortunately rare events. Since September 11, 2001, there have been 200,000 homicides in the United States, of which only 50 were carried out by (American) Islamic terrorists. This does not, however, prevent terrorist acts from being etched on our psyche.
The main contribution of Kahneman and Tversky's work has been to show that these and other heuristics often mislead us. They give many examples, but one is particularly striking: medical students at Harvard made significant errors when calculating the probability that a patient had cancer given certain symptoms. These were the brightest American students, yet their shortcuts in reasoning were not corrected, not even by their brilliant intellects and stellar education.
In economic matters too, first impressions can mislead us. We look at the direct effect of an economic policy, which is easy to understand, and we stop there. Most of the time we are not aware of the indirect effects. We do not understand the problem in its entirety. Yet secondary or indirect effects can easily make a well-intentioned policy toxic.
Throughout this book we will encounter many examples of this phenomenon, but let us start with a deliberately provocative example. I have chosen this example because it allows us to see immediately the kind of cognitive bias that leads to poor public policy decisions. Let's suppose an NGO confiscates ivory from traffickers who kill endangered elephants for their tusks. The NGO has to choose between destroying the ivory or selling it discreetly on the market. The immediate reaction of most readers would be that the latter choice is reprehensible. My spontaneous reaction would be the same. But let us examine this example more closely.
The NGO would receive revenue from selling the ivory, which it could use to provide more resources to detect and investigate, or to provide additional vehicles to limit the traffic in ivory. Selling the ivory might also have the immediate effect of lowering its price. The price would be a little lower if not much was sold, and a lot lower if a lot of ivory was put on the market. Traffickers are economically rational actors: they consider how much money they can make from their activity and consider the risks they take (in this case, prison or meeting armed police). If the price of ivory falls, it would therefore discourage some of them from killing elephants. Given this, would the NGO's sale of ivory be immoral? Possibly. A conspicuous sale by an organization with a respectable reputation might legitimize the trade for potential buyers who would otherwise feel guilty about their desire to purchase ivory – hence my emphasis on a "discreet sale" in this scenario. But at the very least, we ought to think twice before we condemn the choice of selling the ivory, especially since doing so would not prevent the government from exercising its sovereign authority to prosecute poachers or retailers of ivory or rhinoceros horn, or from communicating to the public the importance of protecting endangered animals in the hope of changing the accepted social norms.
This hypothetical scenario helps explain why the 1997 Kyoto Protocol failed. The Protocol promised to be a major step in the battle against global warming. Because of carryover effects (known in environmental economics jargon as "the leakage problem"), whereby polluting activities tend to migrate to countries with more lenient regulations, the battle against greenhouse gases in a single region may have little or no effect on worldwide pollution. Suppose, for example, that the United States reduces its consumption of fossil fuels (oil, gas, and coal). On its own, this effort would be laudable. Experts agree that it would require similar major efforts by every country to limit the global rise in temperature to the 1.5 to 2 degrees centigrade that is considered to be a bearable level of global warming. The problem is that when one country saves a ton of coal or a barrel of oil, the price of coal and oil falls, which encourages greater consumption elsewhere in the world.
Similarly, if a virtuous country forces its resident industries to pay to emit greenhouse gas, these industries are likely to move to another country where the absence of carbon taxation would make it cheaper to produce. This would partly or entirely cancel out the reduction in greenhouse gas emissions in the virtuous country, and there would be only a weak effect on the environment. Any serious solution to the problem can only be global. In economic matters, the road to hell is paved with good intentions.
The Bias toward the Identifiable Victim
Our empathy is naturally directed toward people who are geographically, ethnically, and culturally close to us. Our natural inclination, which has evolutionary origins, is to feel more compassion for people in economic distress from our own community than for children dying of hunger far away, even if we recognize intellectually that the starving children are in more urgent need of help. More generally, we feel greater empathy when we identify with victims; and to do so it helps if we can recognize them. Psychologists have identified our tendency to attach more importance to people whose faces we know than to other, anonymous people.
This bias toward the identifiable victim, no matter how instinctive it is, affects public policies. In the words of the quotation often attributed to Joseph Stalin: "The death of one man is a tragedy. The death of a million men is a statistic." Thus, a deeply distressing photo of Aylan Kurdi, a three-year-old Syrian child found dead in 2015 on a Turkish beach, forced us to pay attention to a situation it would have been more comfortable to ignore. It had much more impact on Europeans' awareness of refugees than the statistics about the thousands of migrants who had already drowned in the Mediterranean. The photo of Aylan had a similar impact on European attitudes toward migration as the 1972 photo of Kim Phúc, a Vietnamese girl burned by napalm running naked down a street, had on opinions about the Vietnam War. A single identifiable victim may affect many more minds than millions of anonymous victims. In the same way, an advertising campaign against drunk driving has a more powerful effect when it shows a passenger flying through a windshield than when it announces the annual number of victims (a statistic that provides, however, far more information about the consequences of drunk driving).
The bias toward the identifiable victim also leads astray the employment policies practiced in Southern European countries, in which some permanent jobs are strongly protected while other jobs are insecure. In many countries with this kind of strong employment protection, the media focuses on the battles to save jobs fought by employees with permanent contracts; their tragedy is made more acute because they live in a country where they have little chance of finding another similarly secure job. These victims have a face. Yet the media reports ignore the much larger group of people who alternate between short-term jobs and spells of unemployment. They have no faces, they are only statistics. As we will see in chapter 9, they are the victims of institutions – some of them set up to protect the first set of employees on permanent contracts – that cause firms to prefer to hire employees on fixed-term contracts rather than create stable jobs. While we worry about dismissals of protected workers, we forget the people who are excluded from the labor market in the first place, even though these groups are two sides of the same coin.
A Tale of Two Professions
The contrast between economics and medicine is striking: in contrast to its low opinion of "the dismal science," the public regards medicine – rightly – as a profession devoted to people's well-being (we call it "the caring profession"). Yet economics takes a similar approach to that of medicine. The economist, like the oncologist, makes a diagnosis on the basis of the best available (though necessarily imperfect) knowledge, and then either proposes the most suitable treatment on that basis or recommends no treatment at all, if none seems necessary.
These diverging perceptions of medicine and economics are easy to explain. In medicine, the victims of secondary effects are for the most part the same people who are being treated (epidemiology is an exception – think for example of the consequences of the spreading resistance to antibiotics, or of the loss of herd immunity when vaccination levels decline). A doctor has only to remain faithful to the Hippocratic Oath and recommend what is in the best interest of the patient. In economics, the victims of secondary effects are rarely the same people who received the original treatment, as the example of the labor market shows very clearly. An economist is obliged to think about invisible victims as well, and so the public sometimes accuses that economist of being indifferent to the sufferings of the visible victims.
THE MARKET AND OTHER WAYS OF MANAGING SCARCITY
Air, water from a stream, or a beautiful landscape can be enjoyed by one person without others being prevented from benefiting as well. But for most goods, one person's consumption means that others cannot consume it too. An essential question in organizing societies is how to manage the scarcity of goods and services that we all want to consume or possess, in rivalry with other people's demands: the apartment we rent or buy, the bread we buy at the bakery, or the rare earths needed to make metal alloys, or dyes, or green technologies. Although society can diminish scarcity by producing goods more efficiently, either by innovation or by commerce, it must also manage people's consumption of goods from one day to the next. Societies vary widely in how well they do this.
Historically, scarcity has been managed in many ways: queues when there are shortages of vital goods such as food or gasoline; drawing lots for green cards, concert tickets, or organ transplants; distributing goods administratively to priority groups; fixing prices below the level that would balance demand and supply. Scarcity is also managed by corruption, favoritism, violence, wars, and, finally, by the market. The market, then, is only one of many ways to manage scarcity. Though the market prevails today and allocates resources between firms (B2B), between firms and individuals (B2C, as in e-commerce), and between individuals (C2C, on platforms such as eBay), it hasn't always been so.
Excerpted from "Economics for the Common Good"
Copyright © 2017 Jean Tirole.
Excerpted by permission of PRINCETON UNIVERSITY PRESS.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.
Table of Contents
Introduction Whatever Happened to the Common Good? 1
The Relationship between Society and Economics 7
The Economist’s Profession 8
A Window on Our World 11
The Common Thread 12
I Economics And Society
1 Do You Like Economics? 17
What Prevents Our Understanding Economics 17
The Market and Other Ways of Managing Scarcity 24
How to Make Economics Better Understood 29
2 The Moral Limits of the Market 33
The Moral Limits of the Market or Market Failure? 36
The Noncommercial and the Sacred 40
The Market, a Threat to Social Cohesion? 47
II The Economist’s Profession
3 The Economist in Civil Society 65
The Economist as Public Intellectual 66
The Pitfalls of Involvement in Society 70
A Few Safeguards for an Essential Relationship 76
From Theory to Economic Policy 78
4 The Everyday Life of a Researcher 80
The Interplay between Theory and Empirical Evidence 80
The Microcosm of Academic Economics 91
Economists: Foxes or Hedgehogs? 101
The Role of Mathematics 104
Game Theory and Information Theory 109
An Economist at Work: Methodological Contributions 118
5 Economics on the Move 122
An Agent Who Is Not Always Rational: Homo psychologicus 123
Homo socialis 137
Homo incitatus: The Counterproductive Effects of Rewards 141
Homo juridicus: Law and Social Norms 147
More Unexpected Lines of Inquiry 149
III An Institutional Framework For The Economy
6 Toward a Modern State 155
The Market Has Many Defects That Must Be Corrected 157
The Complementarity between the Market and the State and the Foundations of Liberalism 160
Politicians or Technocrats? 163
Reforming the State: The Example of France 169
7 The Governance and Social Responsibility of Business 174
Many Possible Organizations … but Few Are Chosen 175
And What Is Business’s Social Responsibility? 185
IV The Great Macroeconomic Challenges
8 The Climate Challenge 195
What Is at Stake in Climate Change? 195
Reasons for the Standstill 199
Negotiations That Fall Short of the Stakes Involved 206
Making Everyone Accountable for GHG Emissions 213
Inequality and the Pricing of Carbon 222
The Credibility of an International Agreement 226
In Conclusion: Putting Negotiations Back on Track 228
9 Labor Market Challenges 231
The Labor Market in France 233
An Economic Analysis of Labor Contracts 242
Perverse Institutional Incentives 245
What Can Reform Achieve and How Can It Be Implemented Successfully? 251
The Other Great Debates about Employment 255
The Urgency 261
10 Europe at the Crossroads 265
The European Project: From Hope to Doubt 265
The Origins of the Euro Crisis 267
Greece: Much Bitterness on Both Sides 282
What Options Do the EU and the Eurozone Have Today? 289
11 What Use Is Finance? 296
What Use Is Finance? 296
How to Transform Useful Products into Toxic Products 298
Are Markets Efficient? 306
Why Regulate in Fact? 321
12 The Financial Crisis of 2008 326
The Financial Crisis 327
The New Postcrisis Environment 335
Who Is to Blame? Economists and the Prevention of Crises 350
V The Industrial Challenge
13 Competition Policy and Industrial Policy 355
What Is the Purpose of Competition? 357
Where Does Industrial Policy Fit In? 365
14 How Digitization Is Changing Everything 378
Platforms: Guardians of the Digital Economy 379
Two-Sided Markets 382
A Different Business Model: Platforms as Regulators 389
The Challenges Two-Sided Markets Pose for Competition Policy 392
15 Digital Economies: The Challenges for Society 401
Who Owns Data? 405
Health Care and Risk 408
The New Forms of Employment in the Twenty-First Century 414
The Digital Economy and Employment 423
The Tax System 427
16 Innovation and Intellectual Property 430
The Imperative of Innovation 430
Intellectual Property 431
Managing Royalty Stacking 435
The Institutions of Innovation 443
Cooperative Development and Open Source Software 447
And Many Other Debates … 453
17 Sector Regulation 455
What’s at Stake 455
A Fourfold Reform and Its Rationale 456
Incentive Regulation 460
Prices of Regulated Companies 466
Regulation of Access to the Network 471
Competition and Universal Service 478
What People are Saying About This
“I predict that Jean Tirole’s Economics for the Common Good will join Thomas Piketty’s Capital in the Twenty-First Century as the two most widely read and important books by economists yet to be published in this century. With Tirole’s terrific, wisdom-filled book, the world will be a better place.”Glenn Loury, Brown University“Jean Tirole is that rare exception, a Nobel laureate who believes he has a responsibility to talk clearly about the concerns of noneconomists. This exceptional book shows the value of careful economic thinking on issues ranging from unemployment to global warming. Required reading for anybody who wants to understand today’s economy.”Olivier Blanchard, former Chief Economist of the International Monetary Fund"Jean Tirole puts at center stage the essential contribution of economics, and economists, to our shared hopes and aspirations for the societies we live in. This is an essential book with a hopeful message for anyone concerned about the key economic challenges we all face today."Diane Coyle, author of GDP: A Brief but Affectionate History"Economics for the Common Good is a delightfully written and deeply insightful book, offering striking and illuminating paradoxes about economic behavior."Harold James, Princeton University