Jackson, a Professor of Economics at Stanford University, “recognized the importance of networks for economics over 25 years ago,” says the award citation, in a theoretical paper that showed “how to predict which networks will form depending on the costs and benefits of forming links, and how these networks differ from the optimal ones.” His work, it continues, “has inspired an enormous literature, both theoretical and empirical, in which networks play an essential role in helping us understand financial markets, economic development, and a host of other economic phenomena.”
In 1996, Matthew Jackson and Asher Wolinsky published “A Strategic Model of Social and Economic Networks,” in the Journal of Economic Theory, a paper regarded today as the launch pad for all subsequent literature on the social network approach or theory in economic analysis. In it, the authors define a network as a set of agents (people, but also firms, institutions and markets) connected by links, and modelled the characteristics such networks must exhibit in order to be efficient, to the extent that their component agents are satisfied and the network remains stable.
“Most of our interactions a human beings are social,” explained the new laureate in an interview shortly after hearing of the award. “We depend on other people for information, connections, opportunities, and also for norms of behavior. So the networks we are embedded in become very important determinants of our behavior and outcomes. In that first paper we tried to build the most basic model we could imagine about how people form relationships, whether they be business contacts, friendships, alliances or of any other sort.”
To this end, they introduced basic tools from mathematics and economics, particularly game theory and graph theory, to an analysis of the social setting, trying to understand that if people strive to form advantageous relationships, exactly what that means for the networks that result and, ultimately, the welfare that ensues.
Salvador Barberá, Professor of Economics at the Universitat Autònoma de Barcelona, is not only among Jackson’s nominators for the award, but was also his very first co-author. He notes that “before Professor Jackson, many social scientists had incorporated the network approach, but without a great deal of rigor. And economics, by and large, had focused on analyzing how individuals relate to each other through the markets. But the use of network theory adds a whole new dimension to economic analysis, and completely changes the way we look at markets.” For Barberá, who has continued to collaborate closely with the awardee, the sea change brought by the introduction of the network approach made itself felt “more formally at first, in an abstract, mathematical fashion, then more empirically and experimentally across a multitude of areas.”
No transacting without information sharing
The committee points out in its citation that “most economic and social transactions are bilateral, that is, they occur between pairs of individuals. But, unless a communication link has been established between the individuals, no transaction may be possible.” Information sharing is accordingly central to the theory of social networks. “There is actually an amazing paper that was written by Sir Francis Galton in 1907 and it was called ‘Vox populi’ (the voice of the people), and what he looked at was a local fair where people were trying to guess how much an ox weighed. So everybody could look at the ox and try and guess how much it weighed. And the weight of that ox was 1,197 pounds. The average guess in the population was actually 1,198 pounds, so if you aggregated all those people – there were about 780 participants – even though each one individually might be wrong, on average they were right. And so the question is, how do we get that information aggregated in a society? Maybe I have an opinion about something. I can talk to my friends, I can get their opinions and update my own, and just keep on like that. In some studies I did with Ben Golub we looked at what happens in a network if I keep asking my friends what their guesses are and keep averaging those and so forth. And it turned out that you eventually get a very good guess.”
A network, as such, can aggregate information very efficiently, resolving one of the classic problems in economics, that of incomplete or asymmetric information. But for this to happen requires a series of factors to operate that are not always met; among them, listening to a broad set of people, not being swayed by the analysis you favor, not being overconfident in your own opinions and, also, for information exchange to be truthful, and free of any intent to deceive others.
Professor Jackson discovered that a key role here is played by homophily, the fact that people tend naturally to associate with others who are similar to themselves in dimensions such as age, religion, social class, ethnic group, language or economic standing. This tendency, he says, “has good and bad effects. On the one hand it is easier to learn from people who are similar to one’s self, such that I learn more from someone with my same background. So if a kid is trying to decide whether they should go to university, somebody else who is very similar to themselves can give them good advice. But at the same time, the fact that homophily divides our networks into different groups means that people in one group might not have access to information that people in another group have, so the fact that your sources of information, your opportunities, your norms of behavior are all determined by the people around you means that these splits in the network can result in very different outcomes for different people in different parts of the network.”
A closely linked concept is that of centrality. Central agents are not necessarily those with the most network contacts, but those who enjoy connections with third parties that are likelier to yield favorable outcomes. It is important to understand that network structure evolves according to different dynamics, taking into account not only the dominant individuals or actors within a network, but also the role of those who act as bridges between separate groups. This matters, for example, when studying instances of segregation and determining what corrective measures can be taken. There are networks with a very high degree of centrality (represented graphically be a star shape), with one hub agent to whom all the rest are connected, though they lack connectedness among themselves.
This network approach is employed in multiple economic areas of current interest: in the analysis and monitoring of the COVID-19 pandemic, in global supply chains, in financial crises, in polarization of beliefs, and even in Russia’s war against Ukraine. “Professor Jackson developed a theoretical framework for network analysis in economics, but not just as an abstract exercise. He has stayed active as a researcher and in pushing forward the field in every possible arena, including experimental work,” says Manuel Arellano, committee secretary and Professor of Economics in the Center for Monetary and Financial Studies (CEMFI) of Banco de España. “Networks permeate everything that an economist studies,” Jackson adds. “Yet we had no real network models until quite recently, so we worked on building basic models, and also introducing the idea of networks and the ways they work into economic analysis.”
Heavily networked labor markets
One of the first empirical studies where Jackson deployed his models was an analysis of labor markets, which stand out as being heavily networked. “Depending on the profession, between a third and 100 percent of jobs are obtained through social contacts. So when you want to get an interview somewhere it helps to have somebody that you know work for that company. Those kinds of contacts can be essential in being able to get your foot in the door, and eventually get that interview and land a job. So if I have a lot of friends who are employed, it’s easier for me to get a job. If I have a lot of friends who are unemployed, it’s hard for me to get a job.”
When we put this together with homophily, what happens is that different parts of a network obtain very different outcomes in that some segments enjoy high employment rates while others are largely unemployed. “Understanding that gives us a different perspective on how to address inequality in wages and inequality in employment,” Jackson affirms. “We have to understand what the network structure is and how it is feeding into people’s ability to get jobs.”
Financial contagion
Professor Jackson has also applied the network approach to financial relations, to establish when bank networks contribute to systemic stability and when they undermine it. “In the case of a viral disease,” he explains, “the more contacts I have, the more chance I have of catching it, and the likelier I am to spread it.”
Conversely, “in the case of a financial network, there are more forces at work than just this simple contact. So think of a bank and imagine that it has four partners. If one of them goes bankrupt, that could mean a major disruption in the bank’s activity because it’s a quarter of their business. But if, instead, they work with a hundred other banks, then if one of them goes bankrupt that’s just one percent of their business. So in that context, working with more banks and having a bigger, denser network can actually be enhancing in terms of stability, whereas if you are talking about simple contagions, that actually makes things worse. So financial contagions require a different kind of understanding of network contagion.”
Jackson showed that individual banks are concerned mainly with their own survival, and think little about the social toll that a bankruptcy would impose on the network as a whole. And that is why they take on more risk than would be optimal for all of society. Analyzing financial networks gives us a better understanding of how banks’ risk-taking strategies can magnify the fallout from a crisis and affect network equilibrium. And this is why, says Jackson, “it is important that we have better maps of financial networks, so we understand how a crisis in one country can impact other parts of the world, as we were able to witness in the financial crisis of the late 2000s.”
Improving the effectiveness of poverty alleviation policies
Experimental studies have taken Professor Jackson to India, where he carried out fieldwork with Abhijit Banerjee and Esther Duflo, founders and heads of the MIT Poverty Action Lab and winners of the Frontiers of Knowledge Award in Development Cooperation. The goal of the project was to garner evidence on how to improve delivery of concrete economic policies by studying which people are the hubs of interpersonal networks in a community.
The study, published in 2012, started from the observation that bank microfinance programs offering loans to poor people in rural Indian were highly successful in some villages but in others didn’t get much take-up. They looked at the structure of social networks in these villages, and found out which people the banks had contacted and how this affected the diffusion of news on the loan programs. “We also studied how the networks reacted to the loans,” Professor Jackson relates. “And it turned out that with people who got loans, their networks improved, and with those who missed out, their networks somewhat disintegrated. So there were changes in the networks as a result of the intervention of the loans. The networks predicted what occurred with the loans, while the loan program, in turn, had effects on the networks.”
For Professor Barberá, this feedback between observation and action is among the most striking characteristics of the social network approach: “What particularly impresses me about this literature is how it has managed to evolve in every direction: towards application, empirical work, and I’d like to think eventually towards a more interactive vision, of general equilibrium. You start from a situation of taking something (the network) as data, then you act on those data, which reacts to this external intervention and evolves. I think he will continue to pursue this agenda because it lends itself to analysis.”
Sanctions against Russia, an instrument that could shorten the conflict
Another of Professor Jackson’s studies shows that throughout history, the more closely economies are interlinked, the fewer incentives countries have to go to war against each other. The resulting paper, co-authored with Prof. Stephen Nei and published in PNAS in 2015, concludes that there is a correlation between the decrease in the incidence of wars and the increase in the number of alliances countries have, positing the growth of world trade as a possible explanatory factor.
Nations, he says, now have “more modern instruments that can dissuade countries from prolonging a conflict,” like that now unfolding in Eastern Europe with Russia’s invasion of Ukraine. “At present the kinds of sanctions that are being imposed on Russia and Belarus to cut off some of their financial ties and banking opportunities, and to cut off social ties where their population can move in and out of the country, those things can have a considerable impact.”
As a lever of pressure on Russia, of course, it could not work if there were not such intense trading between countries: “Undoubtedly the fact that there is now a dense network of international trade and that Russia forms part of the global economy gives cause for hope of a solution to the conflict. Let’s imagine that the Russian banking system was not part of SWIFT and had no foreign reserves or citizens keen to travel abroad, and no oligarchs whose fortunes could be frozen. If we had none of these instruments, we would have no choice but military intervention.”
“It is hard right now to understand what is going through Russia’s leaders’ minds and what we can do to stop them,” he concludes. “But without these economic instruments we would have no hope of doing so. If there is hope, it is that these tools will work and remind them that we live in a global world, and how important it is for them to keep on good terms with the rest of the world. Let’s hope that this is a lesson for all the planet’s leaders: we need other countries to be willing to cooperate with us, so we can all enjoy welfare and prosperity.”
