The Academy explains how Nordhaus and Romer both have built on the work of Robert Solow, who won the prize in 1987
For William Nordhaus and Paul Romer, it was always a case of 'when' rather than 'if' they will win the Nobel prize. At first blush, it is surprising that they are co-recipients of the prize given the two different areas they have pioneered. Nordhaus is the forerunner in the economics of climate change and Romer in endogenous growth theory, which posits that investment in human capital, innovation and knowledge are significant contributors to economic growth.
The Nobel Prize Academy, however, figured a way to put the two on a common platform. It said Nordhaus is the recipient “for integrating climate change into long-run macroeconomic analysis” and Romer “for integrating technological innovations into long-run macroeconomic analysis". Thus, both their analyses help understand the drivers of long-run economic development.
In a way, the award goes back to Adam Smith’s magnum opus An inquiry into the Nature and Causes of The Wealth of Nations, which started economic thinking. In his work, Smith looked at factors that drive and hinder long-term growth and wealth creation. Similarly, the two laureates show that climate change is a hindrance and endogenous technological factors a driver of long-term growth.
The Academy explains how Nordhaus and Romer both have built on the work of Robert Solow, who won the prize in 1987. Solow had explained how economies can generate long-term growth by technological change but he treated this as an exogenous factor, a black-box. Romer improved this model in his 1990 paper where he opened the black-box and showed how simple technological developments can also drive growth.
One of the best ways to understand this is the coffee-cup lid example. Romer explained how having different lids for different sizes of coffee cups was both a wastage and required extra storage. By simply using a common lid and a common mouth for all different sized cups, this problem gets resolved leading to savings and growth for coffee companies. The takeaway is that simple ideas which develop in marketplace can drive growth. His work has helped us appreciate better the need for Research & Development for the creation of ideas and knowledge. Romer advocates well-designed regulation and patent laws to further R&D in the private sector.
Nordhaus, on the other hand, showed how climate change is not looked at seriously and could dampen economic growth. He developed a model to understand impact of climate change on growth combining economic principles with those of physics and chemistry (Perhaps, this time the ‘real science’ winners can have a conversation with the economics winners!). These models now called integrated economic assessment models (IAMs) help us understand the co-evolution of climate and economy in the future along with changing assumptions and policies. He advocates a global carbon tax that is uniformly imposed on all countries which again builds on a similar suggestion by British economist Arthur Pigou in 1920s. There is criticism regarding Nordhaus’s work which assumes high discount rates which leads to a much lower carbon tax than desired by other climate scientists.
To be sure, the Academy also notes that Romer’s and Nordhaus’s research does not provide conclusive answers to these difficult questions of knowledge creation and climate changes. Romer, for instance, once tried to implement his theory of ideas and landed in controversies. He started the charter-city project in 2000s, which aimed at building new cities in developing and underdeveloped countries. These new cities will have better rules and governance than existing cities and encourage knowledge creation and growth. These new cities will attract people for their growth, people who will vote with their feet for or against these rules. The project kick-started in Honduras but quickly folded as Romer withdrew from the project citing lack of transparency. (As an aside, he was made chief economist of World Bank in 2016 but resigned amidst a huge controversy over manipulation of Doing Business Rankings. In his tenure at World Bank, he raised another storm when he questioned the increased use of math to explain macroeconomics which was not adding any value.)
Still, Nordhaus’s and Romer’s work provide us an initial framework to start and begin thinking about these important issues of knowledge creation and climate change. There are some lessons for the Indian economy as well.
On the knowledge front, our firms are seen as laggards in R&D investments. This is due to both lack of well-designed regulations and unwillingness of the firms to think long-term. Most Indian firms are engaged in basic trading and commerce, similar to the colonial past. Even the torchbearers of technology in Indian industry, the information technology firms, do not have a single Google or HP among them. We have also not given much thought to simple market-driven innovations in our development policies.
On the climate change front, the outlook is more positive as the government has taken some measures to curb carbon emissions contributing to the global cause of sustainable growth. But as the October 8, 2018 report by the Intergovernmental Panel on Climate Change shows, there is no room for complacency.(The author is faculty at Ahmedabad University. Views are personal)