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Podcast | Digging Deeper - William Nordhaus and Paul Romer- The winners of the 2018 economics Nobel

The Washington Post observed that Romer and Nordhaus have advanced the conversation around how humanity cares for limited resources.

Moneycontrol News @moneycontrolcom

This year’s winners of the Nobel Prize in economics are two American researchers - William Nordhaus and Paul Romer. The official website of the prize says Nordhaus has been honored for integrating climate change into long-run macroeconomic analysis while Romer was awarded for integrating technological innovations into long-run macroeconomic analysis. “Their findings have significantly broadened the scope of economic analysis by constructing models that explain how the market economy interacts with nature and knowledge,” says the website.

A brief history of the Nobel Prize

The Nobel Prize, or the Sveriges Riksbank Prize, has a distinguished history. It is named, as we all know, after Alfred Nobel, the inventor of dynamite. Nobel was, and I’m not being facetious here...he was the 19th century equivalent of Tony Stark. He invented dynamite and held 354 other patents. He was also the owner of Bofors. Yes, that Bofors. It began as an iron & steel company but transformed into a manufacturer of cannons and other armaments.

Nobel happened to read a premature obituary that said he had profited from the sale of arms. “Le marchand de la mort est mort,” the obit in a French newspaper read. Meaning, The merchant of death is dead. The newspaper mistook his brother Ludvig, who had died, for Alfred. Fake news is a pretty old problem, apparently. But nobody would be happy reading that about themselves, not even the most famous Alfred in history.

The premature obituary had a profound influence on Nobel. He turned over a new leaf, and wrote in his will that his 31 million Swedish Kroner fortune would be used to establish the Nobel prize to recognize academic, cultural and scientific advances. That initial capital is now worth $470 million.

Nobel prizes have been bestowed 585 times since they began in 1895. 892 people and 24 organizations have received the awards. If you’re wondering whether there is a cash prize...yes, around 1 million dollars in prize money besides a medal and a diploma.

The medals have fetched as high as $4.6 million in auctions. So we’re talking rarified air when we’re talking about Nobel prizes. One man’s epiphany went a long way.

There has been more than one Nobel prize faux pas of course. Most notably, Hitler being nominated for the peace prize in 1933, Gandhi being ignored for the peace prize, and Henry Kissinger receiving the Nobel prize for peace. There was some embarrassment in the recent past as well - Barack Obama was awarded the Nobel prize for peace after winning the 2008 US elections. ISIS was still a few years away, so it looks a bit funny in retrospect.

All things considered, the Nobel Prize is an incredible honor. Indian winners of the Nobel Prize are few and far in between. The first was Rabindranath Tagore, who won it in literature in 1913. No, contrary to hearsay, he didn’t return it. He returned his knighthood. CV Raman won the Nobel Prize for physics in 1930. Mother Teresa was given the Nobel prize for peace in 1979 and Amartya Sen won it for economics in 1998.

Broadening the scope of economic analysis

The academy’s statement said, “William D. Nordhaus and Paul M. Romer have designed methods for addressing some of our time’s most basic and pressing questions about how we create long-term sustained and sustainable economic growth,” the academy said in a statement.”

It said Romer's work explains how ideas are different to other goods and require specific conditions to thrive in a market. Prior macroeconomic research had focused on technological innovation as a driver of growth. But, according to the academy, that research had not modelled how market conditions and economic decisions affected the creation of new technologies.

Nordhaus, on the other hand, was the first person to create a model that, in the academy’s words, “describes the global interplay between the economy and the climate." He showed that "the most efficient remedy for problems caused by greenhouse gases is a global scheme of universally imposed carbon taxes."

Though the two men worked separately, the academy recognized them together for work that “broadened the scope of economic analysis” through modeling methods that are used to study long-term change and shape policy practices.

Here’s why Nordhaus and Romer won the Nobel Prize in Economic Sciences.

Both Nordhaus and Romer are macroeconomists dealing with long-run dynamics – that is for big picture questions like what spurs economic growth, the importance of sustainable growth and how to tackle climate change.

In the 1970s, when Romer was a grad student, and Nordhaus an assistant professor, a large part of the mainstream economic analysis was dedicated to what’s known as general equilibrium analysis - if consumers were to maximise their utilities, and producers were to maximise their profits, what would happen?

Romer and Nordhaus provided key insights to understanding what happens over time, how your and my individual decisions taken today influence outcomes for society as a whole in the future. They framed their ideas in a nascent field of economic growth, and transformed it.

Economic growth, as a concept, was pioneered by Robert Solow, a Nobel winner in 1987, with a model that connected the decision to save with the amount of capital available in the economy. It was largely used to connect past and future by obtaining constant growth rates that made sure the economy scaled with time.

But economists struggled to address underlying reasons for technological progress. They just assumed it would happen! They took for granted the fact that it had grown exponentially since the industrial revolution. There was little exploration into why certain countries grew faster than others. It was assume that everyone in the world was using similar technologies.

Paul Romer

Paul Romer of the Stern School of Business at New York University was recognized for integrating technological innovations into long-run macroeconomic analysis. says his work is fundamental to endogenous growth theory - a theory that claims investments in human capital, innovation and knowledge are significant contributors to economic growth. Romer was chief economist at the World Bank from 2016 to 2018, and is credited with the quote “A crisis is a terrible thing to waste.”

Romer was said to have been inspired by a graph showing how economic growth skyrocketed since the industrial revolution. He decided to study that phenomenon. While pursuing that study, Romer ended up changing the approach to economic growth. Instead of technological growth simply happening by itself, his thesis theorized that economic agents - people or businesses - can actively affect the speed of economic growth.

The nice thing about ideas, Romer submitted, was that if one person used your idea, you do not end up one idea short. This was different from capital, labour, and other classical factors of production. If everybody produced more ideas, everyone benefits from such new ideas, not merely the people who ideate.

GDP growth rates per person began to meaningfully depend upon the proportion of the labour force dedicated to developing new ideas. Understandably, more people producing ideas means less people producing goods in the short run. But we get a higher rate of growth in the long run due to more ideas that lead to better productivity.

Other economists embraced this line of thought, like Robert Barro, Daron Acemoglu, Philippe Aghion - economists who were Nobel prize candidates - and the Journal of Economic Growth, which covers these topics, is now one of the most prestigious and most cited in economics.

Researchers have argued before that innovation leads to growth. Romer documented, quantified, and confirmed the assumption. He also showed that government policies have a positive effect on innovation. The right laws and regulations smoothen the process of turning great ideas into economy-sustaining growth.

The Economist explained: “In Mr. Romer’s models of growth, the market generates new ideas. But the pace at which they are generated, and the way in which they are translated into growth, depend on other factors—such as state support for research and development or intellectual-property protections.”

Romer said, “We’ve got to use our powers of collective decision-making to steer this innovation machine toward things that we can know that can benefit everybody...and there’s just no way around the fact that the public has a role here."

The academy noted that, “Romer’s solution, which was published in 1990, laid the foundation of what is now called endogenous growth theory. The theory is both conceptual and practical, as it explains how ideas are different to other goods and require specific conditions to thrive in a market. Romer’s theory has generated vast amounts of new research into the regulations and policies that encourage new ideas and long-term prosperity.”

William Nordhaus

77-year-old Yale economist William Nordhaus started there as a graduate student. After a PhD in economics from MIT, he returned to Yale to as a teacher. He is a popular name with students of economics in the 90s. The Economics textbook he wrote with Paul Samuelson was translated into 17 languages for undergraduate introductory courses. Nordhaus had in interesting take on economic growth as a fundamental virtue.

Growth in the 80s was rather mechanical - the idea was to attain a certain growth rate. This ignored the fact that many economic goods, like natural resources and clean air, were hard to reproduce. Nordhaus sees “energy-cost myopia” as a prime reason governments must regulate markets for appliances.

In his book The Climate Casino, he compared regulations that require efficient products to those that require cars to include airbags.

Praising his research, the Royal Swedish Academy of Sciences said, “Nordhaus’ findings deal with interactions between society and nature.

He decided to work on this topic in the 1970s, as scientists had become increasingly worried about the combustion of fossil fuel resulting in a warmer climate. In the mid-1990s, he became the first person to create an integrated assessment model, i.e. a quantitative model that describes the global interplay between the economy and the climate. His model integrates theories and empirical results from physics, chemistry and economics.”

He pointed out that climate change, and its effect on people’s lives, was not a part of national accounts, unlike profits and GDP. Under his guidance, the Dynamic Integrated and Regional Integrated climate models (known as DICE and RICE) were developed to take climate change into account when analysing global changes like the Kyoto protocol.

His work soon gained recognition. The Environmental Protection Agency in USA used it to analyse the social cost of CO2 emissions. His model is now widely used to simulate how the economy and the climate co-evolve. The academy noted that Nordhaus’s model “is used to examine the consequences of climate policy interventions, for example carbon taxes.”

Sergey Popov writes that both Romer and Nordhaus have contributed to economics in much the same fashion. They recognised that economic growth should not be driven solely by putting more into factories and getting more products out of them.

They recognised that people can influence growth by their choices – whether that’s the speed of growth through exchanging ideas, or what that growth looks like and how sustainable it is. Crucially, they inspired many other economists to address such issues as well.

Romer told the media he was honored to be named alongside Nordhaus, whose work paved the way for his own by taking a “nonstandard” approach to the big questions of the day.

The Washington Post observed that Romer and Nordhaus have advanced the conversation around how humanity cares for limited resources.
First Published on Oct 13, 2018 11:06 am
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