For sustained growth

Nobel prize winners expanded scope of macroeconomic analysis

The Royal Swedish Academy of Sciences on Monday awarded the Sveriges Riksbank Prize in Economic Sciences — also known as the Nobel Prize for Economics — to William Nordhaus of Yale University and Paul Romer of the NYU Stern School of Business. While the two economists worked on completely different topics, their approach and contribution had similarities. Mr Nordhaus started out in the late sixties and early seventies, looking at the growing mountain of evidence of global warming. The macroeconomic modelling of that era did not have the tools to analyse this new component even though it was clear to him that climate change and the increasing temperature of the planet were going to have a significant impact on the trajectory of global economic growth. Mr Romer, on the other hand, was curious to understand why different countries grew at substantially varying rates. The traditional economic growth models, especially the dominant one provided by Robert Solow, who incidentally received the Economics Nobel in 1987, failed to explain the variance and instead attributed it to some exogenous technological change. What binds this year’s winners then is the fact that they used the existing growth theories to create new frameworks of analysis.

When Mr Nordhaus started out, there was no way to account for the adverse impact of fast economic growth on climate. Roughly 50 years later, this is possibly the human race’s biggest challenge; indeed, an existential one. Decades ago, Mr Nordhaus had the foresight to start accounting for such negative externalities. For this, he studied “the bidirectional feed-back loops between human activity and the climate, combining basic theories and empirical results from physics, chemistry, and economics”. By the mid-nineties, Mr Nordhaus had created his first “integrated assessment model” (or IAM), which provided an understanding of the impact of economic activity and climate change and vice versa. Mr Nordhaus’ IAMs have been used since to simulate the consequences of business-as-usual policies as well as those of various policy interventions. While his models have helped other researchers and policymakers to correctly evaluate the costs of higher emissions, from the perspective of an emerging economy such as India, his policy prescription of carbon taxes is seen as deeply iniquitous.

Similarly, Mr Romer found out data did not support the prediction of the Solow model that poorer countries would grow fast and catch up with the richer ones. Indeed, as time went on, for any given technology, adding more capital yielded less and less additional output. The Solow model could not explain the persistent long-run growth in some countries and growth differences between countries. Technological advances were supposed to happen exogenously. Mr Romer’s achievement has been to look into the black box of technological advancement and provide a framework under which market economies could endogenously produce technological change. His work showed that for ideas to produce technological advancement they should be “non-rival” (that is, use by one does not preclude the use by another) and “partly excludable” (that is, production should not be open for all). For instance, a soft drink recipe or a computer programme. Mr Romer also showed that given the imperfections of the markets, policy should focus on carefully designed patent systems and also provide R&D subsidies. On both these counts, India has a long way to go.