William Nordhaus: Connecting the dots between climate change & economics

William Nordhaus, professor of economics at Yale University, passed away recently. His ideas and models laid the foundation for the economics of climate change, one of the most pressing issues of our time.

 

In recognition of his work, Nordhaus was awarded the Nobel Prize in Economics in 2018 “for integrating climate change into long-run macroeconomic analysis” (Paul Romer was co-awarded the prize “for integrating technological innovations into long-run macroeconomic analysis”).

 

Nordhaus completed his doctorate in economics at the Massachusetts Institute of Technology (MIT) under Robert Solow, a Nobel laureate. Solow was awarded the Nobel Prize in 1987 “for his contributions to the theory of economic growth.”

 

 

Solow’s work was instrumental in producing future Nobel laureates.

 

In his autobiography on the Nobel Prize website, Nordhaus narrates how his early interest in the environment and climate change was perhaps due to his father’s deep interest in skiing.

 

He adds that because of global warming, “my boyhood ski area of La Madera will no longer offer skiing” as no ice will remain.

 

This early environmental awareness proved handy as, after completing his doctorate in 1967, he started working seriously on integrating climate change into growth models pioneered by his adviser, Solow.

 

The early 1970s saw a revival of the “high-water mark of modern Malthusianism”, in Nordhaus’s words.

 

In 1798, British economist Thomas Robert Malthus had prophesied that population growth would always be higher than food production growth, leading to continuous human misery.

 

Though Malthusian theory was proven wrong due to constant innovations by humanity, the ideas kept coming back.

 

In the 1970s, books such as The Population Bomb and The Limits to Growth brought Malthusian doomsday predictions to the fore.

 

The 1970s also saw oil shocks pushing the world economy into stagflation — high inflation and low growth.

 

The blame was laid on the growth fetish, which not only placed an enormous burden on natural resources but also created the negative externality of pollution.

 

Famous economists usually say how economic and political crises shaped their early worldview and research.

 

It was no different for Nordhaus. While the world was descending into the chaos of stagflation, it provided food for thought for the then-young economist Nordhaus.

 

Climate change was based on physical sciences, and Nordhaus started to explore the economics of climate science.

 

He was fortunate to have been posted to the International Institute for Applied Systems Analysis in Vienna, where he worked with climate scientists to connect the dots between science and economics.

 

The end result was the first Integrated Assessment Model (IAM), which laid the foundation for modelling the economics of climate science.

 

The Nordhaus model was built on the Solow model, which said the growth of a country is driven by a combination of technology, labour and capital.

 

Nordhaus asked whether growth could continue under the constraints of climate change and carbon emissions.

 

The climate question became integral to the growth process: While economic growth affects the climate, climate change also affects economic growth.

 

Climate change is a global problem and has to be modelled accordingly.

 

The IAM models were later expanded into Dynamic Integrated Climate-Economy (DICE) models and Regional Integrated Climate-Economy (RICE) models, which integrated the global economy and global climate system.

 

These models have been used extensively to estimate the economic consequences of global warming based on multiple scenarios.

 

Key insights from these models were that emitters should face the costs of emitting.

 

Economists use market prices to determine economic behaviour. However, there were no market prices due to externalities. The IAM models used linear programming techniques to estimate shadow prices of carbon emissions.

 

Nordhaus interpreted the shadow carbon price as a “carbon tax”, which has become central to climate policies today.

 

The discussions also shaped the carbon trading system, under which industry players are given carbon permits.

 

Heavy polluters can buy credits from less-polluting entities.

 

The World Bank notes that 47 countries have implemented carbon taxes and 34 countries have carbon credit mechanisms.

 

Nordhaus’s work was also criticised for underestimating the impact of climate change and arguing that aggressive climate change policies would lower economic growth.

 

Apart from laying the foundations of climate science economics, Nordhaus was also a familiar name to economics students.

 

In 1948, Paul Samuelson (his teacher at MIT) started publishing the first major textbook titled Economics.

 

Nordhaus joined Samuelson as co-author in 1985 and continued to revise subsequent editions after Samuelson passed away in 2009.

 

Nordhaus also superbly documented the history of lighting, showing how the cost of lighting has declined several times more than suggested by official estimates.

 

Thus, he argued that measures of economic progress are massively underestimating the actual progress made by innovations and technology in human life.

 

Many economists today cite his lighting paper as being as influential as his work on climate science.

 

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The author teaches economics at the National Institute of Securities Markets