Illustration: Jayachandran/Mint
Illustration: Jayachandran/Mint

Opinion | The economics Nobel picks reflect our times

The prize committee has done well to honour ideas that can help improve economic growth with greater sustainability

This year was the 50th time that the Royal Swedish Academy of Sciences awarded the Sveriges Riksbank Prize in economic sciences in the memory of Alfred Nobel. The academy has done well to select research that is truly global in nature. The two American economists selected this time, Paul M. Romer and William D. Nordhaus, have “broadened the scope of economic analysis by designing the tools that are necessary to examine how the market economy has a long-term influence on nature and knowledge."

Nordhaus recognized that not only does the climate determine economic activity, it is also affected by it. And Romer showed the importance of ideas and knowledge in determining long-term economic growth. Both economists, in a sense, have studied spillovers, which in the absence of appropriate intervention can lead to suboptimal outcomes. For instance, carbon emission due to the burning of fossil fuel in any part of the planet plays a role in climate change and has implications not only for today’s world but also for the future. Similarly, technological progress in one part of the world can be used in other parts to improve production.

In the 1980s, Romer started working on endogenous growth theory, where technological development was not exogenous, as was then assumed in growth models. He observed the wide growth difference among countries. Though some of the lower income countries were growing rapidly, others were not. Growth models at that time—like that of Robert Solow, who was awarded the Nobel Prize in 1987—could not explain the difference in growth. For example, in a 1994 paper, published in the Journal of Economic Perspectives, Romer said that he “…cited the failure of cross-country convergence to motivate models of growth that drop the two central assumptions of the neoclassical model: that technological change is exogenous and that the same technological opportunities are available in all countries of the world".

He showed how endogenous technological change and ideas shape growth outcomes and argued that growth driven by ideas does not experience diminishing returns. However, the market of ideas doesn’t work by itself and needs intervention. It is probable that the market will not adequately reward the creator of a new idea and firms need some monopoly power. Romer also showed that markets tend to not adequately provide for research and development. Therefore, it is important for the state to support research and make patent laws that strike the right balance between the developer and users.

Meanwhile, Nordhaus was working on the issue of sustainability, as economic activity affects the climate with long-term implications. He developed integrated assessment models which can be used to assess the consequences of various policy interventions and non-intervention. Interestingly, on the day the prize was announced a new report by the United Nations noted that limiting global warming will require unprecedented and far-reaching changes. Nordhaus showed that the best way to deal with the problem is carbon taxes. He has built on the work done by economist A.C. Pigou in the 1920s. However, a global consensus on carbon tax remains elusive. While the world has agreed to limit global warming, there is a fair amount of uncertainty on this front, partly because of the US.

Developing our understanding of how the economy functions and the ways in which it can be guided to increase human welfare is a continuous process, as the prize committee has rightly noted: “While Romer’s and Nordhaus’s research constitute critical steps forward, they do not provide final answers. But their methodological breakthroughs have paved the way for a great deal of further research…on global, long-run issues."

The work of both these economists can be useful in the Indian context. India needs a lot more capital to sustain high growth, but improving efficiency is also important. It would do well to create conditions that will help develop ideas and innovation. This will require intervention at various levels, such as government support for research and development, improving the functioning of capital markets that can finance innovation, and protection of intellectual property. It is likely that research and innovation will also make India a more energy efficient economy. Further, the government should resist the temptation of cutting taxes on fossil fuel, as higher consumption will have long-term environmental consequences. Climate change is a major threat for an economy like India where the majority of the population is directly or indirectly dependent on agriculture.

The prize committee has done well to honour ideas that can help improve economic growth with greater sustainability. And by recognizing these areas, it could help attract more researchers to areas that are going to be of vital importance in the decades to come.