How To Foster Sustained Growth: Climate Change and Innovation at the Forefront of this Year’s Nobel

This year’s 2018 Nobel Prize of Economics has been awarded to two economists, William Nordhaus and Paul Romer, for their important contributions to the economics of climate and technological innovation. In this article, I provide my readers with a brief overview of these two men’s brilliant contributions not only to economic theory, but also to sound public-policy making.

Understanding the relation between climate change and economic growth: Nordhaus’ contribution

William Nordhaus, Professor of Economics at Yale, can be best described as a pioneer in terms of the economics of climate change. Considered to be one of the first to study the link between climate change and its impact on macroeconomic growth, Nordhaus developed a cost-benefit approach to measure the existing trade-off between the reduction of C02 emissions and the economic costs of such measures, which I believe is quite interesting. To avoid any big economic jargon for our readers, we must first ask ourselves: what are the social costs of sustained increases in temperature for the global economy? Well, these are two examples: increases in temperatures lead to a sustained increase in wildfires in some areas and sea-level in others, both of which require a substantial investment of resources to be controlled. If climate increases lead to ever-increasing costs to the economy, it is also important to understand that measures to control emissions of CO2, which are considered a major source of climate change, are also extremely costly to firms and individuals. Then, how to strike a balance between both sides of the coin? For Nordhaus, it is about finding a moderate and balanced solution to maximize the welfare of all economic agents. One of Nordhaus main recommendations is to instil a uniform carbon tax in all countries of the world. I highly recommend you, readers, to learn more about Nordhaus’ model: there is so much more to it!

Knowledge development as a source of long-term growth: Romer’s contribution

Paul Romer, economist and teacher at NYU, is one of the first economists to have introduced the notion of “endogenous growth” in economic theory. What does that mean? In simple terms, Romer argues, through his work, that sustained economic growth is caused and dictated by major forces (or actors) “inside” the economy, which consistently allow for increasing living standards. In particular, Romer puts emphasis on the importance of innovation as a driving force of growth. Compared to “traditional inputs”, such as capital and labour, which may generate decreasing marginal returns as their level increases, ideas, which are the source of innovation, have no limit! With new ideas, we are able to develop new technologies and new ways of using our existing factors of production more efficiently and more effectively, thereby fostering growth. Compared to “traditional economic models”, which define technological innovation as an exogenous factor that simply “happens” without any explanation, Romer’s model goes in a different direction by trying to explain how market conditions, in particular innovation, foster growth endogenously, which is a breakthrough!

Beyond simple theories: a lesson for public policy-making

The fact that the economics of climate and innovation have been in the centre of this year’s Nobel Prize is no surprise to me. In fact, it reflects contemporary issues that have enflamed debates for years: we consistently hear in the news that our planet is in danger and that we are using too many of its resources. In addition, firms, facing higher competition due to an increasingly global environment, need to be ahead of their competitors by building a sustainable competitive advantage, which often implies investing in R&D, in order to innovate. Nordhaus and Romer’s theories, in light of this, should not only be seen as abstract economic theories, but as sound guides for public policy making.

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