William Nordhaus, Paul Romer Win 2018 Economics Nobel Prize

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Both of this year’s economics Nobel laureates have been on the short list for some time. Both are deserving, as David Henderson writes in The Wall Street Journal. Paul Romer is best known for his work on the nature of economic growth, and William Nordhaus for his environmental economics, as well as coauthoring, with fellow laureate Paul Samuelson, the 20th century’s most widely used economics textbook (a copy of the 18th edition sits on my shelf). In fact, my only surprise at hearing that Nordhaus won was that I mistakenly thought he already had.

Nominees are not always so deserving; the prize committee often uses the award to make a political statement. Paul Krugman, for example, the 2008 laureate, produced excellent scholarship earlier in his career on international trade. But he later ditched economics for political activism, to the point of famously switching sides on policy issues based on which party proposed them. His strong partisanship almost certainly played a role in his prize—and its timing, announced in October of an election year.

More notoriously, the committee more or less had to give F.A. Hayek a prize due to the quality, quantity, breadth, and influence of his scholarship. But it felt the need to balance Hayek’s unfashionable pro-market views by co-awarding the 1974 prize to the anti-market Gunnar Myrdal, who publicly favored using eugenics to improve the welfare state. Myrdal’s work led to more than 60,000 people being sterilized in his native Sweden, 90 percent of them women.

None of this should tar Nordhaus and Romer’s prize—I am not the only spectator who was surprised by the lack of political message their selections send. Their awards are merit-based, which speaks well both of their work and of the committee’s.

CEI scholars and fellow travelers will find much to disagree with in Nordhaus’ work—but in some ways he also echoes Julian Simon. The biggest criticism is that Nordhaus was an early advocate of a carbon tax. One sees its theoretical appeal to economists—it’s an attempt to create a missing market. But there are serious practical problems.

Nordhaus recently estimated that an ideal tax would be about $30 per ton of carbon emissions. But this sits inside a range of as low as $6 per ton to as high as $93 per ton. This 15-fold difference is a sophisticated way of saying “I have no idea.” Future estimates will also have to account for declining emissions in richer, and still-growing, countries without a carbon tax. And all this ignores public choice concerns. The politicians who would enact a carbon tax do not have strong incentives to act in the public interest, to put it mildly. Moreover, as Henderson notes, “the Nordhaus model shows that the cost of a policy to limit the temperature increase to only 2.7 degrees Fahrenheit by 2100 would have been $37.03 trillion—$16.4 trillion more than the cost of doing nothing after accounting for the damage done by carbon emissions.” So carbon tax opportunity costs are substantial, too.

But Nordhaus’ most famous article is brilliant, almost literally—it’s about light. It also captures the spirit of Julian Simon, as well as the larger reason why economics is worth understanding in the first place. In “Do Real-Output and Real-Wage Measures Capture Reality? The History of Lighting Suggests Not,” Nordhaus shows that macroeconomic statistics don’t capture the full spectrum of improvement in human well-being over history. His chosen example is artificial light.

Open fires were the dominant light source for most of human history. These often take a half hour for even an expert to build and require time-consuming wood foraging and chopping. The indoor air pollution wood and dung fires cause is still a leading cause of death in areas without electricity. Candles and fat- and gas-burning lamps came along later, and were a massive improvement. Electric light bulbs were even better. Even accounting for the fossil fuels they consume, these have a far lighter environmental footprint, are safer, and provide brighter, more consistent light with very low maintenance. Since Nordhaus’ 1996 article, the improvement has continued with LED technology that provides customizable color temperature and brightness, with less power consumption and longer bulb life. The process will almost certainly continue into the future.

Today’s better, safer light sources are also cheaper—much cheaper. Nordhaus calculates the first-generation compact fluorescent bulbs from 1992 were nearly 30,000 times cheaper, per lumen generated than the open fires our ancestors used. That’s not 30,000 percent, that’s 30,000-fold. And CFLs turned out to be a dud technology! Talk about first world problems. Current LED technology is even better. And this has improved the lives of more than just humans. Whales are grateful for the extinction of whale-oil lamps rather than themselves. Forests are grateful that campfires are today mostly an occasional novelty for wealthy city-dwellers, rather than the dominant global light source.

Nordhaus has often fallen into the blackboard economics trap that fells many a talented economist. But his article on the price of light teaches an important lesson that well deserves a Nobel. Official statistics understate human betterment. There is a vast tapestry of non-statistical improvements. Some of them can be quantified, such as the price of light over time. Others cannot, such as the incredible ease with which people can find music, movies, and books today, or the quality difference between a 1988 Camry and a 2018 Camry, accounting for inflation. There is a vast literature on this subject, and Nordhaus prominently influenced it.

Remember, human betterment is the core reason to study economics in the first place. People can’t become better off if they don’t know what causes the wealth of nations. GDP and other statistics are useful. But economists who focus too closely on them not only understate the amount of human betterment that sound economic policy enables, but they can misdirect their time and talents into areas that could possibly cause harm, not betterment.

Economist Don Boudreaux points to another Nordhaus article that makes a similar point about the importance of innovation and the entrepreneurial spirit that makes it possible: “nearly all—about 98 percent—of the benefits of technological innovation are captured, not by the entrepreneurs and businesses who introduce them, but by the general public.” The article, 2004’s “Schumpeterian Profits in the American Economy: Theory and Measurement,” invokes another name familiar in Competitive Enterprise Institute circles. It’s easy to see the billions of dollars that the Mark Zuckerbergs and Jeff Bezoses earn for themselves. By Nordhaus’ estimate, they create about 49 times more value than that for complete strangers such as you and me.

Paul Romer’s work, at its best, follows a similar theme. He is best known for his work on the nature of economic growth. It ties directly into what many economists, myself included, consider the most important graph of all time, pictured below.

People lived on the equivalent of three dollars a day for most of human history, from Mesopatamia through the Middle Ages and the Renaissance, up until about 1800 or so. Now, in the last one tenth of one percent of our species’ history, the average person in rich countries suddenly has fifty times that to live on. More than half of the world’s population, poorest countries included, now qualify as middle class. The proportion of people living in absolute poverty, defined as $1.90 per day or less, is now below ten percent for the first time in history. The absolute number of people in absolute poverty is declining, even as population increases. How the heck is this happening? Romer has helped improve our understanding of this important question.

Unlike cable news economists, Romer has an attention span longer than a fiscal quarter. This enables him to look at what the real engines of economic growth are, and what made today’s mass prosperity possible—and how it can continue to lift people out of poverty in the future.

Romer is not the first to say that technology, innovation, and change are the most important long-term factors driving growth. But many previous theorists, most prominently Robert Solow, thought economies tended to work towards a stable equilibrium state, until some outside technological shock, such as the electric lightbulb or the automobile, changes where that equilibrium point lies. The economy then lurches towards that new point, where it would remain mostly still until another shock comes along.

Romer argues that technological change is not an outside shock, it is built into the human condition. People innovate all the time, and always have—just look at the evolution of stone tools before anything like a modern economy ever existed. The proper concern for policymakers then, is enacting public policies that do not stifle the natural human impulse to change and innovate. Long-run institutional structures matter; whatever the Dow Jones Industrial Average did last quarter does not.

Romer prefers a government with a handsier approach than we do at CEI. But on those fundamentals, we very much agree. Property rights, freedom to trade, rule of law, limited corruption, and the usual Washington Consensus policies tend to work quite well. Countries with governments that more or less follow them are far more prosperous and free than those that don’t, as this year’s just-released 2018 edition of the Economic Freedom of the World report shows.

Romer’s shifting of technology in blackboard models from an exogenous variable to an endogenous variable seems like some ivory tower dispute of little consequence. But it is really about human nature, and human betterment. Despite our inborn tendency to innovate and exchange with each other, poverty is still our default state. A quick glance at the graph above makes this obvious enough. It is wealth and growth that need to be understood. One implication of Romer’s theory is that innovation, while impossible to predict, is very possible to suppress.

Regardless of one’s political leanings, the goal is nearly always the same: freedom and prosperity for as many people as possible. Nordhaus and Romer’s work, in their separate ways, tie into that common theme, and their Nobel reflects that. Congratulations to them both.