2018 Nobel Prize: focus on sustainable growth

By Sergei  Guriev

2018 Nobel Prize: Focus on Sustainable Growth

The 2018 Nobel Prize in Economics was awarded to William Nordhaus and Paul Romer who have both been expected to get this prize for many years. However, the conventional wisdom was that they would get it separately: Nordhaus for "environmental economics" (probably shared with others) and Romer for "endogenous growth" (also likely to be shared with others). The fact that the Nobel Prize was awarded to Nordhaus and Romer together sends a powerful message: we need economic growth and we can and we should make this growth sustainable.

This message is of course very close to the EBRD's heart. Our new Transition Concept is based on a simple proposition: that the Bank's mandate is to foster sustainable market economies. It goes on to specify that a sustainable market economy possesses six qualities: competitive, well-governed, green, inclusive, resilient and integrated.

Implicit in this is the risk of market failures. Unregulated markets may function suboptimally, or even unsustainably: degrading the environment, tending towards market concentration and monopoly power, excluding from economic life important, but disempowered, society groups (including future generations). Hence the need for public policies and regulations, to correct such market failures. On the other hand, government interventions should foster rather than stifle economic growth, otherwise public policy will result in redistributing a pie of a fixed size leading to inevitable conflict.

Green Growth

Since the early 1970s, William Nordhaus was a pioneer in "green accounting", which would estimate the extent of environmental damage when measuring economic growth. His economic modelling was essential in developing a general approach to assessing the costs of climate change.

Nordhaus also pioneered key policy recommendations to address the challenges of environmental degradation and climate change. He was an early advocate of global carbon pricing and helped design regulations on harmful substances that went into the US "Clean Air Act".

In subsequent decades, as the evidence and concern about global warming grew, the economic models and policy recommendations of William Nordhaus have swept the world with the power of an idea whose time has come. They are still at the core of thinking and acting to address the challenge. They underpin the work of the United Nations Intergovernmental Panel on Climate Change which released its new report just a day before the announcement of the Nobel Prizes in Economics.

The Importance of Being Innovative

Paul Romer made key early contributions in another area related to sustainable - and sustained - economic growth: the nature and importance of innovation. Pre-Romer theories of economic growth treated innovation as something that just occurred, without obvious causes, and hence was exogenous to economic agents such as firms and households. Romer was one of the first economists to consider innovation as generated within the model, by the economic agents, and thus crucially dependent on incentives which in turn would be strengthened or weakened by policies and regulations. This new thinking was the basis for what since has become known as the neo-Schumpeterian endogenous growth theory (with ground-breaking work by the EBRD's first Research Director Philippe Aghion).

The key contribution was Romer's demonstration that decentralised markets could result in under-provision of new ideas and technological innovation, which would constitute a market failure. New ideas are essentially a public good. Those who create new technology benefit the whole economy not necessarily being able to capture the returns to innovation. Therefore the innovators may lack incentives to innovate. Under-provision of innovation could be addressed with policies that create the right incentives. This is certainly not a new idea but Romer was the first to introduce it into a tractable model of economic growth - and thus operationalise the analysis of relevant public policies such as promoting investment in human capital, supporting research and development, designing and enforcing intellectual property rights.

Sustainable growth and the Bank

As already indicated above, the intellectual legacy of the two Nobel laureates in economics is richly reflected in the EBRD's thinking on economic development and transition, in terms of research, policy advice and operational priorities. Green growth is so central to the Bank's activities, that it is deservedly considered a leader among IFIs in this field. The importance of promoting innovation and entrepreneurship in an endogenous growth framework is at the core of EBRD research and policy advice, with the 2017-18 Transition Report "Sustaining Growth" being the most recent example. The EBRD also shares the view of Nordhaus and Romer that despite the major challenges they helped identify, we should be optimistic that with collective action and cooperation the challenges can be successfully met.