October 8, 2018 / 3:13 PM / 14 days ago

Breakingviews - Hadas: Nobel rewards pointless economic modelling

LONDON (Reuters Breakingviews) - Monday’s 2018 Nobel economics prize can be looked at in two ways. On the bright side, it is an award for long-term thinking and common sense. Less charitably, Paul Romer and William Nordhaus were rewarded for pushing pointless economic modelling in new directions.

A combination picture shows William D. Nordhaus (L) and Paul Romer, who have won the 2018 Nobel Economics Prize, posing in undated photos provided to Reuters by Yale University and NYU Stern School of Business on October 8, 2018.

Romer, currently a professor at New York University, is a pioneer of so-called endogenous growth modelling. The question such models try to answer is simple and fundamental: what makes economies produce more and better goods and services? Several centuries of tremendous economic growth in some countries and much less growth in others provide a good amount of data to test any possible explanations.

The answer, it turns out, is complicated. Technology, science, education, market structures, political systems, regulatory arrangements, natural resources, spending patterns and cultural values all contribute. These diverse factors interact with each other and each can change over time. People and nations are both influenced by neighbours and constrained by traditions.

With so much going on, including many variables which cannot easily be compared to each other or quantified at all, entirely mathematical models are not an obvious place to look for insight. Romer, however, was trained to use the hammer of such multivariable models, so his theoretical work approaches the economy as a field of nails.

His 1986 breakthrough paper and subsequent contributions expanded existing growth models to show the value of government spending, education and a judicious mix of sharing and hoarding new scientific ideas and technological breakthroughs. Within the economics fraternity, the value of this sort of work is rarely questioned, and Romer’s models are widely praised.

The new sets of equations are undoubtedly less inaccurate than those which came before, which included only capital investment and a single variable for technological gains. For people not interested in economic theory, however, it is much harder to see the point.

The models are still based on implausible assumptions about people’s desires. Worse, all their algebraic glitter rarely if ever adds any insight to the qualitative intuition behind them. On the contrary, they often obscure the key assumptions in a fog of hard-to-follow symbols.

The practical relevance of Romer’s theoretical advances is doubtful, but in comparison to Nordhaus he is down-to-earth. The Yale economist has extended standard growth models to include an additional set of variables, trying to include human interactions with their physical environment.

The issues are certainly significant. Anthropogenic climate change, the central focus of Nordhaus’s models, could become a massive economic negative. On the same day the economics Nobel was announced, the latest UN Intergovernmental Panel on Climate Change report made some dire predictions, including giving a cut-off date of 2030 for avoiding global catastrophe.

Nordhaus developed Integrated Assessment Models (IAMs) to feed the scientific predictions - basically that more carbon dioxide in the air will lead to less human-friendly weather - into the conventional economic growth framework. His ingenuity and ambition are impressive, but the results are hard to take seriously.

Even if the latest scientific inputs are perfectly correct, no one can know how well people will respond to the economic challenges created by global warming. The totally unexpected sharp decline in the cost of solar power gives reason to hope that IAMs rely too much on spurious and unnecessarily gloomy extrapolations.

As far as policy recommendations are concerned, the best that can be said for these models is that they might help frame the issues in a helpful way. Even that claim is doubtful, since the models’ outputs depend on the choice of the real discount rate, a number which purports to quantify how much people do or should care about the future.

Only an economist could love this totally hypothetical variable. Not even an economist can warm up to the possible range of estimates for the social cost of carbon. This key output of the IAMs is a calculation of how much the economy gains over time for each ton of carbon dioxide that human activity does not send into the air. Depending on the discount rate, the answer ranges from $48 to $615.

As the Nobel committee pointed out, Romer and Nordhaus have helped introduce long-term factors into macroeconomic models which were created to explain short-term fluctuations in activity. It is almost as hard to argue with that theoretical advance as with their underlying practical goals, combating poverty and environmental disaster. Whether the theoretical gain will help the world reach the goals is another matter.

In recent years, Romer has gained more headlines for his sharp tongue than for his sophisticated maths. His brief tenure as chief economist at the World Bank ended abruptly in January after he had plausibly accused his own team of excess waffle and equally plausibly criticised his institution’s Ease of Doing Business index for naive bias in favour of free markets. It is a shame that the Nobel Prize citation did not mention his valiant effort to put theory into practice.

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