Nobel Prize in Economics 2018: Climate, Growth and the Economics of Ideas

This note covers the Nobel Prize in Economics 2018: who won it, how William D. Nordhaus built a model linking the economy and the climate, how Paul M.

Romer explained why new ideas keep economic growth going, how both discoveries unfolded, why they matter for policy today and a quick-facts section for exams.

What was the Nobel Prize in Economics 2018 awarded for?

The official citation reads: "for integrating climate change into long-run macroeconomic analysis" for William D. Nordhaus and "for integrating technological innovations into long-run macroeconomic analysis" for Paul M. Romer.

In plain language, both laureates took something economists had always treated as an outside force, either nature (the climate) or knowledge (new ideas and technology), and built it directly into the mathematics of long-run economic growth.

Before their work, models of growth over decades or centuries simply assumed that technology improved at some fixed, unexplained rate, and they largely ignored how economic activity changes the natural environment.

The prize's full official name is the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, commonly called the Nobel Prize in Economics.

It was announced on 1 October 2018 by the Royal Swedish Academy of Sciences and carried a prize amount of 9,000,000 Swedish kronor, split equally between the two laureates.

Who are the laureates?

William D. Nordhaus

William D. Nordhaus was born on 31 May 1941 in Albuquerque, NM, USA. At the time of the award he was affiliated with Yale University, New Haven, CT, USA, where he had worked since 1967 and held a professorship since 1973.

He received one half of the prize. He completed his doctorate in 1967 at the Massachusetts Institute of Technology and later served as an economic advisor to President Jimmy Carter's administration from 1977 to 1979.

Nordhaus's contribution was to build the first integrated assessment model, a quantitative model joining physics, chemistry and economics, that shows how carbon emissions from economic activity raise atmospheric carbon, how that changes global temperature, and how the changed climate feeds back into the economy.

Paul M. Romer

Paul M. Romer was born in 1955 in Denver, CO, USA. At the time of the award he was affiliated with the NYU Stern School of Business, New York, NY, USA, where he had worked since 2011.

He received one half of the prize. He earned his doctorate at the University of Chicago in 1983 and had earlier worked at the University of Rochester, the University of Chicago, the University of California, Berkeley, Stanford University, and as chief economist at the World Bank.

Romer's central contribution, published in 1990, is endogenous growth theory. It explains how firms' and inventors' own economic decisions, not an unexplained outside force, generate the steady flow of new ideas that keeps long-run growth going.

What problem were the laureates trying to solve?

Economics, at its heart, studies how societies manage scarce resources. The Nobel committee noted that nature sets the basic physical limits on what an economy can do, and knowledge determines how well people work around those limits.

Yet for decades, mainstream growth models left both nature and knowledge outside the analysis, treating them as given rather than as things shaped by economic choices.

Both laureates built on the Solow growth model, which itself won the Economics Prize in 1987.

That model showed an economy growing through savings and capital accumulation, but assumed technology simply improved over time without explaining why, and it had no mechanism linking economic growth to environmental damage. This left two big open questions.

First, why do some countries sustain fast growth for decades while others stagnate or shrink, if not purely because of an unexplained rate of technical progress? Second, how should humanity weigh the economic benefits of burning fossil fuels against the long-term climate damage this causes?

Romer tackled the first question by studying patterns he found in global income data from the late 1980s: countries at similar starting income levels showed startlingly different growth rates, with no sign that poorer countries were catching up quickly as older theory predicted.

Nordhaus tackled the second question starting in the 1970s, when scientists were growing increasingly worried that burning fossil fuels was warming the planet, and he wanted a rigorous way to weigh the costs and benefits of acting on that concern.

How does Romer's endogenous growth theory work?

Romer's breakthrough was to show that ideas behave very differently from ordinary economic goods such as machines or workers.

He classified goods along two dimensions: whether they are rival (can only be used by one party at a time, like a machine) or non-rival (many people can use the same idea at once, like a mathematical formula), and whether they are excludable (others can be legally or technically stopped from using them, for example by a patent) or non-excludable (anyone can use them freely, such as basic scientific results).

Romer argued that because patents make an idea excludable, the firm holding the patent gets the monopoly power needed to charge a price above cost and recover the heavy upfront cost of inventing something, even though copying the idea afterwards is cheap, since ideas are non-rival.

This is how a market economy can be made to keep generating new ideas on purpose, rather than growth simply happening by accident.

In simple terms, the logic of his model runs as follows:

1. Firms spend money on research and development hoping to invent a marketable new idea or product.
2. Because the idea is non-rival, once invented it could in principle be copied by anyone at very low extra cost.
3. Patents or similar protections make the idea partly excludable, letting the inventing firm charge a markup and earn profit.
4. Those profits reward further research, so the stock of useful ideas keeps growing rather than levelling off.
5. Because a bigger existing stock of ideas makes new ideas easier to find, growth from ideas does not have to run into the same declining returns that growth from machines and buildings eventually does.

Draw two axes: one from "rival" to "non-rival", the other from "excludable" to "non-excludable". Place a factory machine in the rival-excludable corner, a patented invention in the non-rival-excludable zone, and a basic scientific result such as a mathematical theorem in the non-rival-non-excludable corner.

Because unregulated markets tend to under-supply research (inventors cannot capture all the benefit their ideas create for society), the Academy noted that government policies such as research subsidies and well-designed patent law are needed to keep the flow of new ideas close to the socially best level.

How does Nordhaus's integrated assessment model work?

Nordhaus's answer to the climate question was to build an integrated assessment model (IAM), the first of its kind, combining basic chemistry, physics and economics into one dynamic system.

The model, in its simplified single-region form called DICE (Dynamic Integrated Climate-Economy) and in its multi-region form called RICE (Regional Integrated Climate-Economy), links three interacting parts.

1. A carbon-circulation module tracks how CO₂ emitted by economic activity moves between the atmosphere, the ocean surface and biosphere, and the deep oceans, producing a path of atmospheric CO₂ concentration over time.
2. A climate module uses basic physics to show how that CO₂ concentration changes the balance of energy reaching and leaving the Earth, producing a path of global temperature.
3. An economic-growth module describes how the world economy produces goods using capital, labour and energy (including fossil fuels), and how different policies, such as a carbon tax, change emissions, economic output and the damage caused by a warmer climate.
4. The three modules feed back into each other continuously: economic choices drive emissions, emissions drive warming, and warming drives economic damage that then affects future economic choices.

Draw three connected boxes labelled "carbon circulation", "climate" and "economic growth". Show arrows running economy to emissions to atmosphere to temperature to economic damage, and back again into the economy module, forming a loop.

Nordhaus's own simulations using the model's later version, DICE-2016R2, compared four possible policy paths: a "base" case with no new climate policy, an "Opt" path of carbon taxes that maximise global welfare under conventional assumptions, a "Stern" path with much heavier weight on future generations' welfare (following the 2007 Stern Review), and a path keeping warming below 2.5°C at the lowest possible cost.

The committee reported that Nordhaus's recommended remedy, built on this analysis, was a globally uniform carbon tax, an idea tracing back to the economist A. C.

Pigou in the 1920s, under which each emitter pays a price reflecting the damage their emissions cause society.

A table from the committee's background material illustrates the puzzle that motivated Romer: growth-rate gaps between countries compound dramatically over time.

How did the work develop?

Why does it matter?

The two contributions, though separate, fit together. Romer's theory explains how market forces can be steered, through patents and research subsidies, towards producing more of the ideas society needs, including new clean-energy technologies.

Nordhaus's model gives policymakers a quantitative way to weigh the costs of climate action against the costs of climate damage, and to calculate how high a carbon tax should be under different assumptions about risk and about how much we should value future generations.

The press release was clear that neither laureate offers final answers: the committee said their findings "have brought us considerably closer to answering" how to achieve sustained and sustainable global growth, but did not claim to have solved the problem.

Open questions that the Academy's scientific background highlighted include how to measure climate damages region by region, how societies will adapt to a changing climate, and which specific policies best balance patent protection for inventors against public access to new ideas.

Both laureates also identified the same underlying flaw in unregulated markets, an externality, a side effect on people who were not part of the original transaction.

For Romer, the externality from new ideas is mostly positive, since one firm's idea can spill over to benefit others. For Nordhaus, the externality from carbon emissions is mostly negative, since one country's emissions harm the whole world's climate.

Both therefore argued that some form of government intervention, whether patent policy or carbon pricing, is needed to correct these market failures.

How does this connect to what you study?

Students of economics will meet the Solow growth model early on, with its ideas of capital accumulation, savings rates and labour, as the common starting point both 2018 laureates built upon. Seeing how Romer and Nordhaus each added a missing piece, knowledge in one case and nature in the other, shows how a basic model can be extended to answer new questions rather than being replaced entirely.

Students of environmental science or geography will recognise Nordhaus's carbon-circulation and climate modules as a version of the greenhouse effect and carbon cycle usually taught in science: emissions raise atmospheric carbon dioxide, which changes the planet's energy balance and raises global temperature, which then affects ecosystems, agriculture and economies in a continuous loop.

The idea of a carbon tax, a price placed on every unit of carbon emitted, links directly to lessons on market failure and government intervention in economics courses, since the Academy highlighted it as the policy tool Nordhaus's own analysis recommended for correcting the externality caused by greenhouse gases.

Similarly, the discussion of patents as a way of making a non-excludable idea excludable connects to civics or business-studies lessons on intellectual property, since the same reasoning, balancing reward for an inventor against public access to knowledge, underlies patent law taught in those subjects.

Quick facts for exams

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2018, widely known as the Nobel Prize in Economics 2018, was announced on 1 October 2018 by the Royal Swedish Academy of Sciences.

It was shared equally between William D. Nordhaus of Yale University, cited for integrating climate change into long-run macroeconomic analysis, and Paul M. Romer of the NYU Stern School of Business, cited for integrating technological innovations into long-run macroeconomic analysis.

Nordhaus built the first integrated assessment model linking the economy and the climate; Romer founded endogenous growth theory, explaining how market-driven research sustains long-run growth. The prize carried 9,000,000 Swedish kronor, split equally.

Note: Source. The prize facts in this note are from the Nobel Prize's official site, nobelprize.org.

Glossary

• Endogenous growth theory — Romer's theory that long-run economic growth is driven by factors determined inside the economic system, especially the purposeful creation of new ideas, rather than by an unexplained outside rate.
• Exogenous — coming from outside a model, assumed rather than explained by the model's own logic.
• Integrated assessment model (IAM) — a model, pioneered by Nordhaus, that links economic activity, carbon emissions, atmospheric concentration and global temperature in one connected system.
• Rival good — a good that can only be used by one person or firm at a time, such as a machine.
• Non-rival good — a good, such as an idea, that many people can use at the same time without using it up.
• Excludable good — a good from which others can be prevented from benefiting, for example through a patent.
• Externality — a side effect of an economic activity that falls on people who were not party to the original transaction, such as climate damage from emissions.
• Carbon tax — a price charged per unit of carbon dioxide emitted, intended to make emitters pay for the damage their emissions cause.
• Solow growth model — the earlier neoclassical model, honoured by the 1987 Economics Prize, that both laureates extended by adding knowledge and nature respectively.
• Patent — a legal right giving an inventor exclusive control over the use of an idea for a period, making an otherwise non-excludable idea excludable.
• DICE model — Dynamic Integrated Climate-Economy model, the single-region version of Nordhaus's integrated assessment model.
• RICE model — Regional Integrated Climate-Economy model, the multi-region version of Nordhaus's integrated assessment model.
• Market failure — a situation where unregulated markets do not produce the socially best outcome, often because of externalities.

Common errors and misconceptions

• Misconception: The prize was for inventing the idea of climate change. Correct: Nordhaus was recognised for building a quantitative economic model linking the climate and the economy, not for discovering climate science itself.
• Misconception: Romer's theory says new inventions like writing or the printing press directly caused modern growth. Correct: the presentation speech clarified that Romer's focus was on the ongoing economic motivation behind a continual flow of new ideas created by entrepreneurs and businesses, not on singling out any one historic invention.
• Misconception: Each laureate worked entirely separately with no shared basis. Correct: both built on the same starting point, the Solow growth model, extending it in different directions.
• Misconception: The prize gave final, settled answers on growth and climate policy. Correct: the Academy stated the laureates "do not deliver conclusive answers", but provided methods for further research.
• Misconception: Ideas being non-rival means anyone can always use them for free. Correct: ideas are non-rival, but they can still be made excludable through patents, which is what lets firms earn profit from inventing them.
• Misconception: This prize is officially called "the Nobel Prize in Economics". Correct: its full official name is the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel, though it is commonly called the Nobel Prize in Economics.

Exam-style questions with model answers

Q1. In which year was the Nobel Prize in Economics 2018 announced? [1 mark]

1. It was announced on 1 October 2018 by the Royal Swedish Academy of Sciences.

Q2. State the official citation for William D. Nordhaus's share of the 2018 Economics Prize. [2 marks]

1. The citation reads "for integrating climate change into long-run macroeconomic analysis".

Q3. Explain what is meant by a non-rival good, using an idea as an example. [3 marks]

1. A non-rival good is one that many people can use at the same time without reducing how much is available to others. An idea, such as a mathematical formula or a new design, is non-rival because one firm using it does not stop another firm from using the same idea simultaneously. This contrasts with a rival good, such as a machine, which only one user can operate at a time. Romer's theory relies on this property to explain why ideas, once created, can spread widely and drive growth across the whole economy rather than benefiting only their original inventor.

Q4. Describe the three modules of Nordhaus's integrated assessment model. [4 marks]

1. Nordhaus's model links three interacting modules. The carbon-circulation module tracks how CO₂ emitted from economic activity moves between the atmosphere, the ocean surface and biosphere, and the deep oceans. The climate module uses basic physics to show how that CO₂ concentration changes the planet's energy balance, producing a path of global temperature. The economic-growth module describes how the world economy produces goods using capital, labour and energy, including fossil fuels, and how policies such as a carbon tax affect emissions, output and climate damage. The three modules feed back into one another continuously.

Q5. Discuss why both Nordhaus's and Romer's work point towards a role for government policy, with reference to externalities. [5 marks]

1. Both laureates identified a market failure in the form of an externality, a side effect on parties outside the original economic transaction. In Romer's work, new ideas created by one firm can spill over to benefit other firms and consumers, a mostly positive externality; because inventors cannot capture all of this benefit for themselves, unregulated markets tend to under-invest in research, so the Academy's background material pointed to research subsidies and well-designed patent law as useful policy tools. In Nordhaus's work, carbon emissions from one country's economic activity spread through the atmosphere and change the climate for everyone, a mostly negative externality; because emitters do not pay for the full damage they cause, unregulated markets tend to over-produce emissions, so Nordhaus's recommended remedy was a globally uniform carbon tax, building on an idea traced to the economist A. C. Pigou in the 1920s. In both cases, the laureates' models are described as providing tools to calculate the right scale of intervention, rather than settling the question by themselves.

Q6. Who are the two laureates of the 2018 Nobel Prize in Economics, and what was each one's affiliation at the time of the award? [2 marks]

1. William D. Nordhaus was affiliated with Yale University, and Paul M. Romer was affiliated with the NYU Stern School of Business, both in the USA.

Q7. Explain the significance of the Solow growth model to the 2018 Economics Prize. [3 marks]

1. The Solow growth model, which itself won the Economics Prize in 1987, is the common starting point both 2018 laureates built on. It modelled growth through savings and capital accumulation, but assumed technology simply improved exogenously, without explaining why, and did not account for environmental limits. Romer extended it by explaining where technological progress actually comes from, through purposeful research driven by market incentives, while Nordhaus extended it by adding natural-science mechanisms linking the economy to the climate.

Q8. What four policy scenarios did Nordhaus simulate using his DICE-2016R2 model? [4 marks]

1. Nordhaus simulated four scenarios. The "base" scenario assumes no new climate policies beyond those already in place in 2015. The "Opt" scenario applies carbon taxes that maximise global welfare under conventional assumptions about how much to value future generations. The "Stern" scenario applies carbon taxes that maximise global welfare while placing substantially more weight on future generations' welfare, following the 2007 Stern Review. The fourth scenario sets carbon taxes high enough to keep global warming below 2.5°C at the lowest possible cost.

Key takeaways

• The 2018 Economics Prize was shared equally between William D. Nordhaus and Paul M. Romer, announced on 1 October 2018 by the Royal Swedish Academy of Sciences.
• Nordhaus was cited for integrating climate change into long-run macroeconomic analysis, Romer for integrating technological innovations into long-run macroeconomic analysis.
• Both laureates extended the same starting point, the Solow growth model, which itself won the Economics Prize in 1987.
• Romer's endogenous growth theory shows how patents and market incentives drive firms to keep producing new ideas.
• Ideas are non-rival, meaning many users can use the same idea at once, unlike a rival good such as a machine.
• Nordhaus built the first integrated assessment model, linking carbon emissions, atmospheric concentration, global temperature and economic activity in one connected system.
• Both contributions point to externalities as the core market failure, positive spillovers for new ideas and negative spillovers for carbon emissions.
• Nordhaus's analysis recommended a globally uniform carbon tax, an idea tracing back to the economist A. C. Pigou in the 1920s.
• The Academy stated that neither laureate's work provides final answers, but both opened large new research agendas on growth and climate.

Test yourself

Where was William D. Nordhaus born, and in what year?

William D. Nordhaus was born on 31 May 1941 in Albuquerque, New Mexico, in the United States.

What share of the 2018 Economics Prize did Paul M. Romer receive?

Paul M. Romer received one half of the prize, which he shared equally with William D. Nordhaus.

What is the full official name of the prize announced in October 2018?

It is officially the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2018, commonly called the Nobel Prize in Economics.

What does it mean to say an idea is non-rival?

It means many people or firms can use the same idea at the same time without it running out, unlike a physical good such as a machine.

Name the three modules in Nordhaus's integrated assessment model.

The three modules are the carbon-circulation module, the climate module and the economic-growth module, which feed back into each other.

What policy did Nordhaus's analysis recommend for tackling climate change?

His analysis recommended a globally uniform carbon tax so each emitter pays the societal cost of the damage caused by their emissions.

What earlier Nobel-winning model did both 2018 laureates build upon?

Both built upon the Solow growth model, which won the Nobel Prize in Economics in 1987.

In what year was Romer's most celebrated growth paper published?

Romer's most celebrated paper, which laid the foundation of endogenous growth theory, was published in 1990.