What seriously weakened Nordhaus’ contributions was his commitment to the unrealistic assumptions of neoclassical theory
Michael Roberts is an Economist in the City of London and a prolific blogger.
Cross-posted from Michael Roberts’ blog
Prominent mainstream economist William Nordhaus died last Friday aged 85 years, after a debilitating illness. Nordhaus was a central figure at Yale University for more than 50 years, teaching generations of undergraduate and graduate students and holding key administrative roles for the university, including as provost and vice president for finance and administration.
He was a co-author of the widely used mainstream textbook, Economics. This was first published in 1948 by famous mainstream economist Paul Samuelson, the first American to win the Nobel Prize in economics and remains the standard-bearer for the principles of economics courses in American universities. As a university undergraduate, it was the first textbook I was told to use by our professors to understand economics. Keynesian guru Paul Krugman was his research assistant for a while before he moved onto greater things. Of Nordhaus he said, “he was a great economist, an inspiring teacher, a wonderful academic citizen — and my first mentor.”
Nordhaus was famous in mainstream economics for two things: growth accounting and for the economics of climate change, the latter earning him a Nobel (Riksbank) prize in economics in 2018. Growth accounting is the mainstream way of explaining long-term economic growth. It is a ‘factors of production’ model, where the contributions to output are broken down into ‘inputs’ of capital investment and labour; with a mysterious ‘residual’ which is assigned to ‘innovation’. Full employment, perfect competition and free markets are assumed in reaching a measure of the contribution of each input.
However, as Nordhaus observed, price indexes that deflate output in nominal money terms are seriously flawed for obtaining accurate estimates of the growth of real incomes, because the basket of goods and services that make up the consumer price index continually changes in quality and range. Official price statistics are now adjusted to try and account for these quality changes – this is called ‘hedonic pricing’. It is a problem difficult to solve based on neoclassical monetary accounting; but it is not if you use value theory and measure inputs in labour time – a Marxist/classical approach to growth
Nevertheless, using neoclassical growth accounting, Nordhaus tried to estimate the future economic impact of AI and robots on economic growth and productivity. (SSRN-id2658259). He argued that production requires lots of scarce inputs (“stuff”) in the form of labour, energy, and natural resources for most goods and services. This would be exhausted and slow the implementation of robots. He reckoned that it would be near a century before growth in robot skills would reach the level associated with full automation. So Nordhaus reckoned ‘singularity’ (ie robots taking over) was still a long way away.
Nordhaus also raised the issue of robots out of control – robots ruling the world including us. “The development of superintelligence raises a new concern not contemplated before in the development of political and military spying and weapons. We must be concerned that to the list of adversaries will be added the superintelligent machines themselves…. Will the superintelligent treat us as flies to wonton boys?” But Nordhaus reckoned that there was one job category for humans that would not be easily eliminated: defence against a robot takeover. “We routinely spend 5% of output on defense, and this might rise to a much larger number when faced with a more powerful enemies like superintelligent machines. So one occupation at least would survive into the Era of Singularity.”
However, Nordhaus was best known in receiving the 2018 Nobel Prize for “integrating climate change into long-run macroeconomic analysis,” using what is known as the DICE (Dynamic Integrated Climate-Economy) model, an accounting model that examines the interactions among carbon emissions, climate change and economic growth. Nordhaus was determined to find a way of estimating the economic costs of climate change, including such impacts as crop losses and rising sea levels, and weigh them against the costs of reducing emissions. In his Nobel acceptance speech, he said: “The signal contribution of economics is to recognize that climate change is a harmful unintended side effect of economic growth.” So he tried to develop a model that could supposedly gauge the likely impact on economies from climate change.
Nordhaus constructed so-called integrated assessment models (IAMs) to estimate the social cost of carbon (SCC) and evaluate alternative abatement policies. Nordhaus’ IAMs assumed that the world economy would have a much larger GDP in 50 years, so that, even if carbon emissions rise as predicted, governments could defer the cost of mitigation to the future. In contrast, if you apply stringent carbon abatement measures now eg ending all coal production, you might lower growth rates and incomes now and so make it more difficult to mitigate in the future.
Nordhaus’ answer to climate change was to adopt a ‘market solution’. By using carbon pricing and taxes we could control and reduce emissions without reducing fossil fuel production and consumption at source. So it was no accident that the EU and G20 turned to Nordhaus to provide very convenient advice on how to mitigate climate change. He gave a keynote address at an EU Venice climate change conference in 2021. There, he said that “It is a painful, painful realisation, but I think we need to face it: Our international climate policy, the approach we are taking, is at a dead end.”
But this is where it becomes ironic. Nordhaus’ IAMs had assumptions that made them close to useless as tools for policy analysis. The International Panel on Climate Change (IPCC) pointed out that global economic impacts are “difficult to estimate” and that attempts depend on a large number of “disputable” assumptions. Moreover, many IAM estimates do not account for factors such as catastrophic changes and tipping points ie where global warming gets out of control and damages economies much more quickly and deeply than forecast. Most IAMs struggle to incorporate the scale of the scientific risks, such as the thawing of permafrost, release of methane, and other potential tipping points. Furthermore, many of the largest potential impacts are omitted, such as widespread conflict as a result of large-scale human migration to escape the worst-affected areas.
Most current IAM models of climate-change impacts also make two flawed assumptions: that people will be much wealthier in the future and that lives in the future are less important than lives now. The former assumption ignores the great risks of severe damage and disruption to livelihoods from climate change. The latter assumption is ‘discrimination by date of birth’. It is a value judgement that is rarely scrutinized, difficult to defend and in conflict with most moral codes.
And IAMs also exclude feedback – namely that global warming leads to more natural disasters, droughts and floods and thus to massive disruption and migration of affected populations and thus a sharp reduction in GDP growth rates. The world may not be much ‘richer’ in the next generation if global warming goes unchecked. Finally, as with all these neoclassical growth accounting models of which the IAM of Nordhaus is one, there is no allowance for recurring crises of production in capitalism or rising inequality of income and wealth.
IAMs are now used to calculate the social cost of carbon (SCC). They attempt to model the incremental change in, or damage to, global economic output resulting from 1 tonne of anthropogenic carbon dioxide emissions or equivalent. These SCC estimates are used by policymakers in cost–benefit analyses of climate-change-mitigation policies. But because the IAMs omit so many of the big risks, SCC estimates are often way too low. As the IPCC acknowledged, published SCC estimates “lie between a few dollars and several hundreds of dollars.”
And the results often depend crucially on the ‘discounting’ used to translate future costs into current dollars. The discount rate used to calculate the likely monetary damage to economies is arbitrary. If we use a 3% discount rate, that means the current rise in global warming would lead to $5trn of economic damage (loss of GDP), but the cost in current money of global warming would be no more than $400bn, about what China spends on hi-speed rail. On this discount rate, global warming causes little economic damage and thus the social cost of carbon (SCC) need only be fixed at about $10/ton. This is the discount rate that Nordhaus used in his model. But why 3%? Nicholas Stern, of the famous Stern Review on climate change, took Nordhaus’ data and applied a 1.4% discount rate. The SCC then rises to $85/ton – meaning that it costs economies $85 for every ton of Co2, or closer to $3trn in total and should be priced accordingly.
The other role of IAMs — to estimate the costs of climate-change mitigation — also suffers from major shortcomings. The IPCC’s mitigation assessment concluded from its review of IAM outputs that the reduction in emissions needed to provide a 66% chance of achieving the 2°C emissions reduction goal would cut overall global consumption by between 2.9% and 11.4% in 2100. This was measured relative to a ‘business as usual’ scenario. But the business-as-usual baseline, against which costs of action are measured, conveys a misleading message to policymakers that fossil fuels can be consumed in ever greater quantities without any negative consequences to growth itself.
Steve Keen, a heterodox economist, produced a blistering critique of IAMs and how they understate hugely the impact on global warming on economies and the planet. Keen says the IAM “assumed that empirical relationships derived from data on change in temperature and GDP between 1960 and 2014 can be extrapolated out to 2100—thus assuming that 3.2°C more of global warming won’t alter the climate! They have assumed that tipping points—critical features of the Earth’s climate such as the Greenland and West Antarctic icesheets, the Amazon rainforest, and the “Atlantic Meridional Overturning Circulation” which keeps Europe warm today—can be tipped with only minimal additional damage to GDP.”
The great merit of Nordhaus’ work is that he always tried to use empirical evidence to support his models; he was not just an arcane neoclassical micro theorist. However, what seriously weakened his contributions was his commitment to the unrealistic assumptions of neoclassical theory.
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