Nobel laureate William Nordhaus on measuring the economy and the environment

On Monday, the Royal Swedish Academy of Sciences awarded the 2018 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel to William Nordhaus “for integrating climate change into long-run macroeconomic analysis” and to Paul Romer “for integrating technological innovations into long-run macroeconomic analysis.”

While the Academy recognized Nordhaus for his analysis of the economic implications of climate change, he also joins a long list of Nobel laureates who have made important contributions to economic measurement. Improving the measurement of the economic well-being and the impact of the environment on the economy has been one of his continuing research interests. This post will review some of his contributions to measurement.

One of his earliest contributions is a 1972 paper with James Tobin entitled, “Is Growth Obsolete?” Nordhaus and Tobin reviewed criticisms of gross domestic product—that GDP includes expenditures, such as defense spending and commuting costs, that do not directly contribute to consumer welfare, and that it omits activities like leisure and non-market work that do contribute to welfare. They propose a new “measure of economic welfare” that is designed as a correction to some of GDP’s flaws. Their contribution was one of the first in a long series of efforts by many researchers to refine or update the concept of GDP as the principal measure of economic progress. For good recent accounts of these efforts, you can read any of the following books:

• Diane Coyle (2014), GDP: A Brief but Affectionate History. 
• Ehsan Masood (2016), The Great Invention: The Story of GDP and the Making and Unmaking of the Modern World.
• David Pilling (2018), The Growth Delusion: Wealth, Poverty, and the Well-Being of Nations.

While Nordhaus & Tobin (1972) recognized the importance of environmental factors, they weren’t able to fully incorporate them into their new measure of economic welfare. Nordhaus soon turned his attention to the environment and climate change. In a 1977 article, “Economic Growth and Climate: the Case of Carbon Dioxide,” he was already starting to sketch out a provisional approach to addressing climate change that would eventually lead to his Nobel-prize work. In his framework, the key variable that needed to be measured was the shadow price or social cost of carbon. By the early 1990s, Nordhaus had developed a more complete analytical approach, the “dynamic integrated model of climate and the economy” (or DICE) that combined an economic growth model with the effects of energy used in production on the global temperature—see Nordhaus (1994), Managing the Global Commons: The Economics of Climate Change.

Over the last 25 years, Nordhaus has continued to refine his analysis and estimates, with recent estimates appearing here. The idea of a carbon tax based on the social cost of carbon has also received widespread support from economists—for example, Mankiw coined the “Pigou Club” as a list of public supporters energy or carbon taxes. The case for a carbon tax was revisited this week, for example, in a blog post by Howard Gleckman of the Tax Policy Center and in an article by Matthew Yglesias of Vox.  Among climate researchers, Nordhaus is considered an optimist who recommends a relatively modest carbon tax that would still allow mean global temperatures to increase 3º or more. A blog post by Peter Dorman argues that the Nobel committee should have also recognized Martin Weitzman, who recommends more aggressive policies.

I first met Bill Nordhaus in the mid 1990s when he worked on a topic that was of great interest to me—price indexes and how they are affected by technological improvements, (At the time, I was head of the price and index number research group at the Bureau of Labor Statistics.) The Conference on Research in Income and Wealth met in Williamsburg, Virginia to discuss papers on The Economics of New Goods. It was my first time attending a CRIW conference and one of the most memorable conferences I’ve attended. Nordhaus’s paper asked, “Do Real-Output and Real-Wage Measures Capture Reality? The History of Lighting Suggests Not.” Nordhaus points out that “estimates of real income are only as good as the price indexes are accurate.” He then examines improvement in lighting technology since paleolithic times, and finds that the cost of lighting (measured in hours of work required to produce 1,000 lumen-hours of light) has declined dramatically, especially over the last 200 years. Furthermore, these kind of major inventions are usually omitted in traditional price indexes, causing these indexes to be biased upward. His paper provides a clear and memorable example of why price indexes struggle and usually fail to account for major innovations.

The research at that conference by Nordhaus and others, along with other, similar research, contributed to the Boskin Commission’s Final Report in 1996, which concluded that the U.S. consumer price index overstated inflation by about 1.1 percentage points per year. I recently wrote a report for the Brookings Institution that looks at what’s changed since the Boskin Commission. I conclude that improvements made by the BLS have reduced the CPI bias somewhat to about 0.85 percentage point per year. Although the BLS has endeavored to take account of quality change and new goods, it’s fundamentally very hard to eliminate the bias in its price indexes.

Another measurement project that Nordhaus led around that time was a National Research Council panel on integrated environmental and economic accounting. In 1992 the Bureau of Economic Analysis had begun a project to develop a satellite account to the national accounts that would measure the value and costs of natural resources and the environment. When BEA published its first version of that account, however, it ran into political opposition, and Congress directed them to suspend work and to obtain an external review of environmental accounting.

The Nordhaus panel’s 1999 review was Nature’s Numbers: Expanding the National Economic Accounts to Include the Environment. (Note: I began working for BEA in 1997.) The report strongly endorsed continued work on measuring natural resources and the environment in an integrated framework that would be consistent with, and comparable to the core national accounts. Unfortunately, Congressional opposition to this work didn’t dissipate, and since that time BEA has done relatively little work on the environment. Internationally, however, the United Nations has encouraged countries to implement its System of Environmental Economic Accounting. 

In 2000, the BEA organized an advisory committee. Nordhaus has served on that committee since the beginning and was its first chair. In that capacity, he constantly urged the Bureau to improve the timeliness, accuracy, and coverage of its data, to work with BLS to improve the price indexes used for deflation, to work with the Federal Reserve to develop integrated asset and wealth accounts, to work on measuring nonmarket activities (including time use), and to develop resource and environmental accounts. Other than environmental accounts, BEA was able to make substantial improvements in these areas of measurement.

While I can’t review all of Nordhaus’s other work on measurement, if you peruse his cv you’ll see papers on a variety of measurement topics, including nonmarket accounts, productivity measurement, pollution accounts, and the measurement of computing. In addition to his Nobel Prize-worthy contributions to the economics of climate change, Nordhaus will be remembered as a major contributor to economic measurement.

I’ll close with a few words about Paul Romer, with whom Nordhaus shared the prize. Romer was a graduate student at the University of Chicago at about the same time as me, and I can remember meeting him there, though we really haven’t interacted since. His early work on endogenous growth was recognized almost immediately as path breaking, and it has helped define a new generation of work on economic growth. While, as far as I’m aware, Romer hasn’t worked on economic measurement per se, the measurement of the intangible knowledge capital that was the focus of his theoretical work has been at the center of some of the most important developments in national accounting and productivity measurement of the last 25 years. Over that time, the definition of GDP has been expanded to count knowledge assets such as research and development, computer software, and motion picture and music originals. Researchers like Corrado, Hulten, and Sichel have recommended recognizing and measuring even more types of knowledge assets. Measuring these new types of assets has been challenging, and as discussed at a recent CRIW conference on globalization, the intangible nature of these assets makes them difficult to measure and may distort some traditional statistics. Economic measurement continues to be a challenging area. It has progressed with the help of some of the best minds of economics and statistics, and continued progress may require the contributions of future thought leaders.