From a wide ranging interview of celebrated economist Daren Acemoglu, published at the Minneapolis Federal Reserve website, comes a discussion of what is called ‘directed technological change.’ Simply put, economists try to model the effects of technological changes, both at the micro and the macro level.
In one section of the interview Acemoglu talks about the conflicts between fossil fuel energy systems and technological innovation in so-called ‘clean’ energy. Can a huge economy like that of the US navigate towards cleaner systems without damaging overall future growth?
Directed Technical Change & Global Warming
Region: I definitely want to ask about your related work with James Robinson on economic and political transformation, but first let me jump to another of your seminal contributions in economics: directed technical change. In brief, the idea is that innovation is directed by two competing forces: the price effect that encourages innovation toward scarce factors and the market size effect that does the opposite, directs it toward abundant factors.
You and your co-authors recently applied this idea to the environment—global warming, in particular—and concluded that because of the externalities involved, sound policy should re-direct technical change toward clean technologies without delay, and also that optimal regulation with carbon taxes and research subsidies need not reduce long-term economic growth.
And you compare it to other economic analyses of climate change intervention, such as the Nicholas Stern report and William Nordhaus’ work. But could you give a quick primer on directed technical change and how you apply it to climate change?
Acemoglu: Sure. It’s useful for me to express it the following way, I think. The directed technical change idea really has two layers to it.
The first layer is sort of obvious to economists, but hadn’t really been developed and stated. It’s that just as we think all other factors go toward more profitable areas, investment in new technology and innovative activities also goes toward more profitable areas. I think in a micro sense, nobody would doubt this. We don’t talk of “technological change” in the abstract. We talk of technological change in the pharmaceutical sector, for example. We talk of technological change going after heart disease. We don’t just talk of broad technological change. And when we want to understand technological change for heart disease, we ask, What’s the market for heart drugs, beta-blockers, ACE inhibitors, statins or whatever?
So, that’s the most important part. Directed technical change was pushing this idea at the economywide level. Technology, either across sectors or across different types of factors—factor-augmenting or factor-substituting technologies—is also going to be determined by their profit incentives.
I first tried to develop these ideas in the context of inequality and skill-biased technological change. There the market size and the price effects, which you’ve mentioned, turn out to be quite important. If you want to understand how this works in a more detailed level, you need to understand how these market size and price effects work. They create countervailing forces, but one of them always dominates, and so on.
When we turn to the environment, I think the bigger picture insights seem to be more important. Market size and price effects come out in the context of the environment, and they’re in our paper, of course. But for purposes of our conversation here, I think I can do justice to the main ideas without getting into those details.
Essentially, the bulk of the literature in environmental economics has been about how we have to tax economic activity to slow it down so that we don’t damage the environment. If you think of a single-sector economy, with one sector that depends on coal, or on gas, that’s the only thing you can do: slow down that one sector. If you want to reduce carbon emissions, you just have to slow down that sector. Now, you don’t directly slow it down; you change its composition of factors, perhaps, but you can’t let that sector take off at a very rapid rate and still, at the same time, limit carbon emissions.
Our perspective was, well, the economy has several technologies; some of them are cleaner than others. How should we shift toward the cleaner ones? When you look at the climate science, there’s a lot of emphasis precisely on this and on questions such as, When is it that nuclear power will become economical? When will geothermal or wind or solar solve both their cost and their delivery problems?
Therefore, the perspective shouldn’t be, How can we slow down economic activity? Instead, it should be, How can we shift the composition of economic activity away from dirty technologies to cleaner technologies?
Now, that’s a very directed-technical-change-related question, but it already comes with a very important implication: The focus shouldn’t be on slowing down economic activity, but on changing its composition and changing the type of technological changes that the market generates.
Moreover, and importantly, we expect there to be a distinctive cumulative aspect to research. Different technologies often build on past successes in the same line of technology. So when you’re building a new car, you build on the past advances in car technology; you don’t as much build on advances in solar technology. In the same way as when you build new solar panels, you’re building on the previous solar panels, not on the diesel engine. What that means is that there’s going to be strong self-reinforcement in changing the direction of technological change. So when technological change shifts away from the dirty technologies that are so fossil-fuel-dependent to the cleaner technologies, it will also make it potentially cheaper to produce these innovations, these cleaner technologies, in the future.
That was the basic observation that I think was most important in the approach. And that’s the source of the more optimistic conclusions. Let me explain that in the following way. If you have a Nordhaus-type model—and I don’t want to caricaturize it, because Nordhaus in other work has considered richer models—but the seminal contribution that Nordhaus made in the early 1990s, for example, was sort of a neoclassical growth model used for the environment, and reducing carbons is reducing capital accumulation. In a model like that, parameters are going to determine how aggressive you should be in reducing carbon, but when you reduce carbon, you’re reducing GDP, you’re reducing growth.
The more optimistic aspect of our perspective came from the realization that if what you’re doing with environmental policy is “tax one sector, but subsidize another sector,” you might actually achieve in the long run quite successful growth, because the other sector is going to pick up the slack. If we have enough technological ingenuity—and that is an if, which I think we tried to make explicit in the paper—and can generate cleaner technologies that avoid the negative environmental consequences of coal and oil, then there is no reason for our economy not to grow at a healthy rate in the long run. So that was the optimistic part.
So in that sense, factoring in directed technical change made this conclusion much more optimistic relative to Nordhaus and, of course, more optimistic than Stern’s review, which was much more effective, and I believe rightly so, [in warning] of the potential dangers from climate change.
But on the other hand, it also made policy prescriptions much more proactive than Nordhaus and, in that sense, far more similar to Stern. And the logic of that relates very tightly to the directed technical change aspect. In the Nordhaus approach, it’s like a ramp-up thing: You don’t want to do too much because reducing emissions today is costly, while the future is discounted. If you can cut things in the future, why do it today? Now you can also add, “We don’t know where we’re going to go, so let’s go slowly,” a very gradualist approach.
But let’s think of the logic of directed technical change with cumulative research. The less we do on green technology today, the less knowledge is accumulated in the green sector, so the bigger is the gap between fossil-fuel-based technology and energy, and the cleaner energy, so the harder it will be in the future to close that gap. With more proactive, decisive action today, we already start closing the gap, and we’re making it easier to deal with the problem in the future.
Beezer here. The main point is that somehow the government needs to keep subsidizing technological innovation in the clean energy areas. Without this effort, and Acemoglu argues net GDP growth may be unchanged by the subsidy, it will become harder in the future to transition into cleaner energy systems because postponing initial innovation also postpones other innovations that always follow the initial discoveries. It’s the old saw about when is the best time to plant a tree? Now. As almost always, hat tip to Mark Thoma’s economist’s view for highlighting this interview.