Comments on the Nobel winning paper by Aghion and Howitt

In popular information released by the Nobel committee, it calls the model presented by Aghion and Howitt “a groundbreaking model”. It stated,

The model that Aghion and Howitt presented in their 1992 paper was the first macroeconomic model for creative destruction to have general equilibrium.

Modern general equilibrium models started with the Arrow Debreu model. In their paper, Arrow and Debreu acknowledged an assumption in the model is “clearly unrealistic”, although few people bother to mention it after the model gains dominance over time.

Let’s read the paper by Aghion and Howitt and check its assumptions.

There is a continuum of infinitely-lived individuals, with identical intertemporally additive preferences defined over lifetime consumption, and the constant rate of time preference r > 0. (P 327)

In their model, people live an infinite life. There is no demographic change. It excludes the most important long term factor in social and economic changes. This is clearly unrealistic.

Productivity parameter, defined in (2.3) in their paper, is A_t = A₀*gamma^^t. It is a non-decreasing function of time, here t is the number of innovation. Productivity can never decline. In this economy, the worst thing that can happen is stagnation. Decline is an impossibility in this model. This is clearly unrealistic.

These, and other, assumptions are extremely unrealistic and restrictive. With these assumptions, it is very easy to obtain “sustained growth” from the model. But do the conclusions from such a toy model have any relevance to reality?

If the assumptions are slightly modified to be more realistic, it will be very easy to obtain opposite results. Two recent examples of creative destruction are the blowup of Nord Stream pipeline and the gain of function research that predates COVID19.  In neither case, the creative destruction generates “sustained growth”, although certain people benefited handsomely from such destructions.  

It would be fine for researchers, or anyone else, to play with unrealistic toy models. But why are these models accorded great prestige? This is probably because, for many people, we have been unable to achieve “sustained growth” for some time. The fertility rates in many parts of the world have dropped below the replacement rate. We can’t even replace ourselves, let alone achieve “sustained growth”. When the majority of people in many parts of the world are struggling to achieve the quality of life enjoyed by their parents, it is important for the elites, who have caused so much destruction, creative or not, to the life of ordinary people, to justify the “sustained growth” of their own wealth and prestige.

The interpretation of long term growth since Industrial Revolution is the main topic of this year’s Nobel Prize. From the perspective of interaction between resource and technology, this issue is straightforward to understand. Since the beginning of the iron age, the energy source in iron making is charcoal, which is made from wood. The amount of wood available around the mines of iron ore constrains the size of iron production. This set the limit of size of applications of iron made tools and the limit of the size of the economy. In particular, coal mining requires a lot of iron made tools. The paucity of iron limited the size of ming of coal, an abundant energy source.

Around 1750, Britain developed a method to use coal to make iron. More coal led to more iron. More iron led to more coal, and later more oil and gas. Because of the abundance of fossil fuels, the positive feedback between energy resources and iron is what drives the long term growth since 1750. More detailed discussion can be found at Chen (2005) and Galbraith and Chen (2025).

References

Aghion, P. and Howitt, P., 1992. A Model of Growth Through Creative Destruction. Econometrica: Journal of the Econometric Society, pp.323-351.

Chen, J., 2005. The physical foundation of economics: An analytical thermodynamic theory. World Scientific.

Galbraith, J.K. and Chen, J., 2025. Entropy economics: the living basis of value and production. University of Chicago Press.

Nobel Economics Committee, 2025, From stagnation to sustained growth

https://www.nobelprize.org/prizes/economic-sciences/2025/popular-information/