Inside the Theories That Won the 2025 Economics Nobel

Hello readers! 

If someone asked you how economists measure economic growth, your first instinct would probably be to say, “By looking at how much the total value of goods and services has increased over time.” In other words, by tracking how the Gross Domestic Product (GDP) has grown.

And that’s exactly what one of this year’s Economics Nobel Laureates, Joel Mokyr, was doing. He wanted to understand how economies grew before and after the Industrial Revolution in Europe. But along the way, he noticed something unusual, something that made him rethink how growth actually happens.

The Puzzle of Stagnant Growth

When Mokyr looked at historical data from Sweden and Britain between the early 1300s and the early 1700s, he saw that incomes sometimes rose and sometimes dipped. But overall, there was barely any long-term growth, even after big inventions like the printing press.

If you were to draw this on a graph, the line showing economic growth across those centuries would look almost flat, like a long plateau.

Then, suddenly, something changed in the early 19th century, immediately after the Industrial Revolution began. The graph began rising sharply and steadily. From that point onward, growth became the new normal.

Apart from a few major slowdowns, such as the Great Depression of the 1930s and subsequent financial crises, economies in industrialized countries have continued to expand decade after decade. Most of them grew at an average rate of around 1.5% per year. That may sound small, but steady growth at that rate can double a person’s income over their working lifetime.

This shift fascinated Mokyr. Why did the world remain stagnant for centuries and then suddenly take off?

The Secret Behind the Growth Shift

Mokyr realized the answer came down to three surprisingly simple ideas, all related to how people understood and used knowledge.

Before the Industrial Revolution, innovation relied mostly on what Mokyr called “prescriptive knowledge.” That means people knew how to do something but not why it worked.

Take a blacksmith, for instance. He might know that heating and hammering metal a certain way made it stronger, but he didn’t understand atoms, heat transfer, or the science behind it.

On the other hand, “propositional knowledge” explained the “why,” the theoretical understanding of how things work. But in those days, people who studied theory (scientists) and those who built things (craftsmen or engineers) rarely interacted. So, invention and discovery stayed in separate worlds.

This gap often led to random or misguided innovations. For example, many inventors tried to create perpetual motion machines, devices that could run forever without using energy. But as science later proved, the laws of thermodynamics make that impossible. Energy always gets lost as heat or friction.

In short, innovation before the Industrial Revolution was often hit or miss, more accident than design.

When Science and Craft Came Together

Things started to change during the Scientific Revolution in the 16th and 17th centuries. Europe saw a wave of new thinking, one that favored evidence over superstition and tradition.

Scientists began setting new ground rules for knowledge:

1. Don’t just say something works; measure it.
2. Test one factor at a time to find cause and effect.
3. Make sure your results can be repeated by others.

These simple principles made science more reliable and, importantly, more connected to real-world applications. Theory and practice finally began to work hand in hand.

But knowledge alone wasn’t enough. You also needed skilled workers and financial support to turn ideas into reality.

Think of Leonardo da Vinci. Centuries before the Industrial Revolution, he imagined flying machines, parachutes, and even an early helicopter called the “aerial screw.” Brilliant ideas, but none of them could actually fly. Why? Because the materials were too heavy, and the power sources too weak. The technology of his time simply couldn’t support his imagination.

By the 18th century, though, Britain had the perfect mix: literate workers, practical engineers, and entrepreneurs willing to invest in new machines and factories. And that’s when innovation began transforming into sustained economic growth.

The Power of Openness

However, technical skill wasn’t the only reason the Industrial Revolution succeeded. Societies also had to be open to change, even uncomfortable ones.

Every major invention creates winners and losers. The steam engine replaced manual labor. Mechanized looms displaced weavers. Today, AI and automation are changing job roles again. Progress always disrupts something.

In earlier feudal or monarchical societies, a small elite, nobles, landlords, and clergy, could easily block changes that threatened their power. But by the time of the Industrial Revolution, things had shifted. Political power was more widely shared. Parliaments included not just aristocrats, but merchants and industrialists.

That made it harder to stop technological progress. And as societies started valuing reason and evidence over blind tradition, innovation became something to embrace, not fear.

The Economics of Innovation: Aghion and Howitt’s Model

But this raised another question. If every new invention replaces an old one and sometimes even destroys entire industries, how does the economy keep growing?

That’s where the work of the other two Nobel Laureates, Philippe Aghion and Peter Howitt, comes in. They developed a model to explain how technological change sustains growth in modern economies.

Their model showed that innovation sits between two competing forces:

1. Too little R&D (Research and Development): Companies may hesitate to invest in research because they know that once someone invents something better, their profits will vanish. So they underinvest. But from society’s point of view, every new idea adds value because each innovation becomes the stepping stone for the next one. That’s why governments often step in with R&D subsidies or support.
2. Too much R&D: Sometimes, companies overinvest in chasing small improvements just to outdo each other, which the economists call “business stealing.” This can waste resources without adding much value.

Aghion and Howitt’s insight helped policymakers understand that balance is key: enough competition to keep ideas flowing, but not so much that it destroys long-term investment.

Growth, Jobs, and “Flexicurity”

Innovation doesn’t just affect companies; it affects people, too. When old jobs disappear and new ones emerge, workers need help adapting. That’s why Aghion and Howitt suggested governments focus not on protecting jobs, but on protecting workers, by helping them retrain and transition into new roles.

They called this idea “flexicurity”, a mix of flexibility for firms and security for workers. The goal is to make change less frightening and more manageable.

The Challenge of Sustainable Growth

But there’s a catch. Sustained growth isn’t always sustainable growth. Progress often brings side effects, pollution, climate change, inequality, and resource depletion. These challenges could slow growth again if ignored.

Mokyr believed, however, that these very problems could spark new waves of innovation if guided by smart public policy. Clean energy, healthcare access, and fair wealth distribution could help ensure that growth continues without harming the planet or people.

A Final Thought

For most of human history, economic stagnation was the norm. The steady growth we see today is actually the exception, a fragile achievement built on centuries of learning, experimenting, and adapting.

The story that Mokyr, Aghion, and Howitt tell is a simple one: progress happens when people stay curious, open to change, and willing to balance innovation with responsibility.

If we remember those lessons, we just might keep that growth curve rising and prevent it from flattening again.

📅  Coming up next week!

October 20 (Monday)

• China's GDP and Industrial Production: China will release its GDP data for the quarter ending September 2025. This will give investors a clearer picture of how the economy is performing amid global uncertainties. Alongside, the country will also publish industrial production figures for September. Industrial growth had slowed in August compared to July, so markets will be watching closely for signs of recovery.
• China Communist Party Fourth Plenum: China’s top leaders will gather in Beijing for the Fourth Plenum. The meeting will focus on long-term development goals and the framework for the next Five-Year Plan, which could shape future policy directions.

October 21 (Tuesday)

• Muhurat Trading: Indian stock exchanges will remain closed for Diwali Laxmi Pujan, but Muhurat Trading—a special one-hour symbolic trading session—will take place in the evening. This session is considered auspicious by investors.
• India Infrastructure Output: India will announce infrastructure output data for September. In August, output had shown faster growth, and markets will be keen to see if the positive momentum continues.

October 22 (Wednesday)

• Market Holiday: Indian stock markets will be closed for the Balipratipada festival. No trading activity will take place on this day.

October 23 (Thursday)

• Corporate Earnings: Major companies, including Hindustan Unilever, Laurus Labs, and Colgate Palmolive, will announce their quarterly results. Their numbers will be important indicators of consumer demand and business trends.
• South Korea Interest Rate Decision: The Bank of Korea will meet to decide on its policy rate. In August, the central bank kept its base rate unchanged, and analysts will look for signals on when rate cuts might begin.
• US Economic Data: The US will publish existing home sales data for September, following a decline in August. Additionally, weekly jobless claims will be updated, offering insight into the labor market’s strength.

October 24 (Friday)

• Corporate Earnings: A busy results day with major announcements expected from Dr. Reddy’s Laboratories, SBI Life Insurance, SBI Cards and Payment Services, Coforge, Latent View Analytics, and Aditya Birla Sun Life AMC.
• India Flash PMIs: HSBC will release the October flash PMI data for India’s manufacturing and services sectors. Both indicators had eased in September after hitting record highs in August. The data will provide an early look at business activity trends.
• Global Flash PMIs: Flash PMI numbers for Australia, Japan, France, Germany, the UK, and the US will also be released. These readings will help assess global economic momentum heading into the final quarter of 2025.
• IPO Listing: Shares of Midwest Ltd are likely to list on Indian stock exchanges on Friday. The company’s market debut will be closely watched by investors.
• US Inflation Data: The US will also update consumer price inflation (CPI) figures for September. Inflation had risen in August versus July, so investors will look for signs of cooling or persistence in price pressures.

October 25 (Saturday)

• Corporate Earnings: Kotak Mahindra Bank will report its quarterly results. The performance of one of India’s leading private lenders will offer insights into credit growth and the broader banking sector’s outlook.

🎥 Prime Wealth Finserv In Media

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