How 2025’s Nobel Prize in Economics reinforces the worth of innovation-driven financial modelling for knowledgeable local weather policymaking

December 2025
Authors: Mihaly Fleiner, Márton Simó and Dóra Fazekas

This 12 months’s Nobel Prize in Financial Sciences highlights a shift in how we take into consideration financial development and its affect on local weather coverage.  

These awarded – Joel Mokyr, Philippe Aghion and Peter Howitt – demonstrated the significance of shared data, ‘artistic destruction’ by changing outdated industries and applied sciences with modern, new methods, and the way development is innovation-driven and never equilibrium-driven.  

For the staff at Cambridge Econometrics, the popularity of innovation being the true engine of development reinforces the ideas behind our financial modelling of local weather change – that for efficient policymaking, financial fashions must mirror the true world, not one that’s completely balanced. 

Decarbonisation will be largely seen as a technological change. If insurance policies are designed in order that they help the unfold of innovation, decrease prices, substitute outdated methods, and construct on present capabilities, then the shift to a low-carbon financial system can occur quicker with out hurting competitiveness. 

Innovation-driven development in local weather change mitigation methods 

Slicing emissions and reaching a low‑carbon financial system relies upon closely on the adoption of recent inexperienced applied sciences, which usually emerge by way of the method of artistic destruction.  

This 12 months’s laureates in financial sciences have proven in alternative ways how innovation‑pushed development requires insurance policies that encourage data creation, competitors, and the diffusion of new concepts whereas permitting new corporations and applied sciences to switch much less productive ones.   

For decarbonisation coverage, that is related as a result of lowering emissions at scale largely relies upon on new modern low-carbon applied sciences akin to EVs, warmth pumps or renewable power technology amongst others.  

Equally necessary is knowing the tempo and sample of new expertise emergence and adoption, which regularly follows an S‑curve: new applied sciences start as pricey and area of interest, then scale quickly as studying and deployment drive prices down earlier than ultimately approaching saturation.  

We’ve seen this in historical past earlier than with electrical energy, vehicles, and fridges – as soon as costly novelties, now on a regular basis necessities that reshaped economies and life. Inexperienced applied sciences are following the same trajectory in the present day, scaling rapidly as prices fall and infrastructure improves, resulting in a serious shift in power and transportation. 

Path dependency provides one other layer of complexity.  

Early selections can have long-term impacts, both accelerating or slowing the transition as a result of insurance policies which encourage the take-up of applied sciences kickstart learning-by-doing results. Investing in applied sciences that aren’t but commercially viable however have nice potential paves the best way for future innovation that reduces prices and enhances effectiveness. This is the reason the unfold of low‑carbon applied sciences is anticipated to speed up in a non‑linear approach. As these applied sciences develop into more cost effective, a rising variety of investments will movement into them. These investments, in flip, foster additional innovation, lowering prices much more and in the end enabling the alternative of outdated, polluting applied sciences with cleaner, extra environment friendly ones. 

For policymakers, because of this it’s necessary that the financial modelling instruments and strategies they’re utilizing to tell coverage growth round decarbonisation are capturing these dynamics and permit for non-linear innovation-driven financial development. 

Conventional financial fashions typically assume static value balances and battle to seize the velocity, uneven adoption, and dangers of local weather change akin to tipping factors. If fashions overstate prices and understate the function of innovation, funding could also be delayed – slowing the transition and rising cumulative danger. 

Modelling approaches for innovation-driven development within the transition to web zero 

At Cambridge Econometrics our method to financial modelling implies that our fashions are designed to seize how innovation drives change.  

For example, our macroeconomic mannequin E3ME contains particular parts that monitor how expertise evolves. This modelling method allows us to assess intimately how insurance policies encourage progress – whether or not that’s by way of learning-by-doing, the advantages of scaling up, or shifts throughout totally different industries. These are the identical concepts highlighted within the 2025 Nobel-winning analysis on how new expertise can drive sustained development.  

From working with totally different purchasers and companions internationally, we all know that totally different modelling assumptions can considerably form outcomes and the financial impacts of local weather coverage rely closely on these assumptions.  

Policymakers want fashions that mirror each prices and innovation precisely. The analysis recognised on this 12 months’s Nobel Prize in financial sciences underscores the significance of instruments that seize advanced, path-dependent dynamics – the place coverage choices form the deployment and adoption of applied sciences. 

For local weather coverage, this implies recognising how applied sciences unfold in S-curves, how early selections create path dependency, and the way artistic destruction and the sharing of information drive progress. Insurance policies that embrace these dynamics can ship quicker, cheaper transitions. 

This 12 months’s Nobel Prize in Economics has reminded us of the significance of trying on the financial system by way of an innovation targeted, non-equilibrium lens.  

With the EU’s dedication to local weather ‘neutrality by 2050 and the UK advancing its web zero and industrial technique, fashions and insurance policies must precisely mirror the financial system that we have now, not one which tends in the direction of an ideal stability.