Out of the Ivory Tower: From Academic Economics to Policymaking

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What issues can modern economics help address? How can economists shape government policies? What languages should an economist speak? These are some of the questions Professor Alain Paquet of the University of Quebec at Montreal will talk about at the upcoming meeting of the Discussion Club on Modern Economic Policy hosted by HSE University’s Faculty of Economic Science on November 11. The News Service has talked to Professor Paquet ahead of the lecture.

Alain Paquet is a full professor of economics at the School of Management of the University of Quebec at Montreal (ESG-UQAM), which he joined in 1988. He is also the director of the Research focus axis on business cycles and growth of the Chair in Macroeconomics and Forecasting at ESG-UQAM.

Professor Paquet specializes in the macroeconomics of economic growth and fluctuations, macroeconometrics, financial economics, as well as monetary and fiscal policy and public debt management. He has wide experience working with several public and private organizations in Canada and around the world. Member of the National Assembly of Quebec for Laval-des-Rapides from 2003 to 2012, during his elective terms, he held the positions of Chairman of the Public Finance Committee, parliamentary assistant to the Minister of Finance, and to the Quebec Premier for Economics, and State Minister for Finance. His various mandates have led him to assist the Quebec Premier in pursuing the government's economic priorities and to advise him on specific issues, such as productivity, innovation, and entrepreneurship.

Alain Paquet

Bridging the Gap

Sometimes academics are accused of being isolated in their ‘ivory tower’ talking about theoretical models and constructs. So, in order to be heard, we need to show that theory and empirical evidence are not disconnected from real-world issues for society. We should also document what the issues are and develop a clear economic reasoning. This doesn't mean abandoning one’s work in academia.

Making ourselves heard is also important in terms of having recognition. It turns out that out of four recent Ministers or State Minister of Finance of the Quebec government three came from the Department of Economics at the University of Quebec at Montreal – two were economic professors and one as a former graduate student.

When I was in politics, one of my former students told me that I needed to be multilingual—to be able to translate the same ideas in different ways, depending on whether you talk to top civil servants, elected officials, journalists, or the population directly. The idea is not to change the discourse depending on the audience but to be able to clearly explain the facts and concepts, to show that not doing something can be more costly than doing something, and sometimes to challenge preconceptions.

When I went into the prime minister's office and talked to my colleagues, I wouldn't draw graphs or solve a system of differential equations. Instead, I tried to show the incentives that drive people to make their own decisions and what constraints they are facing and what the optimal course of action is in that context.

You need to find a way to show that the marginal benefits of implementing a policy guided by some economic prescriptions are higher than its marginal cost—that's the basic law of economics

I think it was President Truman who said at some point ‘I wish I had an economist without hands’ referring to the expression ‘on the one hand, on the other hand’. Yet, I don't think it's good to have only one opinion unless there is a broad consensus. It’s good to have a fair competition of ideas based on sound economic reasoning.

And sometimes the government may decide to do something even though economists wouldn't recommend it. When I belonged to the government, sometimes I lost some battles on some issues they were not fundamental for me, but I was very lucky to bring about some major policy changes regarding fiscal policy in Quebec.

For a very long time the companies were taxed based on the value of their assets. The tax was first introduced to counter the effects of recession when profits went down, thereby decreasing tax revenue. I was probably the first economist in Quebec to criticize this tax as the worst tax possible because it disincentivised investment in capital assets, and put a drag on Quebec’s economic growth. I was able to convince the public opinion and the civil servants of the need for change. Certainly, the change could not happen overnight but by 2012 the tax was abolished for all the sectors in the economy except for banks. Now, all major political parties agree with that change.

What’s important to keep in mind is that bad decisions have long-lasting effects while good decisions don’t have immediate effect

To give another example, the government I belonged to began to reverse the policy concerning investment in public infrastructure which had been previously neglected for decades. That was a challenge because governments generally have short-term horizons because of the electoral cycle but it often takes time before we see the result of addressing important issues – 5, 7, or even 10 years. Even now, more than fifteen years later, Quebec has not yet fully finished reinstating the state of its existing infrastructure, while it also has to address new needs.

Pressing Economic Challenges

One challenge many countries are facing today is the ageing population. For instance, with a longer life expectancy, the issue is how we can encourage people to retire later. This may require adjusting the fiscal structure to create incentives, for instance, such as lowering the tax rate for those who voluntary postpone their retirement. That’s an example of a basic principle from economic theory that can help respond to the issues the society is facing by accounting for how people respond to incentives. We also need to build a better trained workforce, so better education is important.

The danger we all face all over the world is the policy of ‘well, let's wait’. We've waited too long—we knew about demographics 40 years ago and it was one of the easiest variables to foresee.

When a country decides to wait out while other countries are advancing, it will fall behind. This is true for every country around the world

To deal with some poverty issues, one solution sometimes proposed has been to raise the minimum wage, but it is argued that this might lead to more unemployment in low-income groups because lower wage jobs may become scarce. Yet, two weeks ago the Nobel Prize in Economics was given, in part, to the Canadian economist David Card (University of California, Berkeley, USA) who has shown that in some cases raising the minimum wage does not increase unemployment for people with low wages. 

Our choice in Quebec as a government was not only to reasonably increase the minimum wage (to keep up with inflation, without harming employment opportunities), but also to pay non-taxable subsidies to people accepting low and low-middle level paying jobs. This kind of policy comes straight from economic theory and at the same time it’s a policy that is good because it encourages people to enter the job market where they can develop their skills to build their confidence to find better jobs. So, it is also good on efficiency and equity terms.

Then there is the issue of encouraging innovation. One of the worries is that with the new technologies we will need fewer workers. This type of debate is not new. There was the same debate in the early 20th century when electricity came about and people started saying that candle factory workers would lose their jobs. But it doesn’t mean we need to stop progress and stop innovation.

What we need is to find ways to help the workers transition to this new economy as there will still be a need for workers, especially because of the ageing population

Finally, one of the main challenges we'll be facing over the next 10 to 30 years is the transition towards a more sustainable economic growth. I like very much the idea of a former professor of mine, Paul Romer, who received a Nobel prize a few years ago, that economic growth is a bit like cooking—instead of repeating always the same recipe, we should get better ingredients and invent new recipes.

Part of it is to minimize the impact of pollution on the society. We will still need some gas or oil for quite some time but we need to prepare the transition in order to fight climate change.

Development of Economics

As macroeconomists, we try to understand the world around us and of course this world is very complicated, so our models are simplifications. George Box, a British statistician, said that ‘all models are wrong, but some are more useful than others’. What it means is that we don't judge a model in terms of their capacity to be a perfect reconstruction of reality but rather in their capacity to explain and address some of the questions we observe. When we find that a model is missing something which we deem important we need to build better models, just like in physics where general theory of relativity has replaced the Newtonian model.

Economics and macroeconomics, in particular, have faced a major evolution in the last 30 or 40 years. For instance, microeconomic foundations have been built into macroeconomics because, to begin with, macroeconomics is the sum of the behaviors of all the consumers, all the savers, all the investors, all the firms, and the government.

There have also been significant developments in terms of mathematical tools and the computing power, which now allow us to build more heterogeneity and higher degrees of approximation into the models.

One of the major advancements in macroeconomics over the last 40 years has been the development of dynamic stochastic general equilibrium models, which account for dynamics and uncertainty and are more consistent

It is also important to learn from events. Most of the macroeconomics models used until 2007-2008 assumed that the financial markets were working reasonably well. However, as the misregulation of the US financial markets brought about the collapse of Lehman Brothers and other financial institutions, it showed that something taken for granted before was not so innocuous. This led researchers to improve the models to better understand some of the issues previously neglected due to the lack of knowledge or experience.

Econometricians have also started using big data. Maybe in 20 years or even five or ten years from now we will be able to press a button on a supercomputer and do a live simulation during a conference. This means that we'll be able to address more complicated issues that we can’t envision addressing now—just like we could not envision 20 or 30 years ago dealing with issues we deal with now.

For example, models of the 1960s were omitting the importance of expectations. Of course, we don't have a crystal ball to know exactly the future but every economic agent's decisions today are shaped but what they think the future will be—people’s expectations regarding inflation affect their present day decisions and have implications for government policies as well. For instance, Professor Olivier Loisel in his paper A Model of Post-2008 Monetary Policy, presented at the recent 3rd ILMA Workshop at HSE University Moscow, showed that in order to avoid core inflation going up, it's important that people expect the monetary policy to correct the large temporary increase in money growth that was implemented to deal with crises, such as the 2008 Great Recession, and presumably the current COVID crisis

So, building expectations into economic models has been another one of the key advances in macroeconomics

Also, sometimes people are not always pragmatic so if we are going to build a sound economic policy, it needs to be to be rooted on sound positive economics which describes what is likely to happen given the circumstances, and not only on a normative point of view about what some would want it to be. In reality, there has to be a right combination of positive and normative aspects.

Interconnected World

I think that trade of goods, services, and ideas across countries is very important. It’s one theory dating back to the 18th century that still holds as trade across nations is beneficial for all nations and most people are better off. Some people have been displaced by innovations and globalization, but they can be assisted in this transition with the net benefits gained. However, the transitional measures have not always been implemented as fully or as well as needed.

In the academic world, as in the 3^rd ILMA workshop and other conferences held recently have shown, there is more connection now and we're all talking the same language of economics. There are very good and very promising Russian economists. They are all very dedicated to their research and make great comments and great contributions. We share the same thirst for knowledge and the desire to better understand the world we're in. More people sharing ideas, challenging one another in a constructive way allows us to address tough issues.

Economics is difficult because nobody has the perfect answer and everything moves around simultaneously. But the tools we are developing allow us to consider tougher questions. I believe that we are called on this planet to embark on a quest to better share our common problems and solutions.  This is already happening in economics and research activities at ILMA provide good examples of this.

For young men and women who are interested in addressing issues which have a direct effect on the day-to-day life of their country and the world going into economics is a right choice

Register to attend the online meeting on November 11