Thinking (about) economics

INSLEY: After my masters I worked for a while in Calgary in the oil business. Seeing the importance of economics and the relevance of economics in my job there – I was an economist in a major pipeline company. The price of oil had tanked, this was in the 1980s and there were lots of layoffs.  I saw the huge impact of that.  In my job I saw the impact of bad policies on the industry particularly of the National Energy Board and the Canadian National Energy Program[1].  The National Energy Board at the time tightly regulated the export of oil and gas.  There was a place for people with training in economics to bring some sense to the regulation of the industry.  That felt very exciting, just after I had obtained my masters degree, that we had something to say and contribute. It felt like economics could make a real contribution to getting the right policies as far as the energy industry was concerned.

NIMUBONA: I really started noticing that what I was learning was important at the end of my undergraduate degree when I had to write my thesis. That was when I really noticed that the tools and theories that I had been learning could be used in order to understand and explain real world problems.  I tried to figure out what went wrong in the 1990s in Burundi with the structural adjustment policies imposed by the World Bank.  Because after the policies were introduced it was the end of economic growth – while the objective had been to stimulate growth.   I was trying to figure out the implications of the devaluation of the Burundian Franc.  I showed that this draconian devaluation policy had negative effects on fiscal revenues.  I used very simple things really, very simple econometric tools.  I noticed that what happened was expected but no one really paid attention.   Clearly, they did not anticipate the adverse effects on the economy that these policies might have.

RUS: When I studied international economic relations as an undergraduate in Romania it was still a strange mix of Marxist economics and free market economics that was being taught.  It was not long after the fall of the Berlin wall, in the early 1990s.  Some of the professors of my university had updated their curriculum and some hadn’t.  So I had exposure to both.  I wasn’t satisfied with the state of either there wasn’t a coherent method or vision because of this discrepancy. 

I did a Masters in International Relations after that in a university sponsored by George Soros’ Open Society Foundation[2] – it was supposed to be a masters program for the Eastern Bloc – that was as close to the US or Western European standards as possible.  It is still going and it is a very successful university by the way.  That programme left me a bit dissatisfied with the fact that in most qualitative analyses you could argue both sides of the argument almost equally convincingly.  So I said I want something more quantitative, with more definitive policy conclusions, or implications.  That drove me to Economics.

As I started my Masters programme in Economics and in the first years of the PhD, I started familiarizing myself with the way of conducting research in economics and I realized how influential economists and economic ideas are in driving policy.  I started to appreciate the impact that you can have as an economist in forming good policy making in general. Coming from a small country in Europe that is quite integrated into the region, my initial interests were in international trade.  And then I moved on to become interested in environmental issues and it just so happened that the methods used in these two fields were very similar.  So it was easy for me to transition into one and then back.  My interest was piqued and is still driven by policy implications.

RUS: I see the value of learning of different approaches and excluding any approach from the very beginning is not productive.  That being said you can’t continue to give equal attention to all approaches in economics because there are not that many hours in a day and courses in a curriculum that will afford you to go for four years with a three-pronged approach or four-pronged approach to economics. There are many different schools of thought.  I see the value of some exposure for our students to heterodox approaches.  Alternative approaches should be given attention and students should be made aware that they are out there.  I’m sure that many students are not even aware that there are alternatives to the main approach to doing economics.  For practical reasons however I don’t think we can start offering various versions of the same course according to the different approaches.

NIMUBONA: I think it depends on the fields that you are talking about and the topics that you are teaching as well.  On one hand, for some specific topics, it is very important to adopt a more inclusive and heterodox strategy to approach the issues at hand. I will give an example from environmental economics. At a certain moment it is very important to let the students know that there are different perspectives to analyzing the different issues related to environmental resources.  On another hand, I have to admit that for some topics it makes sense to keep using the same tools and theories that we have been using. Another requirement nowadays is maybe to make sure that you highlight the simplifications and assumptions underlying the different approaches that you are using.

INSLEY: With environmental and natural resource economics I would say ecological economics is held up as the alternative approach.  But I think they have a lot in common.  I think environmental economics has really expanded its perspective.  All of the textbooks that we use now have an ecological economics flavour and talk about the critiques of the utilitarian framework, defining natural capital, defining constraints.

The ecological economics framework has really been infused into environmental economics.  I don’t know to what extent that is so in ecological economics, whether the two perspectives are merging.  But I’ve always felt that this is in some ways a false dichotomy - the dichotomy between ecological economics and environmental economics.

RUS:  It’s a personal choice about the kind of research you’re doing.  If you look at a leading journal in ecological economics – titled Ecological Economics - you find that many people publishing there are environmental economists, doing what we call mainstream environmental economics, but they contribute to the field of ecological economics. The same kind of papers are publishable elsewhere, it’s not a very different outlet.  It does have its own preferred topics but not so much in terms of method of analysis or technique. 

NIMUBONA: Economists and ecologists have noticed that most of the differences that were between their reasoning were due to some misunderstanding, so now they are trying to communicate as much as they can.  They want to talk to each other.

RUS: This year at a leading conference for Canadian environmental and ecological economists which is the CREE conference,[1] out of roughly twenty papers presented there were three or four that were clearly not using the methods of neoclassical economics.  They were dealing with ecological issues, and with sustainability issues.  And they were embraced and invited and included in the program.  So there’s no real separation that I can see going on at the moment.  It appears to be more like a convergence.

INSLEY: It depends on what your main focus is.  Models have to be simplified.  So if your main focus is modeling the ecological environment and the economy is less important, then you would  put more of your effort into the ecological components of the  model.  And if your main focus is on modeling human behaviour then you would have a more simplified ecological model. You won’t generally have equally detailed models of human behaviour and the natural environment, because you want to have something that’s stylized so that you can figure out what’s happening.  That’s what I tell my students.  For any particular problem, you should  try to model most accurately  and in most detail your main area of concern and the other components can be included as constraints or in a more simplified form.

RUS: When I think about a new project I start with the idea or the policy application, something that’s unexplained, not well understood.  And when I do my initial review of the literature, I don’t only search econ journals.  I do start there of course.   I would say some of the best papers published in environmental economics, and to a certain extent in international trade as well, have been papers that actually do look across disciplinary bounds, and borrow ideas or approaches from either ecological or environmental science, or sometimes engineering, operational research methods, and trying to translate those methods into economics.  That’s one way to introduce innovation in the field is to borrow from other fields.  As far as I can tell a lot of the innovative papers in economics are borrowing from other fields.  That being said, as a young researcher on a tenure track, you do have to be mindful of where you are aiming your research.  So if you’re aiming your research at a certain journal or certain group of journals then you of course need to consult those as well.  You cannot exclusively look at original approaches.  Originality is something that’s important but it’s not the most important thing in doing good research.  Maybe your policy question doesn’t need to have a super original answer, but it has to have a correct answer, to be a useful answer.  That being said I pay very close attention to the leading journals in the field, but not at the expense of everything else.

NIMUBONA:  Most of my research questions are also policy oriented.  It could be a suggested policy or a policy that has already been in place, where I’m trying to see what the impact has been, or anticipate what would be the impact of it.  Because environmental economics is an applied field of economics I always start with my search of papers within the field of economics itself, see if there are tools that have been used in other subfields of economics that I could apply to understand the issue that I’m interested in.  But I’m very open minded, sometimes it turns out that I need to also look at other disciplines.  Recently, for example, when I was working on a project on the search of abatement technologies in the Alberta oil-sands[1], a topic with a significant technical component, I had to understand what are the main issues with the mining activities in the Alberta Oil Sands, which is not really economics. When there’s some technical aspect that I need to address, I do not hesitate to go outside economics and see what’s available out there.

INSLEY: My work brings together finance, natural resource and environmental economics.  I’m trying to bring these together to look at the impact of uncertain commodity prices and how that affects our use of the environment.  Industry is driven by all this uncertainty and the huge volatility in commodity prices as we’re seeing today.  So how does that affect the environment?  So I certainly have to draw on other disciplines, for instance from engineering regarding the details of an oil-sands operation.  There is great expertise here at the University of Waterloo through the Water Institute regarding the environmental impact of oil sands operations. One of my PhD students is looking at  the regulation of water withdrawals by oil sands operations.   Surface water availability  doesn’t seem to be a constraint right at this moment except during some periods of low water flow.  But are we heading into a time when water availability is going to be more of a constraint?   Roland Hall[2] is a biologist at UW who looks over long time scales of history.  His research indicates we’re likely heading into a time of water shortfall as flows in the Athabasca River are declining. We’d expect that is going to have an impact on oil sands operations and this should inform policy to protect water supplies.  So certainly in environmental economics you have to rely on scientists who can tell you what the environmental constraints are for your economic system.

NIMUBONA:I think this division is working, everyone has different interests and skills and we complement each other.  In my case, I am really interested in some specific policy related problems and in order to address those issues I definitely have to find the right tools to do that.  While I won’t say that I’m currently interested in developing new tools, I might have to do that in some specific circumstances. For example, I might have to deal with an issue for which there is no available tool that could help me answer the question.  In that case, I could be drawn into trying to develop a new tool. I think that’s something very interesting as well.

RUS: You hear sometimes that some economic research is driven by the method and not the problem.  I’d say there’s basically two kinds of research done in economics.  One is mostly theoretical, and the other one is empirical. I wouldn’t say the empirical research is oriented towards applying some tools just for the sake of applying the tools.  I think most empirical research in economics tries to evaluate policies, tries to see if something works or doesn’t work, tries to assess the need for some new policy.  So useful results are usually what drives this kind of empirical research.  And modern economics is predominantly empirical.   On the theory side, if you are writing a paper, that paper cannot be written in a vacuum, you have to draw on previous research.  You have to look at what other models are there and try to explain a similar phenomenon – and borrow from them, or amend them, or contradict them with your own work. So in that sense I think our models and tools and understanding keep evolving on both sides, on the theoretical and on the empirical side.  On the empirical side you need new econometric techniques to deal with things like missing data, and imperfections in the data, or to try to identify your variable of interest in a correct way and so forth.  So methods are important, but I would say – at least in modern economics it’s mostly driven by the need to find answers to economic problems.

INSLEY: I’d say it is iterative.  I exploit the tools I have to answer policy questions.  But then a question arises that I can’t answer, so I have to find a new tool.  For the economics profession as well, new tools are developed and used depending on the critical questions of the day.  And of course our analytical capabilities have greatly increased in the past decade with new technologies.

RUS: I would say in the case of global warming it’s a case where economists clearly do defer to scientists – there’s a scientific consensus that climate change is real, that it’s happening, and it’s due to emissions of green house gases.  But then economists’ job is to take that knowledge and try to figure out policy solutions to curb emissions growth, to come up with ways to adapt against the impact of climate change.  So I think in that case the division of labour between different fields is very clear.  Going further with the same idea, there are tools in economics that are very useful for dealing with problems of international political co-ordination, tools from game theory, and the formation of international agreements.  There’s a whole subfield that deals with that, and it has a lot of contact points with political science for instance: how competition and co-operation works.  Drawing on Olson, Ostrom and other political scientists[1].  By the way Ostrom got a Nobel Prize in economics while being a political scientist and working on that. So I wouldn’t say economics is useless in answering those questions, but at the same time its contributions are linked to the contributions from other fields.

NIMUBONA: I agree.  Particularly with analyses of those topics of the hour like global warming.  There’s a lot of collaboration between people from different disciplines.  And the contribution of economics is really significant.  The contribution of economics is particularly interesting in the sense that economists themselves tend not to agree on the way the issue should be addressed.  There’s lots of debate for instance on the right way of accounting for inter-temporal aspects of the global warming, the right discount factor to be used.  It is interesting to see how economists within the field itself are trying to contribute to the problem by suggesting different approaches to the problem, and criticizing each other.

INSLEY: I observe that in speaking with scientists they’ll say they can do all this great science but then what?  And that they feel very powerless because their scientific research does not necessarily lead to change Many scientists are interested in working with people that translate science into policy recommendations.  Similarly for economists, we come up with policy recommendations, like a carbon tax that we pretty much all agree on, but we’re powerless too.   Because policy makers typically don’t  listen, and politicians don’t listen.  So then we look to other disciplines who deal with the political side.  I see each group, each discipline, feeling their limitations.  Economists may be saying “Yes we want a carbon tax” but we’ve been saying this since before Stéphane Dion got into trouble advocating for a carbon tax.[2]  So then there’s room for people who are activists, because you need people who are actually putting pressure on politicians to get the policies implemented.  You need people who are out there protesting the Keystone Pipeline, whatever we think in terms of that pipeline per se, we need activists who get the public excited.  I see all these groups from different disciplines having their role in pushing for societal changes and also and feeling somewhat powerless and frustrated by their limitations.

RUS: I don’t teach a lot of undergraduate courses but I do teach non-economists in a couple of courses, and those people will not become economic researchers either.  What I see as the tension right now in economics is between the current state of research in economics and the way economics is taught in the first couple of years.  The principles and even the intermediate courses.  The truth is there’s a big gap between the two.  The current research mostly deals with departures from the neoclassical paradigm and that is the bread-and-butter of the principles and intermediate courses.  And I see that as an issue because we teach a simplified version, and sometimes an extreme version of economics that no-one really believes applies to real life. At the same time, we do research that accounts for all these imperfections and the messiness of the real world.  The problem is that that’s really hard to teach in the first years, and again there’s not enough space and time to cover both, the basic ideas of how an economist thinks in the abstract, and at the same time to say, we know that the world is much more complex, and that’s why all of this new research done in economics in the various fields tries to account for that.  And also in addition to this gap, I see a gap between empirics and theory. So that not enough empirics are being taught, and students don’t have exposure to the fact that modern economics not only departs from the neoclassical paradigm, but is also very empirical. It’s motivated by real issues and it’s trying to test some of those ideas on to real data.  So I would say injecting some more empirics alongside the main theories should be a way of reforming the curriculum that would make economics more relevant and palpable for those students at the same time as making it more real.  At the same time as teaching the more cutting edge stuff in a simplified way.  That’s probably extremely hard to do to change the textbooks, to change the curriculum, but it’s something that might need to happen sooner or later.

NIMUBONA: Depending on what students want to do in the future they might have different expectations.  People who don’t want to become researchers, for example, are mostly interested in the practical aspects of economics.  I won’t say that I really make any particular compromises. I make sure I teach the different tools and theories even if some of them might appear to be a bit abstract. However, I try to show students from the beginning that those seemingly abstract theories could be interestingly applied to try to understand real world problems.  At the very beginning of a course, I make a list of real world issues or policy issues and I ask my students to choose a question and answer it with the maximum of economic analysis that they can think of.  And then after a few weeks, after they have really learned some new tools and theories, I ask them to revisit their answers.  In this way, they see that they can make a more coherent analysis and they understand that what we’re doing is very important, even if it is a bit theoretical.

INSLEY: I just taught natural resource economics[1] and I find it really a nice course to teach because the students have had 201 [Microeconomic Theory I] so I’m able to talk about the imperfections and the problems with natural resource markets.  Students can see how they can use what they’ve learned and apply it to real problems.  For instance, students get a better handle on the impact of discounting on decisions which is one of the big things in natural resource economics, and decisions that promote efficiency, and balancing efficiency and equity.  We talk about those issues all the time in that course.  It’s a pleasure to teach it, and we do talk about the critiques.  We say “Here’s what an efficient economics policy is” – and ask “How would you critique that?”

INSLEY: Not among my students.  Because I’m always focusing on the public good.  To me, that’s where you start.  As opposed to in a business school where the focus may be more  on maximizing profit.  In my courses, we are focusing on the public good, making students aware of that.

RUS: Maybe we’re not a representative sample of economists, because our field is dealing with externalities.  The things we are maximizing while being rational are public in nature. 

I don’t think that focusing on non-rational choice would entice more pro-social behaviour.  If you would have an approach that totally goes against rational choice I’m not sure that would yield more pro-social outcomes with students.I have seen some of the studies and I’m not sure whether this is the effect of self-selection of people into those programs and how much is the effect of what we’re teaching them. [1]   I don’t think there’s conclusive evidence that economics turns those students into self-interested individuals, whereas they weren’t before.

That being said, there is research in economics, not so much in environmental economics, about pro-social behaviours and non-market motivations for people while still taking into account their incentives.  People might be interested in selfless behaviour, may have altruistic sentiments, and all that can still be modeled within economics.  This is still part of the mainstream, it’s not fringe.  I think there are a variety of approaches that are included here.

NIMUBONA: I would almost say the same thing.  For instance in my environmental economics course[2], when I’m addressing some of the criticisms of environmental economics particularly with the utilitarian approach used, I show the students that depending on your preferences you could definitely behave in a rational way, without compromising your preferences as someone who would care about the environment, or other people.  For example, a utility function that includes some aspects of the well-being of future generations or environmental resources represents the preferences of someone who is both rational and altruistic. 

Economics is commonly described as the study of tradeoffs. Economists often estimate implicit valuations made by society in allocating resources in this spirit. What comes next is an argument that the introduction of markets for things that are not conventionally traded (pollution, human organs) will lead to more efficient allocations. How can this be legitimate if economists do not provide an accompanying analysis of inequality? 

INSLEY: I always tell my students that you have to pay attention to the distribution of income and you can’t really make these judgments about efficiency if you don’t have a fair distribution of income to start.  So that’s kind of presumed in these models.  But when you make a policy recommendation you have to actually look at that perspective.  Willingness to pay as a measure of value is very inappropriate in certain circumstances.  Measuring willingness to pay may bring some incremental efficiency improvements in circumstances where you’re satisfied with the income distribution. But if you’re not, then you need to think of other policies that are redistributive, and be aware of the implications of your policy recommendations on inequality.  Where people start out matters, their “initial position” in the world is just luck. The analysis of inequality is receiving increasing attention in the discipline.

RUS: I’d agree.  I would add that I don’t think pricing things necessarily perpetuates inequality.  I think it just brings this inequality to the forefront to be able to be dealt with in a policy setting.  Because if you are not pricing water, or if you are not pricing pollution and polluting that water, then you are just basically allowing big companies to pollute the local water supply and get people sick.  By not putting a price on the ton of carbon or on the ton of industrial waste that’s spilled in the environment you are not behaving in a more compassionate way, or taking inequality into account.  People in poor areas, who are less economically and physically mobile will pay the cost of you not putting a price on those things, economic bads or economic goods.  Water shortages are not maybe a concern for a lot of locations in Canada, but in many places in the US and other places around the world, water is running out.  So what is a fair allocation mechanism?  I would say people who are better off will always find alternative solutions, people who are not – once the free water runs out, are the ones who will find it most expensive to find those alternatives. 

That being said I don’t think you can have a theory of everything.  If you are just an environmental economist trying to price water, you need a mechanism to take into account inequality.  You can’t have a study that takes into consideration everything and tries to come up with a comprehensive solution, that’s the role of politicians, and policy makers to try to combine various strands of policy.  For instance, Roth got a Nobel Prize for a [non-monetary] kidney exchange and that saved lives because it’s a mechanism that resulted in a lot more matches of compatible donor and patients than before.[1]  And that’s a net gain for those patients.  There are ethical issues around it, definitely, but I wouldn’t necessarily say it’s a bad idea.  Though I think we should try all of the above type of approaches to deal with these hard issues.  And not just markets or just free goods.

INSLEY: It has to be framed in an ethical framework.  Society might say, for example, that ethically we do not want to put a price on organs, or we do not want people to be able to buy surrogacy for a parent or whatever.  Economics has to operate within ethical parameters that are established by religious leaders, philosophers and others; that’s beyond the mandate and expertise of economists   We have these greater values which society must decide upon, and this provides the framework for economic decisions.

NIMUBONA: The question reminds me of an interesting debate between environmental economists and environmentalists regarding pricing pollution by implementing carbon taxes or cap-and-trade systems.  Environmentalists care about motives.  Many don’t like carbon pricing because this is giving the polluters the legitimacy of doing their activities because they know they will be paying for the damage they have generated.  Some people say that this is where the cliché ‘license to pollute’ is coming from, and cap-and-trade systems or carbon-taxes are sometimes considered a license to pollute.  Economists look at the problem the other way around.  Environmentalists, not all of them, are more interested in standards, for example technology standards, or emission standards.   This is because firms that are using specific standards are proving that they have done their best to comply with the regulation and made sure they minimize the effect on the environment.  But when economists are analyzing standards they often consider them a ‘license to pollute’. When there is a technology standard in place, for example, firms that are using the recommended technology can pollute as much as they want.

To sum up, when it comes to the ethical criticism of the pricing of pollution, for example, it depends on which approach you are using, and the criticism could go the other way around as well.  Moreover, as the others have said, I don’t think economists are really saying that markets are a panacea, sometimes they work, and sometimes they don’t work. 

RUS: I also don’t think markets are a solution for everything.  But not talking about the tradeoffs doesn’t mean that they don’t exist.  So sometimes they are hidden, they are affecting people who are poor and do not have representation, so we kind of have to be mindful of the tradeoffs that are most often there.