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The fololiwng is an excerprt from lectur he prpersd for hat ocaasiosn. The Role of Controversy in Academia Knowledge in the natural and social sciences is very important in the determination of our living standards. For this reason it is important that we continue to add to this knowledge through the work done in academia. To promote advances in knowledge, academia rewards research success with promotions, tenure, money, prestige and laurels like the Nobel Prizes. Unfortunately, there are also institutional barriers that reduce these incentives. Few students challenge their professors’ views, worried about getting their degrees and jobs. Governments distribute research support through panels of experts that have a great stake in existing knowledge. Governments favor with grants research that supports their political agendas. Rocking the boat comes with great personal costs and many in academia prefer to stay away from research that potentially stirs up controversy. Nora and Ted Sterling established their prize to shift the balance a little more in favor of controversy and thus the advancement of knowledge. They should be praised for their initiative and the encouragement it offers to academics at ЖЁЯудАAV to engage in knowledge-advancing and welfare-enhancing potentially controversial research. In what follows I want to share with you the story of how some of my research results that challenged the conventional wisdom gave rise to a nation-wide controversy and many personal attacks. However, I will also relate to you the personal satisfaction I am able to derive to this day from knowing what impact the research has had on the present conventional wisdom and some government policies. Unemployment Insurance The first of my stories concerns unemployment insurance, now known as employment insurance (EI) and work done jointly with my colleague Dennis Maki. It is well known that as a result of the existence of public unemployment insurance workers no longer have to fear and suffer the consequences of unemployment. They can afford to take their time to find the most suitable job and as a result face a smaller risk of becoming unemployed in the future. The money spent by the unemployed during recessions keeps up demand and prevents wide cyclical swings in the economy. The system is fair since it takes money from the fortunate employed, who can afford to give up some, to the truly needy who are unemployed. The system is self-financing and it is cheap to operate since there are no profits and wasted advertising. Honest, fair and hard working civil servants operate it. As a result of these characteristics, the unemployment insurance system has been a sacred cow among Canadian elites that believe in the need to use public policy to deal with the failures of free markets. In this spirit in the late 1960s the Trudeau government decided that the more generous the system was, the more market failures could be reduced and Canadians made to benefit. So, under Minister Bryce Mackasey the generosity of the existing UI system was increased primarily by making benefits a larger proportion of previous earnings, reducing the work time required to establish eligibility and extending the length of eligibility for benefits. Let me show to you what happened to the unemployment rate in Canada after that policy change in the early 1970s. Since unemployment is determined by many factors, the Canadian experience needs a standard for comparison. For this the US experience is very useful. Figure 1 shows that between 1947 and 2003 the unemployment rates of Canada and the United States have been highly correlated, as one would expect for the two strongly integrated economies. However, the graph also shows that the postwar history consists of two periods with distinctly different characteristics. During the first period between 1947 and 1981 the gap between the two rates was very small. During the second period covering 1981 to the present the gap was much larger. The arithmetic difference in the first period was 0.1 points with the Canadian below the US rate. Thereafter, the Canadian rate was 3.2 points above the US rate. Let us consider briefly the cost of the increases in the generosity of the Canadian system in the early 1970s by calculations that assume that in their absence the unemployment rates in the two countries would have been the same. Under this assumption in 2003, the Canadian unemployment rate would have been 3.5 points lower and at 4 percent rather than the actual 7.5 percent. As a result, the benefit payments to the unemployed in Canada would have been $5.5 billion lower. Canadian workers would have earned $22 billion more. Governments would have collected about half of this increased national income as taxes and workers would have benefited from $5.5 billion lower EI premiums. All of these good things would have happened to Canadians annually in similar amounts over the last 25 years. The calculations just made still are not widely known and demands for reform of the present system meet much opposition from labor and politicians. In the middle 1970s any criticism of the existing system was considered equivalent to an attack on a sacred cow. Nevertheless, Dennis Maki and I in 1975 published in the Canadian Journal of Economics the first study in the world linking unemployment with unemployment insurance. We used official data and standard econometric technique to estimate that the increased generosity of the system caused Canada’s unemployment rate at that time to be higher by about one to 1.5 points. In our theoretical model we attributed this result to changes in the behavior of workers, employers and governments that were initiated by changes in incentives created by the system. The basic argument is that the more the EI system lowers the cost of the good called not working, the more of this good is consumed. This law of demand is well established. What many find difficult to accept is that for some people unemployment is not a pure personal disaster but an opportunity to enjoy leisure. Many supplement their benefits with income from work in the underground economy. Some use the time to fix their homes and cars. To enjoy these opportunities, some workers engage in behavior that causes their layoff. Much episodal evidence supports this analysis. During the 1970s the media reported young people bragging about their membership in the UI ski teams at Whistler and Banff. One of my ЖЁЯудАAV colleagues, Richard Schwindt grows raspberries on his hobby farm in the Fraser Valley. During the peak of the harvest on a Friday afternoon a few years ago, all of his pickers demanded their pay and declared that they quit their jobs, in spite of his pleadings to stay on and bring in the last of the ripe berries. The next day, however, the workers were back and asked to be rehired. They explained that on Friday afternoon the government had announced that economic conditions in BC were so good that they would be eligible for EI benefits only if they had worked one additional week. Official statistics suggest that this episode is repeated often in Canada. The rate at which unemployed workers find jobs and stop the receipt of benefits shows a strong peak just a few days before they become ineligible for benefits. Employers must also be blamed for the higher unemployment rate. The EI benefits allow firms in the seasonal industries like construction, forestry, fishing and recreation especially to attract workers at lower pay than otherwise they could because the workers supplement their income through EI benefits during the off-season. Competition forces these firms to pass the lower costs of labor on to consumers, who buy more of the lower priced output of these seasonal industries. The industries expanded correspondingly and the average unemployment rate is raised as a result. Government employers also have adjusted to the new environment. In the Atlantic Provinces government employment is often limited to the number of weeks needed to establish eligibility for benefits. Cohorts of different workers are rotated through this provincial government employment scheme. The provincial economy profits but unemployment rates are correspondingly higher. Of course, the higher benefits also increased the return to outright cheating like holding two jobs, claiming benefits under different names or never really looking for work. But data on such activities are scarce and the EI system is understandably reluctant to discuss and measure the phenomenon. When I published an article based on the findings of my joint paper with Maki in the Financial Post, I found myself embroiled in a major controversy. No one in Canada gets away without a big fight challenging sacred cows. The media were after me for interviews. I received many letters condemning me personally. Newspapers happily published critical letters they had received. An ЖЁЯудАAV professor was quoted in a newspaper saying that he was ashamed to have me as a colleague. In response to this and other sentiments, Dean Robert Brown organized a seminar for me to face the academic community. When I arrived, I had to fight my way through the overflow crowd that sat in the aisles and stood in the back of the room. Never before or since, not even during my years in parliament, had I faced such a hostile crowd. There was an electric charge in the room that literally raised the hair on my arms and the back of my neck. I explained briefly the theory underlying our paper, the data and empirical results. Then came the questions. Unforgettable and setting the tone was the first question posed by graduate student in sociology. With an accusatory tone of voice she said, “We all know how hard you work and that the availability of unemployment insurance benefits would not make you work less. So why do you suggest that other Canadians would do so?” To my surprise, in the middle of the controversy in the media I was invited to fly to Montreal and appear on the national phone-in program Cross-Country Checkup. A large number of callers suggested that the Grubel-Maki findings reflected their own experience and that they did not understand the fuss that was being made about them. They saw it as just another example of how professors in their ivory towers and politicians were out of touch with the real world. Bryce Mackasey tied up the phone-in program with a self-serving monologue that the moderator did not dare to cut short since, after all, he was the minister responsible for putting the increased generosity into place. The controversy was hard on me, causing me anxieties, sleepless nights and worries about the correctness of our analysis. In retrospect it is clear to me that the controversy was less over facts or the validity of economic analysis and econometric results. It was ideological and was fed by the guardians of conventional wisdom in academia, the designers and operators of the system in government and all the high-minded advocates of social democratic policies designed to deal with the failures of capitalism. At that time, they still believed that Sweden’s socialist experiment was a great success, Russia would soon overtake the United States economically and that Cuba had built a paradise for its people. But eventually evidence emerged that our analysis had some very important effects on economic policy. Simon Reisman, who had arranged the interview on Cross-Country Checkup program, told me a few years later that as the Deputy Minister of Finance at the time he had been asked by Trudeau’s cabinet to prepare a strategy of deficit spending and lower interest rates to combat the recent rise in the unemployment rate. Reisman resisted these demands for inflationary policies on the grounds that we had developed in our paper. The increase in the unemployment was due to the increased generosity of the UI system and therefore could not be cured by the conventional deficit spending and lower interest rates. These policies would only cause inflation and would not lower the unemployment rate. In support of this argument he referred to the result of our study. Eventually, due to Reisman’s efforts and our empirical support, cabinet withdrew its demand for inflationary fiscal and monetary policies. In the early 1980s, Donald MacDonald headed the Commission of Inquiry into the Future of the Canadian Economy. I did not write a paper for this commission, but later MacDonald told me “your study hung like a shadow over the deliberations of the Commission”. In 1986 the Forget Commission on the Future of the Canadian Unemployment Insurance system reported on the need for reforms, drawing heavily on the analysis and empirical results of our paper. None of the Forget Commission recommendations were implemented. The political costs of reducing the system’s generosity simply are too high. The modest reforms introduced by Minister Lloyd Axworthy in the 1990s were aggrandized by the costly change of the name of the system so that it is now known as “employment insurance”. He never spoke to me about his reform programs, even though I approached him a number of times before question period, when we were sitting two-sword lengths across from each other in the House of Commons. When the Liberals lost a few seats in the election after the introduction of these reforms in the Atlantic Provinces, the reforms were rescinded shortly before the 2004 elections took place. It saddens me that Canada’s economic prosperity continues to suffer because the political system is unable to adopt reforms that so clearly would benefit Canada as a whole and that have been worked out reliably by many other economists in the wake of Maki’s and my first challenge to the conventional wisdom and after much controversy. However, I take great satisfaction knowing that our work played an important role in preventing the adoption of inappropriate, inflationary economic policies during the 1970s. The economic costs avoided as a result are a multiple of my lifetime professorial income and the pension I now receive. A Common Currency for North America The conventional wisdom and the official government position presently are that Canada needs a flexible exchange rate to deal with external shocks that threaten the stability of employment and the economy. In particular, it allows the Bank of Canada to shelter the economy from the fluctuations in the prices of commodities, which still are an important part of our total exports. Figure 2 shows the value of the Canadian in terms of the US dollar that existed since 1951. As can be seen, this exchange rate has been on a distinct downward trend, interrupted by three periods of increases, the last one of which started in 2003 and appears to continue to this day. The explanation of the determinants of this exchange rate is complicated and even the best estimates are not totally satisfactory. One simple answer found in textbooks is that it reflects different rates of inflation in Canada and the United States. Figure 3 shows clearly that this explanation is not valid. Consumer price inflation in the two countries has been highly correlated during the postwar years. Adding up the annual price increases shows that the cumulative increases have been virtually identical in the two countries. The explanation favored by the Bank of Canada is that the drop in the dollar value reflects the downward trend in world commodity prices. Figure 4 these prices since xxx and it is clear that the downward trend resembles that of the exchange rate and that the fluctuations in the two time series are correlated, though other factors clearly also were at work. In a study published in 1999 I started a controversy that continues today and is likely to continue for some time to come. I do not question the validity of the observed correlation but I argue that if the Canadian dollar had been fixed, the economy would have performed much better. Let me explain why I think so. Flexible exchange rates are indeed helpful in dealing with commodity price fluctuations. However, as can be seen from the graph, the dominant characteristic of the time series on commodity prices is their downward trend, which is driven by increasing global supplies of these commodities coming mostly from less developed countries that have rich resources, low costs of labor and low levels of effective regulation and environmental standards. When a private business faces declining world prices for its output, it stops producing the affected product lines or goes out of business. That is the way in which labor and capital move from low to high productivity uses. The process is essential for economic growth and prosperity. Canada should have been moving out the production of commodities at a rate greater than it did. The desirable reallocation of labor and capital in the economy was slowed because the downward drift in the exchange rate kept artificially high the returns in these industries in Canadian dollar terms. This process provided our commodity producers with the equivalent of tariff protection at the rate of about one percent average a year, or 30 percent over the last 25 years. Such subsidies never are good for an economy. The lack of labor and capital prevents the development of more profitable industries. Consider what happened just south of the border. The economy of the State of Washington has historically been dependent on the production of commodities, much like Canada. In the face of falling world prices and a fixed exchange rate towards the rest of the United States, Washington’s commodity producing industries shrank rapidly and fed the boom in high tech industries symbolized by Microsoft and Boeing. Tom Courchene of Queen’s University and Rick Harris of ЖЁЯудАAV in 1999 jointly published a study that points to another unintended and damaging effect of the secular decline of the exchange rate. According to their analysis, the low Canadian dollar caused capital goods, imported mostly from the United States, to be more expensive relative to labor than they were in the United States. As a result, during the 1990s especially, US investment per worker has been greater than that in Canada. The important effect of this difference is that US living standards rose more rapidly than those in Canada. A monetary union between Canada and the United States will avoid the costs identified by Courchene and Harris and me. It would also save on transactions costs, estimated to be about $3 billion annually as banks and firms could shrink the size of their foreign exchange departments and Canadian travelers no longer need to buy and sell US dollars. There would also be the near elimination of the historic premium on Canadian interest rates of about 1 point, which is equal to about 15 percent of the cost of capital. So what would the benefits of a Canada-US monetary union be in terms to which the ordinary Canadian can relate? A study by Rose and Frankel used a gravity model of trade and data from many countries and different time periods and found that in the long run, a monetary union between Canada and the United States would raise income per capita in Canada by about 30 percent. In my 1999 study I argued for the creation of a formal North American Monetary Union modeled after the European Monetary Union so that Canada would be able to enjoy all of these economic benefits. A North American Central Bank would issue the Amero, which would circulate in Canada, Mexico and the United States. Its value would be equal to one US dollar. Canadians and Mexicans would get one Amero for their national currencies at a rate designed to maintain the competitiveness of their economies, probably close to the existing exchange rate. The profits from printing the Ameros would be shared equitable among the three countries. While I still think that a formal monetary union would be economically best, many discussions with economists and political pundits have persuaded me to recommend an alternative proposed by Courchene and Harris and by Robert Mundell, the father of the European Monetary Union. Under this scheme Canada would replace our current currency with a New Canadian Dollar designed to be worth one US dollar. Notes on one side would show the Queen and other national symbols. On the other side, they would display prominently the government’s promise to exchange them for US dollar notes of the same denomination. All assets, including currency notes and all liabilities expressed in the present dollar would be converted into the New Dollar at a rate that would preserve our competitiveness and would probably be close to the market exchange rate at the time. Canada gets all the profits from printing and minting the New Dollar. The currency reform would not require any consent from the US government. In the short run, the real income and wealth of Canadians would be unchanged. However, whether the US and New Canadian dollar would exchange at par and the fixed exchange rate would bring all of the benefits noted above – lower transactions costs and interest rates, an end to the protection of industries and high prices of capital goods – depends decisively on the credibility of the promise that the government of Canada will and can at all times convert the two currencies at one to one. In my view, the creation of this credibility requires that the Bank of Canada surrenders officially its right to set interest rates different from those set by the US central bank and that it keeps sufficient reserves in US dollars to meet likely demands for currency conversion. As I found out during a luncheon meeting with Governor David Dodge and his top advisers at the Bank of Canada, such institutional changes are strongly opposed at the Bank. The Department of Finance is in the same camp and thus the official position of the Government of Canada is that the present system is just fine. The House of Commons Finance Committee proposed an official study of the issue, but the Liberal majority vetoed the idea. The Banking Committee of the Senate held special hearings and in its report endorsed the move towards a monetary union. Opinion surveys show that public support for the policy fluctuates between 47 percent and 51 percent, depending on the level of the exchange rate. Since 1999 I have attended and given papers dealing with the issue of monetary unions at several academic conferences every year. Many academic opponents to the grand experiment of the Euro up to the date of its launch predicted that it would never be adopted. They now predict confidently that it will fail eventually. In the meantime, few of the problems these academics foresaw developed in Europe. More countries are clamoring to join the union and proponents of the system assert that their accession will not create serious difficulties. There are also several economists who have analyzed the merit of monetary unions for a number of countries whose economies are close, like those of the Gulf States, the Southern Cone of South America, the Caribbean, Central America, South Africa, Australia and New Zealand and ASEAN. Robert Mundell promotes a grand scheme for the eventual creation of a world currency. The economic analysis contained in these studies suggests that the benefits from a union are likely to exceed any costs. Mainly, political problems and the self-interest of central bankers and politicians prevent the creation of the new institutions. Having worked on this project for a long time, I have a list of other points I could make. But my time has run out and I invite your questions and comments with the rallying cry: Long live academic controversies. 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