Beggars, Neighbours, Free Riders and Free Traders : Buy-American Provisions

A lot of ink, virtual and otherwise, has been spilled over the last few days with respect to the “buy American” revisions to the Obama administrations 800 billion stimulus package.   In particular the whole of the Canadian continentalist establishment is up in arms, not to mention a good section of the respectable left.  Left or right in Canada it seems we are all continentalists and “free” traders now.  The question for Canadians is are we all Free Riders too?

On the one hand, for Canadians critical of NAFTA the buy-American provisions demonstrate once again that NAFTA was not quite the shibboleth that Canadian continentalists had hoped for.  Time and again when the going gets tough the Americans demonstrate their unwillingness to play by rules when it comes to free trade: soft wood lumber being and example of how American intransigence is actually reworded given the asymmetrical power relations between the US and Canada.  The buy-American provisions are just one more example of how despite what the Americans do, Canada will remain continentalists.  Is there anyone who actually takes the tough talk of Stockwell Day seriously?

On the other hand, it must be pointed out that the US has no obligation to introduce any stimulus at all.  If you listen to the right in the US like the Heritage Foundation you quickly realize that the necessity of stimulus (rightly or wrongly) is hardly a consensus position.  A policy of no stimulus would however amount to a beggar-thy-neighbour policy. That is, the US would be widely (and rightly viewed) as free-riding on other nations’ stimuli.

So how does a US stimulus package with the buy American provisions wash out on the free trade-autarky spectrum?   And it is a spectrum because no country can ever perfectly occupy one pole or the other.  Part of the problem lies in how even those who should know better explain the situation.  Paul Krugman argues thus:

“Now ask, how would this change if each country adopted protectionist measures that “contained” the effects of fiscal expansion within its domestic economy? Then everyone would adopt a more expansionary policy — and the world would get closer to full employment than it would have otherwise. Yes, trade would be more distorted, which is a cost; but the distortion caused by a severely underemployed world economy would be reduced. And as the late James Tobin liked to say, it takes a lot of Harberger triangles to fill an Okun gap.”

That all sounds very good but there is a slip-up right in the first sentence “…if each country adopted protectionist measures that “contained” the effects of fiscal expansion within its domestic economy.”  However, the buy American policies do not attempt to contain the all of the effects of the stimulus within the domestic economy.  What they do attempt do is to contain the first round effects of the stimulus within the domestic economy.   That is, the buy American provisions are only partially protectionist in that they do not attempt to contain the second round effects of the stimulus to the domestic economy.

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For example, imagine that a state government takes some stimulus money for an infrastructure program say 200 million.  The initial 200 million is spent on locally sourced material and labour but that is where the protection stops.  The incomes and profits earned from that 200 million is free to be spent (the second round effects) on any goods or service no matter of its country of origin (well ok not Cuba Iran or S-Korea).   Thus the second round effects of US stimulus will still leak out to the rest of the world.  It is so odd to see a New-Keynesian like Krugman miss this point given the whole basis of the effectiveness of stimulus relies on a multiplier.  The buy-American provisions do not apply after the first link in the chain of the multiplier.

Given the degree to which the production of goods and services is globally integrated and given that the buy-American provisions do not contain any calls for erecting barriers to trade in general such that the protectionism only applies to the first round effects of the fiscal stimulus it is hard to argue that this is the thin edge of Autarky’s wedge.

Moreover, there remains the problem of free-ridership by other nations.  The extreme case would be where the US was the only nation to engage in stimulus.  This is, of course, not the case other countries are engaging in stimulus of their own.  So the question of free-ridership comes down to degrees.  China, Japan and then the US have announced by far the biggest stimuli: well over 4 % of GDP (by some measures China’s totals 18% of GDP!  Cut that in half and it still pretty impressive).   Canada sits with Europe, including England, in the cheapo-seats not even managing to achieve 2% of GDP with their stimulus programs.   And curiously it has been Canada and Europe who have been crying the loudest about the tepid protectionist elements of the buy-American provisions.

If I was a US legislator I might conclude that Canadian continentalists were fair-weather friends as well.  And interestingly in Canada, the continentalist establishment which includes almost every major media outlet—including the CBC—was more than happy to focus on the buy-American provisions of the US stimulus package instead of focusing on how the inept, incoherent, ineffective and paltry Conservative stimulus package meant that Canada was basically hoping it could have an economic recovery on the cheap by begging-off of Asia and the US.

Such, I suppose, is the state of nationalism in Canada.

Stimulus as a % of GDP

Japan: (+/-) 15
China: (+/-) 9-18
US: (+/-) 5-7
Germany: (+/-) 1-2
France: (+/-) 1.4
UK: (+/- ) 1.1
Canada: (+/-) 1.5 *Reuters

North Bay P3 Math

It hasn’t been covered in southern Ontario, but there is an emerging controversy over the cost of a public-private-partnership (P3) arrangement undertaken to expand and manage the North Bay hospital. See the article here.

Those following my regular rants on P3s may find it surprising that I agree with the province in their methodology for calculating total cost. The province originally announced the project as a $551 million venture. The project involved a company (Plenary Health) building, financing, and operating the additions to the hospital. The province has agreed to pay Plenary Health $35 million a year over the 30-year contract period.

The Ontario Health Coalition and others did the quick math, 30 times $35 million, and got $1.05 billion. But that comparison is illegitimate — streams of payments over time must be adjusted into today’s terms as $35 million in the future is not worth $35 million today (for those interested, see a discussion on discounting )

The real problem with the province’s math is in the figures and analysis that have not been shared with the public, particularly when it comes to cost comparisons to non-P3 arrangements. Infrastructure Ontario, the province’s P3 broker, put out a press release citing a report by PriceWaterhouse Coopers that estimates the savings (relative to traditional infrastructure delivery) of the P3 at $57 million.

But the consultant’s report hasn’t been made public. No questions can be asked about the assumptions underlying the report, which would range from financing cost differentials between the government and the private sector to hospital operating costs under a government model. As far as I’m concerned, the conclusion is useless without the full report. The public has been completely ignored — perhaps the term private-private partnership is more appropriate?

Mandatory P3s. Coming soon to a municipality near you?

Continuing on our P3 and infrastructure discussions, an unreported part of the 2007 federal budget. The conservatives announced the establishment of a “new federal office to identify and implement opportunities for public-private partnerships in infrastructure”. They then go on to say that

In the case of large projects seeking funding from the Building Canada Fund and the national fund for gateways and border crossings, proponents will also be required to demonstrate that the option of undertaking the project as a public-private partnership has been fully considered.

One wonders whether only considering the option will be enough to receive needed grant dollars. Also funny how the feds are willing to subsidize up to 25% of P3 projects — talk about bad incentives. It seems Flaherty has picked up where he’s left off in the move towards infrastructure privatization.

Six Priorities for the Upcoming Elections

Travis Fast

1.) Environment: Kyoto and its associated mechanisms for reducing carbon emissions are a place to start but it is clear from the European and American experience that government will have to use a series of carrots and sticks to force / encourage compliance within the private and household sectors. This means creative use of the tax system and legislated reductions in carbon emissions. Given the urban density in Canada the federal and provincial governments need to come up with a ten year road map for the public transit in the cities and an expansion of inter urban rail transit. This plan needs to be supported by a robust set of disincentives to automobile usage.

2.) Income Inequality: In an era of regulatory arbitrage particularly with regards to corporate and capital taxes there is a limit to how progressive the tax system can be made. Even if we conclude that Canada is already competitive in this respect it still means that there is not much room to increase corporate and capital taxes. As such stronger legislation for employee standards and industrial relations, which empowers workers to bargain over their share of the output they produce, is the easiest way to decrease income inequality between employers and employees.

3.) Taxes: As Canada is already quite competitive on corporate and personal income tax rates within High Income OECD countries tax cuts should be given low priority. Instead a revaluation of the tax mix and burden of the tax system should be engineered to accomplish social and economic goals.

4.) Health Care: We have long since past the point where tinkering at the margins of the system will suffice. It is time for a radical rethink of socialized Health-Care. Private delivery is not the direction to go. The left needs to think how health care can be delivered in a more cost effective and direct fashion. Ultimately this will involve creating new classes of health practitioners that can perform some of the functions now preformed by doctors. Community Public Health needs to be re-envisioned so that it takes the burden off the short supply of doctors and the expensive use of emergency health services.

5.) Education: For too long the K-12 system has been asked to do much more than simply educate young Canadians. It has become the primary agent of socialization for broad classes of citizens. This role needs to be recognized and accepted and specific policies and resources need be developed for the public education system, which allow it to accomplish these goals alongside producing high quality students. Given that a university degree / trades degree is now all but standard there should be greater emphasis on integrating the grades 10-12 curriculum with that of the first two years of university / occupational training.

6.) Higher Education: University and Technical training are now standard requirements in the Canadian Job market. The funding of higher education needs to be made more accessible and affordable. The system of student loans is inadequate and regressive. Serious consideration should be given to using the personal income tax system to fund higher education. The most elegant solution would be to instigate an income tax premium for every year of higher education beyond grade 12. This would effectively allow the public to see a return on investment in education over the lifetime of workers earnings and would allow citizens to pay for their education over a lifetime of their earnings. Along side of this proposal special incentives need to be developed for the training of professionals and trades that are currently in short supply or are projected to be in short supply.

Pensions and P3s: A Costly Investment

If somebody walked up to you and said they had an investment tip that would give you a return of 8-10% a year for 25 years, you’d probably ask, “what’s the catch”.

Infrastructure is a hot topic in investment circles these days, particularly for pension funds. The major public pension funds (Teachers, OMERS, etc.) and our collectively owned CPP have been seeking out infrastructure deals of all sorts, including energy, water, and roads/bridges. A few examples:

– Borealis Infrastructure, a subsidary of OMERS, owns parts of Associated British Ports, the Confederation Bridge (in PEI), and 16 elementary schools in Nova Scotia.
– Teachers has significant stakes in two U.K. water systems, 10 U.S. power plants, and a U.K. gas distribution network.
– CPP has a stake in a the major Chilean electricity company.

It’s no secret why pension plans are all over infrastructure investments. Everybody needs the services infrastructure provides, so they generate steadily increasing revenue streams over time, perfect for funds looking to get decent, long run, low risk returns.

Good returns on the long run? Sounds great! I’ll be able to retire! The problem is that users of this infrastructure, which for all intents and purposes is every citizen, are paying for these returns.

Returns imply that profits are made, and profits imply that prices are above costs. Take a water plant. If your pension fund is making money from owning a water plant than it’s charging you more than would otherwise charge so that it can earn a profit. Seems like a shortsighted plan, doesn’t it.

Some would say that the profit is earned from efficiency enhancements rather than higher prices. I will discuss this myth in future posts. “Efficiency enhancements” usually come from fewer services at lower quality and/or lower labour costs. Labour costs are lowered through layoffs or the dismantling of unions and the ability to bargain collectively. Again, another cost to this “investment”, whether in poorer services or in, well, your job loss.

Although we never think about it this way, governments earn a similar return from investing and owning infrastructure assets. Investments in publicly owned/managed hospitals, schools, transportation networks, and water systems provide benefits (a different kind of “profit”) to society as a whole. When private profit is introduced to these services, the return to society is subsequently reduced.

So there is “a catch”. Broadly speaking, these infrastructure arrangements are about undermining the role of the public sector, something I’ve discussed in an earlier post. We must start paying more attention to the investments being made by the large pension funds that supposedly represent our interests.

Part 2 of an ongoing series on P3s.

The Ideology of P3s

Those watching the federal and provincial focus on infrastructure will notice a shift towards public-private partnerships (aka P3s, aka PPP, aka AFPs in Ontario only). The main players are Ontario and BC, with Quebec also in the game. The feds have been pushing it at every opportunity.

So what are they all about? The basic story is that most P3s involve the private sector building the piece of infrastructure and leasing it back to the government over a 20-30 year period. In many cases, the private sector operates/maintains the building and usually provides financing. All of these costs are built into the lease payments made by the government.

Governments have made several arguments for going ahead with this type of arrangement rather than sticking to traditional infrastructure financing (which usually involves government financing it’s own project, hiring the private sector to build it, and keeping operations and maintenance public). They say that P3s allow governments to shift “construction risks” to the private sector, a fancy way to say that cost overruns will be absorbed by the private sector. The key to a successful risk transfer, they say, is for the private sector to operate the asset over its lifetime so that they properly maintain it. Incentives, incentives, incentives.

There are at least two problems with that argument. First is that risk transfers come at a cost: ultimately, risk is priced and governments pay to transfer this risk. Secondly, the root of the alleged cost overruns is unclear. Some cost overruns have occured because of governments changing the project itself. This could be, for example, adding more beds to the original hospital expansion plan. Obviously, here the cost would be higher than the original estimate. Other cost overruns occur because building costs rise significantly for various reasons. I will return to the cost overrun issue.

Groups like the Ontario Health Coalition have slammed P3s because of their fear that this arrangement is a first step towards privatization and job losses. They also note that private sector financing costs are higher than governments, an irrefutable point which has been acknowledged by the Government of Ontario.

While I agree for the most part with groups like the Ontario Health Coalition, the most significant problem with P3s are what they mean to the public sector as a whole. Business groups and “the right” have used the cost overrun issue to sell the public on the idea of P3s. (See speeches by David Dodge and Don Drummond.) Few have suggested the logical approach to this problem, which would be to analyse why cost overruns are occuring in the traditional infrastructure financing approach.

The reason why this step is not being taken is because this was never the point of pursuing P3s in the first place. Supporters of P3s (ranging from banks to pension funds) want access to guaranteed streams of revenue that stem from these leasing arrangements. What is dangerous about the ideology of P3s is that they sell the idea that we cannot as a society undertake projects without profits. And that, of course, undermines the very idea of government.

First in an ongoing series on P3s.