Should Ontario Become an Independent Country?

Ok just forget how crazy the question sounds.  The recent wrangling between Ontario and Alberta over the value of the Canadian dollar, oil output and the decline of manufacturing in Ontario (and other provinces east of Ontario) raises some reasonable questions about the Canadian monetary and fiscal union, aka the Confederation of Canada, aka, British North America, aka Canada.

Critics have long argued that the Bank of Canada’s single minded attention to price stability, i.e., inflation, and to a single policy instrument, i.e., the interest rate, was both too crude and too cruel.  Too cruel because it makes unemployment the site of dynamic economic dynamic adjustment and too crude because it is both geographically insensitive and structurally daft.

Here I will put the cruel to one side and consider the crude.  Interest rate adjustment is a crude way to attempt to manage the macro-economy.  Think about the regional dimensions.  If you exclude Western Canadian growth the beavers teeth look not nearly so sharp, or as long.  The present interest rate regime is probably too low for western Canada and too high for eastern Canada.  Suggesting that, all things being equal, the Canadian dollar is probably too high and too low.  Too low for the resource sector and too high for manufacturing.

Federal tax policy has not helped either.  The unilateral decrease in corporate income tax rates deprived the federal government of resource revenue while having little if any impact on investment in the manufacturing sector.   The west did not need a GST rebate the east did.  And to add insult to injury, the Federal government has decided to move to an austerian footing.  Again viewed through the lens of the west probably not a totally idiotic position to take (countercyclical one might say).  Viewed from the east, however, a completely counter-productive, pro-cyclical policy.

All of which raises the question if Ontario, or indeed if all of the provinces east of Manitoba, would not be better off with their own federal government and their own central bank.

O.k. time to remember how crazy the question was.  Not that crazy after all.  But it is only a sane question because macroeconomic policy (fiscal and monetary policy) is so cruel and crude.

Gordon V Jackson: the corporate tax cut myth

Apparently Stephen Gordon is having a hard time figuring out where Andrew Jackson, the chief economist for the CLC, got the bizarre idea that:

The argument for corporate income tax cuts has been that increased after-tax corporate profits would be re-invested in company operations, boosting economic growth, productivity, and jobs.

Stephen replies in the comments section:

No. That’s not the argument. At least, I’ve never heard anyone make it.

No one, ever, anywhere, has insinuated or made that argument.  Really?  To continue reading and comment click.

NGDP targeting: wither monetarism?

Monetarism is like a Zombie: it can be found theoretically wanting, empirically false and technically infeasible but in one form or another it just soldiers on.  In some ways the hype surrounding the conversation about the possibility of moving from an inflation based paradigm to targeting NGDP could be read as the end of monetarism.  But viewed from another angle it (NGDP targeting) can also be read as the latest reincarnation of monetarism.

Purists will of course bulk: monetarism died along time ago as central banks realized they did not control the money supply as private banks also create money all the time in the form of credit.  But if in narrow technical terms monetarism died soon after its birth, in broader political terms it came of age in the ensuing years.  As I see it there were three initial pillars to monetarism only one of which technical.  First, the CB can control the money supply (false) and thereby inflation; second, the CB should be independent (from democratic influence) to pursue price stability (not amenable to boolean operators); third, monetary policy is the preferred technocratic as opposed to democratic policy (fiscal) lever.  Even though the first be dead the second and third live on.

My problem with NGDP targeting is threefold.

First, proponents of of inflation targeting like the quasi monetarists are want to argue that the last twenty years of  inflation targeting has been a dizzying success.  As per Nick Rowe:

 We have 20 years of empirical evidence showing how inflation targeting works to stabilise expected and actual inflation.

Not so fast.  We have twenty years in which many things were happening: a move across the advanced capitalist zone to flexibilise labour markets and the incorporation of broad swaths of eastern European and Asian, and south Asian labour reserves into the global market; and increasing trade liberalisation and capital mobility. So I am not sure the CB’s should get all or even most of the credit for price stability over the last twenty years.  Although they may warrant some of the blame for higher average unemployment than the pre-monetarist CB regime.

Second, I remain to be convinced that the CB’s can actually target NGDP.  They, the CB,s, have a limited range of arrows in their tactical quiver.  If anything the present crisis has taught us (like the crisis of Keynesianism) at such periods in the micro-economic motivations swamp the thinking of businesses.  I suspect the BOC could announce tomorrow that it had raised its inflation target to 6% and not much would happen in real or nominal terms.  Defeating inflation was a rather simple exercise even if politically difficult.  All the CBs had to do was to put interest rates through the roof and kill off every marginal producer of goods and services.  Similarly keeping inflation in check (on target) was and is a relatively easy affair when one simply has to throw sand in the financial gears.  It becomes a problem of second order magnitude to target NGDP growth when everyone who counts knows you do not really have the ability to independently bring it about.

Nominal growth targeting means nominal investment targeting and in the context of already hyper low interests rates it is hard to see where the CB has a viable policy lever.  They can play around with quantitative easing (as they have already done) but all that appears to have done is set a soft floor on some classes of asset values.  And it is an open question as to whether or not this is a good thing.  On what rational basis was it decided that some asset values were worth preserving and others not?  More importantly putting a soft floor under some classes of asset values has done next to nothing for investment rates which is after all how you target underlying economic growth even when not discounted by inflation.

Third NGDP targeting is opaque in a way that inflation targeting is not.  There is a relatively decent link between the credible threat of high real interest rates and the threat of low real interest rates.  The former pushes noun against a verb the latter not so much.  Without the direct ability to determine aggregate investment rates the CBs are forced into much more cloistered channels with little to no capacity to sanction the relevant actors should it not get what it wants.

My critique probably boils down to the following.  It is only under a supremely unique set of circumstances that CBs found their targeting regime and interest rates to have such a profound positive influence on the level of economic activity.  In capitalist economies it is businesses that invest and hire (something both liberal and Marxist economists agree on) interest rates and asset valuations play only a small part of the calculus to invest.  The government on the other hand can use fiscal policy to indirectly stimulate investment through tax policy and directly control aggregate investment and thus employment via direct spending.

Ironically if the government was to monetize the debt by putting Peter in bed with Paul (the CB and the treasury) it would inadvertently give some real teeth to the CB’s ability to prove to the relevant economic actors that it was serious about targeting NGDP growth.  But I suspect Tory New-Keynesians like Rowe and Sumner would not abide.  For once you show that fiscal policy is in fact a powerful force for economic regulation the last two pillars of monetarism come a tumbling down.  Some version of industrial democracy would be back on the table.

Hardly what a Tory goes shooting for when they wake up early in the morning.

The economy lab, the dark age of free trade theory, and the naive view on natural resources and economic development

Over at the Economy Lab in the Globe which Failed, which itself has gone from bad to worse, one of the economists they keep in their stable has either produced an extraordinarily naive analysis or a dishonest one.  I am going to go with naive for the sake of professional courtesy.  Not that that is the MO of economists but I am atheist fan of Jesus and not an economist…so here goes.

To be honest I can’t figure out which vintage trade model Gordon is using.  My informed gut tells me something like an off the shelve H-O-S intro text book model of free trade.  That would fit with his own vintage and the fact that he is an econometrician.  Although that creates a paradox because, as surely Gordn knows, the H-O-S free trade theorem preforms dismally–by even economic standards–in econometric work outs.  In layman’s terms: the work-horse model of free trade which is standard in introductory economics texts fails at a predictive level.

There are any number of reasons for this but just for fun here are few in no particular order:

  1. The economies entering into trade were in a state of autarky (self sufficiency) and full employment.  Both of which are patently false.  More often than not nations pursue trade in the search for a remedy to chronic underemployment and unemployment and have already been engaged in trade.
  2. Product and capital markets are perfectly competitive.  Again patently false.
  3. Factors (capital and labour) are perfectly mobile within a national jurisdiction but not between.  You might get me to agree on labour but the whole point of neoliberal globalisation and its animating quintessential core is the free movement of capital.
  4. As a corollary, capital (investors) is made up of 100% domestic nationals.  Extremely dubious assumption with respect to mining, oil and gas and a whole host of other sectors.
  5. There are no firms.  While capital and labour are the only inputs (and resource endowments) there are no firms.  Just one large something or other allocating labour and capital according to their scarcities.  A model without firms that actually do the trading?  Bizarre me thinks.  This becomes particularly important with respect to determining who benefits from the gains of trade.
  6. Capital is a natural endowment.  Which translated means that for the standard model the explanation is that some countries have lots of capital some do not.  Why that is; the model does not care.  But saying that you don’t care is far cry from saying anything remotely interesting.  Capital is after all nothing other than produced means of production in its physical form and its ephemeral and essential form a complex social relation.  Sorry I can’t really simplify that at this time.  But to get a sense of what I am getting at just recall that the origins of Canada is a colonial enterprise in which colonial settlement was driven by the desire to expropriate natural resources from the original inhabitants.  The origins of Canada, and its rich endowment of natural resources is thus the history of politically constituted property and not some “natural” process of economic development.

O.k. so that is that.  Of course the OEM version of free trade theory is going to be a predictive disaster.  Why anybody bothers to teach it outside of using it is an example of what happens when liberal geeks go wild is beyond me.  But let me do a real world work-out.

Let us take Newfoundland and Labrador as a historical case in point.  Here is region that has leaped from one natural resource boom to another and it has always ended in some form of administration.  The failure to develop a modern diversified economy in which resources play a role but not the primary role.  Contrast the fortunes of early diversifiers in the union, who did so via a tariff wall and you get the picture.

In Newfoundland and Labrador Gordon’s advice is being followed as the mining and oil and gas sectors account for around 40-45% of provincial output but only 4-5% of direct employment including temporary construction employment.  Neither the oil, nor the profits touch land (outside of royalties taxes and wage payments which are all relatively low) in that province because of the weak to non-existent processing of raw materials.

Gordon thinks this is the road map to economic success, I think it leads to ruin.  He is willing to bet standard trade theory on it, I am going with history.

Here is why.  Two seconds of reflection will reveal that in Newfoundland and Labrador almost every single assumption built into the standard free trade model is violated: most certainly 1 through 6 outlined above.  Perhaps most interestingly is that Newfoundland and Labrador would not have a comparative advantage in oil and gas had it not been for the federal and provincial governments.  I am sure Gordon was decrying Hibernia as white elephant back in the day.  The problem is today the two levels of government are fighting over the allocation of royalty payments as the project is paid in full and is churning out lucrative profits for all involved.

Maybe Gordon can write something about that in his next post to the Economy Lab.  I won’t hold my breath.  My discipline right or wrong and all that jazz.

UBC economist Milligan throws cake at educated, unemployed youth

I tuned into a rebroadcast of this morning’s the CBC’s the Current while cleaning the kitchen this evening which had an unusually good documentary on the problem of youth unemployment; specifically, the problem of university undergrads in finding jobs.  As someone who suffered the 90s recession in spades (really you should see my work history I can sharpen your kitchen knives and the teeth on your chainsaw to a fine edge of efficiency*) I was very much in sympathy with these newly minted baccalaureates.  Personally I pursued my education as an end in itself.  If I had become a logger full time I would a least be able to attempt to make sense of something beyond the hill.  That said I can totally understand why so many of those interviewed in the documentary felt let down: they did what they were told; they followed the path as laid out by parents, teachers and councillors; they volunteered; they studied hard and upon graduation the ambitious among them took jobs as servers.

One of the newly minted graduates arrived to a jobs fair with 40 resumes in hand, another paid a months rent to get a professionally designed CV worked-up.  All for nigh.

In any event a very sobering documentary about the problems facing the educated unemployed youth.  That was until they finally interviewed the economist Kevin Milligan from UBC.  In true Victorian form, Milligan’s bottom line was that however this documentary might tempt you to think something can be done for these wayward educated unemployed forget about it:  Denmark tried it in the eighties and it was a disaster.

Let us just forget about the fact the eighties and early nineties brought all kinds of ideas to the rocks of reality and let us similarly forget that Denmark is a small open economy (this will work in my favour below), what Milligan fails to do and what an economist ought to be able to do and suggest the form that public policy could take to ameliorate the situation.  But that is the rub, the mainstream of the profession takes a do nothing position as the default optimal policy stance with respect to unemployment.  As a nod to their objectivity I suppose I should say their glib nature is not particularly directed at the youth: if the 55+ cohort was suffering above average unemployment rates Milligan’s response would be FIF you too.

Ok so those are the preliminaries.  What Milligan fails to mention is that instead of admitting defeat Denmark learned from its mistakes and doubled down and developed a different strategy to combat youth unemployment.  This time they coupled income support with training and an integration of training with private sector demand.  In short they revamped both their retraining regime and welfare state institutions to match incentives and crucially demand.  So at the height of the down turn in 2009 the youth unemployment rate was fully 4% higher (12 vs 16) in Canada with an overall unemployment rate of 7.2 vs 8.6.  What does that mean? It means with some policy effort that both the general rate of unemployment and the youth rate of unemployment can be lower.  In short, instead of throwing cake, you can have your cake and eat it too.  Serious economists would do well to concentrate their efforts on making the world better rather then resting with lame ideological proclivities to leave it as is; and those of us who pay their salaries would be well advised to demand the same.

Cake just don’t cut it any more.

*In the abstract the sharpest blade would have a length but no width.  It would therefore be a line.

Lifetime investment hypothesis

Last odd thought before sleep.  What if we think of investment as a lifetime investment function akin to the lifetime incomes hypothesis?  How would that change the standard view on corporate income tax and investment rates?

Let us assume that investment is a constant function of output.  Thus investment today is a function of long term output growth in each sector.  This fits the facts: in Canada manufacturing investment is pretty stable around 4 and 5.5 % of output over the last thirty years.  Let us also assume that investment is not directly related to profits.  This also fits the facts as investment as a percent of profits is highly volatile and negative.  What then accounts for the fluctuation in investment rates as a percent of output?

If as I have above that investment is a near constant of output then we might be tempted to write:

I = A + q * 1-Y

Where I is investment, A is a fixed independent part (the amount that needs to be invested to maintain medium run growth rates) q is a proportional share of un-anticipated output growth (Y) for the sector.

This tells us a couple of things.  Investment decisions today are determined by commitments made at t-1 and the actual level of output growth realized from those investments.  So if present realized output levels are higher then expected investment levels increase, if lower than expectations they decrease.

This is a nice formulation because it actually gives a material explanation to investment rates with respect to output and anticipations.

But what does all this have to do with corporate taxes.  Quite a bit.  Given capital depreciations allowances, corporations can write-off investment in plant and equipment and as such their decision to invest in expanding production is only tenuously related to tax rates.  What however will induce corporations to invest is an exogenous increase in demand for the sectors output given by q * 1-Y.

Within limits, corporate tax rates are therefore of little consequence on investment decisions.

Update to conclusion: If CIT cuts permanently increased demand then they would lead to a permanent increase in investment.