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.

Understanding Corporate Tax Cuts: embracing conventional wisdom and coming to radical conclusions

Warning this post contains scenes of graphic illustration, it is not intended for short attention spans or people who can not locate coordinates in two dimensional space.  Viewer patience is therefore highly advised.

The debate on corporate income taxes brings out a really nice teachable moment in that it provides an occasion to clarify the terrain of past present and likely future debates on macroeconomic policy.  In what follows I will hew closely to the standard story, but what I intend to show is that even within the terms of the conventional collective memory there is an important contradiction that helps clarify what the real debate over corporate cuts ought to be about.  Let me see if I can deliver.

The conventional account of history runs something like this.  By the 1970s and early 80s unions had become too strong, unemployment insurance and welfare programs too generous and together they produced highly distorting macroeconomic outcomes: high unemployment, high inflation and low output (referred to at the time as stagflation).  Let me just accept this account for argument sake because I think it represents the story in the back of the head of most policy makers and economists over forty.  Let us represent this conventional story by line A in the diagram below.  Notice the oscillating line around A.  That represents the economic cycle.  From the vantage point of policy makers and economists over forty  the problem with the Keynesians is that they were preoccupied with stabilizing those oscillations when they should have been preoccupied with moving the economy towards line B.  Line B represents an equilibrium in which both employment creation and output proceed in a balanced manner.

Point Y represents the bad equilibrium that Keynesians were unwittingly fixated.  In their drive to stabilize the macro economy via employment they gave short thrift to output and thus created an inflationary environment which produced increasing high levels of unemployment, low levels of output and high levels of inflation. In time policy makers and economists shifted their attention away from cyclical stabilisation to structural change .  That is, from attempting to smooth the oscillations around line A to moving the macroeconomic trajectory from line A to B.

Notice that point Y does not entail a lower level of employment but rather a higher level of output.  And this was what was so seductive about the supply side arguments of that time.  What they in fact said was that it was possible to maintain employment and increase output provided the appropriate structural reforms were undertaken.  Everybody and I mean everybody wanted lower inflation and higher employment.  And in the face of stagflation the punters got onside and away we went.

My argument is simply this.  After the largely successful attack on trade unions was accomplished, after the reform of both welfare and unemployment insurance programs were completed and within the context of free trade and capital mobility the real impact of he structural changes was to move the economy to line C point Z.  That is to say, even granting neoliberalism was not some radical attempt to reconfigure income and wealth distribution between economic classes the structural reforms were more successful than its antagonists imagined and thus instead of landing on trajectory B point Y we landed on trajectory C, point Z.

When therefore there is the call to cut corporate income taxes it explicitly assumes that the Canadian economy is still stuck on trajectory A point X.  But if in fact we are on trajectory C, point Z; we are thus in fact stuck at a bad equilibrium.  The move to further juice up output without a commitment to juice up employment is like the Keynesians of yore trying to smooth the oscillations around a bad equilibrium. But this time around it is employment which is lacking not output capacity.

What does this have to do with corporate tax cuts?  Corporate income tax cuts are suppose to be a stimulus to increase the output capacity of the Canadian economy over the medium to long term.  But if as is widely recognized output is not the problem but employment why are we even talking about supply side measures (i,e. corporate tax cuts)?

I think economists are still fighting the last war and not the war we are in.  And as any historian of war will tell you an army that does so will loose.

Update: this is not as radical an idea as it may appear: see this article in the business section of the Globe online.  The difference with Canada is that I think are debt growth is papering over the underlying bad equilibrium.

The Fraser Institute thinks deficits should be the cause celeb of Canadian elections. Do you?

Maybe. But it all depends on how the issue is framed. Over at the FP online Niels Veldhuis and Jason Clemens are all sweaty under the collar from working overtime on trying to convince us that slaying the deficit is the single biggest issue facing Canadians and the conservative government. In their subtly* titled comment “Cut spending now” they argue provocatively that the government must reduce the deficit to zero not some time in future but over the next two years.

A true austerity plan aimed at balancing the budget would have taken a page from former prime minister Jean Chrétien and finance minister Paul Martin’s 1995 plan. The reforms by Chrétien/Martin eliminated a deficit much larger than the current one (4.8 % of GDP compared with 2.8%), within three years.

Chrétien and Martin’s 1995 plan proposed cutting program spending by almost 9% over just two years to get a handle on federal spending. These weren’t reductions in spending growth. These were actual reductions in spending.

Even more impressive is that Chrétien and Martin outperformed their goal and reduced spending by 9.7%.

This represented a remarkable fiscal transformation that, in part, made Canada the envy of the developed world. Spending reductions, balanced budgets, and debt repayment contributed to our outstanding economic performance from 1997 to 2007.

To emulate this success, Canadians need a serious commitment to balancing the books. The sooner the government gets its fiscal house in order, the sooner it can take action to reduce taxes and improve the country’s competitiveness. To that end, Mr. Flaherty should put forth a true austerity budget that actually cuts spending to balance the budget over the next two years.

It would be sad indeed if the Fraser Institute and the National Post succeeded in making a balanced budget in two years the frame of the fiscal debate and the central issue in the upcoming election. Here is why. Scale the deficit out of GDP and the miraculous Canadian recovery does not exist. In fact without the deficits run by the provincial and federal levels of government nominal GDP would still be at Q4 2007 levels. Nothing makes the point more poignantly then a graphic.

The deficit hawks want to make the case that we are in perilous times, that immediate and austere, tough manly action is required tout de suite within the next two years to drive the governments’ fiscal houses into balance and then some.

But what about the macroeconomic balance: just where is the stellar private sector growth of +/-  3% of GDP per year over the next two years going to come from to make up for the decline in government spending?  Analysts over at Scotiabank have a nice little table in their Global Forecast Update estimate that in 2011 and 2012 that without federal deficit spending real GDP growth is going to be 0.7% of GDP and 1.5% respectively.  None of this of course takes into account what would be the real implication of a 3% reduction in aggregate demand in each of 2011 and 20012.  If there is any multiplier at all to deficit spending those forecasts would have to be adjusted even further southward.

This is not 1995, debt to GDP is lower and so too is the deficit.  Further it looks as though that it was only in Q4 2010 that the Canadian economy managed to climb back to its q3 2008 level which was only achieved by deficit spending.  And even with that deficit spending we are nowhere near back to 1995.  So why all the hand waving and warmongering over the deficit?

Much of it is a genetic trait of neo-conservatism, much of it do with the lack of originality in the Canadian conservative movement in that it seems only capable of echoing is conservative cousins south of the border, and much of it has to do with a certain amount of nearing or in retirement age sub-urban idiotic ranting myopathy.  I am not convinced they can even divine their own narrow self interest at this point.

The fact is we do not even hear the private sector clamouring for public restraint at this time.  Business knows that without government deficits into the near future revenue growth is going to be anaemic.  Sure they are protesting to keep their scheduled tax cuts but that is about who is going to pay for the stimulus not about deficits per se.

Should deficits become the cause celeb of the Canadian elections they should only be so in two ways.  Do we need to commit to higher projected deficits in the short term to get the unemployed and underemployed back to work? And who is eventually going to pay for them?

* I say subtly titled because they, unlike my undergraduate students, had the sense not to throw an exclamation mark on the end which demonstrates a little restraint on their part… so credit where credit is due. Pun intended.

David Henderson makes one good point on Canada’s budget triumph

Note, if you are pressed for time just scroll to the last paragraph for the punch-line.

Seems like everyone is picking on poor David Henderson of GMU for his working paper Canada’s budget triumph. The thrust of the paper is that Paul Martin Jr’s 1996 budget proves that through austerity you can spur economic growth. Or simply stated, that austerity = stimulus. As Stephen Gordon–and Stephen is no pinko progressive–pointed out, the paper is disingenuous in two major respects.

First, private sector employment had already recovered by 1996. And second, interest rates had fallen nearly 9% from the onset of the recession prior to the 1995-96 budget. This in and of itself probably helps explain why private sector employment had recovered prior to the 95-96 austerity budget. As Stephen also points out interest rates would fall another 500 basis points after the austerity budget to their lowest level in living memory (exaggeration but close given what counts for memory these days). The culmination of which was a massive depreciation in the CAD dollar such that Canadian exporters got a 10% boost in their competitiveness without having to lift an eyebrow. The bottom line is this: Henderson’s paper is wrong because the austerity budget came after the recovery had well begun in Canada and was further helped along by interest rate cuts and a depreciating dollar.

What Stephen does not explicitly remark on unfortunately–although he does implicitly by including public sector employment in his graph–is that the austerity budget and the cuts to the public sector contained inter alia helped keep labour markets very depressed. Indeed, it would take nearly 8 years for unemployment to drop to its post recession levels.

Paul Krugman picks up on Stephens remarks over at his blog which is fitting given that Henderson specifically tries to link the Canadian experience of 1996 to current American problems. As both Stephen and Paul point out the two simply are not amenable: private employment is not back to its pre-recession levels and the FED has no more room to reduce interest rates. It was a little disheartening that neither Stephen nor Paul chose to ask the question if the 1996 austerity budget nonetheless fit with the Canada of today. That is a more interesting question; namely, will austerity today produce the same results as it did (not) back in the mid 90s. My answer would be no for the following reasons.

Canada has been witness to a steady appreciation of its dollar. This means that much of the capacity in the manufacturing export sector is likely not coming back. To the extent that commodity exports will continue to thrive is of little importance from a labour market point of view because as pointed out in a previous post these sectors are employment lean sectors. That is, you need a 5 % increase in total value added, just to get one percent of growth in employment. So unless agriculture fishing and forestry are driving the commodity exports then resources are not going to make up for the loss of manufacturing jobs.

Second, and related to the first. Commodity markets are relatively strong (that is prices are high). This was not the case back in the 90s. Interest rates are already very low (1%) so there is not much stimulus to be gained there either and the BOC is not talking about funky QE tricks either (which probably would not work anyway). The implication on interest rates is doubly bad news for Canada. Not only is there not much room to cut rates, not much evidence to suggest it would but but there is also thus no instrument (politically viable that is) to depreciate the CDN dollar. The Canadian dollar is thus out of the stimulus picture as well.

The Canadian austerians, from the Federal government (and members of the loyal opposition), to the provincial governments, down to the op-ed pages of the Globe and Mail are busy clamouring for both tax cuts and fiscal austerity. And it looks like the corporate tax cuts are a done deal.

And this brings me to the one thing Henderson got right in his paper (pp17-19) but Stephen and Paul failed to note. Namely, Martin RAISED taxes including corporate and capital gains taxes but not personal income taxes in the 93 and 94 budgets. So I guess you can raise taxes on capital and not retard private sector employment growth. Who knew?

Oh my! Krugman jumps ship

Judging by Krugman’s online post today Same as he Ever Was, he has jumped off the good ship Obama. If Krugman is gone then that means a hole ship load of progressive activists are too (not that Paul leads them but rather is a bell weather of sorts). Watch demobilised progressives sit out the next congressional cycle and then the next presidential race. The republicans have won the day and perhaps the field through no merit of their own.

Same As He Ever Was

These days quite a few people are frustrated with President Obama’s failure to challenge conservative ideology. The spending freeze — about which the best thing you can say in its favor is that it’s a transparently cynical PR stunt — has, for many, been the final straw: rhetorically, it’s a complete concession to Reaganism.

But why should we be surprised? Here’s one from the vault. Two years ago, I was deeply frustrated with Obama’s apparent endorsement of the Reagan myth.

There was a lot of delusion among progressives who convinced themselves, in the face of clear evidence to the contrary, that Obama was a strong champion of their values. He wasn’t and isn’t……

Something interesting happened on CBC Radio this morning: spending cuts or tax increases

I believe it was the 7:oo am news cycle when the CBC started carrying a interview they did with a bank Conference Board economist  who argued that the Cons were going to have to make some hard program spending choices when it came to getting the 60 billion deficit under control.  And that  was that.  I of course wondered why the bank Conference Board economist had failed to mention the possibility of raising taxes.  I further wondered why the CBC had missed this rather obvious side of the fiscal equation?  And I further wondered why the CBC keeps going to bank private sector economists for a balanced presentation of the issues?

Fortunately, by the 8:00 am cycle someone had intervened and the end of the clip with the economist was amended with “and or which taxes will have to be increased”

Update:  At 10:00am the CBC went back to just replaying a clip from the interview without the editorial interjection in the end.  Apparently the CBC believes that the question of the deficit is just about program cuts.  Too bad for them given they are a program.

The War on EI reform Commeth

Conservative economists are up in arms that anyone could suggest lowering the qualification requirements for workers wanting to access an insurance program they are obliged to contribute but for which they do not necessarily have access.

Case in point, Stephen Gordon an economist at Laval was interviewed on CBC and he had the temerity to assert that the opposition parties were purporting to return Canadians to the dark days of UI dependency where workers worked 10 weeks and then took a “vacation” (10-42 which he admits was a small group of “users”).   An honest look at the previous programme would conclude that although there was a small user base of “bilkers” the other group was more a victim of a defunct east coast growth paradigm, entrenched rural local business interests and governments bereft of vision (with some irony what we might call an “industrial policy” the very thing conservative economists hate).  It would in fact take the complete collapse of the fishery to provoke a fundamental rethink of the structural dependence by design aspect of the old UI system. Apparently this is wrong.  They still have not yet arrived at areal solution for the structural dependence on the EI program.

But all of this is beside the point.  No one in the opposition is suggesting a return to UI as a guaranteed income scheme.  Although I do not know why this should disturb a conservative economist?  Conservative economists tend to love programs which enforce some requirement to work.  Let us call this their Victorian vice.  Indeed the reason conservative economists like the WITB is because it gives an incentive to welfare recipients an incentive to work.  It is therefore somewhat perverse that they should prefer to exclude formally employed workers from the EI system so that they can go on welfare and then be incentivised to work through programs like the WITB.  In a bizarre twist during the interview Gordon suggested that while access to the program (which all workers are forced to contribute) should remain restricted those who do qualify should have their benefits increased!  A new moral milestone: not only a distinction between the deserving poor but a distinction of merit between deserving and undeserving workers:  All enough to make a good Victorian blush at the recognition of their Dickensonian sentiments.

But I digress.  Gordon even went further and conceded that relaxing the qualifying criteria would only benefit 2% more of the unemployed.  He went further to say that there were other ways to help the poor: such as beef up the GST rebate.  For a man who does not receive the GST rebate and is woefully ignorant of how much income replacement it would represent it was not only callous it was disingenuous.  It was disingenuous because Mr. Gordon knows full well the EI system should be well funded requiring no draws on general revenue. It was only a fleecing of the program which moved billions from the program to general revenue that voila the program needed extra funding.  As an aside, this is why the finance minister’s suggestion the increased EI payments are partly to blame for the increased deficit ring hollow.  It was that minister who raided EI to make room for his silly tax cuts.

But the point is this, there is no choice between increasing benefits or increasing eligibility if we make an honest accounting of how large the surplus was in the EI fund.  Similarly it is a false choice between beefing up the GST credit or the WITB program or extending eligibility.  The EI fund should be fat; it was raided to pay for silly tax cuts that even the economist in question wrote a long blog post against.  It is therefore disingenuous to turn around and make it a question of where money is best spent.  EI is paid for by employers and employees, the fund was fat, and it was depleted by a raid on what appeared to be its fat in good times.  In short, the trade off can only be posed if one accepts the hanky panky involved in the raiding of the EI fund.

Delong is Wrong Again

What is up with Brad Delong?  It is like he is itching for a job in the Obama administration.  By his own admission he is no macro-economist but surely he knows the difference between effective demand at the level of the grass roots and supply push.  Then again maybe he is a macro-economists…of the fresh water variety.  Just read the following:

Even after central banks have pushed government bond prices as high as they can go, they should keep buying government bonds for cash, in the hope that people whose pockets are full of cash will spend more of it, and that this will directly pull people out of joblessness and into employment.

Here is a rather old fashioned idea: temporarily beef-up both the number of those covered by UI and the level of the replacement wage so that unemployed workers will have cash to spend on things like mortgages, rents, food and transportation.  Surely this seems better than hoping those who already have pockets full of cash will spend more of it and pull people out of employment.  And while unemployed workers are spending their UI, the Obama administration can find a little bit of breathing room to come up with a coherent plan to the financial mess instead of playing hanky panky ad hocery with the Fed, the Treasury and Wall street.

Dude trickle down is so like…the eighties.

Economic Forecasts: Roubini makes the Bear’s Case

There are lots of rosy forecasts flirting around predicting a quick turnaround in the Canadian economy.  They all rely on some notion that global effective demand is going to raise commodity prices and thus restore growth in Canada.  So much of this hinges on what the prospects are for future global growth, not just if house prices stop falling and house and car sales pick up a little in the US.

Roubini who has been consistently ahead of the game has an expanded Q&A in the Financial Times. It needs to be read in full.  The point I would make is that any analysis which discounts uncertainty, does not take a more global dynamic approach, and which relies on a couple of discrete sectors is likely to give a false sense of security (or insecurity).

In many ways Roubini makes the point that has been made on this blog several times:  the neoliberal growth model is crumbling and there is no simple sense in which we return to 2006.

The basic difference between the bears and the wanna-be bulls seems to resolve itself to whether or not the present crisis is viewed as deeply systematic or superficially located in some auxillary system.  That is, whether the problem is with the starter of the engine or with the engine itself.

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