Worthwhile Canadian Initiative

How economic policy analysis is done, and why it's not the same as forecasting

Third-year students in Laval's Baccalauréat intégré en économie et politique are required to take a seminar course on policy evaluation, and this week, I'm going to be giving a lecture on the basics of how it's done. It occurs to me that this is a lecture that many, many people should sit in on, so here is a summary.

The GST and Lord Voldemort

I can't - and won't - count the times where I've pointed out that increasing the GST is probably the best way of raising revenues to deal with a federal structural deficit whose size is almost exactly equal to the revenues foregone by the 2 points the Conservatives cut from the GST. And I have sung - and will continue to sing - its merits as an efficient, growth-friendly tax.

But every time I do this, someone invariably points out that "everyone knows" that increasing the GST is ballot-box poison, that there's no way it will ever happen and that I should take this into account. I understand why people keep telling me this, but I really don't see why I should pay attention.

Firstly, I don't buy it. It's not clear to me that the Conservatives owe their 2006 victory to the GST cut, and governments in Quebec and Nova Scotia recently increased the TVQ/HST without - as far as I can tell - a great amount of fuss. Voters are adults, and can generally be counted on to make adult decisions if offered adult choices.

And even if voters do have an irrational aversion to the GST, I don't see why I should be internalising this tendency. When politicians choose to sacrifice evidence-based policy in favour of electoral gain, they should be called on it.

Finally, it's important to keep the option alive in policy debates. If people are afraid to even mention the GST, then it falls off the table. Fear of a name increases fear of the thing itself.

Some corporate tax talking points I wish people would stop talking about

The issue of corporate taxes is becoming an issue, and it may even be an issue that provokes an election. Perhaps unsurprisingly, the debate has deteriorated even faster than I had feared. Here are five Bad Talking Points that I wish people would stop talking about.

Does the construction industry suffer false consciousness?

According to research carried out by Professor Jack Mintz of University of Calgary, the construction industry stood to gain enormously from Ontario's adoption of the Harmonized Sales Tax (HST):

 In 2009, the business tax  structure was heavily biased against investments in construction (42.2%) and services... By 2018, however, Ontario’s business tax structure will be not only internationally competitive but also more neutral and fair across industries. The highest-taxed industry in 2018 will be construction, at 20.9%, but this will not be significantly more than manufacturing (18.2%) or transportation and storage (16.3%). 

Most of this reduction in the effective marginal tax rate on construction-industry investments is, Jack Mintz argues, due to the introduction of the HST.

Corporate Tax Rates, the Conservatives and the Liberals

It's been interesting watching the back and forth between the Conservatives and the Liberals regarding corporate tax rates.    However, I've become frustrated with a question that isn't being asked of the Liberals.

The Pro-Usury Party meets the Neo-Wicksellians

Most macroeconomists believe that the real interest rate is what equilibrates AD and AS. If the real interest rate is too high, AD will be too low, and lower than AS, so there's excess supply of output. And the fall in AD will cause an equivalent fall in output. That's the orthodox Neo-Wicksellian position.

I want to consider a thought-experiment: assume the economy is initially in equilibrium at a 3% real interest rate. (The natural rate of interest is 3%). The Pro-Usury Party then gains power. The new PUP government passes a law that says all loans must be indexed for inflation, and the real rate of interest must be a minimum of 10%. The governor of the central bank pleads for an exemption from the law, on the grounds that money is barren. The PUP allows that central bank liabilities, like currency, can pay 0% interest. The central bank is also granted the power of compulsory purchase of bonds, if it wishes to do an open market operation.

What happens? In particular, will AD fall and will output fall with it? Will the PUP cause a recession?

A new Canadian economics blog!

Andrew Leach is an environmental economist at the University of Alberta, and he has started a blog: Rescuing the frog. I have just subscribed to his feed, and you should, too.

Understanding the Keynesian Cross

(Almost) every economist has learned the Keynesian Cross. (Almost) nobody (IMHO) understands it. (Or, less provocatively, we all understand it differently). Here is my interpretation of the Keynesian Cross model. This is how I understand it.

(This is inspired by Steve Williamson's post. I partly agree and partly disagree with Steve, but have decided to start from scratch anyway.)

What equilibrates AD and AS?

Arnold Kling says it's W/P.

"4. When it comes to aggregate supply and demand, the regulating mechanism is what is called the real wage rate, which means the wage rate adjusted for the general level of prices (or the cost of living). When prices go up, the real wage rate falls, and vice-versa. When the real wage rate falls, firms hire more workers, raising output and employment. That is the aggregate supply that goes along with aggregate demand."

I disagree. (But I'm not sneering, because Arnold is far too bright and original to sneer at, ever.)

Why Statistics Canada oversamples Newfoundland

When playing around with some data the other day, I noticed something odd.

I was trying to figure out where my respondents lived, so I typed "tab PROV" and was surprised to see that about four percent lived in Newfoundland. That's the number in the distribution of respondents column in the table below.

Distribution of respondents by province: unweighted and weighted, January 2009 Labour Force Survey. Calculated by author.

	Distribution of respondents (%)	Weighted distribution (%)	Relative over/under sampling
Newfoundland	3.89	1.58	2.46
Prince Edward Island	2.55	0.43	5.93
Nova Scotia	5.24	2.84	1.85
New Brunswick	5.12	2.29	2.24
Québec	17.82	23.61	0.75
Ontario	29.75	39.04	0.76
Manitoba	6.85	3.38	2.03
Saskatchewan	6.88	2.86	2.41
Alberta	10.13	10.43	0.97
British Columbia	11.76	13.55	0.87

University crashes

The optimal size of a university is always a little bit bigger than its actual size. More precisely, the size of a university doesn't really matter. What does matter is whether it's growing or shrinking. A growing university is easy to manage. If you need to grow one department relative to another, you hire people in one department and don't hire them in another. A constant sized university is harder to manage. If you need to grow one department relative to another, you hire people in one department and fire them in another. It's easier to not hire than to fire. And a shrinking university is very hard to manage.

The War on Demand, and the short-side rule.

Paul Krugman thinks the War on Demand is strange. I think it's weird. But I've got a different take on what's happening.

[Update: Paul Krugman responds.

"Nick Rowe makes a good point: most of the time, in market economies, sellers feel constrained while buyers don’t. I’m somewhat surprised that he doesn’t mention why: it’s because perfect competition is actually rare, because oligopoly or monopolistic competition — in which prices exceed marginal cost — is actually the norm."

I totally agree. This is a point I've been pushing in the past more than once. Just didn't feel like repeating myself again. ]

Faith as a substitute for savings

Saving for retirement is a gamble. You live, you win, because you reap the benefits of your thrift; you die, you lose, because you sacrificed enjoyment for no good reason.

Historically, retirement saving was even more of a gamble than it is today. In 1810, world life expectancy was less than 40 years (see this wonderful youtube video by Hans Rosling).

Yet, although an individual's likelihood of living the biblical "three score years and ten" (i.e. to 70) was highly uncertain, that some people would live to that age could be prophesied with accuracy. In situations like this, insurance works. Everyone contributes a small amount of their income, and the insurance company provides old age pensions.

The Catholic church is one of the world's oldest insurance companies. When the Church of England split off in 1534, it took over the insurance operations. Religion as social insurance, Christian style, works as follows: individuals tithe, or give 10 percent of their income, to the church. In exchange, the church provides alms for the poor, that is, a minimal guarantee against destitution.

Inequality and debt: the soft bigotry of low expectations

"The poor don't have enough income to save, and can't help going into debt to the rich. Debt is caused by inequality".

That statement is wrong on many levels. It's wrong theoretically. It's wrong empirically. But most of all, it's wrong because it might make inequality worse. It's the soft bigotry of low expectations. Providence is especially important to the poor. Saying that the poor can't help but be improvident is the last thing they need to hear.

(This post will piss some people off. "Nick's blaming the poor; of course they can't help either their poverty or their lack of saving!")

Tracking the Bank of Canada's forecasts during the recession

Globe and Mail journalist Jeremy Torobin called me a while back to talk about Bank of Canada forecasts for this article, and that call prompted me to go back and look at how the Bank's forecasts evolved during the recession.

Three ZMPs and two Co-ordination failures

"ZMP" stands for "Zero Marginal Product". It should really stand for "Zero Value Marginal Product". Can an additional worker produce no additional goods of any value? Is that why they are unemployed? Yes, but.

There are three types of ZMP. Two of them are based on two different types of coordination failure. The disagreement between macroeconomists is on what type of coordination failure is causing the ZMP of unemployed workers.

High Canadian Dollar Damaging to Exporters. An (Unexpectedly) Rising One Moreso

This is a post I've been meaning to write for months, but I couldn't find the words to do so.  Instead I've decided to create a very simple microeconomic model to illustrate my basic point - that since prices are sticky, an unexpectedly rising Canadian dollar can do more damage to an exporter's bottom line than a high but stable Canadian dollar.

The decline of American economists and the European cultural revolution

In 1991, two thirds of the articles in Econlit, a comprehensive index of academic economic research, were written by people based in North America. By 2006, that share had dropped by one third to 45 percent.  

These numbers are taken from a recent working paper by Cardoso, Guimaraes and Zimmermann. Their evidence suggests that the relative decline in North American share has come about because of a substantial increase in the productivity of European economists, and also because of an increase in Asian publication rates:

Cyclical productivity growth and the manufacturing sector

This post was written by Simon van Norden of HEC-Montréal.

Here is a quick graph from FRED of US economy-wide vs manufacturing employment growth:

One of the questions that I've had is whether the more rapid productivity growth in aggregate was the result of (a) faster productivity growth across lots of sectors, or (b) concentrating the contraction on the sectors with lowest productivity growth, or (c) concentrating the contraction on those sectors with the lowest productivity levels, or (d) all of the above. Now, I don't know where to get a good sectoral breakdown of productivity figures, but I know that most macro people focus on non-farm business (NFB) and the manufacturing sector. My first take on what I see in the graph is that the upturn in manufacturing productivity is bigger than that in the economy-wide measure. That suggests to me that construction is not the most important part of the story. It also shifts my priors a bit towards (a).

I also suspect manufacturing was particularly hard-hit by the recession; perhaps there is something to the recession-severity/productivity rebound link that you mentioned.

Partial vs General equilibrium lumps of labour

Does an increase in productivity cause labour demand to increase or decrease?

The answer to that question, and how we go about answering it, depends on whether we are talking about one small sector of the economy (partial equilibrium), or the economy as a whole (general equilibrium). (I was doing general equilibrium in my previous post).

If you start with the answer for one small sector, and just add it up across all sectors, you get into a total mess. That's the Fallacy of Composition. What's true for each of the parts isn't necessarily true for the whole.