Worthwhile Canadian Initiative

The forex market is dumber than a sack of hammers

Or maybe it's just the people who comment on its gyrations. A Reuters piece from today is a case in point:

Loonie slips on US economic outlook: The Canadian dollar slid lower against the U.S. dollar as investors were loath to bet on the currency, given Canada's heavy dependency on the waning U.S. economy...

Huh?

Yes, the Canadian economy is exposed to the risk of a severe US downturn, so it's reasonable to expect a depreciation against currencies that are better insulated, such as the euro or the yen. But that reasoning also means that the CAD should appreciate against the currencies of economies that are less insulated from a US recession. A good example of an economy that is more exposed than Canada is to a US recession is - wait for it - the US.

Unless someone has a story in which a Canadian slowdown would be even more severe than what will hit the US - and I've yet to see anyone explain how it will - then this story from Reuters makes no sense at all.

How will the subprime crisis affect the Canadian economy?

I don't really know, but that didn't stop me from accepting an invitation from the local Radio-Canada station to do a radio interview on the subject (in French). You can listen to it here.

Mercantilism at the Globe and Mail

Today's Globe and Mail's editorial on the prospect of a Canada-South Korea trade agreement is just silly:

Free trade? First, lower the barriers: To the dismay of some Canadian exporters, free-trade talks with South Korea have reached an impasse. But that shouldn't be the end of any smart free trader's world, given South Korea's refusal to lower its non-tariff barriers to automobile trade despite almost 2½ years of negotiations. The South Koreans won't even grant the same automotive concessions to Canada that they recently made to the United States, and the U.S. Congress is balking at approval of that free-trade treaty.

The inequity is palpable. Canada currently imposes a tariff of 6.1 per cent on South Korean car imports, mainly vehicles from Hyundai Motor Co. and Kia Motors Corp. North American automotive manufacturers are afraid that the elimination of this duty could trigger a flood of small Korean cars that are not assembled here.

But Korea has far greater barriers, including an 8-per-cent tariff on auto parts and most vehicles and a 25-per-cent tariff on some trucks. South Koreans face tax audits if they buy foreign cars. Korean licence plates are a different size from those elsewhere in the world, so foreign automotive companies must do a separate production run. South Korea applies a tax on automobiles based on engine-displacement size, which disproportionately affects larger foreign cars. It's little wonder that Canada's annual exports of automotive products to South Korea were worth only $11.5-million last year, while the value of Korean automotive exports to Canada was roughly $1.7-billion.

There is much to be gained from a free-trade deal with South Korea, including the elimination of tariff and non-tariff barriers and the easing of restrictions on investment and services. A deal could open doors to other fast-growing economies in that region, if companies used Korea as a strategic base. Canada could snare major export gains in agriculture, fish, forestry, information technology and industrial equipment. After all, with GDP of more than $1-trillion, South Korea is the 12th-largest merchandise-trading nation in the world. No one wants the negotiators to give up.

But while International Trade Minister David Emerson has said the talks have not irreparably broken down, he made it clear that Canada is "not going to rush into a deal." That is an appropriate stand to take. Canada should not sign a deal that allows South Korea to keep such punitive non-tariff barriers in place. Such trade is neither free nor fair.

         

The reason why free trade is a good thing is that it allows us to buy things more cheaply than we can make them ourselves. A Canada-South Korea FTA should be evaluated on the basis of how it affects consumer welfare, not how it affects exports.

 

Manufacturing provincialism

The CAD has been climbing fast, so it's to be expected that its altitude would start to affect some people's decision-making skills. But you'd think that the premiers of Canada's two largest provinces would keep their heads, wouldn't you? Well, no. Calling on Stephen Harper to "do something" about the appreciating CAD is an extraordinarily cheap way of getting uncritical media attention. Ontario's Dalton McGuinty (example) and Quebec's Jean Charest (example) are likely not alone in their indulgence in this dodge, but I'll limit my attention to them in what follows.

The common theme in these interventions is the unstated premise is that the (very real) problems of the manufacturing sector over the past five years are representative of the  provincial economies. This simply is not the case. Here are graphs of the unemployment and employment rates for Canada, Ontario and Quebec since the CAD started its upward journey at the start of 2002:

Dalton McGuinty's complaint about tough times in the Ontario labour market are hard to understand: jobs are being created as fast as the working-age population. And although it would be churlish to whine about the rest of the country catching up to Ontario, it's hard to see what other complaint he could make.

Jean Charest's campaign is paradoxically both more bizarre and easier to understand. Although Quebec's unemployment rate is at a record low and its employment rate is at a record high, Charest is running a minority government, and desperately wants to be seen Doing Something. Anything. Whatever it takes to make the front pages.

It is in times like these that we should all be thankful for the fact that monetary policy is a federal jurisdiction, and that the Bank of Canada has a reasonably thick layer of insulation between itself and its political masters.

Bad economic journalism o' the day

From today's Globe and Mail:

GM deal 'a black day' for Canada's auto sector:  One of the key pillars supporting Canada's long-standing competitive advantage in the auto industry began crumbling Wednesday, less than a week after another one collapsed.

General Motors Corp. and the United Auto Workers reached a deal that shifts the burden of retiree health-care costs for U.S. workers to the union. The agreement dramatically reduces GM's burdensome cost structure and once it's followed by Chrysler LLC and Ford Motor Co. , will reduce the health-care advantage Canada has used for more than a generation to help lure automotive investment to this country...

GM will transfer its $51-billion (U.S.) retiree health care obligation to a trust, called a Voluntary Employees Beneficiary Association or VEBA, and finance it with a cash infusion of about 70 cents on the dollar or $36-billion.

That move will trim its average labour costs – including benefits – by about $18 or $19 an hour, Deutsche Bank AG auto analyst Rod Lache estimated. Average hourly U.S. labour costs will fall to about $55, close to the $48 that Japan-based auto makers are estimated to pay their U.S. workers.

The notion that the US arm of GM has suddenly become more competitive comes from not understanding the difference between marginal and average costs. That $19/hour is not disappearing; it's being capitalised and written off as a dead loss. Marginal costs - what it costs to actually produce an extra car - are what matter, and those haven't changed.

CAW economist Jim Stanford described shifting the retiree health-care burden to the union as simply a shell game.

The U.S. auto makers will still be paying for the health care of their active employees, Mr. Stanford pointed out and retiree health costs are irrelevant when it comes to deciding where investments are made.

Jim Stanford has it right. Too bad the story wasn't written from that perspective.

Manufacturing pointlessness

I can understand that the Toronto Star's editorial board has fallen victim to the Manufacturing Obsession, and that it feels obliged to make the case that the interests of seven people who work outside the manufacturing sector are as nothing before those of a single Manufacturing Worker. But I can't understand why it thinks that The Cause will be helped by calling on the Bank of Canada to lower interest rates in order to bring the exchange rate back down.

The problems of the Canadian manufacturing sector are best summarised by the following graph from a National Post Op-Ed by the CD Howe's Institute's Wayne Robson:

During the past 5 years, the price of automobiles relative to oil has decreased by about a factor of about three. If you were in the business of producing cars and oil, then the appropriate response to this kind of a relative price shift is to re-allocate productive resources away from cars and into oil. And that's what has happened, to the general benefit of Canadians. (See also this). But if sustained real wage growth and record employment rates are part of a package that involves a smaller fraction of the work force employed by the manufacturing sector, then The Star wants no part of it. If relative price movements are the cause, then by golly, The Star will  do all it can to get influence public policy so that those relative prices go back to where they were.

Except that it's choosing the wrong relative price as a focus for policy. Suppose that the Bank of Canada did decide to abandon inflation targeting in order to lower the CAD-USD exchange rate. Manufacturing exports would become more profitable. So would energy exports. A lower exchange rate would have no effect on the trends that are leading to a transfer of productive resources out of the manufacturing sector.

Manufacturing obsession

Here are some data* on how the Canadian labour market has evolved since the CAD started appreciating against the USD five years ago:

Very belated update: As a faithful reader of Andrew Gelman's blog, I've been wondering if there was a better way of conveying this information. I think a bar chart would have been better:

What feature of this graph these graphs do you think is most important in a discussion of monetary policy?

1. The 1.4m new jobs in Canada?
2. The 480,000 new jobs in Ontario?
3. The 80,000 fewer jobs in the Ontario manufacturing sector?

If you answered (3), then you might consider applying for a job writing Toronto Star editorials; it's pretty much the only place on earth where such silliness is viewed as serious commentary.

*For those of you trying this at home, the data are taken from Cansim Table 281-0025. The data are monthly, and I took the quarterly averages.

Reports of the retreat of globalisation in Canada are greatly exaggerated.

Jim Stanford's column ($ link) (update: free version here) in today's Globe and Mail makes a surprising claim:

Everyone knows globalization is an irresistible worldwide process enveloping every economy, including Canada's, in its market-driven tentacles. Right?

Wrong.

In fact, since 2000, Canada's economy has been curiously de-globalizing before our eyes. The importance of global markets to our employment and production has been diminishing, not increasing -- and at a remarkable pace.

Economists are at their happiest when they're skewering conventional wisdom, but I think Jim is drawing the wrong conclusion here:

In 2000, Canada's total exports were equivalent to 45.6 per cent of our GDP. That was the highest share ever, and reflected the effect of globalization on our economic orientation. After then, however, globalization began to unwind for us, and the export share began to fall. By 2006, it had shrunk to just 36.5 per cent of GDP.

Let's look at the data. For reasons I don't understand, Jim is using nominal exports and nominal GDP, so he's looking at the combined movements of prices and quantities:

This decline in the importance of international trade is utterly unprecedented in Canada's postwar economic history. Incredibly, Canada's economy (excluding energy) is now less dependent on exports than it was in 1994, when the North American free-trade agreement was signed. Exports are now falling in economic importance more quickly than they expanded in the early years of continental free trade.

(Emphasis added.) Why would we exclude energy, when the most important thing driving the Canadian economy is an energy-price-induced terms of trade shock? The whole point of the sectoral shift story we're seeing is the increase in production and exports of the energy sector.

This is followed by a puzzling proviso:

A word of caution is required here, because this measure -- exports as a share of GDP -- is somewhat misleading. It includes the value of imported commodities (such as auto parts) that are then processed and re-exported in another form (such as finished vehicles).

This is the only mention of imports in the column. I don't understand how the increase in cross-border integration of production processes can be so easily dismissed in an article that argues that globalisation has become a weaker force in the Canadian economy.

Another puzzle is why the appreciation of the CAD doesn't show up in this analysis. A 30% appreciation in the CAD is a much more plausible explanation for a decline in exports than a story based on the retreat of globalisation in Canada.

But more fundamentally, it's hard to see how an examination of the effects of a terms of trade shock could be interpreted as being evidence that the importance of the global economy is diminishing.

Is The Economist trying to make me crazy? Because it's doing a damn fine job of it

A chart from this story in The Economist:

Spot the missing G-7 country. Its population is roughly the same as the top five countries put together; the vast majority of which are able to read English.

Hint: it's not Chad.

I think this is how the Lucas supply curve works

The Economist reports that we have the 'most positive influence' on the world:

I suspect that if we ever tried to use it, it would disappear.