Worthwhile Canadian Initiative

The Hospitalization Life Cycle

The Canadian Institute for Health Information has just released a report on Hospital Stays in Canada which provides a plethora of interesting tables on hospital stays in Canada at a national and provincial level.  Both the age-standardized hospitalization rate (per 100,000 population) and the age standardized average length of stay (in days) in Canada have fallen since 2013-14 going from 8,205 to 7,944 and 7.0 to 6.8 respectively.  The summary graphic for their report lists the top 5 reasons for inpatient hospitalizations as:1) Giving birth (362,700), 2) COPD and bronchitis (93,353), 2) Acute myocardial infarction (71,192), 4) Pneumonia (70,149) and 5) Heart failure (68,972) with the total number of inpatient hospitalizations in brackets beside each reason.  These five causes make up 21.6 percent of total hospitalizations in 2017-18.

Robinson Crusoe and the Carbon Tax Rebate

Suppose I impose a carbon tax on Robinson Crusoe. But I give him a rebate exactly equal to the tax he pays. That tax plus rebate will have no effect on Robinson Crusoe's behaviour. He knows that if he cuts carbon by 1kg, and pays $1 less tax, his rebate also falls by $1, so his net tax (= tax minus rebate) stays the same. He has no incentive to cut carbon.

Now imagine an archipelago of 100 identical islands, each with one identical Robinson Crusoe clone. And suppose I impose the same tax per kg on each of them, but give each one a rebate equal to 1% of the total tax I collect from all.

You might think the result would be exactly the same. But it's now very different.

Each of the clones knows that if he were to cut carbon by 1kg, and pay $1 less tax, while the 99 other clones kept doing the same thing, his rebate would fall by only $0.01, so his net tax falls by $0.99. Which gives him an incentive to cut carbon.

In the new equilibrium (we call it a "Nash Equilibrium") they all cut carbon by the same amount, and so each gets a rebate equal to the tax he pays. But each knows that if he alone were to move away from that equilibrium, by increasing carbon, his net tax would increase by $0.99 per 1kg of extra carbon. Which is sufficient incentive not to move away from that equilibrium. Which is what makes it an equilibrium.

It's like a competition, where each entrant has to put the same $10 into a pot for prize money, and the total pot is divided between them in proportion to how quickly they each run. That creates an incentive for each to try to run faster relative to all the other competitors. Only if they all collude, and collectively agree to walk the race slowly, and none cheats on the agreement, would the incentive fail. Except the carbon tax works in reverse, because they pay money into the pot in proportion to how much carbon they create, and share the pot equally. So they compete to create less carbon.

What is true for each of the parts is not necessarily true for the whole, and vice versa, even if each part is identical to the others. What is individually rational is not necessarily collectively rational, and vice versa, even if each individual is identical to the others. Prisoner's Dilemma is one example that illustrates this point. My carbon tax example is another.

This post is not really about the carbon tax. I know nothing useful about the carbon tax, except for this one point. It's about teaching economics. The point I am making above is true and important, but it is not obvious. Teaching is hard.

Maybe what non-economists don't get is not income effects vs substitution effects; it's the Fallacy of Composition and the difference between individual rationality and collective rationality. Free riders, collective choice problems, and all that. (If there were no difference we wouldn't need a carbon tax anyway.) And the best way to explain the difference is in a representative agent model, because the difference is at its starkest and clearest in a symmetric equilibrium.

[Update: I changed the title from "Robinson Crusoe and the Carbon Tax". Because it dawned on me that it's about the rebate, not the tax.]

Guest Post: Comparing Technological Change in the Health and Taxi Industries

Well, here is a guest post forwarded to me by Ruolz Ariste - a colleague whom I originally met during my annual interactions with the CIHI and with whom I have co-authored.  Ruolz Ariste is currently pursuing a PhD in Industrial Relations in a program run by run jointly by Université Laval and Université du Québec en Outaouais.  Enjoy.

Canada's Gross Domestic Income and trading gains: An update and estimates for the provinces

This builds off an earlier post about the terms of trade, trading gains, and Gross Domestic Income and it extends the analysis to the provincial level. It's probably a good idea to take a look at it before continuing on.

Hopefully, Tomorrow Won't Be Yesterday

A short quick post.  Yesterday’s job numbers for Canada were greeted with surprise.  With 55,900 jobs added in February, the sentiment as best summarized by Doug Porter, Chief Economist with BMO Capital Markets is that: “The economy clearly is not falling off a cliff by any means, arguably quite the opposite”.  This is despite what seems to be a slowdown in the Canadian economy as indicated by consumer spending, exports and capital investment by business in 2018.  The more entertaining headline was by BNN Bloomberg which led with the Canadian labour market is off to its best start since 1981 as “The two-month gain is the best start to a year since 1981.” Of course, if the economy is doing so well one wonders why we are holding off on interest rate increases but I digress.

More to the point is what those of us with more historical memory remember about 1981.  Take a look at Figure 1 which plots seasonally adjusted monthly employment gains from January 1980 to December 1982.  January and February 1981 were certainly the two biggest consecutive gains in that period and quite impressive at 66,500 and 76,800 jobs respectively.  But look at what happened next – employment shrank in March of 1981, growth resumed for a few months afterwards and then – well, the economy fell off a cliff into the 1981-82 recession which saw unemployment rates soar to peak at 13.1 percent in December of 1982.

 

 

If we compare monthly employment in the year leading up to January February 1981 to a similar range for January-February 2019 as in Figure 2 one sees that it is not inconceivable that we are again about to fall off a cliff especially given the accompanying aforementioned economic indicators for 2018.  However, a big difference between now and then is monetary policy and interest rates which peak at their post war high about this period.  We are currently still at pretty historic lows for interest rates.  However, based on what happened to employment in 1981, we should know by the end of summer if we are in store for some employment drops.

NAFTA - The “Worst” Trade Deal Ever

With time on my hands over the last week of the holiday season, I spent a bit more time than usual surfing news channels and watched a press conference by U.S. President Donald Trump in  which among other things he again reiterated how the United States had been hard done by NAFTA and that it was the worst trade deal ever.   Needless to say, while he has pronounced from the mount on this matter numerous times, for some reason it particularly annoyed me this time, so I decided to see what simple evidence could be mustered to weigh in on this point.

Australian Economic Growth in Longer Term Perspective

A recent issue of The Economist highlighted the stellar economic performance of Australia – or as it was termed, “The Wonder Down Under” – arguing its economy is most arguably the most successful in the rich world.  Australia has apparently not seen a recession for 27 years, seen its median income has grown four times as quickly as the United States and has low public debt.  The Economist attributes some of this to good luck – natural resource endowments – as well as proximity to Asian markets particularly China.  However, policy decisions are also seen as important with key ones being the reform of social spending – health care and pensions – shifting more of the burden of these systems onto users as well as a more enthusiastic immigration policy which has brought in many skilled migrants.

This Australian resurgence is quite interesting given the ebbs and flows of Australian economic performance over the long run.  According to Ian McClean, in the late 19^th century, Australian incomes per capita were on average actually 40 percent higher than those in the United States with this advantage the result of high labour force participation rates, higher labour productivity and of course natural resource endowments.  Yet, by 1914 this lead over the United States had evaporated as a result of the transitory nature of these advantages.  In particular, “periods of weakest Australian growth, relative to benchmark economies, occur when the resource-based sectors of the economy have languished.”

Tracking the Bank of Canada's staff projections through the 2008-9 recession

The Bank of Canada has released an archive of the staff projections prepared for the Governing Council for the quarterly Monetary Policy Reports. There's a five year lag, so the most recent set of projections are the ones prepared in 2013Q4. While these projections don't answer the question "What was the Governing Council thinking?", it does answer the question "What projections were the Governing Council looking at?"

Why do we care about the labour share of income?

And by 'we', I mean 'Canadians'.

A lot has been said and written about the decline in the labour share of income, usually calculated as total employee compensation divided by nominal GDP. This decline is generally regarded as a negative development: the reduction in the share of income going to workers is interpreted as a symptom of suppressed wage growth and of increased income inequality.

I don't doubt that this is a useful narrative for understanding what has been happening in many countries, the US in particular. But I can't see how it fits the Canadian experience. Movements in the Canadian ratio of wages to national income  appear to be a story of the denominator, not the numerator.

Military Spending in the G7: A Quick Post NATO Summit Comparison

Well, the Disruptor-in-Chief, US President Donald Trump is at it again.  At today’s NATO summit he demanded that the members of NATO need to quickly increase their defence spending not only to meet the committed target of 2 percent of GDP but to also double their commitments to 4 percent of GDP.  Needless to say, all of this presented an opportunity to try and take a look at some of the numbers to see where things actually stand and to put the numbers into some kind of longer term perspective.

So, I have put together data on military spending, GDP and central government expenditure for the G-7 countries.  For Canada, I have data from Historical Statistics of Canada, the Urquhart and Statistics Canada GDP numbers and the Federal Fiscal Reference Tables.  For the other countries, the numbers for 1950 to 2000 are taken from the Correlates of War Data Project while those from 2001 to 2017 are from the World Bank database.  Note that for Germany, it is military spending for both East and West Germany from 1955 to 1989 and GDP also is combined for both countries for the 1955 to 1989 period. Why only the G-7 and not all of NATO? Well, time is money and as I do not have much of either I have opted for a truncated comparison.

Project Link update

I've just updated Project Link, my attempt to piece together the bits and pieces of published Statistics Canada data into a coherent history of the post-war Canadian economy. (The introductory post is here, and a post on the first update is here.)

Here are the main elements:

1. Incorporating Statistics Canada's long-awaited publication of its expenditure accounts from 1961-1980. As you may recall, when they revised the GDP numbers back in 2012, the new series started in 1981 instead of 1961. (This is what I had in mind when I fumed that "Statistics Canada must be the statistical only agency where the average length of its time series gets shorter from one year to the next.")
2. Pushing back the starting date for the LFS and SEPH employment numbers to 1946, along with unemployment rates and average weekly wages. The CPI and CPI inflation have also been pushed pack to 1946.
3. Including the income measures of the economic accounts : GNI (what we used to call GNP), NNI and disposable income. I've also gone out on a limb and tried to construct measures of Gross Domestic Income consistent with StatsCan's methodology, and that's covered in a separate post.

More details below the fold.

Gross Domestic Income in Canada, 1947-2018

The latest update of Project Link includes estimates for national accounts income measures: Gross National Income (formerly known as Gross National Product), Net National Income, compensation of employees, and disposable income, all going back to 1947Q1.

I've also added Gross Domestic Income. GDI is a fairly recent arrival in the national accounts, and it takes into account the income effects of changes in the terms of trade. Looking at GDI has been particularly useful in understanding the Canadian economy over the past fifteen years, since it picked up the incomes gains and losses incurred as the prices of Canadian resource exports rose and fell. Since GDP measures activity - and not necessarily the income it generates, GDP was not as useful as it usually is. (See my beer and pizza explainer.)

Addressing Ontario's Fiscal Challenges

While 2017-18 saw a surplus of $642 million after years of deficits, the 2018-19 Ontario budget now projects a deficit of $6.7 billion and a net provincial debt of $325 billion with deficits projected to continue for five years afterwards.  If one considers the recent report of the Auditor-General, then Ontario’s deficit may be even larger at $11.7 billion.  Furthermore, the Ontario government has committed to spending more on public infrastructure and as a result can be expected to add at least another $156 billion to its net debt bringing it near $500 billion dollars by 2026-27.  This will add substantially to provincial government debt charges even if interest rates remain at historic lows.  There are a number of measures that Ontario’s provincial government could adopt in an effort to address the sustainability of the public finances over the medium-term.  I recently put out one of the Ontario 360 policy papers run through University of Toronto School of Public Policy and Governance in which I outlined the long-term evolution of Ontario’s fiscal situation as well as outlined some recommendations for change.  Here is a quick summary of the five-point strategy.

Natural Resources, Living Standards and Inequality

Kevin Milligan had an op-ed in the Globe and Mail a few days ago drawing the link between natural resource development, middle class incomes and inequality.  The point essentially was: “Without income derived from the resource boom, Canadian inequality and the well-being of the Canadian middle class would be much worse than we’ve experienced.”  The point was being made with reference to the current pipeline debate and the consequences of erecting barriers to the transportation of resources to market.  Erecting barriers in the end would result in less resource development and by extension fewer good jobs that would diminish “the income source that has best shielded the Canadian middle class from the harsh economic forces that are increasing inequality in other countries. For Canadians concerned with inequality, the equalizing effect of resource development on our economy is too strong to ignore.”

Another Picture That Will Define Ontario Politics for the Next Four Years

Ontario is getting a Throne Speech this week and a budget next week and these events will set the stage for the June election.  In her recent post, Frances drew attention to the province's public finances via the public sector wage bill and the public-private sector wage differential and that cutting the public sector wage bill may certainly be an option pursued in the future.   This is because the province has accumulated a large public debt that given the prospects for an economic slowdown and/or rising interest rates will potentially increase fiscal pressure via debt service costs which in 2016-17 totaled  $11.7 billion or just over 8 percent of total government spending.  That is more than what is being spent to fund the provinces post-secondary education and training system (The Ministry of Advanced Education and Skills Development) which came in at $10.1 billion.

Monetary and Fiscal Federalism, Debt, Canada, and the Eurozone.

A government that undertakes a commitment to target 2% CPI inflation does not, strictly speaking, "borrow in its own currency". Its bonds are an indirect promise to pay, via transversality transitivity (damn!), a specified quantity of CPI baskets of goods and services. In much the same way that bonds under the gold standard were an indirect promise to pay a specified quantity of gold. See my old post.

It is true nevertheless that a government whose bonds are promises to pay money that it itself prints, even if it targets 2% CPI inflation, cannot suffer a liquidity crisis. If there were a run on those bonds, where bondholders wanted to sell and hold money instead, the central bank could and would (to keep inflation on target) simply print as much extra money as people wanted to hold and use it to buy back the bonds they did not want to hold.

It cannot suffer a liquidity crisis, but it can nevertheless suffer a solvency crisis. The Magic Money Tree is real, but not very big. If we assume a currency/NGDP ratio of 5%, and Nominal GDP growing on average at 4% (2% Real GDP growth plus 2% inflation), the Magic Money Tree gives the government that owns the printing press profits worth 0.2% (=5%x4%) of GDP per year. Which isn't very big, and is already built into the government's budget anyway, as the profits from the central bank. In a solvency crisis the government would face a choice between defaulting on its bonds and defaulting on its commitment to not let inflation rise above 2%. Much like a government under the gold standard would face a choice between defaulting on its bonds and defaulting on its commitment to making its money worth a specified quantity of gold. But a solvency crisis like that could not coincide with a deficiency of Aggregate Demand where inflation threatens to fall below the 2% target. Instead it could coincide with an excess of Aggregate Demand, where inflation threatens to rise above the 2% target.

The above describes the Canadian Federal government.

Canadian Provincial governments are different. They do not "borrow in their own currency"; they can't pay their debts by printing money. They can suffer a liquidity crisis and/or a solvency crisis.

Canada is not like other countries. Canadian provinces play a big role fiscally, in taxing, spending, and borrowing. [Can anybody find that lovely graph I saw a few months ago showing Canada at the extreme end of the fiscal federalism measure?] Update: Thanks to Jim Sentance for pointing me to Kevin Milligan's post.

If you drew a line, with a unitary state at one end, and the Eurozone at the other end, Canada is halfway along that line. If you abolish the Federal government, leaving only the Bank of Canada, you get the Eurozone. Eurozone national governments are like Canadian provincial governments.

So what happened in the Eurozone could happen here, at the provincial level, even though it wouldn't be exactly the same. The biggest difference is that someone is in charge who can ultimately control both monetary and fiscal policy at the Federal level and decide who gets bailed out under what conditions.

I am not aware of any problems in the near and foreseeable future. But then I don't trust my foresight. And it may be a good idea to think through how we should respond to problems before they happen, and how we might reduce the probability that they do happen. Under what conditions should the Bank of Canada do a Draghi whatever it takes buying provincial government bonds?

The Balance of the Federation: Canada 1870 to 2016

My contribution to Maclean’s 2018 Chartapalooza was a plot of the federal government’s share of total government expenditure in Canada since 1870.  The chart showed that until World War I, with the exception of period marked by the building of the federally subsidized CPR, the federal share of total government spending in Canada was approximately 40 percent. After the peak of over 70 percent reached during World War I, the federal share came down quickly but went up again during the Depression era and soared during World War II reaching over 90 percent. The federal share of spending came down more gradually after World War II—leveling off at almost 50 percent during the 1970s and 1980s before falling once again to about 40 percent during the 1990s.

However, this chart can be improved upon in two ways.  First, it would be useful to include not only the federal government but also provincial and local government expenditure shares over the period 1870 to the present.  As well, if one is going to include federal, provincial and local governments, it would be useful to take transfers to lower tiers into account and look at spending shares net of those transfers.  So, this is what I attempt to do in the accompanying chart  where I present federal, provincial and local expenditure shares net of transfers – at least for the period since 1933.

Donald Trump is a Mercantilist

A lot of ink is being spilled on Donald Trump and his America First approach to trade negotiations which has generated considerable trepidation and angst in both Ottawa and Mexico City as NAFTA appears headed for termination. Donald Trump is obsessed with the concept of trade deficits – which the United States does have on an overall basis. If one is to take President Trump at his word, he believes that if the United States sold more to the rest of the world than it imported from them, the country’s economy and manufacturing sector would be better off.

He appears to feel that the trade deficit is bad for the economy even though the evidence over time demonstrates that US GDP has grown at the same time that its trade deficit has grown. True, some sectors have done better than others and manufacturing employment has suffered but overall, per capita GDP and total output in the United States has grown in an environment of free trade – or reciprocity – if one feels like using a nineteenth century term. In the end, there seems to be an absence of evidence based decision making going on here but that does not mean Donald Trump is not making decisions based on some type of economic theory. It clearly seems to me that Donald Trump is simply a Mercantilist.

Don't even try to "Normalise" interest rates

If you think that the rest of the economy is normalised, so it is time to normalise interest rates too, you are wrong. If the rest of the economy is normalised, then interest rates must already be normalised.

Wicksell said there was some underlying "natural" rate of interest. If the central bank sets a rate of interest below the natural rate this would cause inflation; and if the central bank set an interest rate above the natural rate this would cause deflation. So any central bank that wanted to stabilise the price level should aim to set the actual rate of interest equal to that underlying natural rate of interest. And the actual rate of interest would need to be (roughly) equal to the natural rate on average over any extended period of time if we wanted price stability.

We haven't advanced much since Wicksell. The only important thing a Neo-Wicksellian would add is that it's important to distinguish between nominal and real rates of interest (real = nominal minus inflation), so if we have a 2% inflation target we add 2% to the natural rate to get the "neutral" nominal rate. And the actual nominal rate would need to be (roughly) equal to that neutral nominal rate on average over any extended period of time if we wanted to keep inflation stable at 2%.

You can see how this matches the idea of "normalising" interest rates. We've got "normal" both in the sense of an average over time, and in the sense of a desirable norm that central banks should aim for.

But when I hear the words "The Bank of Canada (or some other central bank) needs to normalise interest rates soon" I reach for my shovel. Let me try to tell you why.

The Long Restructuring of Ontario's Health Spending

Ontario’s hospital sector has made a submission to the provincial finance committee making the case that overcrowding has become so serious that there is a need for more funding.  They are seeking a 4.55 percent increase in operating funds for the 2018-19 fiscal year in their pre budget submission.  According to numbers calculated from data from the Canadian Institute for Health Information(CIHI), over the period 2010 to 2017, the average annual growth of nominal provincial government hospital spending in Ontario has been 1.9 percent while provincial government health spending as a whole has averaged 2.6 percent.

Part of what is going on here is the usual maneuvering for more funds as part of any budgetary process which this year is expected to be a bit more active given that Ontario is apparently out of the deficit woods and balancing its books.  This should provide fuel for any number of claims across the province that there is a crisis and more funding is needed. The provincial government health care sector has seen its nominal spending growth since 2010 restrained to just over 2 percent annually (compared to about 7 percent annually between 1997 and 2009) as part of the Ontario government’s attempt to slay its deficit.  However, a look at the longer-term numbers also suggests that the hospital sector in Ontario has borne a disproportionate share of spending restraint over the last few decades.