Worthwhile Canadian Initiative

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.

So What Happens in the Next Recession?

I’m not a macro economist by any stretch of the imagination and yet I cannot help wondering what is going to happen in terms of policy response the next time Canada goes into a downturn.  It is not a question of whether there will be another recession, only when. By policy response, I am of course wondering about the traditional tools used to affect aggregate demand such as fiscal and monetary policy.

Provincial Government Health Spending: The Force Awakens?

The Canadian Institute for Health Information (CIHI) recently released its 2017 edition of its National Health Expenditure Trends and its worth a trip to its website for the downloadable data on all things related to health spending.  I've been on an advisory group to the CIHI with respect to its national health expenditures for a number of years now and I always enjoy the release of the product and the assorted materials provided that can shed light on recent trends in health spending. 

The last few years have seen a flattening out of real per capita ($1997) provincial government health spending and a fall in growth rates as Figures 1 and 2 show.  However, after a decline from 2010 to 2014 that saw real per capita provincial government health spending fall from $2,589 to $2,508 - a drop of 3.1 percent - spending is expected to increase to $2,585 by 2017 for an increase of 3 percent since 2014.

Regional disparities in Canadian economic growth: Theory and evidence

In its recent release of income data from the 2015 census, Statistics Canada helpfully provided data tables for median incomes in 2005 and 2015 for various regions in Canada. The headline number was the 12.7% increase in median Canadian incomes, and there's been some commentary about how the gains during the last decade were not uniformly shared. But there but there was something missing in those discussions of regional gains, namely, the initial level. When you start thinking about both starting points and the changes, it's not clear why you would expect - or want - the gains to be evenly distributed.

Health Spending and System Characteristics in Canada and Spain

I gave a talk at Memorial University in Newfoundland & Labrador last week sponsored by the Department of Economics and the Collaborative Allied Research in Economics Initiative (CARE). My talk was based on joint research currently underway with David Cantarero Prieto at the University of Cantabria in Spain comparing the determinants of government health spending in Canada and Spain and particularly the role of physicians as a factor in that spending.

Looking for a University President

“Some people think that a college president’s life is full of joys and a host of friends. I know that he frequently walks in sorrow and alone because of the times he must do what seems impossible.” Paul V. Sangren (1948) “What a President Learns” Journal of Higher Education, 19, 6, 287-288.

Well, my university is looking for a new President and Vice-Chancellor and the process of consultation has begun in terms of establishing what opportunities, issues and challenges awaits the new President as well as what characteristics and experience they should possess. A search company has been selected so if you are interested feel free to contact Laverne Smith and Associates Inc. at [email protected]. In the interim, a few thoughts come to mind about what being a university president might entail these days.