Fraser Forum - October 2009

Fraser Forum A Fraser Institute review of public policy in Canada

AFTER THE MELTDOWN Is the recession ending?

Stop the stimulus spending

Canadian Publication Mail Sales Product Agreement Number 40069269.

A “clunker” of an idea

October 2009 $3.95

From the editor

Fraser Forum Publisher Chief Editor Managing Editor Editorial Advisor Contributing Editors Art Direction and Cover Design Cover Photos Production and Layout Copyediting Media Relations Advertising Sales

Fraser Institute Peter Cowley Kristin Fryer Kristin McCahon Nadeem Esmail Amela Karabegović Niels Veldhuis Bill Ray Fotolia Kristin Fryer Mirja van Herk Dean Pelkey Advertising In Print Tel: (604) 681-1811 E-mail: info@advertising inprint.com

The Fraser Institute’s vision is a free and prosperous world where individuals benefit from greater choice, competitive markets, and personal responsibility. Our mission is to measure, study, and communicate the impact of competitive markets and government interventions on the welfare of individuals. Founded in 1974, we are an independent research and educational organization with locations throughout North America, and international partners in over 70 countries. Our work is financed by tax deductible contributions from thousands of individuals, organizations, and foundations. In order to protect its independence, the Institute does not accept grants from government or contracts for research.

For additional copies, or to become a supporter and receive Fraser Forum, write or call Fraser Institute, 4th Floor, 1770 Burrard Street, Vancouver, BC V6J 3G7 Telephone: (604) 688-0221; Fax: (604) 688-8539 Toll-free order line: 1-800665-3558 (ext. 580—book orders; ext. 586—development) Copyright © 2009 Fraser Institute ISSN 0827-7893 (print version) | ISSN 1480-3690 (online version) Printed and bound in Canada.

Return undeliverable Canadian addresses to: Fraser Institute, 4th Floor, 1770 Burrard Street Vancouver, BC V6J 3G7 The contributors to this publication have worked independently and opinions expressed by them are, therefore, their own and do not necessarily reflect the opinions of the supporters, trustees, or other staff of the Fraser Institute. This publication in no way implies that the Fraser Institute, its trustees, or staff are in favour of, or oppose the passage of, any bill; or that they support or oppose any particular political party or candidate.

Fraser Institute Board of Trustees Hassan Khos-

rowshahi (Chairman), Edward Belzberg (Vice Chairman), Mark W. Mitchell (Vice Chairman), Gwyn Morgan (Vice Chairman), Salem Ben Nasser Al Ismaily, Louis-Philippe Amiot, Gordon E. Arnell, Charles B. Barlow, Everett E. Berg, T. Patrick Boyle, Peter Brown, Joseph C. Canavan, Alex A. Chafuen, Elizabeth Chaplin, Derwood Chase, Jr., James W. Davidson, John Dielwart, Stuart Elman, Greg C. Fleck, Shaun Francis, Ned Goodman, Arthur N. Grunder, John A. Hagg, Paul Hill, Stephen A. Hynes, David H. Laidley, Robert H. Lee, Brandt Louie, David MacKenzie, Hubert Marleau, James McGovern, Eleanor Nicholls, Roger Phillips, Herb C. Pinder, Jr., R. Jack Pirie, Con S. Riley, Gavin Semple, Rod Senft, Anthony Sessions, William W. Siebens, Anna Stylianides, Arni C. Thorsteinson, Michael A. Walker, Catherine Windels, Michael Perri (Secretary-Treasurer)

I

t has been just over one year since Lehman Brothers filed for bankruptcy, unequivocally demonstrating that the US financial system—and the world’s financial system at large—was facing some serious problems. Since then, the world has been struggling towards recovery after entering a recession that many have called the worst crisis since the Great Depression.

There is no doubt that the crisis has had a significant effect on Canada’s economy: the TSX has declined considerably since it peaked in June 2008, and thousands of jobs have been lost since last October—387,000 in Canada alone.

But as 2009 draws to a close, we may have reason to be cautiously optimistic. Stock markets are once again rising and, as our analysts note in this issue of Fraser Forum, many economists are predicting growth in Canada’s economic output (GDP) for the third and fourth quarters of this year (“Stop the ‘stimulus’ spending,” pg. 19). And just a few weeks ago, US Federal Reserve Chairman Ben Bernanke said that the recession was “very likely over.”

This is, of course, very good news, assuming that these predictions are accurate.

However, it is important to remember that we are not out of the woods yet. The situation may not be as dire as was expected but, as Fred McMahon points out (“Is the recession ending?” pg. 14), there are still a number of threats that could jeopardize our economic recovery.

The most significant of these is out-of-control government spending. “Stimulus” spending in Canada, as well as many other countries, is resulting in record-breaking deficits: our deficit is expected to amount to almost $56 billion this year, while the US government is predicting a deficit of $1.58 trillion.

In this issue of Forum, Fred McMahon examines a number of problems associated with this kind of government spending, including long-term debt and inflation (“Is the recession ending?” pg. 14).

In another article, Niels Veldhuis, Charles Lammam, and Milagros Palacios explain that government stimulus spending can actually stunt economic recovery as government funds compete with private investment (“Stop the ‘stimulus’ spending,” pg. 19). They recommend that, instead of continuing to spend money on stimulus initiatives, the federal government should cut back on spending and start working towards reducing the size of the government.

Predicting the world’s financial future is by no means an exact science; there are many economic and non-economic factors to consider. But there is one thing we can be sure of: more government spending is not the way to ensure a stronger economy in the future.

From market meltdown to recovery

Kristin Fryer (kristin.fryer@fraserinstitute.org)

www.fraserinstitute.org

Fraser Forum 10/09

1

Fraser Forum

Contents 5

1

From the editor

4

Forum authors

5

Freedom to choose Amela Karabegović and Niels Veldhuis Saskatchewan’s proposed labour law changes are a step in the right direction, but further action is needed to give workers more choice.

Saskatchewan’s Bill 80

8

Canadian Medicare deserves its criticism Nadeem Esmail A careful look at the realities of Medicare shows that it regularly fails Canadians.

12

10

Corporate headquarters in Canada Alex Gainer and Nadeem Esmail On a per population basis, more corporations locate their headquarters in Calgary than in any other Canadian city.

The natural resource “curse”

12

Economic growth and the “curse” of natural resources Amela Karabegović Institutions such as the rule of law play an important role in determining whether natural resources become a curse or a blessing.

14 2

Is the recession over?

Fraser Forum 10/09

www.fraserinstitute.org

26

BC’s big-spending, tax-increasing budget

FROM MARKET MELTDOWN TO RECOVERY

Niels Veldhuis, Charles Lammam, and Milagros Palacios Yearly deficits, coupled with a significant increase in spending, will increase BC’s debt by an alarming $14.7 billion over the next three years.

28

Key Concepts: Opportunity Costs Niels Veldhuis Calculating the value of the next best alternative.

30

14

John Robson

Farewell to Rose Friedman

Fred McMahon Governments around the world have avoided many of the errors that gave rise to the Great Depression, but out-of-control government spending will make recovery more difficult.

The right tool for the job?

Capitalism provides the best means to achieve social ends.

32

Is the recession ending?

19

Michael A. Walker

Stop the “stimulus” spending Niels Veldhuis, Charles Lammam, and Milagros Palacios Rather than continue to roll out stimulus money, the Canadian government should tighten the reins and put forth a plan to reduce the size of the federal government.

22

A clunker of an idea Diane Katz The “Cash for Clunkers” program provides no real economic or environmental benefits.

www.fraserinstitute.org

Fraser Forum 10/09

3

Forum Authors

Featured Authors Diane K atz (diane.katz@fra​serinstitute.org) is the Director of Risk, Environment, and Energy Policy Studies at the Fraser Institute. She has an M.A. from the University of Michigan.

Charles Lammam (charles.lam​mam@fraserinstitute.org) is a Policy Analyst

in the Fiscal Studies Department at the Fraser Institute. He has a B.A. in economics and is completing an M.A. in public policy from Simon Fraser University.

Fred McMahon (fred.mcmahon@fraserinstitute.org) is the Director of the Centre for Trade and Globalization Studies at the Fraser Institute. He has an M.A. in economics from McGill University.

Milagros Palacios (milagros.palacios@fraserinstitute. org) is a Senior Economist with the Fraser Institute’s Fiscal Studies Department. She has an M.Sc. in economics from the University of Concepcion in Chile.

Niels Veldhuis (niels.veldhuis@fraserinstitute.org) is the Director of Fiscal Studies and a Senior Economist at the Fraser Institute. He has an M.A. in economics from Simon Fraser University.

Contributors Nadeem Esmail (nadeem.es​mail@fraserinstitute.org) is the Director of Health System Performance Studies at the Fraser Institute. He has an M.A. in economics from the University of British Columbia.

Alex Gainer (alex.gainer@fraserinstitute.org) is a Research Economist in the Fiscal Studies Department at the Fraser Institute. He holds an M.A. in economics from the University of British Columbia.

Amela K arabegović (amela.karabegovic@fraserinsti​tute.org) is a Senior Economist in the Fiscal Studies department at the Fraser Institute. She has an M.A. in economics from Simon Fraser University.

John Robson is a columnist with the Ottawa Citizen, a commentator-at-large with CFRA radio, a policy analyst with Breakout Educational Network, and an invited professor at the University of Ottawa.

Michael A. Walker is a Senior Fellow of the Fraser Institute and President of the Institute’s Foundation.

He served as Executive Director of the Fraser Institute from its establishment in 1974 until 2005.

4

Fraser Forum 10/09

www.fraserinstitute.org

Freedom to choose Saskatchewan’s proposed labour law changes are positive but further steps are needed

iStockphoto

Amela K arabegović and Niels Veldhuis

W

ith the fall session of the Saskatchewan Legislature set to start, the province will once again consider proposed amendments to the labour relations laws governing the construction industry.1 The goal of the amendments set out in Bill 80, The Construction Industry Labour Relations Amendment Act, 2009, is to increase labour market flexibility and give employees and employers in the industry increased freedom of choice in relation to unionization and bargaining (Saskatchewan, 2009a, b). While the bill is an incremental step in the right direction and should be passed, Saskatchewan should give workers complete freedom to choose whether to join and financially support a union.

The Construction Industry Labour Relations Amendment Act, 2009 A quick examination of Saskatchewan’s current labour relations laws for the construction industry highlights the lack of choice for employers and workers. Currently, firms in Saskatchewan’s construction industry that employ unionized workers are required to belong to a representative employers’ organization (REO) for the purposes of collective bargaining (Saskatchewan, 2009b).

Saskatchewan’s laws specify which unions are allowed to represent construction workers and requires workers to join the unions associated with their particular trade. This means that workers currently are not able to choose which union represents them.

All bargaining in the industry takes place between the government-mandated REOs and unions designated by the government; individual employers and unions are prohibited from bargaining directly with each other (Saskatchewan, 2009b).2 The 2009 proposed amendments to the Construction Industry Labour Relations Act, 1992 (CILRA) would significantly change the way unions, employers, and employees interact.3 Four of these changes are worth highlighting4: 1) Trade unions would be permitted to organize on a multi-trade, all-employees, or craft (i.e., singletrade) basis (Saskatchewan, 2009b). Currently, designated unions can organize on a craft basis only.

2) Any trade union would be permitted to represent employees. At this time, only unions designated by the government can represent workers and only for a designated trade.

3) Employers would be able to choose the REO that represents them (Saskatchewan, 2009b). Under the current system, employers are not able to choose the REO that represents them for the purposes of collective bargaining.

4) The Saskatchewan Labour Relations Board would be able to investigate and decertify a union if an abandonment claim is proven. An abandonment claim can be brought in cases where the union has been inactive in representing workers in its bargaining unit for a period of at least three years (Sas-

www.fraserinstitute.org

Fraser Forum 10/09

5

Saskatchewan should give workers complete freedom to choose whether to join and financially support a union. katchewan, 2009b). Under the current law, some contractors may be subject to old union bargaining agreements and may even be forced to pay union dues retroactively, even if they have operated on a non-union basis for decades, as recent Board decisions have indicated (see, for example, SLRB, 2009).

These changes would clearly give both employers and employees more choice when selecting their representatives for the purpose of collective bargaining.

These changes would also likely result in a reduction in the proportion of province-wide collective bargaining agreements,5 a change that would benefit both the province’s construction industry and the economy in general.

Labour market flexibility and centralized wage bargaining The key to a high-performing, efficient labour market characterized by strong job creation, low unemployment, short durations of unemployment, and a highly productive workforce is flexibility. Labour market flexibility refers to the ease with which workers and employers can reallocate their resources to respond to changes in market conditions.

Centralized wage bargaining can affect flexibility and, therefore, labour market performance (OECD, 2006).

If the centralized collective bargaining wages are set too high and do not reflect local conditions and productivity, then unemployment will increase. Moving away from centralized bargaining will allow employers and unions to write agreements that better reflect their local realities.

Centralized collective bargaining also tends to reduce wage dispersion at the bottom and the top of the wage distribution, resulting in higher wages at the bottom and lower wages at the top. This wage compression is most prominent in places where wage bargaining is highly centralized (i.e., when wage bargaining occurs at a sectoral or national level as opposed to a firm level) (OECD, 2006) and leads to higher unemployment rates among young and unskilled workers.

Evidence from around the world indicates that a lack of labour market flexibility, including centralized wage bargaining, has detrimental effects on labour market outcomes. This has also been confirmed in a seminal study completed by the Organisation for Economic Cooperation and Development (OECD) in 1994 which is

6

Fraser Forum 10/09

www.fraserinstitute.org

commonly referred to as the Jobs Study. The Jobs Study recommends, among many other things, the adoption of policies that allow for more flexibility in wages through the elimination of restrictions that prevent wages from reflecting local conditions (OECD, 1994a, b).6 These findings are supported by a study by Di Tella and MacCulloch (2005) which examined how flexible labour markets performed relative to less flexible labour markets in 21 OECD countries from 1984 to 1990. The authors found that greater centralization leads to higher unemployment and lower levels of employment and labour force participation.

Broader reforms needed While the proposed amendments to the labour relations laws for the construction industry are a step in the right direction, they will not really provide “the freedom to choose” as the government claims. Unfortunately, Saskatchewan’s workers can still be forced to join and financially support a union as a condition of their employment, even if they would prefer to not be members and would rather deal with their employer on an individual basis.

This stands in stark contrast to the choice afforded to workers in other countries. In the United States, for example, workers cannot be forced to join a union and have the ability to opt out of union dues that are not related to their representation (i.e., collective bargaining, arbitration proceedings, etc.), such as political activities.

Further, in 22 US states, workers are afforded even more choice and can opt out of all union dues payments.

When they are able to choose whether to join a union, workers tend to choose unions in lower numbers.

Research has shown that the difference in worker choice between Canada and the US explains in part why unionization is so much higher north of the border (see, for example, Clemens et al., 2005): in 2008, unionization in Canada was 31.2% compared to 13.7% in the US (Statistics Canada, 2009; Hirsch and MacPherson, 2009).

Higher unionization rates resulting from biased (pro-union) labour relations laws have been shown to have numerous deleterious economic effects. For example, research indicates that jurisdictions with higher unionization rates suffered from lower employment growth and higher unemployment rates. Higher unionization rates also reduce investment in physical capital and research and development (see Palacios et al., 2009).

Conclusion The government of Saskatchewan should be commended for proposing positive changes to the CILRA—however incremental they might be—that will provide both employers and employees with more choice. But the government should not stop there. Workers in Saskatchewan should also be given complete freedom to choose whether to support union representatives or to bargain for their own wages and benefits.

Notes 1 Canadian provinces tend to have a different set of labour relations laws for the construction industry. While construction industry labour legislation and the general labour legislation that apply to the rest of the private sector have many common provisions, there are also some striking differences, such as province-wide bargaining in Saskatchewan which is not used anywhere else in the private sector.

2 These laws make Saskatchewan an outlier within Canada.

In fact, Saskatchewan is the only Canadian jurisdiction where the labour relations laws require unionized employers in the construction industry to be a member of a representative employers’ organization (REO) (Saskatchewan, 2009b). Moreover, Saskatchewan is also the only jurisdiction that sets out in its labour relations laws which unions are allowed to represent construction workers in each trade (Saskatchewan, 2009b).

3 It is important to stress that the collective agreements signed between REOs and unions will stay in force even after the 2009 amendments come into effect. Further, the government-mandated REO system will be maintained and employers will remain in the system. The move to a new system can only come from unionized employees who wish to join a different union or from employers who wish to choose a different REO. 4 There are a few additional changes proposed in the 2009 amendments: employers outside the REOs will be able to negotiate project-specific agreements (currently, only a member of a REO can sign a project-specific contract) (Saskatchewan, 2009b); and the official definition of the construction industry under the CILRA will be changed to no longer include “maintaining” a building or structure (Saskatchewan, 2009b).

5 The 2009 amendments do not prohibit province-wide collective bargaining. However, allowing unions to organize on a multi-trade or all-employee basis, where resulting collective bargaining agreements are firm-specific, will reduce the proportion of province-wide collective bargaining agreements over time.

6 A follow-up OECD study (2006) again recommended the adoption of policies that facilitate greater flexibility for work-

ers and employers, including a greater degree of wage flexibility to enhance performance.

References Berry, Michael, Policy Analyst, Policy and Planning, Advanced Education, Employment and Labour, Government of Saskatchewan. Personal e-mail communication with Amela Karabegović, September 9 to 18, 2009.

Clemens, Jason, Niels Veldhuis, and Amela Karabegović (2005). Explaining Canada’s High Unionization Rates.

Fraser Alert. Fraser Institute.

The Construction Industry Labour Relations Act, 1992, S.S. 1992, c. 29.11, as am. by S.S. 2000, c. 69. <http://www. qp.gov.sk.ca/documents/English/Statutes/Statutes/C2911.pdf>.

Di Tella, Rafael, and Robert MacCulloch (2005). The Consequences of Labor Market Flexibility: Panel Evidence Based on Survey Data. European Economic Review 49: 1225–59.

Hirsch, Barry, and David MacPherson (2009). Union Membership and Coverage Database from the CPS. Unionstats. com. <http://www.unionstats.com/>, as of July 3, 2009.

Organisation for Economic Co-operation and Development [OECD] (1994a). OECD Jobs Study: Facts Analysis, Strategies. OECD. Organisation for Economic Co-operation and Development [OECD] (1994b). OECD Jobs Study: Part 1. OECD. Organisation for Economic Co-operation and Development [OECD] (2006). OECD Employment Outlook: Boosting Jobs and Incomes. OECD. Palacios, Milagros, Alex Gainer, Amela Karabegović, and Niels Veldhuis (2009). Measuring Labour Markets in Canada and the United States: 2009 Edition. Fraser Institute.

Saskatchewan (2009a). Amendments to Construction Labour Legislation Introduced. News release (March 10). <http:// www.gov.sk.ca/news?newsId=3e4e7754-084b-4e48-bea713da303b27d5>.

Saskatchewan (2009b). Backgrounder: Construction Industry Labour Relations Amendment Act, 2009 (CILRA). <http:// www.gov.sk.ca/adx/aspx/adxGetMedia.aspx?mediaId= 735&PN=Shared>.

Saskatchewan Labour Relations Board [SLRB] (2009). International Brotherhood of Electrical Workers, Local 529, v.

Saunders Electric LTD. <http://www.sasklabourrelations board.com/recent-board-decisions/2009/019-05rea.pdf>.

Statistics Canada (2009). Labour Force Historical Review 2008. Catalogue No. 71F0004XCB. CD-ROM. Statistics Canada.

www.fraserinstitute.org

Fraser Forum 10/09

7

Canadian Medicare deserves its criticism Nadeem Esmail

C

anada’s Medicare system has been mentioned many times in the US debate over health care reform, and not all of the mentions have been positive. Liberal MP Bob Rae (2009, Aug. 5) has gone as far as to suggest that Canada’s Medicare has become a “whipping boy” for at least one side of the US debate, and has joined a cadre of politicians and commentators in rising to Medicare’s defence.

The truth, however, is that the criticism of our health care system is well deserved. A careful look at the realities of Medicare shows that it is a very poor health care system that regularly fails Canadians.

First, Canadians are funding the developed world’s second most expensive universal access health care system. On an age-adjusted basis (older people require more care) in the most recent year for which comparable data are available (2005), only Iceland spent more on their universal access health care system than Canada as a share of GDP, while Switzerland spent as much as Canada. Remarkably, Canada’s health care expenditures were 22% higher than the expenditures of the average universal access developed country (Esmail and Walker, 2008; calculations by author).

With that level of expenditure, you might expect that Canadians receive world-class access to health care.

The evidence shows that this is not so.

Consider Canada’s waiting lists. In 2008, the median wait time from general practitioner referral to treatment by a specialist was 17.3 weeks in Canada. Despite

8

Fraser Forum 10/09

www.fraserinstitute.org

substantial increases in both health spending and federal cash transfers to the provinces for health care over the last decade or so, that wait time was 45% longer than the overall median wait time of 11.9 weeks back in 1997.

It was 86% longer than the overall median wait time of 9.3 weeks back in 1993 (Esmail and Hazel with Walker, 2008; Esmail et al., 2007; calculations by author).

Canada’s waiting lists are also, according to the available evidence, among the longest in the developed world. For example, a 2007 survey of individuals published in the journal Health Affairs found that when

Canadians are funding the developed world’s second most expensive universal access health care system. compared to patients in Australia, New Zealand, Germany, the Netherlands, the United Kingdom, and the United States, Canadians were most likely to wait more than one month for elective surgery, six days or longer to see a doctor when ill, and two hours or more for access to care in an emergency room (Schoen et al., 2007).

rates of surgery outside the priority areas [hip and knee replacements, cataract surgery, cardiac revascularization, and cancer surgery] are about the same as they were in 2004–2005” (CIHI, 2009: 12). Within the priority areas, rates of surgery climbed by 7% between 2004/2005 and 2005/2006, and then essentially stopped growing to 2007/2008 (CIHI, 2009). These non-increases occurred during a period when provincial health spending (not including Quebec) grew by $16.5 billion, or about 25% (CIHI, 2008; calculations by author).

Those who criticize Canada’s health care system often raise the ire of politicians and pundits, both here and in the United States, who are quick to defend Canada’s unique approach to health care policy. But an examination of the facts shows that it is the pundits who are wrong. Medicare is failing Canadians.

Fotolia

References

That is hardly the sort of access you might expect from the developed world’s second most expensive universal access health care system. It is also worth noting that seven developed nations—Austria, Belgium, France, Germany, Japan, Luxembourg, and Switzerland—maintain universal access health insurance programs that deliver access to health care without queues for treatment (Esmail, 2004).

Access to medical technologies is also relatively poor here. Canadians struggle with a relatively small inventory of medical technologies compared to what other nations manage to deliver through their universal access programs. At the same time, much of Canada’s limited inventory of technologies is old, outdated, and in need of replacement (Esmail and Wrona, 2008).

Canada’s health care system is also a study in decline. Once the home of one of the developed world’s highest physician-to-population ratios, Canada now ranks a miserable 26th among 28 developed nations that maintain universal approaches to health insurance.

And the decline is firmly set to continue. Largely due to government restrictions on physician training, Canada’s physician-to-population ratio will fall in the coming years without a significant intake of foreign-trained physicians (Esmail and Walker, 2008; Esmail, 2008).

Moreover, recent data suggest that Medicare’s ability to squander financial resources has not abated. The Canadian Institute for Health Information found (not including Quebec) that in 2007/2008, “Age-standardized

Canadian Institute for Health Information [CIHI] (2008).

National Health Expenditure Trends: 1975–2008. CIHI. Canadian Institute for Health Information [CIHI] (2009).

Surgical Volume Trends, 2009: Within and Beyond Wait Time Priority Areas. CIHI. Esmail, Nadeem (2004). Fixing Waiting Times. Fraser Forum (May): 3.

Esmail, Nadeem (2008). Canada’s Physician Supply. Fraser Forum (November): 13–17.

Esmail, Nadeem, Jason Clemens, Niels Veldhuis, and Milagros Palacios (2007). Federal Health Transfers to the Provinces: Expensive and Ineffective. Fraser Alert. Fraser Institute.

Esmail, Nadeem, and Maureen Hazel, with Michael Walker (2008). Waiting Your Turn: Hospital Waiting Lists in Canada (18th ed.). Fraser Institute.

Esmail, Nadeem, and Michael Walker (2008). How Good is Canadian Health Care? 2008 Edition. Fraser Institute.

Esmail, Nadeem, and Dominika Wrona (2008). Medical Technology in Canada. Fraser Institute.

Rae, Bob (2009, August 5). Keep Canada Out of the US Health-Care Debate. The Mark. <http://www.themark news.com/articles/402-keep-canada-out-of-the-us-heal th-care-debate>.

Schoen, Cathy, Robin Osborn, Michelle M. Doty, Meghan Bishop, Jordon Peugh, and Nandita Murukutla (2007).

Toward Higher-Performance Health Systems: Adults’ Health Care Experiences in Seven Countries, 2007.

Health Affairs 26, 6: w717–w734. <http://www.healthaf fairs.org>.

www.fraserinstitute.org

Fraser Forum 10/09

9

iStockphoto

Corporate headquarters in Canada Alex Gainer and Nadeem Esmail consultants, and accountants tend to establish themselves near these headquarters and create a larger professional community, a greater concentration of knowledge, and easier access to high-quality services for other companies nearby.

By this measure, Calgary is by far the Canadian leader in the concentration of corporate headquarters, with 6.7 corporate head offices per 100,000 people in 2008. Calgary’s concentration is more than double that of Toronto, which had 3.2 corporate head offices per 100,000 people (table 2; figure 1). Winnipeg had 2.3 corporate head offices per 100,000 people. Montreal was fourth among the cities with 2.0 corporate head offices per 100,000 people, while Vancouver had 1.8 corporate head offices per 100,000 people.

Which Canadian city is home to the largest number of corporate headquarters for Canada’s top 500 corporations?1 How has this changed over time?

Table 1 contains data from 1990, 2000, and 2008 showing how many corporate headquarters are located in Canada’s five main corporate centers: Montreal, Toronto, Winnipeg, Calgary, and Vancouver.2 Toronto was overwhelmingly the dominant location for corporate headquarters in all three years examined. In 2008, 35.2% of corporate headquarters for Canada’s top 500 corporations were located in Toronto. Calgary ranked second, Montreal third, Vancouver fourth, and Winnipeg last.

Is the absolute number of corporate headquarters an effective measure of corporate headquarter activity?

How does adjusting for Canada’s government-held corporations affect the rankings?

No. A better way to measure corporate headquarters activity is to adjust for population. Simply counting the number of corporate head offices without adjusting for the size of the city ignores the real effect that the concentration of corporate headquarters can have on an economy. This concentration is important because of the spin-off effects associated with corporate headquarters. Support professionals such as lawyers,

There were a total of 50 government corporations3,4 among Canada’s top 500 corporations in 2008, representing 10% of the total. Twenty-five of the 50 (50.0%) are among the top 200 Canadian corporations. Put differently, 12.5% (one-eighth) of the top 200 Canadian companies in Canada are government owned.

Table 1: Corporate headquarters overview 1990

2000

2008

Number of top 500 headquarters

% of top 500

Number of top 500 headquarters

% of top 500

Number of top 500 headquarters

% of top 500

Montreal

96

19.2%

92

18.4%

76

15.2%

Toronto

186

37.2%

190

38.0%

176

35.2%

Winnipeg

18

3.6%

18

3.6%

17

3.4%

Calgary

44

8.8%

50

10.0%

79

15.8%

Vancouver

45

9.0%

41

8.2%

41

8.2%

Sources: FP Magazine, 1991, 2001, 2009. Calculations by authors.

10

Fraser Forum 10/09

www.fraserinstitute.org

Table 2: Canadian corporate headquarters per 100,000 population, 1990, 2000, and 2008 1990

2000

2008

Montreal

2.9

2.6

2.0

Toronto

4.7

4.0

3.2

Winnipeg

2.7

2.6

2.3

Calgary

5.9

5.3

6.7

Vancouver

2.8

2.0

1.8

Sources: FP Magazine, 1991, 2001, 2009; Statistics Canada’s CANSIM database <http://cansim2.statcan.ca/>. Calculations by authors.

Figure 1: Canadian corporate headquarters per 100,000 population, 1990, 2000, and 2008 Corporate headquarters per population

8

1990

7

2000

6

2008

4 3 2 1 Montreal

Notes 1 Only corporate headquarters for the top 500 Canadian corporations as reported by the Financial Post are included in this analysis.

5

0

Table 3 shows the concentration of private corporate head offices, excluding government-held corporations. If government corporations are removed from the mix, Winnipeg’s concentration is the most affected, dropping 29.4% (five headquarters). After Winnipeg, the concentration in Vancouver is the next most affected (9.8%, or four headquarters), followed by Montreal (7.9%, or six headquarters), and Toronto (4.5%, or eight headquarters). Calgary’s count is affected the least with a change of only 2.5% (two headquarters).

This significant change in the absolute numbers of headquarters in each city has a noticeable impact on the relative rankings among the cities. While Calgary and Toronto remain in first and second place, respectively, Montreal moves up to third, while Vancouver and Winnipeg tie for fourth.

Toronto Winnipeg Calgary Vancouver

Sources: FP Magazine, 1991, 2001, 2009; Statistics Canada’s CANSIM database <http://cansim2.statcan.ca/>. Calculations by authors.

Table 3: Private Canadian corporate headquarters per 100,000 population, 2008 2008

Percentage change in concentration of corporate headquarters

Montreal

1.9

(7.9)

Toronto

3.0

(4.5)

Winnipeg

1.6

(29.4)

Calgary

6.5

(2.5)

Vancouver

1.6

(9.8)

Sources: FP Magazine, 2009; Statistics Canada’s CANSIM database: <http://cansim2.statcan.ca/>. Calculations by authors.

2 The five centers are defined as “Census Metropolitan Areas” by Statistics Canada for the 2001 census. This means, for example, that Toronto includes not only the City of Toronto, but also Mississauga, the fourth largest city for headquarter activity (headquarter count), as well as the municipalities of Ajax, Aurora, Bradford West Gwillimbury, Brampton, Caledon, East Gwillimbury, Georgina, Halton Hills, King, Markham, Milton, Mono, New Tecumseth, Newmarket, Oakville, Orangeville, Pickering, Richmond Hill, Uxbridge, Vaughan, and Whitchurch-Stouffville.

3 Forty-nine of these government-held corporations were wholly owned, while 90% of the 50th (Enersource Corp.) was held by the City of Mississauga.

4 Thirty-one percent of Power LP in Edmonton is owned by EPCOR utilities, which is wholly owned by the City of Edmonton. This organization is not counted as a government-held corporation here due to the minority nature of the holding.

References Financial Post Magazine (2009). The FP500. Financial Post Magazine (June): 41–112.

Statistics Canada (2009). Population of Census Metropolitan Areas (2006 Census Boundaries). Catalogue No. 91C0029.

Statistics Canada.

The full FP500 for 2008, as well as rankings for 2006 and 2007, can be found on the Financial Post’s website: <http://www.financialpost.com>.

www.fraserinstitute.org

Fraser Forum 10/09

11

Economic growth and the “curse” of natural resources Amela K arabegović

12

Fraser Forum 10/09

www.fraserinstitute.org

sometimes negatives rates of economic growth, while many nations that were poor in natural resources were experiencing much higher growth rates.

The adverse impact of natural resources on economic growth could come from two sources. Natural resource booms could lead to the shrinking of a nation’s manufacturing sector by artificially boosting the exchange rate (as resource exports increase) and/or by increasing costs in the economy as manufacturers compete with resource industries for workers, contractors, and so on. The second possible explanation for the resource curse is that natural resources have an impact on economic growth indirectly, weakening governments and institutions as different groups compete for resource revenues and power over resources, resulting in corruption.

This slows reform and reduces accountability, which in turn leads to poor economic performance.

However, a number of researchers have recently questioned the concept of the resource curse.

One of the first criticisms arose from the way natural resources are measured. Recent research (see, for example, Ding and Field, 2005) shows that when natural resources are more precisely measured—for example, in terms of natural resource capital per capita instead of primary exports as a percentage of the economy—the resource curse disappears. Primary exports as a percentage of the economy measures the extent to which a nation is dependent on natural resources; a high ratio is usually a sign of underdevelopment. The recent research indicates that it is not natural resource endowment per se, but rather resource dependence that has an adverse impact on economic growth.

Fotolia

I

n the past, natural resources were thought to create economic growth and prosperity. But in recent years, debate has flared over whether natural resources, such as minerals and metals, oil, agricultural resources, and so on, stimulate economic growth or act as a hindrance to growth. The idea that natural resources actually hinder growth is known as the “curse” of natural resources.

A recent Fraser Institute paper called Institutions, Economic Growth, and the “Curse” of Natural Resources examined the research on the resource curse and found that many of the studies that showed support for the resource curse hypothesis ignored the role of economic institutions.

The importance of the research on the role of natural resources in economic growth and prosperity cannot be emphasized enough as this research has the potential to shape the development policies of nations across the globe. Many developing nations, including those in Sub-Saharan Africa, are rich in natural resources; consequently, this line of research may play a role in their future prosperity. The goal of Institutions, Economic Growth, and the “Curse” of Natural Resources was to review the current state of the natural resource curse literature and determine whether it is cohesive and persuasive enough to affect critical policy decisions designed to enhance economic growth and relieve poverty.

In the early stages of this research, it appeared that the literature was reaching a consensus: the natural resource curse was both statistically and economically significant. These empirical findings were further supported by numerous examples of resource-rich developing nations—such as oil-rich Nigeria and Venezuela, and diamond-rich Sierra Leone—that experienced low and

iStockphoto

some of the bureaucratic obstacles that tempt individuals to engage in corruption in the first place and by increasing the likelihood of getting caught by establishing the rule of law, further mitigating the resource curse.

National leaders in developing nations who are seeking to build a strong economy would be wise to focus on building sound economic institutions—the rule of law, property rights, an independent judiciary and impartial judges, and limitations on government power. These institutions would increase prosperity and help their countries avoid the curse of natural resources.

The research into this question is still in its preliminary stages, but the importance of economic institutions in determining whether natural resources become a curse or a blessing is a key finding.

It enables resource-rich nations to better understand what policies are necessary to ensure a better standard of life for their citizens and to shape their policies accordingly to produce the desired results.

Fotolia

The second finding was that using a statistical analysis that is different than the analyses commonly used in the literature can change the results. For example, some studies found that analyzing data over time, rather than using averages of the data over the same period, eliminates the resource curse.

Moreover, some types of resources may have much stronger adverse effects than others. Primary commodities include a wide range of resources, agriculture, fuels, and minerals, all of which consist of subgroups. Some of the primary commodities are highyield or high-rent resources,1 such as diamonds, fuel, and non-fuel minerals, and are thus more likely to have a negative impact on economic growth and the quality of institutions. This is most likely because they create more opportunities for corruption and rent-seeking than agricultural resource endowment.2 The most important finding, however, was that institutions—such as the rule of law, which leads to transparency and accountability—play a significant role in determining whether natural resources become a curse or a blessing.

That is, early studies overlooked the role of institutions and possible interactions between natural resources and the quality of institutions. Nations with higher-quality institutions are more capable of managing their resource revenue and turning it into economic growth. On the other hand, when sound institutions are absent, monies from natural resources, instead of stabilizing a country’s budget and sparking growth, can deepen corruption, lead to conflict, and strengthen the concentration of power among the ruling elite who, directly or indirectly, manage these funds. Moreover, high-quality institutions also reduce incentives for rent-seeking and corruption by eliminating

Notes 1 In this case, “rent” refers to the difference between the price of the commodity and its production cost.

2 Rent-seeking is defined as efforts and resources spent on securing wealth through wealth redistribution.

References Ding, Ning, and Barry C. Field (2005). Natural Resource Abundance and Economic Growth. Land Economics 81, 4: 496–502.

Karabegović, Amela (2009). Institutions, Economic Growth, and the “Curse” of Natural Resources. Fraser Institute.

www.fraserinstitute.org

Fraser Forum 10/09

13

Forum Focus

FROM MARKET MELTDOWN

Is the recession ending?

Policy mistakes, past and present Fred McMahon

Dorothea Lange

M

any economists are now tentatively predicting that the end of the recession is nigh while also warning about the great uncertainties still troubling the economy. Yet not too long ago many believed that this recession could lead to another Great Depression and, possibly, to the end of capitalism as we know it.

This article looks first at some of predictions concerning the economic crisis and then examines the reasons why the situation may not be as dire as first predicted.

One example of a gloomy prediction comes from Roger C. Altman (2009: 2). He writes, “It is now clear that the global economic crisis will be deep and prolonged and that it will have far-reaching geopolitical consequences. The long movement toward market liberalization has stopped, and a new period of state intervention, regulation, and creeping protectionism has begun.”

Altman’s article, as well as others published in the widely respected Foreign Affairs magazine where it appeared, goes on to praise the Chinese model, arguing that “only China has prevailed” (Altman, 2009: 7).

Altman’s article is interesting for two reasons. First, the writer is not some left-leaning ideologue gloating over the defeat of markets and the victory

14

Fraser Forum 10/09

www.fraserinstitute.org

of state-managed capitalism. (This may be an oxymoron, but it does seem to be what the Chinese leadership has in mind.) Instead, Altman is a former Deputy Treasury Secretary who served under George H.W. Bush. Second, his essay is interesting because of when it was published—in the July/August 2009 edition of Foreign Affairs.

As this article is being finalized in early September, the dark talk of just a few weeks ago is dissipating.

Promising signs are appearing in Canada, the United States, Europe, and, yes, especially in Asia.

While the purpose of this article is not to review economic news from around the world—the reader will have much more recent data (good or ill) available than the author at the time of writing—a couple of examples are in order.

As early as the beginning of August, a Wall Street Journal poll of economists showed that the majority agreed with an earlier statement from Federal Reserve Chairman Ben Bernanke that the recession had already ended (Izzo, 2009, Aug. 11). Even before that, Bank of Canada Governor Mark Carney was ready to say that the recession was waning: “We’re on track for the recovery, both in Canada and globally … But it’s early days. I mean, it’s a long road” (Egan, 2009, July 23).

So why were the predictions of doom premature and, despite that, why are there still a number of threats to our economic recovery?

Five errors that created the Great Depression The world, by and large, has avoided four of the five big mistakes that created the Great Depression after the stock market crash of 1929. Even so, a number of potential problems remain.

Dorothea Lange

TO RECOVERY

Squeezing liquidity One error—perhaps the biggest one—was pointed out by long-time Fraser Institute friend, the late Nobel Laureate Milton Friedman. In numerous writings and particularly in a ground-breaking book he co-authored with Anna Jacobson Schwartz (1971), he showed that the squeezing of liquidity (which was caused by a significant shrinking of the money supply)1 caused a virtual collapse of the US financial system, leading directly to the Great Depression.

Whatever the flaws of monetary and other policy prior to the recent recession, central banks—particularly

the US Federal Reserve—have dumped shiploads of liquidity into the system, almost like the merchant ships of old that would dump their cargo to save themselves in a storm. That is not to say that all of these actions have been perfect, or that Friedman would have endorsed all of the tactics used—particularly the ones that could give rise to moral hazard2—but at least, with this strategy, the banks have moved in the right direction.

However, many would argue that too much liquidity has been created, raising the spectre of an inflation storm down the road. An outburst of inflation as the economy comes out of recession could force central banks to raise interest rates, cutting off the recovery, or not take precautions against rising inflation, risking a repeat of the economy-destroying inflationary spiral of the late 1960s to the early 1980s.

Wage inflexibility The second big error of the Great Depression was wage inflexibility. As Vedder and Gallaway (1997) show, after the start of what would become the Great Depression, governments, businesses, unions, and even church leaders colluded to keep wages high so that consumption would stay high and the economy would keep pumping away. However, higher wages meant that employers

www.fraserinstitute.org

Fraser Forum 10/09

15

Forum Focus

FROM MARKET MELTDOWN TO RECOVERY

The world, by and large, has avoided four of the five big mistakes that created the Great Depression …

Closing down trade The third big error of the Great Depression was the closing down of international trade, particularly after the infamous American Smoot-Hawley Tariff Act of 1930, which sent tariffs skyrocketing in the United States and launched a global trade war.

2009, July 23). However, protectionists are still out there trying to drum up support for those kinds of policies.

Radical ideologies The fourth catastrophe that deepened the Great Depression and led to even greater calamities was the rise of radical fascist and communist parties throughout the world.

Nothing like that has happened this time. For example, the business-friendly Ricardo Martinelli recently won the Panamanian presidential election and, in general, left-wing and populist parties are failing to gain popular support despite the recession (The Economist, 2009, July 30).

Vancouver Public Library

could not afford their workers because of deflation—the price of their products declined while wages remained stable—and unemployment soared.

In this recession, even the most militant unions— at least those in the private sector—have often been willing to make some concessions, even if the magnitude of those concessions was hotly debated. But as the economy recovers, unions could launch a whirlwind of catch-up wage demands, adding more turbulence to an inflationary storm.

Franklin D. Roosevelt Presidential Library and Museum

Government spending

While there has been much talk of protectionism during this recession—for example, in relation to “Buy American”3 policies—the protectionist measures that have been enacted seem fairly minor, and several countries have even lowered trade barriers (The Economist,

16

Fraser Forum 10/09

www.fraserinstitute.org

The fifth error of the Great Depression—an error that governments today are repeating—was the belief that massive government spending could end the downturn.

Debate still rages about the effects of stimulus spending—too big a topic to explore in an article of this nature, though the author personally believes that most stimulus spending is ineffective (for a discussion of this topic, see “Stop the ‘stimulus’ spending,” pg. 19).

Both friends and foes of stimulus measures worry about the potentially devastating effects of huge debts and deficits. While the Canadian government has its own stimulus package, the greatest danger lies south of the border.

The US government itself is predicting a deficit worth 11.2% of gross domestic product for this year. This deficit, which amounts to $1.58 trillion, is about three

… but a number of potential problems remain. persuaded by the lower price, it is likely that most will have simply purchased a car or house while they could take advantage of the subsidies, meaning that the US government is spending billions of dollars just to move purchases around in time.

Finally, vast government spending, particularly when financed through the printing of money, can boost inflation, leading back to the worries noted earlier. Moreover, if people believe that the spending will increase taxes in the future, they may anticipate these involuntary expenditures and cut back on voluntary expenditures. The full impact of these stimulus measures will only become apparent over time. times the deficit of the spendthrift George W. Bush in the last year of his administration. Next year’s deficit is estimated to be in the same ballpark ($1.502 trillion), and public debt is expected to rise to almost $10 trillion in 2010—about 70% of the US economy (OMB, 2009: 25).

This debt could be grounds for another crisis of confidence. Stability—not just for the United States but for the world more generally—depends on foreigners’ willingness to buy US debt, with China being the biggest player. Problems in this area could lead to all kinds of troubles: the collapse of the US dollar, escalating economic and political tensions between China and the United States.

Washington’s stimulus package may even sabotage itself. Massive but temporary subsidies for home and auto buyers in the United States—the home-buyer’s tax credit and the “Cash for Clunkers” program—increase immediate demand, but they also change price expectations. If people expect to pay subsidized prices, then demand for market-priced houses and autos will shift down (see “A clunker of an idea,” pg. 22).

The more serious effect is satiated demand. Those considering buying a house or a car may move their purchases up to take advantage of the subsidies, creating a void after the subsidies end. While some buyers may be

Other potential problems The problems discussed here are not the only potential problems. Also looming on the horizon are noneconomic threats, such as political problems that could cause an oil supply and/or price disruption in areas like the Middle East, Iran, Russia, and Venezuela.

Moreover, several factors that led to the financial crisis have not been fully resolved. Most worrisome are the many billions of dollars of unsavoury assets on the books of the American federally backed mortgage giants, Fannie Mae and Freddie Mac.4 Those two lenders have received a great deal of attention, but the quality of the mortgages held by their cousin Ginnie Mae has continued to deteriorate (The Economist, 2009, Aug. 13 and Aug. 20).

More problems in this area, plus federal mortgage guarantees, could further tax the US treasury, exacerbating the deficit problems discussed above. As of midAugust, the federal government had already pumped about $100 billion into Fannie Mae and Freddie Mac and had agreed to fund losses by buying up to $400 billion of equity (The Economist, 2009, Aug. 13).

So while the economic forecast is looking somewhat brighter, a number of dangers remain ahead.

www.fraserinstitute.org

Fraser Forum 10/09

17

Forum Focus

FROM MARKET MELTDOWN TO RECOVERY

Notes

References

1 As Investopedia (2009) explains, “a liquidity squeeze occurs when a financial event sparks concerns among financial institutions (such as banks) regarding the short-term availability of money. These concerns may cause banks to be more reluctant to lend out money within the interbank market.

As a result, banks will often impose higher lending requirements in an effort to hold onto their cash reserves. This cash hoarding will cause the overnight borrowing rate to spike significantly above its benchmark rate and, as a result, the cost of borrowing will increase.”

Altman, Roger C. (2009). Globalization in Retreat. Foreign Affairs (July/August).

2 Moral hazard occurs when a policy encourages perverse behaviour by protecting against bad outcomes. For example, having fire insurance may discourage one from taking precautions to prevent fires. Similarly, a belief that the government will bail out failing banks may encourage risky behaviour.

3 “Buy American” sentiments have been misrepresented in the Canadian media as a pure piece of American mischief.

In fact, the United States offered to negotiate a procurement agreement with Canada that would have foreclosed such policies, but Canada refused in order to protect mostly provincial procurement rules. See McKenna (2009, June 19) for an excellent brief discussion of this topic.

4 Some see these agencies as the principal culprits behind the financial crisis. See Walker (2009) for a fascinating discussion of their role in the crisis.

The Economist (2009, July 23). Unpredictable Tides. <http://www.economist.com/displaystory.cfm?story_ id=14082950>.

The Economist (2009, July 30). The Challenge of Turning Malcontents into (Sensible) Militants. <http://www.econ omist.com/world/international/displaystory.cfm?story_ id=14133716>.

The Economist (2009, August 13). The Toxic Trio. <http:// www.economist.com/businessfinance/displaystory.cfm? story_id=14214879>.

The Economist (2009, August 20). Where It All Began. <http://www.economist.com/businessfinance/display story.cfm?story_id=14258851>.

Egan, Louise (2009, July 23). Recession Ends in Canada, Says Upbeat Central Bank. Reuters. <http://www.reuters.com/ article/GCA-CreditCrisis/idUSTRE56M5UN20090723>.

Friedman, Milton, and Anna Jacobson Schwartz (1971). A Monetary History of the United States, 1867-1960. Princeton University Press.

Investopedia (2009). What Is a Liquidity Squeeze? Investopedia. <http://www.investopedia.com/ask/answers/07/liq uidity-squeeze.asp?viewed=1>.

Izzo, Phil (2009, August 11). Economists Call for Bernanke to Stay, Say Recession Is Over. Wall Street Journal. <http:// online.wsj.com/article/SB124993702311020493.html>.

McKenna, Barrie (2009, June 19). Provinces Have Only Themselves to Blame for Buy American Woes. Globe and Mail. <http://www.theglobeandmail.com/news/opin ions/columnists/barrie-mckenna/>.

Franklin D. Roosevelt Presidential Library and Museum

Office of Management and Budget [OMB] (2009). Mid-Session Review: Budget of the US Government, Fiscal Year 2010.

United States, Executive Office of the President. <http:// www.gpoaccess.gov/usbudget/fy10/pdf/10msr.pdf>.

18

Vedder, Richard K., and Lowell E. Gallaway (1997). Out of Work: Unemployment and Government in TwentiethCentury. New York University Press.

Walker, Michael (2009). The Great Collapse of 2009 (Part 1).

Online video clip. Fraser Institute. <http://www.fraser institute.org/newsandevents/frasertv/mike-walker-greatcollapse-2009-part1.htm>.

Fraser Forum 10/09

www.fraserinstitute.org

Stop the “stimulus” spending Canada must reduce the size of government Niels Veldhuis, Charles Lammam, and Milagros Palacios

iStockphoto

P

rior to the recent international meeting of finance ministers and central bank governors from G-20 nations, Canadian Finance Minister Jim Flaherty encouraged his counterparts to follow through on their stimulus pledges.

According to Flaherty, “What we need to do is continue to implement our stimulus package, not only in Canada, but in other countries around the world” (Reuters, 2009, Aug. 30).

Oddly, Flaherty’s push for stimulus comes at time when we are seeing signs that the end of the recession is near. As the economy begins to recover, government stimulus spending will compete with private sector investment and dampen the recovery. Rather than continue to roll out stimulus money, the Canadian government should tighten the reins and put forth a plan to reduce the size of the federal government. Doing so will ensure a brighter economic future. Our own history provides the evidence.

www.fraserinstitute.org

Fraser Forum 10/09

19

Forum Focus

FROM MARKET MELTDOWN TO RECOVERY

Government spending as a % of GDP

Recently released data from Statistics Canada presmonths of preparation before construction can begin, ents an encouraging picture of economic recovery, highand it may be years before the construction is complete. lighting a small increase in economic output (gross doWhile some money may be “committed” to certain projmestic product, or GDP) in June, the first monthly increase ects, most of the funds have yet to be spent and will not in nearly a year (Statistics Canada, 2009a). Furthermore, provide jobs in time to counteract the recession, which the Bank of Canada and most major Canadian banks are may already be ending (CBO, 2008: 19). predicting positive growth in Canada’s economic output Instead, there is a significant risk that a large portion (GDP) for the third and fourth quarters of the year (Bank of the stimulus package will hit the economy as it is natuof Canada, 2009; Shenfield, 2009; RBC Economics, 2009; rally moving out of recession. As a result, the “stimulus” TD Economics, 2009; BMO Capital Markets, 2009). If the will be destabilizing rather than stabilizing. The governpositive data from Statistics Canada continue and these ment will be competing with the private sector for scarce predictions come to fruition, the “great” recession of 2009 resources, resulting in increased costs and fewer private will be much like previous recessions, and nowhere close sector projects than would otherwise be the case. to the doomsday many predicted.

In addition, stimulus spending that is financed by Interestingly, the economy is showing signs of redeficits will “crowd-out” or replace private sector investcovery despite the fact that most of the stimulus spendment. Since governments borrow from the market and ing has yet to be implemented. For example, first quarter provide investors with “risk-free” government debt, they (January-March) real GDP results show that government compete directly with and supplant the development spending at all levels of government (federal, provincial, and financing of private projects, which are crucial to a and local) increased at an annualized rate of 1.2% (comsustained recovery. pared to 3.3% in 2007 and 3.7% in 2008). Government Rather than follow through on their stimulus pledge, capital investments increased at an annualized rate of 1.1% the Canadian government should return to the economic in the first quarter of 2009 compared to 6.0% in 2007 and policies of the 1990s that made Canada’s economy one of 12.2% in 2008 (Statistics Canada, 2009b). Put differently, the most vibrant in the developed world. They should put governments actually slowed their increase in spending forth a plan to reduce the size of the federal government. considerably during the early stages of the recession—hardly what one Figure 1: Size of government (general government outlays as a would call stimulus spending. percentage of nominal GDP), 1990 to 2010 While comparable data for the second quarter (April-June) has yet 60 to be released, the federal government’s June report to Canadians was intended to outline the progress 50 the federal government had made on its stimulus initiatives. In June, 40 Prime Minister Stephen Harper claimed that “fully 80 per cent of 30 our Plan’s funding has been committed and is being implemented across the country” (Harper, 2009).

20 Money being “committed” is very different from money actually 10 spent. Consider that the government claims that more than 40% of the total federal stimulus package 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 is being devoted to infrastructure projects (Canada, 2009). However, Sources: OECD, 2009a, 2009b. building infrastructure requires

20

Fraser Forum 10/09

www.fraserinstitute.org

Most Canadians are not aware of Canada’s 15-year (1992–2007) track record of reducing the size of government. After peaking in 1992, the size of government in Canada—best measured by total spending at all levels of government as a share of GDP—decreased from 53.3% to 39.1% in 2007 (figure 1).

If the politicians, journalists, and activists who claim that government spending creates jobs and increases economic activity are right, then the decreases in government spending in Canada during the 1990s should have negatively impacted Canadians and our economy.

In reality, the very opposite occurred: as governments reduced and constrained spending, a greater share of the resources in our economy was controlled by individuals, families, and businesses rather than governments. The result was a robust economy with average inflation-adjusted economic growth exceeding that in the United States and every other G7 country from the mid-1990s to 2007 (OECD, 2009b).

Since 2007, however, the size of government relative to the economy has increased dramatically, thanks mainly to the economic stimulus packages that the federal and provincial governments have implemented. The size of the Canadian government (all levels) is expected to reach 44.1% of GDP by 2010, a level not seen for more than a decade (figure 1). Unless the Canadian government enacts an aggressive plan to rein in spending, its legacy could undo nearly a decade of reductions in the size of government.

Implementing a spending plan aimed at reducing the size of the federal government would avoid the crowding out of private sector projects. It would also provide the fiscal room necessary to reduce economically damaging taxes, thereby encouraging economic activity and further strengthening the Canadian economy.

There is a long list of potential areas where Canadian governments could reduce or even eliminate spending with no effect on long-term economic growth or social progress, including regional development subsidies, corporate welfare, agricultural supports, and broadcast subsidies, to name a few.

Rather than encourage his global counterparts to follow through on their stimulus pledges, Finance Minister Flaherty should focus on scaling back his own government’s profligate spending. Reducing, rather than increasing, the size of government will ensure a faster economic recovery and a brighter future for Canadians.

References Bank of Canada (2009). Monetary Policy Report: July 2009. <http://tinyurl.com/lmvyqq>.

BMO Capital Markets (2009). Canadian Economic Outlook. <http://www.bmonesbittburns.com/economics/forecast/ ca/cdamodel.pdf>.

Canada (2009). Canada’s Economic Action Plan: A Second Report to Canadians. <http://www.plandaction.gc.ca/eng/ feature.asp?pageId=113>.

Congressional Budget Office [CBO] (2008). Options for Responding to Short-Term Economic Weaknesses. CBO. <http://w w w.cbo.gov/ftpdocs/89xx/doc8916/01-15Econ_Stimulus.pdf>, as of January 29, 2009.

Harper, Stephen (2009). Canada’s Action Plan at Work: A Second Report to Canadians. Prepared speech, delivered in Cambridge, Ontario, June 11, 2009. Office of the Prime Minister. <http://pm.gc.ca/eng/media.asp?id=2633>.

Organisation for Economic Co-operation and Development [OECD] (2009a). OECD.Stats Extract. OECD. <http:// stats.oecd.org/index.aspx>, as of September 8, 2009.

Organisation for Economic Co-operation and Development [OECD] (2009b). OECD Economic Outlook No. 85. OECD. RBC Economics (2009). Economic and Financial market Outlook: June 2009. Royal Bank of Canada. <http://www.rbc. com/economics/market/pdf/fcst.pdf>.

Reuters (2009, August 30). Canada’s Flaherty Says Too Soon to Trim Stimulus. <http://www.reuters.com/article/us DollarRpt/idUSN3041669120090831>.

Shenfield, Avery (2009). Shades of Grey. Forecast (September 11). CIBC World Markets. <http://tinyurl.com/nppcwa>.

Statistics Canada (2009a). Canadian Economic Accounts, Second Quarter 2009 and June 2009. The Daily (August 31). <http://www.statcan.gc.ca/daily-quotidien/090831/t dq090831-eng.htm>.

Statistics Canada (2009b). Canadian Economic Accounts Quarterly Review: First Quarter 2009. Catalogue No. 13010-X. <http://www.statcan.gc.ca/pub/13-010-x/13-010-x 2009001-eng.htm>.

TD Economics (2009). TD Quarterly Economic Forecast: June 16, 2009. TD Bank Financial Group. <http://www. td.com/economics/qef/qefjun09.pdf>.

A version of this article was published in C2C: Canada’s Journal of Ideas at <www.c2cjournal.ca>.

www.fraserinstitute.org

Fraser Forum 10/09

21

Forum Focus

FROM MARKET MELTDOWN TO RECOVERY

A clunker of an idea “Cash for Clunkers” offers no economic or environmental benefits Diane K atz

C

anadian politicians, both Liberal and Conservative, have expressed interest in replicating the United States’ “Cash for Clunkers” subsidy scheme to boost auto sales. Although touted as “wildly successful” by advocates (US Department of Transportation, 2009a), Ottawa has no plans to adopt a US-style program, according to Environment Minister Jim Prentice (CBC News, 2009, Sep. 3). That’s the right call given the lack of evidence that the program creates economic or environmental benefits.

Formally designated as the “Car Allowance Rebate System,” or CARS, the US program granted auto dealers a federal tax credit of $3,500 or $4,500 in return for lowering sticker prices by equal amounts on new models for which buyers traded in less fuel-efficient vehicles (US Department of Transportation, 2009b).1 While the program, which ran from July 27 to August 24, 2009, was in place, a total of 690,114 vehicles were sold, generating $2.9 million in rebate applications (US Department of Transportation, 2009b).

The program sales represent a gain of 26.7% in August compared to July, and a 1.3% increase compared to August 2008, according to Edmunds.com (2009, Sep. 1), a California-based automotive research firm.

US Transportation Secretary Ray LaHood has called Cash for Clunkers “a win for the economy, a win for the environment and a win for American consumers” (US Department of Transportation, 2009a). But a more objective evaluation, as detailed below, shows that the program is an object lesson in misguided policy. The subsidies definitely boosted vehicle sales, but did so at the cost of future auto purchases and other retail spending (Purdue University, 2009a).

“If the average monthly loan payment for a new car is $400, then the amount of money not available for retail sales per month could be $300 million,” says Richard

22

Fraser Forum 10/09

www.fraserinstitute.org

Feinberg, a researcher with the Purdue University Retail Institute. “That would translate to $1.5 billion taken out of circulation for the five months of back-to-school, preholiday and holiday sales.”

Moreover, contrary to proponents’ claims, replacing clunkers with more fuel-efficient vehicles will have no effect on the environment (Columbia Law School, 2009). However, analysts say the destruction of nearly 700,000 “clunkers” is likely to make used cars more costly (Kelly Blue Book, 2009).

“The effect of a supply reduction of this magnitude could have a monumental impact on the values for used vehicles,” according to a recent market report by Kelly Blue Book, the industry leader in automotive valuation (Kelly Blue Book, 2009).

Canada’s current version of the subsidy program, launched in January, is meager by comparison. “Retire Your Ride” offers a variety of rewards—from $300 cash to bicycles and bus passes—to consumers who dispose of vehicles of the model year 1995 or older. Few Canadians have actually used the program, in large part because the so-called clunkers are far more valuable on the open market than the incentive offered.

At the provincial level, British Columbia’s “Scrapit” program offers cash rewards ranging from $750 to $1,250 for the presumed reduction of greenhouse gas emissions resulting from the scrapping of older vehicles.

BC also offers provincial sales tax reductions ranging from $1,000 to $2,000 for the purchase of alternatively fueled vehicles and more fuel-efficient vehicles (British Columbia, 2009).

Despite the popularity of the US program, analysts do not expect that Cash for Clunkers will result in an auto industry rebound in the United States (Autoline Detroit, 2009). The uptick in sales largely represents both pent-up and future demand for new vehicles. According

Fotolia

“As a carbon dioxide policy, this is a terribly wasteful thing to do … The amount of carbon you are saving per federal expenditure is very, very small.”

— Henry Jacoby, Massachusetts Institute of Technology

Crowded showrooms certainly were welcomed by dealers. But the sales spike pales in comparison to the five million units needed to reach normal annual volumes by the end of 2009. Nor did the domestic automakers fare all that well under Cash for Clunkers, though that was the program’s intention. According to government data, all of the top 10 trade-ins were domestic brands (GM, Chrysler, and Ford), but only two of the top 10 purchases were a domestic brand (table 1) (US Department of Transportation, 2009c).2, 3 With inventories of popular models now running thin, sticker prices are expected to edge up in the coming weeks. Used car prices are also likely to rise because the Cash for Clunkers program required dealers to destroy the engines of all trade-in vehicles. Thus, some lower-income consumers will keep their older, dirtier, and more dangerous Table 1: Top 10 trade-ins and top 10 purchases under the vehicles until prices relax. The mass deCash for Clunkers program struction of some 700,000 engines also will reduce opportunities for recycling Top 10 trade-ins Top 10 purchases valuable auto parts (ARA, 2009).

1. Ford Explorer FWD 1. Toyota Corolla Particularly disturbing is the evidence that the Cash for Clunkers sub2. Ford F150 Pickup 2WD 2. Honda Civic sidies may have enticed consumers to 3. Jeep Grand Cherokee 4WD 3. Toyota Camry purchase new cars that they could not 4. Ford Explorer 2WD 4. Ford Focus FWD actually afford—suggesting that the government has learned little from the 5. Dodge Caravan/Grand Caravan 2WD 5. Hyundai Elantra consequences of the incentives it cre6. Jeep Cherokee 4WD 6. Nissan Versa ated to foster home ownership, which precipitated, in part, the crash of the 7. Chevrolet Blazer 4WD 7. Toyota Prius US housing market. According to 8. Chevrolet C1500 Pickup 2WD 8. Honda Accord CNW Research, 17% of program participants have said that they have “some 9. Ford F150 Pickup 4WD 9. Honda Fit or serious doubts” about their new car 10. Ford Windstar van 4WD 10. Ford Escape 4WD purchase—and first payments have not Source: US Department of Transportation, 2009c. even been made yet.4 Buyers’ remorse to “purchase intent” tracking by Edmunds.com, more than 100,000 US buyers put their auto purchases on hold until the program was launched (Anwyl, 2009, Aug. 3).

As Jeremy Anwyl, CEO of Edmunds.com, notes, “We have crammed three to four months of normal activity into just a few days. In effect, we are paying consumers to do something most would do anyway.”

Analysts are projecting a steep drop in sales in the coming weeks, just as experience elsewhere foretold.

Similar incentives in Germany between 1994 and 1996 boosted vehicle sales at a rate comparable to that in the United States (Schwartz, 2009, Mar. 31). However, this was followed by a “severe drop” in sales during 1997 and 1998, after the program ended.

www.fraserinstitute.org

Fraser Forum 10/09

23

FROM MARKET MELTDOWN TO RECOVERY

typically ranges from 6% to 8% within a month, according to Art Spinella, president of CNW Research (LeBeau, 2009, Aug. 25).

Consequently, households are cutting back on other spending, which certainly does not help the beleaguered retail sector that comprises the largest segment of the economy. Indeed, retail sales in July fell 0.1% after two months of modest gains (Rugaber, 2009, Aug. 13). Excluding autos, retail sales fell 0.6% although economists had forecast an increase of 0.7%. Sales estimates for August likewise appear weak (Holmes and Zimmerman, 2009, Sep. 2).

Much as been made about the environmental benefits of replacing gas guzzlers with more fuel-efficient vehicles. Even ignoring the empirical flaws of global warming theories, any fuel consumption savings are virtually meaningless in the larger scope of things. Various estimates peg the fuel savings prompted by the Cash for Clunkers program as equivalent to reducing carbon dioxide emissions by 700,000 tons per year—roughly the amount of CO2 produced hourly in the United States (Borenstein, 2009, Aug. 4a).

“As a carbon dioxide policy, this is a terribly wasteful thing to do,” said Henry Jacoby, co-director of the Joint Program on the Science and Policy of Global Change at the Massachusetts Institute of Technology. “The amount of carbon you are saving per federal expenditure is very, very small” (Borenstein, 2009, Aug. 4b).

The scant fuel savings are likely to be offset to some degree by the tendency of drivers to increase their travel after switching to a more fuel-efficient vehicle (Huber and Mills, 2005). Furthermore, replacing clunkers with new vehicles requires a huge energy investment, both in scrapping the old vehicles and manufacturing the new ones.

The only real boon of the program, therefore, appears to be the political capital garnered by Congress and President Barack Obama for appropriating $3 billion for the program at the behest of the United Auto Workers union and executives of General Motors Corp. and Chrysler Corp., to whom Washington has already given tens of billions of dollars.

With a looming deficit of $56 billion (Argitis and Donville, 2009, Sep. 10), Ottawa has no business even considering more generous subsidies to automakers. Canadian taxpayers have already lavished billions of dollars on GM and Chrysler. Spending taxpayers’ money on a subsidy scheme that delivers no benefits to the economy or the environment is a real clunker of an idea.

24

Fraser Forum 10/09

www.fraserinstitute.org

Fotolia

Forum Focus

Notes 1 The $4,500 credit applied if the new vehicle had a fuel economy value that was 10 mpg or more than the trade-in for passenger cars, 5 mpg or more for small trucks, or 2 mpg or more for large trucks. The $3,500 credit applied if the new vehicle had a fuel economy value that was between 4 mpg and 10 mpg greater than the trade-in for passenger cars, 2 to 5 mpg greater for small trucks, or 1 and 2 mpg greater for large trucks. Work trucks were eligible only for the $3,500 rebate if the trade-in was from the 2001 model year or older.

2 Many of the popular models made by foreign-owned auto manufacturers are in fact produced in the United States.

3 The government data on trade-ins and purchases have been disputed.

4 Consumers’ new debt load is exacerbated by the fact that— unbeknownst to many—the Cash for Clunkers subsidy is taxable for the purposes of levying sales tax on the vehicle purchase price, and is taxable as income in some states.

References Anwyl, Jeremy (2009, August 3). More Cash for Clunkers?

Wall Street Journal. <http://online.wsj.com/article/SB10 001424052970204619004574324350084909302.html>, as of September 1, 2009.

Argitis, Theophilos, and Christopher Donville (2009, September 10). Canada’s Flaherty Increases Budget Deficit Forecast. Bloomberg. <http://www.bloomberg.com/apps/ news?pid=20601082&sid=anQ_xJ80jlUA>, as of September 15, 2009.

Autoline Detroit (2009). Assessing Cash for Clunkers. <http://www.autolinedetroit.tv/show/1329/1>, as of September 15, 2009.

Automotive Recyclers Association [ARA] (2009). Car Allowance Rebate System (CARS). <http://www.a-r-a.org/content. asp?admin=Y&contentid=697>, as of September 1, 2009.

Borenstein, Seth (2009, August 4a). ‘Cash for Clunkers’ Effect on Pollution? A Blip. Associated Press. <http://www. google.com/hostednews/ap/article/ALeqM5gBK8ygR_ GgJVJ_9QEjvOcx4J8MxQD99SA4101>, as of September 2, 2009.

Edmunds.com (2009, September 1). Post-Clunkers Second Half Becomes Huge Sales Question Mark. Edmunds Auto Observer. <http://www.autoobserver.com/2009/09/postclunkers-second-half-becomes-huge-sales-questionmark.html>, as of September 15, 2009.

Holmes, Elizabeth, and Ann Zimmerman (2009, September 2). Weak Back-to-School Sales Spell Trouble for Holidays. Wall Street Journal. <http://online.wsj.com/article/ SB125185602188778185.html>, as of September 2, 2009.

Huber, P., and M. Mills (2005). The Bottomless Well. Basic Books.

Kelly Blue Book (2009). Blue Book Market Report - August 2009. <http://mediaroom.kbb.com/index.php?s=66&cat =7>, as of September 15, 2009.

LeBeau, Phil (2009, August 25). Clunker Blues? You Aren’t Alone. CNBC. <http://www.cnbc.com/id/32556597>, as of September 15, 2009.

Purdue University (2009a). Cash for Clunkers Could Drive Retail Sales into Slump. News release (August 5). <http:// www.lafayette-online.com/business/2009/08/cash-forclunkers-hurts-retail-sales/>, as of September 15, 2009.

Purdue University (2009b). “Cash for Clunkers” Could Shift Retail Sales into Reverse, Expert Says. News release (August 5). <http://www.purdue.edu/UNS/x/2009 b/090805T-FeinbergRetail.html> Rugaber, Christopher (2009, August 13). Bleak Sales Are Another Reality Check for Economy. Yahoo! Finance. <http://finance.yahoo.com/news/Bleak-sales-are-anoth er-apf-1948834182.html?x=0>, as of September 1, 2009.

Borenstein, Seth (2009, August 4b). Climate Experts Criticize ‘Cash for Clunkers.’ CNews. <http://cnews.canoe. ca/CNEWS/Environment/2009/08/04/10362086-ap. html?cid=rssnewsenvironment>, as of September 15, 2009.

Schwartz, Nelson D. (2009, March 31). In Europe, ‘Cash for Clunkers’ Drives Sales. New York Times. <http://www.ny times.com/2009/04/01/business/global/01refunds.html>, as of September 1, 2009.

British Columbia (2009). Encouraging Cleaner Choices. <http://www.bcairsmart.ca/transportation/cleanerchoic es.html>, as of September 15, 2009.

US Department of Transportation (2009a). Cash for Clunkers Wraps Up with Nearly 700,000 Car Sales and Increased Fuel Efficiency, US Transportation Secretary LaHood Declares Program “Wildly Successful.” News release (August 26). <http://www.cars.gov/files/08.26%20Press%20 Release.pdf>, as of September 1, 2009.

CBC News (2009, September 3). No Expanded Car Scrappage Program: Prentice. <http://www.cbc.ca/canada/story/20 09/09/03/scrappage-cars-not-expanded-jim-prent ice-environment.html>.

Columbia Law School (2009). Cash-for-Clunkers Program a Missed Opportunity to Reduce Greenhouse Gases. News release (July 31). Columbia Law School. <http://www. law.columbia.edu/media_inquiries/news_events/2009/ july2009/clunkers>, as of September 15, 2009.

US Department of Transportation (2009b). CARS: Helpful Q&As for Consumers. <http://www.cars.gov/faq>, as of September 1, 2009.

US Department of Transportation (2009c). CARS Program Statistics. <http://www.cars.gov/files/official-information /August26Stats.pdf>, as of September 1, 2009.

www.fraserinstitute.org

Fraser Forum 10/09

25

BC’s big-spending, tax-increasing budget New HST a bright light in BC’s September Budget Update Niels Veldhuis, Charles Lammam, and Milagros Palacios

T

he BC government’s September Budget Update is unlikely to live up to its promise of “protecting vital services” and “building for the future.” Instead, the big-spending, tax-increasing, debt-loving budget is a step back from BC’s recent progress and will burden, rather than benefit, British Columbians in the future.

First, there is the province’s seemingly unavoidable $2.8 billion deficit. According to Finance Minister Colin Hansen, the government was “forced into deficit” largely as a result of a loss of “$2 billion in expected revenues” (British Columbia, Ministry of Finance, 2009a: 1, 2).

However, total revenue for this year (2009/2010) is projected to be $37.6 billion, down from $38.3 billion in 2008/2009. Put differently, total government revenue is down by only about $700 million.

So why is BC facing a $2.8 billion1 deficit?

The real culprit is massive increases in spending. Government spending is up by over $1.8 billion,

26

Fraser Forum 10/09

bringing this year’s total to $40.1 billion—a 4.9% increase over last year when total spending amounted to $38.3 billion. Among the largest government programs, social services spending is up by 7.2%, health spending by 5.2%, and education spending by 4.0% (table 1).

The unfortunate reality is that 75% of the forecasted deficit for 2009/2010 is the result of profligate spending increases, not plummeting revenues (before the $250 million forecast allowance). In fact, if the government were to hold spending at its 2008/2009 level, then the budget could be balanced next year rather than in 2013/2014 as the government predicts (British Columbia, Ministry of Finance, 2009b: 5).2 The budget is also a demonstration of the BC government’s steadfast refusal to acknowledge that increased spending will not improve “vital services.” Health care is perhaps the best example.

As the finance minister pointed out in his speech, “provincial health spending has risen by 45%” since

www.fraserinstitute.org

2002 (British Columbia, Ministry of Finance, 2009a: 5). Despite the increased spending, the median wait time for medically necessary care is over 17 weeks, a delay that ranks among the worst in the developed world (Esmail et al., 2008a, 2008b). In addition, British Columbians’ access to doctors and medical technology significantly lags behind that in most other developed nations.

BC’s problems with health care, education, and many other government programs, have little to do with how much the BC government spends but with how it spends those dollars.

Rather than reform the health care system, the budget pledges to continually increase taxes for British Columbians through annual increases in BC’s Medical Service Plan (MSP) premiums to match ever increasing health care spending. Of course, as health spending far exceeds MSP premium revenue, this measure will only ease the budgetary pressure of health expenditures

Table 1: British Columbia’s budget projections, 2008/2009 to 2011/2012, in millions of $ 2008/09

2009/10

2010/11

2011/12

Total revenue

38,328

37,608

38,845

41,072

Total spending:

38,250

40,133

40,320

41,767

Health

15,121

15,911

16,555

17,527

Education

10,477

10,894

10,736

10,887

Social services

3,245

3,480

3,533

3,497

Other expenses

7,263

7,622

7,008

7,070

Debt charges (interest)

2,144

2,226

2,488

2,786

78

-2,525

-1,475

-695

0

-250

-250

-250

78

-2,775

-1,725

-945

19.1%

22.4%

24.8%

25.7%

Deficit (before forecast allowance) Forecast allowance Surplus (Deficit)

Provincial debt: Total provincial debt as a % of GDP

Source: British Columbia, Ministry of Finance, 2009b.

Figure 1: Total provincial debt as a percentage of GDP, 2000/2001 to 2011/2012 30

Percentage of GDP

25

20

15

10

5

0

1 2 3 4 5 6 7 8 9 0 1 2 0/0 001/0 002/0 003/0 004/0 005/0 006/0 007/0 008/0 009/1 010/1 011/1 2 2 2 2 2 2 2 2 2 2 2

200

Sources: British Columbia, Ministry of Finance, Provincial Budgets from 2004 to 2009.

www.fraserinstitute.org

and will ultimately do little to make health care sustainable.

The budget does contain some small tax reductions, including decreased personal income taxes (through a higher basic personal exemption) and lower small business taxes. In addition, British Columbians will benefit greatly from the previously announced implementation of a harmonized sales tax (HST), which will encourage business investment and lead to higher rates of economic growth (Veldhuis and Lammam, 2009).

However, the increased MSP premiums and slightly greater sales taxes that British Columbians will pay under the new HST will offset the other small tax reductions and result in a net tax increase for British Columbians. At a time when families are already struggling, the government is making things more difficult by increasing, rather than decreasing, taxes.

Most troubling of all is the alarming increase in government debt. Yearly deficits coupled with a significant increase in capital spending will increase government debt by an alarming $14.7 billion, or 39%, over the next three years.

As a percentage of the total output of the province’s economy (GDP), the provincial debt will increase from a low of 18% in 2007/2008 to 26% in 2011/2012, approximately the same debt level the Liberals inherited from the previous NDP government back in 2001 (figure 1).

Because of this dramatic increase in debt, a substantially larger portion of provincial revenues will be devoted to interest payments instead of funding government programs or improving the competitiveness of BC’s tax regime.

Apart from the implementation of the HST, British Columbia’s 2009 September Budget Update is continued on page 31

Fraser Forum 10/09

27

OPPORTUNITY COSTS Calculating the alternatives Niels Veldhuis

T

hough we may not realize it at the time, most of us get our first dose of economics at a relatively early age. More often than not, our first exposure to economics is through the concept of opportunity costs. When economists refer to the “opportunity cost” of an action or purchase, they are referring to the value of the next best alternative to that action or purchase.

The opportunity cost of something is what you give up in order to get it. The “opportunity” in opportunity cost reminds us that an opportunity was forgone in taking a particular action or making a purchase.

The concept of opportunity costs hit home recently while my wife and I were babysitting our three-yearold nephew. We wanted to buy him a small toy. At the toy store, our nephew found plenty of toys he wanted.

We were thankful that he eventually gravitated toward a truck and a steam-train engine, both of which were affordably priced at $10 each. When we were ready to leave, we told our nephew that he had to choose between the two. He reluctantly chose the truck and in doing so clearly understood that the cost of getting the truck was the lost opportunity to get the train. The opportunity cost of the toy he chose (the truck) was the toy he gave up to get it (the train).

running her small business was the largest portion of the total cost of her trip. Laura estimated that she would lose approximately $3,150 in income during her twoweek vacation. The total opportunity cost of the trip was the value of the next best alternative: staying at home and working. If Laura decided to stay home, she would have earned $3,150 and not spent $1,500 on a flight. Therefore, the opportunity cost of her trip was $4,650.

This hairdresser is no economist, but her calculation indicates that she understands the concept of opportunity costs better than most.

KEY CONCEPTS

Another example of the importance of opportunity costs in economic reasoning came up during a recent conversation with my friend Laura, who runs a hairstyling business. For some time, Laura has been planning to take a two-week holiday in Europe to visit family. She made a budget and estimated that the flight to London would cost $900. However, since she calculated her budget, ticket prices have increased to roughly $1,500. Being an economist, I asked her whether the increase was enough to make her reconsider her trip. Laura told me that the increase would likely not make her reconsider because it was not the most significant cost. Indeed, she said that the income she would have to forgo while not

28

Fraser Forum 10/09

www.fraserinstitute.org

Opportunity costs are also extremely useful in analyzing government policy, though they are unfortunately often glossed over by those proposing the policies.

When governments, politicians, and interest groups propose new government programs or increased spending on existing programs, the benefits of their proposals are most often their single focus. For example, governments frequently provide subsidies to certain industries (often ones that are not doing well), claiming that the money will create jobs and improve the economy. Likewise, governments often subsidize sports stadiums with the hope of attracting a major

instead of being extracted by governments. For example, taxpayers would have spent the money on all sorts of goods and services or invested it in the economy, and done so in a way that more accurately reflected their preferences.

The opportunity cost of government programs also includes the costs of the taxes themselves, as well as the resources used by governments to collect taxes and the costs borne by individuals and businesses to maintain appropriate tax records and comply with various tax rules.

Fotolia

It is important to remember, as well, that collecting taxes distorts the economy by influencing our incentives to work, save, and invest. That is, taxes reduce the return (the after-tax income) people receive from these activities, which ultimately reduces how much people are willing to work, how hard they work, and the amount they save and invest.

professional sports franchise or keeping an existing franchise from moving to another city. The argument for using millions of taxpayers’ dollars to subsidize the construction (and in some cases operation) of stadiums is that attracting a major sports franchise will positively influence the jurisdiction’s economy by increasing jobs and incomes.

When governments or others focus exclusively on the benefits of a subsidy (real or not), they do not account for alternative uses of the funds. For example, the funds used to subsidize companies or build stadiums could have been spent on transportation infrastructure, medical technologies, or education, all of which might have had a more positive impact on the economy and created better overall social outcomes than corporate subsidies or sports stadiums.

But the opportunity cost of government programs goes beyond just alternative uses for the money. An analysis of the opportunity cost of government programs must include the economic outcomes that would have been achieved if the money was left in taxpayers’ pockets

Clearly, there are costs associated with imposing new taxes or increasing existing ones. When these costs are considered as part of the opportunity cost of government programs, the claims made by governments, politicians, and interest groups about the benefits of these programs are often not true because they have not included the value of the next best alternative as part of their evaluation of the cost.

The concept of opportunity costs is relevant to all aspects of our lives. Whether the decision is an individual day-to-day decision, a major investment decision, or a government policy decision, the cost of undertaking a particular action or making a purchase is ultimately determined by the value we place on the next best alternative.

Suggestions for further reading Bastiat, Frederic (1995). Selected Essays on Political Economy.

Foundation for Economic Education.

Buchanan, James M. (1999). The Collected Works of James M. Buchanan (Vol. 6). Liberty Fund, Inc. Jorgensen, Dale W., and Kun-Young Yun (1991). The Excess Burden of Taxation in the United States. Journal of Accounting and Finance 6: 487–508.

*Key Concepts is a series of essays on the fundamentals of economics and markets. In addition to appearing in Fraser Forum, these essays will form the basis of a live Ask the Professor discussion, held at www.fraserinstitute.org each month.

Please join us on October 29 at 11:00 am Pacific time for an online discussion of this essay with Niels Veldhuis.

www.fraserinstitute.org

Fraser Forum 10/09

29

The right tool for the job?

Capitalism provides the best means to achieve social ends Fotolia

John Robson

I

f you have ever tried to sink screws with a hammer then you probably know that a hammer is not the right tool for the job. But if you kept trying despite repeated failure, I expect that it would have eventually dawned on you that you were a chump. It is curious that no such mental process seems to operate in the public policy world, where failed methods remain highly popular.

It is especially odd since, in principle, we all favour matching tools to jobs. Indeed, consider the philosophy of two of the twentieth century’s most famous socialists, Sidney and Beatrice Webb.

Reading my grandfather’s old copy of their 1923 The Decay of Capitalist Civilization, I was delighted to find in it a fictitious report from an alien visitor who firmly denies “that the inhabitants of the Earth are showing any approach to sanity.” The alien reminds his readers that “we are forbidden, by our instructions, to inquire into the ultimate aims or ideals of the Earthians” but must take “as the test of the sanity of individuals or races, sanctioned by the law of the universe, the capacity of selecting the appropriate means to a given end, as verified by the subsequent event. The end or ideal of the Earthians is not in dispute. They are never tired of asserting to each other, with fatuous smiles, that the end they have in view is the health and happiness of the whole community.” Yet, to

30

Fraser Forum 10/09

www.fraserinstitute.org

the alien visitor’s indignation, humans persist in adhering to capitalist economics.

This passage amused me because, during my time with the Fraser Institute, I frequently heard Michael Walker insist that his argument with socialists was not about ends, but about whether the means they advocated would actually lead to those ends. He frequently referred to Sir Roger Douglas, a socialist finance minister in New Zealand during the 1980s, who undertook a sweeping program of deregulation in the late 1980s on the grounds that special legal privileges tend to increase rather than decrease inequality. But I never thought Mike Walker and Sidney Webb would agree.

The Webbs’ alien visitation pleased me for two main reasons. First, 86 years after the book was written, I Fotolia have no doubts about what a dispassionate space being would say about the comparative effectiveness of central planning versus markets in delivering health and happiness to human communities. And, second, I think it offers a splendid opportunity to avoid the sort of head-banging arguments that so often prevent real intellectual progress.

The Decay of Capitalist Civilization, by the way, is as good a manifesto for socialism as one could want. Though slightly dated, it is intelligent, humane, reasonably argued, and mainly civil in tone. Free marketers should read it, partly because we cannot ask socialists to take the time to

understand our arguments if we will not take the time to understand theirs. But there’s another reason.

If we take the Webbs at their word, in the above passage and elsewhere, their socialism is not an economic doctrine at all. However fervently they advocate central planning, abolition of profit, and so on, these policies are, in principle, just tools selected on pragmatic grounds to achieve ends that are primarily social and moral, and do not entail a commitment to any particular economic methodology. What makes the Webbs socialists is not fatuous hostility to marginal utility as an analytic device.

Rather, they are outraged at poverty, social exclusion, selfishness, greed, the blighting of lives, and smug callousness. And why not? I know socialists tend to insist that such things are inherent in capitalism, often in offensive tones. But most capitalists would admit that, except when provoked beyond endurance by some obtusely interventionist polemic, they are against that stuff, too.

Consequently, it should be possible to argue a socialist out of his or her most ill-advised proposals without insisting that they jettison their core beliefs. You could even start by saying that you share those beliefs.

Please remember here that the classic line, “Greed is good,” is not ours. It came from a deliberately unsympathetic character in an Oliver Stone film. And most of

us do not agree. Why should we allow the discussion to get sidetracked by this statement, or agree to wear it in public?

Most businesses that make money for any length of time flourish because the people involved love what they do and play fair. For instance, Sam Walton, founder of Wal-Mart, cannot plausibly be portrayed as having done what he did for the money or having done it dishonestly.

And would you not prefer to invest in a restaurant where the chefs love cooking more than cash?

So it is possible to agree with socialists that greed is not good without giving up your stance on incentives, property rights, or capitalism. Instead, when you meet someone using a hammer to drive in a screw, you can say, “Pardon me, but I notice that you are getting hot, tired, and flustered, and are making a mess of that job. You really need one of those pointy things with the square tip. So put down that hammer for a second and let’s talk about the Webbs.”

Reference Webb, Sidney, and Beatrice Webb (1923). The Decay of Capitalist Civilization. Fabian Society.

BC’s big-spending, tax-increasing budget Continued from page 27 the wrong approach for these difficult economic times. Unfortunately, the BC Liberals have bought into the idea that a spendthrift government will help the province out of the economic recession and “protect vital services.”

These massive spending increases, large deficits, expanding debt, and tax increases are reversing the Liberals’ record of sound fiscal management. Let’s hope future budgets return to the economic policies that have made BC’s economy one of the most vibrant in Canada. Controlled spending, tax relief, and lower government debt are policies that would truly build for the future.

References

Notes 1 The projected deficit is $2.5 billion before the $250 million forecast allowance.

Esmail, Nadeem, and Michael Walker (2008b). How Good is Canadian Health Care? 2008 Report. Fraser Institute. <http://www.fraserinstitute.org/researchandpub lications/publications/6353.aspx>.

2 The deficit does not include the $250 million forecast allowance, a budget line item that protects against unanticipated events that might impact revenue or expenditures.

Veldhuis, Niels, and Charles Lammam (2009). Smart Thinking on Sales Taxes. Fraser Forum (September): 8–9.

British Columbia, Ministry of Finance (2009a). September Budget Update 2009: Budget Speech. <http://www. bcbudget.gov.bc.ca/2009_Sept_Update/highlights/ Highlights_Sept_2009.pdf>.

British Columbia, Ministry of Finance (2009b). September Budget Update 2009/10 – 2011/12. <http://www. bcbudget.gov.bc.ca/2009_Sept_Update/bfp/Budget_ and_Fiscal_Plan_Sept_2009.pdf>.

Esmail, Nadeem, and Maureen Hazel, with Michael Walker (2008a). Waiting your Turn: Hospital Waiting Lists in Canada (18th ed.). Fraser Institute.

www.fraserinstitute.org

Fraser Forum 10/09

31

Farewell to

Rose Friedman

O

n August 15, I learned that my friend Rose Friedman had been hospitalized for a heartrelated event. By the time I got the message, she was back at her home in Davis, California, but as she was in her 99th year, I dropped everything and flew down to California that night. I phoned Rose en route to tell her that I was coming. Not for the first time I was surprised by the vigour and clearness of her voice. The next morning, when she came to answer my knock at her door, I received the usual warm smile, a little laugh, and a big hug.

Notwithstanding the fascinating, absorbing, and celebrity-filled life she lived, Rose Friedman was one of the most down-to-earth people and most easy to talk to that I have encountered. And so, as ever, we fell into converRose and Milton Friedman at the Fraser Institute in 2003 sation about her health, how much she missed Milton, a wide variety of current affairs issues, death, religion, China and the recent release of the memoir of Zhao One very important policy and practical issue for many Ziyang, and the fantastic life she had lived. Her conversational citizens about which they completely concurred was the need skills, so much engaged in what was to be her second last day of to provide families with the ability to choose their own schools. life, were an important part of Rose Friedman’s contribution to They were of one mind that the most important issue for the the development of sensible economic policies around the world. future was the adequacy of the mechanisms that develop the huDuring the course of their seven decade long collaboration, man capital of the nation. They had grave misgivings about the Milton and Rose together produced four books. The first, Capieffectiveness of the largely government operated school system talism and Freedom, like the subsequent, Free To Choose and The in the United States and resolved to use the residue of their estate Tyranny of the Status Quo, was the result of ongoing conversato create a new organization, the Milton and Rose D. Friedman tions between Rose and Milton about how human behaviour is Foundation, which would have as its objective the attainment of affected by incentive systems and particularly how it is affected school choice for every family in America. by government interventions. Their conversations started when Their vision of a day when parents, not governments, would Milton Friedman was seated next to Rose Director in an alphaallocate government funding to schools continues to be pursued betized seating plan for an economics class at the University of by the Foundation for Educational Choice, the successor to the Chicago. Because they recorded the results of those conversafoundation they created. tions in three books, the world will forever have the benefit of their insights about the fragility of freedom and how important When Rose said—and she said it often—that she and Milit is to human development. ton never disagreed about anything important, she was referring to family issues. As we reminisced on that last day, she pointed It is easy for casual observers to suppose that Milton was out that this was largely because Milton was so easy to get along the key driver in these collaborations because he was the fawith and had such a good sense of humour. In fact, it could be mous economist. The truth is that while Milton Friedman was said that she and Milton had the perfect marriage in that they the spokesperson for the family enterprise, when the subject was completed each other. the relationship between citizens and the state, Rose was often the entrepreneur and provocateur. It was Rose’s penetrating Of necessity, the death of one partner in such a union is questions about topics of great concern to ordinary citizens that bound to leave the other bereft, and that was certainly the case made Free to Choose one of the most powerful instruments for with Rose Friedman. She could not bear the separation from her economic policy change that the world has ever seen. partner of nearly seventy years. She was as clear minded, genial, and intellectually energetic in our last conversation as she had The power of Rose’s intellect and the strength of her opinions been in our first, and as I left to go to the airport, she was preparon a wide variety of subjects were dominated only by her coming to go out with mutual friends for dinner and the theatre. But plete devotion to Milton and her desire to ensure that he would for all that, she carried with her a void that could not be filled. be the focus of all attention both inside and outside the family.

This did not prevent her from having very strong opinions on We should not mourn Rose’s passing. When she died the every topic and particularly on those that were currently in the next day, it was the completion of a perfect life and the end of news and likely to be the subject of discussion on social occasions. her separation from Milton. We should celebrate the enormous intellectual and practical policy gift that she and Milton have left And Rose did not always agree with Milton about policy the world and the wonderful example they set for us all in how and politics. Often the source of Rose’s contention was rooted to live life. in her practical and pragmatic approach to these issues. Their most famous recent disagreement was about the advisability of —Michael A. Walker pursuing the war in Iraq.