EDonomics 101

In yesterday's post about Ontario's planned sale of Hydro One, I wondered how Premier Kathleen Wynne had persuaded former banker Ed Clark to support the deal, given that he initially recommended against it. Evidently I wasn't the only one pondering this, because reporters put the question directly to Clark himself. His response can be found at the end of this article from today's Toronto Star. It's worth picking apart, because I get the clear impression that Clark is rationalizing to himself something that he doesn't really believe.

Here's the full quote; exegesis follows.

“Do you believe that infrastructure is an important element of a modern economy and will the economy perform better if we put the money into infrastructure?” said the Bay Street tycoon.

“My personal view is that the rate of return for infrastructure is higher than the rate of return that we’re in a sense getting compensated for when we sell these shares, so the province is making money — it may not be the provincial government is making money.”

• "Do you believe that infrastructure is an important element of a modern economy..."

 Absolutely no problem with that!

•  "...and will the economy perform better if we put the money into infrastructure?" 

Well, that depends on the infrastructure you put the money into. Is the $480 million that Ontario spent to jerry-build a train to the Toronto airport that runs 90 percent empty making the economy perform better?  How about the long-mothballed Mirabel airport north (waaaay north) of Montreal? It's obviously not going to be Ed Clark's decision where the money gets spent, but given the track record of Canadian governments in choosing where to invest, we might well be better off if it was.

• ....said the Bay Street tycoon. 

Oh, please! Clark was the very well compensated CEO of TD Bank but he was never the owner of the company, which is how I normally think of a tycoon. He's always been left-of-centre politically, which is why he's giving his time free of charge to try to help the Wynne government address some of its intractable financial issues.

• "My personal view is that the rate of return for infrastructure is higher than the rate of return that we're in a sense getting compensated for when we sell these shares...."  

That starts very poorly -- you'd hope that there was more than a "personal view" on the relative rates of return on infrastructure and Hydro One -- but of course, whether Ed Clark is right about that depends on what exactly the Province spends the money on, and as I just noted, that's out of Clark's hands.

• "...so the province is making money -- it may not be the provincial government is making money". 

Right; returns on infrastructure investment, unless you capture them directly (through tolls on a new highway, for example), don't tend to accrue as returns to the body making the investment. Instead, as Clark is suggesting in the final phrase, the gains accrue more broadly (and largely non-measurably) in the form of greater overall prosperity.

All in all, you may be thinking, Ed Clark's explanation for his position holds up quite well. In what sense, then, is he (to quote the opening paragraph of this post) rationalizing to himself something he doesn't really believe?  Well, even if the returns on the infrastructure investments are higher than the return the Province currently earns from Hydro One, the fact remains that this is not the cheapest or most cost effective way to finance those investments. Selling a chunk of Hydro One is equivalent to the Province borrowing money at an equity rate of return, at a time when its own borrowing costs in conventional forms (via bond issuance) are much lower than that -- indeed, at an all time low.

That's what the Province's financial accountability officer is saying, in effect, when he says that the Hydro One sale will provide only a short-term boost to the provincial finances. Both the deficit and the debt will rise in the medium term as a result of the sale, unless the provincial government takes further steps -- but of course, if it were prepared to take those steps, it wouldn't be selling off part of Hydro One, would it?  Ed Clark, the highly experienced financier, undoubtedly knows this, and has surely imparted it in private to Premier Wynne, but like a good (if unpaid) team man, he's trying to stand behind the decision that the politicians have made.

A bad deal, still going ahead

When Kathleen Wynne's Liberal Party was running for office in the Ontario provincial election last year, it said nothing about privatizing Hydro One, the publicly-owned electricity distribution network. As soon as her government took office, however, Wynne commissioned former banker Ed Clark to look at ways of "monetizing" key public assets, including Hydro One and the provincial booze monopoly, the LCBO.

It's reported that Clark's initial recommendation was that Hydro One should be retained in full public ownership -- which, as we'll come to in a moment, is the only logical conclusion that can be drawn. However, Wynne needed funds to pay for some of her election promises, including a big program of infratsructure investment, and she somehow managed to persuade Clark to endorse a plan to sell off a majority interest (60 percent) in Hydro One to private investors.

Both of the opposition parties are opposed to the sale; so are large swathes of the media and, it appears, most of the public. Now we learn that the province's new financial accountability officer (a post created by Wynne herself) is warning that the selloff will only improve the province's financial position in the year it banks the proceeds of the sale; after that, the loss of a portion of Hydro One's reliable revenue stream will increase the provincial deficit year after year, obviously adding to the provincial debt.

The media are reporting this as if it's a shock-horror revelation, but in fact it's just simple financial math. Returns on equity are always higher than returns on debt because of the greater risks that the equity holder is taking -- debt is a first charge on cash flow. The discrepancy between the two returns is particularly high at present, when interest rates are so low. What Ms Wynne is proposing to do is to shed a productive asset and the equity returns it generates, rather than use Hydro One's cash flow to support low-interest borrowing to finance her spending plans. It's hard to understand how she persuaded the hard-headed Ed Clark to lend his name to this.

There is, of course, another angle to the story. Ontario is now apparently the single most-indebted sub-national jurisdiction in the world, a dubious encomium which it recently inherited from California. Much of the debt was incurred by Wynne's predecessor as Premier, the unlovable Dalton McGuinty. Wynne is desperate to avoid seeming as fiscally improvident as McGuinty.  No doubt, if she were to propose borrowing to fund her spending plans, the same opposition parties that are castigating her for the Hydro One sale would be even more outraged.

Despite today's report, therefore, there seems little likelihood that the sale will be halted. It's distressing, though, to think of what it says about the state of the provincial fisc. In the past I've compared selling public assets to selling the furniture to buy gin. If the financial accountability officer's report is correct -- which it is -- then even if Ms Wynne sells the furniture in the next few months, she'll be even less able to buy gin in a couple of years time.

Thoughts on Hurricane Patricia

To the relief of millions of Mexicans, Hurricane Patricia turned out to be much less fearsome than had been forecast. There may still be more damage to come, as the remnants of the storm head across the already soaked plains of Texas and up towards the Great Lakes, but for a storm that was briefly being described as the strongest ever recorded, it turned out to be, well, not all that.

Patricia's sudden burst of strength -- it went from a depression to a strong Category 5 hurricane in less than 24 hours -- was clearly due to the powerful El Nino in the Pacific, but that hasn't stopped meteorologists from drawing links to climate change. Maybe the most panicky weather guy of all, and the one most shameless about attributing individual weather events to climate change, is Eric Holthaus over at Slate. Here's what he wrote just before the storm started to weaken.

If I were to cite a one-off event, say the fact that last February was the coldest ever recorded in southern Ontario (you could look it up) to proclaim that climate change was a myth, I'd be quickly and condescendingly put in my place by an army of self-appointed experts, telling me that climate and weather aren't the same thing. Holthaus and others don't seem to be governed by the same rules, but that doesn't save them from withering sarcasm from the internet when their dire predictions turn out to be wrong -- just check out the comment string on the linked article.

Of course, that criticism in turn brings out the acolytes of climate science to silence the dissent. If you care to scroll through the comments on the article, you'll find one skeptic asking why the storm weakened sharply even before hitting land. This prompted one "expert" to respond: "Cooler water near the shore. Next question?",  At this point I was foolish enough to get involved, wondering why nobody had suggested that might happen until after it actually did. This got me into a minor scrap with a guy posting under the charming handle "Fetus Gerulaitis", who challenged my suggestion that climate science is much better at coming up with explanations for what just happened than at providing useful predictions of what will happen.

I'm not a climate scientist and I'm not a climate change denier.  I'm truly agnostic about the whole thing, but tend to think a version of Pascal's Wager is the best way to proceed -- better to be safe than sorry.  However, the fact that I may not be able to cite chapter and verse from peer-reviewed academic papers on the subject doesn't disqualify me from using my logical faculties to express an opinion on it. Let's give it a try, assuming you're still with me.

The most famous proposition in modern climate science is the Hockey Stick graph of global temperatures, most closely associated with Professor Michael Mann. Now of course, in looking back many centuries for climate trends, Mann did not have access to actual temperature records, so he had to use a proxy, and the main one he chose was tree rings. So far, so good, although there seems to be some dispute about whether the size of the rings in bristlecone pines is really a good indicator of temperature changes.

Within the last couple of centuries, actual temperature measurements have become available, so the researcher has the opportunity to splice that data onto the older, tree-ring derived stuff. In doing that, however, you'd surely want to check that for the period for which you have both sets of data, there's some degree of congruence between the two measurements. One of the main criticisms of Mann's work is that on finding that the tree ring data for recent decades did not match the rise in temperatures he discerned from actual measurements, he went ahead and spliced the two series together anyway.    

The other major criticism of Mann's work (and others on similar lines) is that the tree ring data seem to imply no natural variance in temperatures for many centuries, until a sudden upward trend emerges as fossil fuel burning leaps higher after the Industrial Revolution. What about the well-documented Medieval Warm Period and the subsequent Little Ice Age?  Well, guess what -- climate scientists are busying themselves in proving that those things never happened.  All that well-documented evidence of the River Thames freezing over every winter, of Europe-wide crop failures and the rest of it is apparently invalid when compared to studies prepared by academics using unverifiable proxy measurements of their own devising. (Unverifiable because if actual temperature data were available, there'd be no need to use proxy measurements in the first place).

One more thing and I'll stop! Climate change skeptics have been claiming for some time that the most recent data were showing a "pause" in the global warming trend, starting around 1998. Climate scientists, including the aforesaid Dr Mann, have come up with a number of explanations for this, mostly focusing on the theory that the deep oceans were somehow absorbing the extra energy. Needless to say, this possibility was never mooted until it became necessary to come up with an explanation of the pause.

But here's the thing -- the NOAA, usually seen as the go-to source on climate measurement, has gone back and adjusted the supposedly historical data and....there never was a pause at all! As the Church Lady would say, "isn't that conVEENient?'  Well actually, not really. If the new NOAA data are correct, then all of the highly confident theories that Prof Mann and others concocted to explain away the "pause" are wrong, aren't they?

I very much doubt if Fetus Gerulaitis will ever read this, but I'd like to thank him for getting me to think these things through again.  The science isn't settled: it never is.

Who dares, wins

Astonishing! If you had asked anyone in Canada, when the election campaign began more than eleven weeks ago, what was the least likely outcome, the answer would have been "a Liberal majority government". Yet that's what we now have -- and indeed it's a solid majority that will easily last a full term. Stephen Harper has already announced his resignation as Tory leader, and will probably hand over power to incoming PM Justin Trudeau by the end of the week.

In the end it appears that the electorate's desire for change, after ten years of Harper's bludgeoning style of government,  easily outweighed the Tories "trust us and fear everyone else" message. This was always possible and even likely, but when the campaign began, it seemed that the once-socialist NDP would be the beneficiaries -- after all, the Liberals were all but wiped out in the 2011 election. It seemed inevitable that the NDP and the Liberals would split the ABC (anyone but Conservative) vote, possibly allowing Stephen Harper to cling to power as the leader of a minority government.

Where the NDP went wrong was in running the campaign as if the election was theirs to lose. By cautiously promising very little change -- balanced budgets, no major tax hikes -- the NDP effectively drove away much of the electorate for whom change was the main imperative. Trudeau's Liberals were far from bold, but the promise of tax hikes on high income earners and a three-year budget deficit to jump-start the economy at least held out the hope that things might be different.

It's interesting to speculate about whether the Liberal victory on a slightly old-fashioned tax-and-spend platform signifies a shift in Canadian attitudes. Harper's resolutely anti-tax, anti-deficit rhetoric has permeated all levels of government in the past decade, to such a degree that when Trudeau first unveiled his economic programme, it seemed to many like a suicide note. However, coupled with the success of the NDP in the Alberta provincial election earlier in the year, the Liberal win may be evidence that the Canadian electorate is no longer convinced of the benefits of never-ending austerity.

Whether that viewpoint persists will, of course, depend on how good a job the Liberals are able to do once they take office. After a decade out of power, the party is not in a position to call on many MPs with previous ministerial experience -- Trudeau himself is a Cabinet neophyte. Some of the party's elder statesmen -- Jean Chretien, Paul Martin -- may offer advice, but Trudeau will have to be careful about how much he listens to them if he wishes to maintain his image as a bringer of change.

The key post in the government, given the party's tax and deficit pledges, will be the Finance Minister. Setting a credible budget plan for the entire four-year term that resorts to modest deficits for three years but a return to surplus in the final year will be a difficult challenge, especially as it implies a return to a degree of austerity just as the government is gearing itself up for the next election.

Many months ago, Trudeau told a TV interviewer that the best approach to balancing the budget was to get the economy growing faster. That would boost revenues, and then "the budget will balance itself". The Tories tried to use that last phrase, minus the context, to damn Trudeau as too naive to run the economy. The fiscal plan that Trudeau and his new Finance Minister will be putting into place may show us who's right.  

Fiscal fibbing

Stewardship of the economy has been one of the key issues in the Canadian election campaign, now mercifully nearing its end -- we head to the polls on Monday. Liberal leader Justin Trudeau has distanced himself from both the Tories and the NDP by promising to run small deficits for three years in order to jump start the economy. The other parties have jumped all over this, accusing Trudeau (or "Justin" as Harper always calls him) of irresponsibility.

The myth that right-wing parties are better managers of the public purse dies hard: just a couple of nights ago, a Tory-supporting friend of mine, while watching the Blue Jays knock off the Texas Rangers, listed Trudeau's deficit pledge as his key reason for supporting Harper this time. Yet the facts clearly show that over the last two decades, it's the Tories that have run deficits, while the Liberals have run surpluses. Check out this interesting table for the facts.

Let's shorten the time frame just a little. Harper has been PM since 2006, so let's call that nine years, and compare it with the last nine years of Liberal government, under first Jean Chretien (1997-2003) and then Paul Martin (2003-06). All nine Liberal years saw budget surpluses. As for Harper, his government ran surpluses in 2007 and 2008, then deficits each year until the current one, when a small surplus was eked out. Deficits, in other words, two-thirds of the time -- and if you were really mean, you could say that the early surpluses actually reflected Liberal fiscal rectitude, and this year's surplus was only achieved through an asset sale.

Now there's a lot about this comparison that warrants caution. I don't like to compare politicians over time ('Harper has the worst record in creating jobs since the Great Depression", to quote one recent example) because each government can only play the cards it's dealt. We can't know whether Harper would have been as fiscally cautious as the Liberals were from 1995-2005 if he'd been PM then, any more than we can know how Chretien and Martin would have handled the financial crisis after 2008. Harper and his then Finance Minister, Jim Flaherty, were well-advised to put their principles on hold for a while at that time and run deficits to protect the economy from catastrophe. My only point here is that it's downright mendacious for a party whose fiscal record has been less than stellar to be painting his opponents as irresponsible.

The myth of that progressive parties are irresponsible is not just a Canadian one, of course. We just need to look south of the border for evidence. A key reason that Harper was able safely to run deficits in response to the financial crisis was the fiscal rectitude shown by his liberal predecessors for more than a decade. By contrast, Barack Obama's spending in response to the same crisis came after almost a decade of staggeringly poor fiscal management under President George Bush (43).  Interestingly enough, we recently learned that the US budget deficit for this current year will be the lowest since 2007, though that is unlikely to stop the GOP from painting Obama as a spendthrift.    

Turning briefly to the election itself, polls suggest that the Liberals will be the largest party in the Commons, but will fall short of a majority, so there will be a lot of wrangling and maneuvering in the days and weeks ahead. The Liberals' strong showing has surprised many -- including, at least in our riding, the party itself.  To run against a Tory incumbent, the party has fielded a visibly tired 70-year-old with no previous experience at the national level. It's impossible to imagine that they'd have done that if they had had any real thoughts of winning the seat. Given the way this seems to be turning out, you have to wonder how many similar placeholder candidates might actually wind up in the House of Commons by this time next week.

With apologies, another rant about the Bank of Canada

Bank of Canada Governor Stephen Poloz continues to amaze and astound, and not in a good way. Speaking on the fringes of the IMF/IBRD's annual bash in Washington, Poloz delivered some quite remarkable thoughts on the inflated level of household debt in Canada. Everyone, including the IMF, is telling Poloz that the debt is a problem and that he should be doing something about it. Poloz admits it's a problem but declines to do anything about it. 

Poloz is quoted in the linked article as saying that "We knew that easing policy would have implications for financial stability, However, we also knew that those concerns had to remain subordinate to the primary mission of achieving our inflation target and getting our policy back in the zone where the risks are balanced". 

Fine words, those,  that could have been uttered by Alan Greenspan or Ben Bernanke in the years and months before they drove the bus off the cliff back in 2007. Central bankers were supposed to have learned lessons from that, yet the only risks Gov. Poloz seems interested in balancing are the risks surrounding his 2 percent inflation target. If, in the process, the risk of a collapse in the financial system builds up again, well, that's just too bad. He's quite explicit about that:

“Even in extreme conditions, when financial stability risks constrain monetary policy from achieving the inflation target over a reasonable time frame, a central bank would want to ensure that all macroprudential options were exhausted before trying to address those risks with monetary policy,” he said.

Ah, but Gov. Poloz will retort that he is, so, concerned about financial system stability:  “What’s important now is that we finish the job. Ensuring the safety of the global financial system is in all of our interests. We can’t be distracted and lose sight of this objective,” he said.

It appears that Poloz believes that financial stability can be achieved in a world of sustained near-zero interest rates, historic levels of over-borrowing (by governments in the developing world as well as Canadian households) and increasing risk-taking by investors stretching for yield.  Forgive me if I (and, I may say, the IMF, which is becoming increasingly alarmed about the global debt mountain) disagree, very strongly. 

Data daze

Business economists like to tell clients that you shouldn't read too much into one monthly data point, but it's advice that they don't always follow themselves. Case in point: last week the US reported that employment rose by only 142,000 in September, significantly lower than expected. Just one reading, right?  No reason to panic. Yet a large majority of economists quoted by the media immediately said that the report was a clear indication that economic problems abroad, notably the slowdown in China, were starting to weigh on US exports. Market participants, many of whom had been expecting a rate hike in September, promptly priced out any likelihood of a Fed rate hike in this calendar year.

So what do we make of today's Canadian employment data, also for the month of September?  Headline number of jobs created: 12,000 -- moderately positive. However, behind that number there was a reported 62,000 loss of full-time jobs, against a 74,000 gain in part-time employment, so it can be argued that the total labour input into the economy actually fell slightly. In addition, the unemployment rate edged up to 7.1 percent -- moderately negative.  However, with the number of jobs increasing, this was attributable entirely to a rise in number of people seeking work, which is generally taken as a sign of worker confidence.

There are plenty of conclusions we can draw from this report. One is that Canada's labour force survey still seems to suffer from wonky methodology.  I've written here before about the wild gyrations that are reported for full-time versus part-time employment, or paid employment versus self -employment, that StatsCan reports almost every month, only to revise away subsequently. A full-time job loss of 62,000 in one month is surely significant if it's true, but even in the oil patch, there have been few news reports that could be taken as evidence of such severe job-shedding.

Turning to the sectoral breakdown, we find truly bizarre numbers from the educational sector: a 51,000 decline in employment in the month when the kids go back to school. Delving a little into the StatsCan report, it turns out that the actual number of people employed in the sector actually rose in the month, and it was seasonal adjustment that produced the reported decline. Might be time to take another look at the adjustment factors.

These quibbles illustrate very clearly why you shouldn't read too much into the monthly headline data: there's too much going on under the surface for you to draw reliable conclusions.  Not that that will stop anybody from doing so, but is there anything in today's report that helps us to get a handle on how the overall economy is performing? StatsCan is very helpful here, pointing out that employment grew more than 60,000 in the first quarter (when GDP was reported to have fallen), by more than 30,000 in Q2 (when a second straight GDP decline led the media to scream "recession") and by a further 20,000 in Q3, for which we don't yet have full GDP data. What's more, the total employment gain of 161,000 in the year to September was entirely accounted for by full-time employment.

True, Canada needs to create more than 161.000 jobs in a year to absorb the growth in the labour force. Still, it's hard to be outright pessimistic about these numbers, given what's going on elsewhere.  And it's all but impossible to believe that the economy was really in a recession in the first half of this year.  

Canada and the TPP

The Trans Pacific Partnership trade agreement that was reached in Atlanta overnight represents the culmination of five years of negotiation among the twelve participating countries.  Strange to say, the final push to get the stalled negotiations completed was provided by the Canadian election. Fears that the October 19 vote might produce a government in Ottawa that was much less favourably disposed to free trade finally broke the many logjams that had arisen.

Not surprisingly, Prime Minister Stephen Harper is lauding the deal, but with exactly two weeks left until polling day, this may be a risky strategy for him and his party. There can be little doubt that Canada's existing trade deal with the United States and Mexico, the so-called NAFTA treaty, has contributed mightily to the rapid erosion of the country's once-dynamic manufacturing sector that has been seen over the past decade and more. The painfully slow recovery in manufacturing that is now taking place in response to the weakness in the Canadian dollar is clear evidence that the sector has experienced an irreversible structural shift, and not just a cyclical slowdown.

Among the major opposition parties, the NDP has already indicated that it will not be bound by the new deal, while the Liberals seem inclined to read the fine print -- of which there will be a great deal -- before coming to a position. The Tories have promised that the new Parliament will have the final say on whether Canada signs the TPP treaty, but it seems inevitable that claims and counterclaims about its likely impact on the economy will be flying in the last two weeks of the campaign.

It's already known that the deal will make things even harder for the beleaguered auto sector, thanks to a slightly scuzzy side deal between the US and Japan over the content of "Japanese" vehicles sold in North America. Japanese manufacturers (and others) will now be able to include more components from cheaper sources in their vehicles while still claiming preferential tariff treatment. The difference -- a fall from a 60 percent local content requirement under NAFTA (i.e. 60 percent of the value of the vehicle from Canada the US and Mexico) to 45 percent under TPP (i.e. 45 percent from all twelve TPP countries) stands to be very significant for what's left of the auto sector in southern Ontario.

Fears that the Harper government would bargain away Canada's so-called supply management system for dairy products -- a scheme that keeps local farmers in business by ensuring that I pay three times as much for milk here as I would five miles away, across the border -- have largely been neutered. Very limited quotas for imported dairy products will be phased in, but it's much more likely that this will mean we start to see New Zealand cheddar in our stores than that the price of liquid milk will drop.

The full agreement will be published, we are told, in the next few days, at which point affected parties will presumably start to squawk.  One major element of the deal that has not been mentioned at all in the early going is the treatment of investment. NAFTA and the TPP are lazily described as trade deals, but it's very often the treatment of multinational investments that proves most significant (and contentious) in the long run. Expect Canadian nationalists to come out strongly against the deal if it affords foreign companies protection from the actions of Canadian governments and courts. (Come to think of it, expect Canadian nationalists to come out strongly against the deal anyway -- that's what they do.)

Canada's Trade Minister, Ed Fast, confidently asserts that the government "certainly doesn't expect" any job losses from the TPP. Pull the other one, Ed: the whole point of deals like this is to compel inefficient sectors of the participating countries to face competition from abroad, which inevitably means there will be job losses. The hope is always that these will be offset by job gains in other sectors.

Economic theory, relying on a concept known as comparative advantage, asserts that free trade deals always make the participating economies as a whole better off. Thus governments can supposedly redistribute the gains made by one sector to offset the losses incurred by another. Great in theory, but does it ever really happen? And in a huge country like Canada, where so much power is held by provincial governments rather than federally, is it ever really possible? It will be interesting to see how Messrs Harper, Mulcair and Trudeau answer those questions in the next two weeks.