Tampering with FDI

When it comes to the effects of foreign direct investment (FDI), Canada's policy makers have been an indecisive bunch. Our fickle policy stance has been a reflection of that. Surely this comes at a cost.

From The Globe and Mail (28 August), “Bernier backs bureaucrats on foreign investment”:

...Some Canadians view almost any foreign takeover as bad for Canada. Mel Hurtig, a publisher and noted economic nationalist, said foreign investment is almost always a purchase of an existing business, not an investment that creates a new operation. In the past two decades, he said, Investment Canada has reviewed $620.7-billion in foreign investment and that 97.1 per cent of that involved acquisitions. "Foreign investment is not good for us,” Mr. Hurtig maintains.

I'm of course making an example of an extreme view. Hurtig sees FDI as zero-sum and fails to recognize the ambiguous effects of FDI. Hurtig, who argues that FDI is invariably bad, is not alone with his view; however, surely he is the minority among economists. Still, this doesn't stop the media from pandering to them.

The point remains: over the years, policy makers have been indecisive about the effects of FDI. Canada's irresolute policy stance is a reflection of that. Never mind the inherent costs associated with FDI, surely a nation's indecisiveness comes at a cost, too.

Lucie Laliberte, “Globalization and Canada's International Investment Position,” Canadian Economic Observer (1993):

The Foreign Investment Review Agency (FIRA) was created in 1974 to screen new
foreign investment and to review foreign acquisitions of existing assets. This was followed in 1980 by the National Energy Program, which, among other things, also monitored the extent of foreign control in the energy industry. The foreign control ratio dropped dramatically from a peak of 36% at the end of 1971 to 23% at the end of 1986, largely through Canadian takeovers of foreign controlled companies. In 1985, Investment Canada was set up with the mandate of promoting, among other things, [FDI] in Canada. Subsequently, the foreign control ratio rose to 28% at the end of 1991. The recent gain in foreign control was widespread in non-financial industries except for two sectors (food, beverage and tobacco; electrical and electronic products) where foreign control declined.

Another paper points out, “Canada agreed to stop imposing performance requirements, such as requiring an investor to export a certain amount of goods, and) beginning in 1992, to stop screening U.S. direct acquisitions of Canadian assets of less than C$150 million (in constant 1992 Canadian dollars).”

The actions that Canada undertook (to allow FDI, and later to prevent FDI, and even later to promote FDI ...) occurred all the while that economic conditions varied (eg – changes in the exchange rate regime, increases in efficiency, changes to tariff structures). This makes the impact of FDI in Canada all the more difficult to account for. This only adds to the uncertainty about the merits of FDI.

One thing we can assume is that tampering with FDI policy (for example, performance requirements), is not a good thing. Never mind the costs associated with FDI in itself, it's surely not unreasonable to hypothesize that all of the potential volatility caused by Canada's indecisiveness could possibly be more costly. If the benefits of FDI are relatively greater in the long run, stylized fact would lead us to believe that turning the FDI tap on and off will damper the benefits the nation could reap. Studies have shown that with the proper performance requirements in place (when necessary, such as in certain cases in the mining industry) the benefits of FDI in Canada generally outweigh the costs (such as the loss of control of domestic policy) in the long run.

We can't agree on the merits of FDI, but surely Hurtig would agree that inconsistency hurts.

Capturing commodity prices

Yesterday Pierre Duguay, Deputy Governor of the Bank of Canada (BoC), gave a speech to the Canadian Association for Business Economics in Kingston.

He offered a (too short) introduction to the new model that the BoC uses (named ToTEM) to study how changes in terms of trade and the subsequent economic adjustment affect the economy. Duguay explains that the uniqueness of ToTEM is that it incorporates a separate commodity sector. He promises the BoC will issue a paper on the subject this fall. Until then, here is what he had to offer on the subject:

In contrast to the Bank's previous model, which treated economic activity as a single aggregate, ToTEM—which stands for Terms of Trade Economic Model—makes explicit the distinction between raw materials or commodities, and manufactured goods. This distinction is crucial for two reasons. First, commodity production represents a sizable proportion, some 11 per cent, of Canadian GDP, and commodity exports account for nearly 45 per cent of the dollar value of our total exports. Second, the commodity sector and the manufacturing sector are characterized by different technologies and different competitive structures, which have important implications for the behaviour of inflation.

For instance, the production of commodities is more capital-intensive and more price-inelastic than the production of other goods and services. Moreover, commodity prices are set in world markets, whereas manufactured goods are subject to product differentiation and to a greater degree of price-setting influence by firms.

In ToTEM, the key driver of consumer prices is the marginal cost of producing consumer goods. Consumer goods are produced using four inputs: labour, capital, an imported intermediate good, and commodities. In this framework, the marginal cost can be expressed as a function of labour costs (including the costs of hiring and training), as well as the price of imported intermediate goods, the price of commodity inputs, the price of investment goods, and the rate of capacity utilization.

ToTEM is a clear improvement over the previous model in its ability to capture the response of the Canadian economy and the Canadian dollar to changes in commodity prices. That's all I'll say about ToTEM for now. But this fall we'll be publishing an article in the Bank of Canada Review that will discuss this new model in some detail.

Yesterday's state-owned oil, today's debt

The Economist recently highlighted the problems of state-owned oil firms, namely how they influence prices and supply, and “...are prone to over-staffing, underinvestment, political interference and corruption.” From The Economist (August 12-18) “Oil's Dark Secret: National Oil Companies [NOC's]” (subscription req'd):

Few of the princes, politicians and strongmen who wield ultimate authority over these firms can resist the urge to meddle. At best, this leads to the sort of inefficiencies found at most state-owned firms: overstaffing and underinvestment. At worst, the business of pumping and selling oil is entirely subsumed by politics. In ither case, national oil companies produce less oil, more expensively, than they should.

The Economist may as well have been criticizing Canada for its fiasco with Petro-Canada, an experiment of the '70's in which we still have a debt to show for. Instead, the article gave Venezuela centre stage and spared Canada. We didn't deserve that. Not when more than 20 per cent of Canada's national debt is attributable to what we still owe for Petro-Canada, as reported by Neil Reynolds (“Petrocan debt has taxpayer over a barrel,” The Globe and Mail: Aug. 25 -- $ subscription req'd).
Here are some excerpts from Reynold's piece:

How much did Canadians pay for Petro-Canada? David L. Yager, a Calgary oil field service industry executive, asks it in a different way. How much are we now paying? The federal government sold its last Petrocan shares a couple of years ago, and you may have thought that we had finished with this sorry 1970s experiment in state-owned oil companies. Not so.

We sold off the assets for less than we paid, then kept all the debt. By Mr. Yager's calculations, a detailed spreadsheet that covers 25 years, we now owe $80-billion for Petrocan — more than 20 per cent of the national debt. At 5-per-cent interest, we're paying $4-billion a year for an enterprise we don't own. This is slightly less than we pay for national defence; slightly more than we spend for foreign aid.
***
Liberal prime minister Pierre Trudeau established Petrocan in 1975. In its first direct acquisition, the company paid $342.4-million for Atlantic Richfield (1976). It paid $1.4-billion for Pacific Petroleum (1979) and $1.4-billion for Petrofina (1981). It paid $347.6-million for Gulf's upstream assets (1982) and $1.8-billion for Gulf's downstream assets (1985). Along the way, it accumulated 10,000 people on the payroll, twice as many as it needed. Although oil prices collapsed in the mid-eighties, Petrocan kept spending. As Mr. Yager observed: “With its move into refining and retailing, Petro-Canada's original mission (security of supply) was forgotten. The new marketing slogan was ‘It's Ours.'
***
We'll never know the entire public investment but it had certainly exceeded $6-billion when Conservative prime minister Brian Mulroney put the company on a path to privatization.

For his calculations, Mr. Yager made two assumptions — that the funds for Petrocan's acquisitions were borrowed (and remained borrowed) and that the debt compounded in the normal way. He used the current value of the money in the years in which it was borrowed, then expressed the accumulated debt in 2005 dollars. He used the Bank of Canada rate (on each successive Jan. 1) plus one percentage point to determine interest charges. On the gargantuan balance, he says: “We'll continue to pay interest on this debt all of our lives. Rest assured that it is ours.”

The great (!) health care debate, pt II

Two days after my last post, I am a less bitter person. The health care debate isn't as ugly as I thought. In fact, it's exciting. I attribute my turn-around, in part, to the comments made in response to my last post, and to Dr. David Gratzer.

Dr. Gratzer is a physician (having practiced in Canada and the US) and, according to Milton Friedman, “a natural-born economist.”

His book, “The Cure,” is going to turn heads, guaranteed. We can expect to see it on shelves in October. It features a forward by Friedman and it looks very promising. Although, I wonder if the duo are advocating a health system that's more of a free market than the hybrid I prefer, or if they instead favour a mass reconstruction of the current U.S. hybrid system. Friedman has said that the U.S. “has a socialist-communist system of distributing medical care,” so I assume (rightly or wrongly) that my former presumption is the correct one.

From the book's Web page:

Dr. Gratzer mounts a bold and provocative argument, rejecting the conventional wisdom that socialized health care is compassionate and that top-down government agencies like the FDA actually save lives. Instead, he prescribes a strong dose of capitalism.

Gratzer's Web page at the Manhattan Institute for Policy Research features links to his most recently published articles in the Canadian and U.S. press.

Addendum: On this same subject...over at Cafe Hayek, Don Boudreaux has an excellent post on health insurance. He discusses "...the myth du jour of those who agitate for government-supplied universal health insurance." (h/t Marginal Revolution)

The great (?) health care debate

A couple days ago I was composing a post about the privatization of health care in Canada. The issue is of course in the forefront now that The Canadian Medical Association has a new president, Dr. Brian Day, the owner of Canada's largest private health-care clinic. He advocates the introduction of a (legal) hybrid of public-private health care. After reading more than a few inconsistent and inaccurate news reports, I said to hell with it and trashed my post. The CMA and the media are giving me the excuse I need to continue to loathe health care issues. Further, I'm young, fit, healthy, and therefore ignorant. Still, I'm glad the privatization debate is being pushed to the forefront. No more pussyfooting around. I was thrilled to see Maisonneuve accurately describe the debate:

The CMA is merely laying the foundation for a debate that is long overdue in this country: a debate that has to transcend the overly simplistic notion that public health care is a zero-sum game.

In fact, Joe Boughner did such a nice job, I'll post his entire blurb (I'm not sure how long it's available on-line for) .

FYI: I plan to post more frequently once again in the near future, I'm just fraught with more deadlines than I can handle right now.

FYI #2: Canada's seven major dailies are referred to by Maisonneuve as The Big Seven.

CURING THE HEALTH-CARE DEBATE, by Joe Boughner (Aug. 24):

Public health care is dead; long live public health care! Canadians who are used to bold proclamations from the various interest groups involved in the health-care debate can be forgiven if they are confused about the Canadian Medical Association's take on the matter. It would seem that even the Big Seven can't agree on what the group has to say. “Doctors split on health-care solution,” remarks the Globe across the top of today's A7 a cautious observation when compared to the Post's declaration: “Doctors ok with private health option.” At least the Citizen, which runs the same Norma Greenaway article as the Post, offers a qualifier: “MDs back private care if wait times too long.” Looking beyond the headlines, the story starts to get a little clearer, even if the CMA's stance doesn't. Delegates at the association's national council in Charlottetown passed a series of resolutions described by the Globe as “confusing and sometimes contradictory.” Creating a parallel private system to ensure better access? Agreed! Opening the door to the private insurance that would allow such a system to exist? Nay! To further the confusion, delegates backed a motion to ”acknowledge the strengths” of the public system while repeatedly lamenting its lack of funding, insufficient staffing and poor patient care. All in a day's work for the association that earlier this week elected a private practitioner that supports medicare as its new president.

While it's tempting to lambaste the CMA for its ambiguous stand, the reality is that the delegates are only reflecting the true nature of health care in Canada. Contrary to what many folks on either end of the political spectrum will tell you, the health-care debate is no longer simply a matter of black vs. white, private vs. public. As anyone who wears glasses or gets their teeth cleaned could attest, Canada already has a mixed system. Such “non-essential” services aren't covered by government health plans in most provinces, and private sector insurance has moved in to fill the void. The CMA is merely laying the foundation for a debate that is long overdue in this country: a debate that has to transcend the overly simplistic notion that public health care is a zero-sum game. It won't be an easy debate for the Big Seven to cover, but avoiding misleading one-sided headlines like the Post's would be a good start.

Sen on multiculturalism

Nobel Prize-winning economist Amartya Sen has an interesting commentary in today's Financial Times.
He explains how Canada was first to adopt multiculturalism as an official policy and he offers an accurate description of multiculturalism as it exists today.

In terms of human freedom, the merit of diversity must depend on precisely how it is brought about and sustained. If a young woman in a conservative immigrant family in Britain wants to go out with an English boy, her choice can hardly be faulted on grounds of multicultural freedom. In contrast, the attempt by her guardians to stop her doing this (a common enough occurrence) is hardly a multicultural move, since it wants to keep the cultures separate in (what can be called) a "plural monocultural" form. Yet it is the parents' prohibition that seems to strike the most sympathetic chord with the dedicated "multiculturalists" today.

His entire article can be read here.

When activism diverges with capitalism

When it comes to economics, the recent consensus from all sorts of media (from Foreign Policy magazine to Adbusters magazine) seems to be that economic thought is too rigid and fails to meet the needs of society and the environment. For example, economics, they say, has failed to recognize that not all resources are renewable. Despite such criticism, I argue that the science of economics deserves more credit. In fact, the divergence of economic thought and human intuition is an excellent measure of the accuracy and flexibility of economics.

My most memorable initial impression of economics when I was a first-year undergraduate student was that many of the concepts in economics are incredibly intuitive. Similar to my observation, a reader in the comment section of the Economist's View blog points out that intuitive questions asked by activists are at times diverging with the solutions proposed by economists.

The comment was made specifically on the subject of Wal-Mart's expansion. It pointed out that activists have intuitively asked why Wal-Mart cannot offer higher wages. Meanwhile, economists are seeing that Wal-Mart truly can offer higher wages without affecting the store's profits. (Of course, not all economists agree that Wal-Mart's expansion is associated with adverse impacts, as I often observe when I find myself to be the lone defender of the anti-Wal-Mart-ization agenda on other blogs)

The Wal-Mart debate isn't the only platform where economics and activism diverge. The subject of subsidies is another example. Environmentalists argue that farm subsidies promote the degradation of soil long after the land has lost its ability to support farming. When a region is simply too hot and dry to farm on, subsidies encourage farmers to pursue costly irrigation measures, even at the risk of salinization. Similarly, economists have applied the anti-subsidy argument to 'our insane farm policy' and to urban development issues. Their view is that such subsidies drain the economy.

In today's Toronto Star Tyler Hamilton wrote on the subject of the divergence of green attitudes and business initiatives:

Tima Bansal, a professor at the Richard Ivey School of Business and an expert on sustainable business practices, says there's been a "mind shift" just over the last year or two with respect to the business world's approach to environmental issues.
"It used to be when you thought about environmental or sustainability issues, it was just a good thing to do," she says. "But people are realizing we can make money and do these things, and we don't have to leave our personal values at home. This is part of business — good business."

Perhaps it's worth asking if economics is too slow to find empirical evidence to support common sense intuition. As Milton Friedman once wrote, a theory cannot be judged by its assumptions, but only by the accuracy of its predictions. I would argue that the answer to my own question is no, economic theory does not hold back progress. For example, consider nuclear energy production. Not long ago it would have been unheard of for an environmental group to promote nuclear power; however, today this is not the case. Many environmentalists have recently begun embracing nuclear power.

Meanwhile, as an article in today's Globe and Mail points out, the profitability of uranium mining has soared since 2002, promoting further interest in the capabilities of nuclear power. Uranium's profitability began to climb simultaneously with increased public approval of nuclear energy. In other words, economic feasibility did not slow down progress.

Although economic theory doesn't have all the answers, it has kept up with society's needs more so than it receives credit for.

Education, c'est délivrance

Paul Wells has noted that the federal government is consulting the public on post-secondary education. According to Human Resources and Social Develpment (HRSDC), public feedback "...may be used by HRSDC for policy analysis, research and evaluation purposes, including policy development." Send your comments here. As Derek Bok once put it, if you think education is expensive, try ignorance. The deadline for input is Sept. 08.

I explored the HRSDC website and found a list of consultation themes and questions (No link - you have to accept the privacy statement to access this page).

1. Objectives for post-secondary education (PSE) and training
What objectives should Canada aspire to for PSE and training? Which objectives would you rank among the top three priorities for action?
2. Clarifying roles and responsibilities in PSE and training
Given what you have identified as objectives, what would be the most important roles for the Government of Canada to play?
Where would clarifying roles and responsibilities amongst governments be most helpful? Do you have advice on how these roles could best be defined?
3. Developing a framework for ensuring measurable results and accountability
What results would be most useful to measure in terms of PSE and training?
How could governments report on progress so that they are held accountable?

Commandeering 'the profit margin puzzle'

Amendment: I've made a couple changes to this piece to correct bad terminology.

I'm stumped. Knzn points to an odd pattern occurring in the U.S.:

Labor costs have risen at an average rate of 1.5% over the past 15 years, but prices have risen at an average rate of more than 2%. That means labor is really cheap today compared to what it was 15 years ago. Why isn’t somebody hiring that cheap labor and undercutting competitors by charging lower prices (bringing down the rate of price growth, or bringing up the rate of labor cost growth by bidding more for labor)? I consider several explanations, but none seems quite satisfactory.

I came up with two explanations of my own. I don't think either of these (if they stand up) could account for huge discrepancies between the growth of labour costs and the growth of prices, but surely it's more likely that behind every .1%, a myriad of factors are working in favour of high prices over costs of input.

1. Rival acquisition and vertical integration. Consider if a firm buys out its competition and then proceeds to control everything it needs: it cultivates raw material, it handles factory production, and it finalizes its own product. Labour and capital costs could be kept down, but prices could be kept artificially high. Further, with an artificially high price of the final product, they could subsidize their own labour costs. As long as the company is self-contained through vertical integration, an increase in the price of raw materials wouldn't mean that profits are escaping to other industries. An example of this is a tire maker that cultivates rubber trees, as explained in an article from the Aug 14 WSJ (h/t Barry Ritholtz):

Shortages and high prices for raw materials are fueling a new and unusual wave of acquisitions and deals. Steelmakers are buying iron-ore mines, airplane manufacturers are striking long-term deals for titanium, and the world's second-largest tire maker is cultivating rubber trees.
This return to a type of vertical integration that has been out of favor for decadessignals a new phase of industry consolidation. Having bulked up by acquiring rivals, manufacturers are turning their deal-making prowess to raw materials providersin hopes of ensuring adequate supplies and controlling costs."

2. Marginal revenue product of labour could be increasing above wages.
Perhaps an increased number of firms are operating where marginal revenue product of labour equals marginal expense, while wages are offered below both. Firms would be able to subsidize the costs of their own factors of production. The growth of labour costs would therefore rise at a lesser rate than the growth of prices.

For example, this situation could occur as the amount of firm-specific training increases. If a firm invests in the specialized training of employees, it can pay lower wages because the employees can't (or won't, perhaps due to mobility costs) use their firm-specific skills elsewhere (if the firm were a monopoly, we could replace “firm-specific” with “industry-specific”). Employees usually only pay the burden of training when the training is generalized (the employer wouldn't want to pay if the employee can use his/her general skills elsewhere).

Over a period of time we could expect the number of firm-specific workers to multiply: when

the economy is going through a slump, workers with general training (or no training at all) will be the ones laid off (Ehrenberg, 2004). Skilled, firm-specific workers will be retained. And remember, the workers with firm-specific training are the ones getting paid less than the marginal revenue product of labour.

Unfortunately, I can't think of any good examples of this, so maybe my case is weak.

Also, I think Knzn brings up a good point: “Some of what is counted as profits may actually be rents, and those rents may be rising.”

Natives agree not to log

According to Global Insight, there has been an agreement between environmental and native groups to prevent logging in areas of B.C. As the article explains, this single agreement allows authorities to avoid a costly uprising between the two groups (at least in the short term).

Even if a second war in the woods is avoided in B.C., authorities and natives still face a challenging economic problem.

What economic alternatives will natives come up with? I'm eager to find out (perhaps more sustainable logging in alternative areas?). Authorities will have more to fret about than costly protests if the natives get a bum deal. For example, consider the UNDP Human Rights Index, which gives Canada a failing grade in terms of its relationship with natives.

James Auger, Global Insight (10 Aug 2006), “Deal to Protect Canadian Rainforests Lifts Threat of Violent Protests” (sorry, no link):

Logging on Vancouver Island in the 1990s prompted huge protests, christened the "War in the Woods". There was widespread civil disobedience, logging roads were blocked and an international boycott of products from the area was organized. The recent announcement by aboriginal chiefs that they were planning to allow limited logging of some 90,000 hectares prompted fears of a repeat of the protests. However, a deal was eventually struck that leaves most of the rainforest untouched in Clavoquot Sound and on Vancouver Island. These areas are located off the westernmost province of British Columbia and host some of the world's last untouched temperate rainforests. A United Nations Biosphere Reserve is located nearby. It is hoped that the federal government will help develop economic alternatives to logging.
The main environmental groups involved are Greenpeace, ForestEthics, the Sierra Club of Canada and the Western Canada Wilderness Committee. They say that the agreement is not enough, but that it is sufficient to prevent large-scale protests for the time being. The groups would like permanent legislation that would ban logging outright and provide economic alternatives for residents. The area already attracts some one million tourists a year, but the local aboriginals receive little of the revenue. Significance: The authorities will be relieved that a repeat of the "War in the Woods" is not on the cards, but the dispute is likely to flare again unless a more lasting solution is found.

Friedman did what?

Sure, Milton Friedman is an influential economist. But I'm frequently catching myself saying, “Friedman did THAT?” Perhaps I just need to join the club and read his biography.

Apparently Friedman is responsible for the Bank of Canada's (BoC) decision to adopt a flexible exchange rate in 1950. My surprise is that it took a genius (easy enough to say in 2006). Although, it only took him 30 minutes of radio time with Bank of Canada Deputy Governor Donald Gordon and W.A. Mackintosh, a professor of economics at Queen's University.

From the BoC:

During the debate, Friedman argued that Canada's direct controls on imports should be replaced by a flexible exchange regime because "that is the most effective way of . . . making [import] goods more expensive to Canadians and your export goods cheaper to other people." . . . and "is it not better to let every individual decide for himself what items he wants to curtail in [the] face of higher prices than to have a government official do it in some ...across-the-board, rough manner?" (Friedman, Gordon, and Mackintosh 1948, 6).

Less than 18 months after the radio debate, on 30 September 1950, Douglas Abbott, Canada's Minister of Finance, announced that "today the Government ... canceled the official rates of exchange. . . . Instead, rates of exchange will be determined by conditions of supply and demand for foreign currencies in Canada." Friedman could not have written it any better.

It wouldn't be surprising if he had a finger in Japan, too. The next time he would speak to an official of the BoC would be in November 2000. He was the keynote speaker on a conference about exchange rates. When asked for his opinion on Japan's economic situation, he had this to say:

They can buy long-term government securities, and they can keep buying them and
providing high-powered money until the high-powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary
policy.

Of course in March 2001 the Bank of Japan began with quantitative easing. The BoJ purchased “trillions of yen of financial securities, including about $120 billion per year of Japanese government bonds in an operation known as “Rinban.””

Perhaps the BoJ had quantitative easing in the cards before Friedman proposed it. After all, Japan lacked alternatives.

Either way, surely no other economist's words have such global influence when it comes to central banking.

Can a central bank be too transparent?

On Friday I posted an article filed by Bloomberg News. The article is based on a memo that the reporter obtained from the Bank of Canada through the Freedom of Information Act (FOIA). My initial response was to criticize the journalist for making assumptions based on an internal memo (I won't repeat myself here - my comments are below my last post). I began to wonder how much empirical work has been done on FOIA's impact on monetary policy.

The benefits of FOI laws must not be undersold, but what impact do do such laws have on central banks that take pride in transparency? Is there such a thing as too much transparency?

Tara Vishwanath and Daniel Kaufmann (1999):

As argued by Stiglitz (1999)....the information economics literature supports the notion that better information will improve resource allocation and efficiency in an economy. Disclosure of financial information directs capital to its most productive uses, leading to efficiency and growth.

The perception that one has of FOI surely depends on how one defines transparency. At least one economist has said that the BoJ is more transparent than the BoC, for example (noted by Pierre L. Siklos: 2004), while others disagree.

Australia's outgoing central bank governor, Ian Macfarlane, found that too much transparency is harmful, apparently. He is said to be a "vocal critic" of releasing the minutes of Reserve Bank meetings and has been known to block FOI requests from newspapers.

To what extent should the financial community be concerned about FOI?

Tara Vishwanath and Daniel Kaufmann (1999):

Some research suggests there are instances where more information may cause speculation and hence greater market volatility. A recent empirical study (Bushee and Noe: 1999) indicates that firms with improvements in disclosure practices experience subsequent increases in their level of stock market volatility. They find that a policy of greater disclosure skews the composition of investors, toward those with a strong propensity to trade in the short run because they value it more than longer-term investors. The result of a greater prevalence of ‘fickle’ traders leads to greater volatility.
Second, even in cases where disclosure regulation is justified, the design of appropriate disclosure policies requires a careful weighing of the extent of disclosure.
This weighting should be sensitive to its costs and benefits. It should consider what information should be disclosed, who provides the information and verifies the quality, what are the enforcement requirements and so forth.

I'm a strong supporter of freedom of the press, but I have my criticisms of FOIA. I'll quickly cite two criticisms. First, anyone who has seen an agency's log of FOIA requests knows that FOIA is no longer used as a last resort. The Act is abused, and the costs are high (hence the reason Britain may introduce a fixed fee, unfortunately). Second, I haven't seen much empirical evidence against FOI laws pertaining to central banks. If such an absence exists, this represents a flaw.

Still, FOIA is important and it is nearly as good as it could ever be, in Canada. Holding authorities accountable for their actions is crucial. As is the case with any institution, FOIA requests are denied if the central bank can prove that disclosure is damaging. As for irrelevant memos....they're unfortunately fair game. It's the cost of a greater benefit.

Addendum: Mark Thoma points to an article from the WSJ where the journalist criticizes the Fed's transparency. I'm still not sold.

Canadian dollar still undervalued

According to researchers at the Bank of Canada, the Canadian dollar is still undervalued and its “long-run equilibrium value” is 91 U.S. cents. This comes from a Bloomberg report filed today. The report states that the OECD has estimated the dollar to be worth 80 U.S. cents in 1995 and the IMF estimated it to be 82 U.S. cents this year. Both the OECD and the IMF estimates are based on the Purchasing Power Parity model.

Here are some excerpts from the Bloomberg report:

Aug. 11 (Bloomberg) -- The Canadian dollar is undervalued and doesn't yet reflect the benefit to the country's economy from soaring energy exports, according to an internal Bank of Canada report written in March.

The currency's "long-run equilibrium value'' is 91 U.S. cents, central bank researchers Jeannine Bailliu and Ramzi Issa wrote in a March 27 note to Bank of Canada Governor David Dodge and his five deputies. The six-page document was obtained by Bloomberg News under the nation's Access to Information Act.

The Canadian dollar climbed to a 28-year high of 91.44 cents on May 31 before retreating to trade at 88.68 cents at 5 p.m. in Toronto yesterday. The report helps explain why Dodge raised interest rates in January and March to cool inflation even as provincial leaders, labor unions and manufacturers protested that the dollar would strengthen and erode demand for exports.

"Most of the recent appreciation of the Canadian dollar is driven by the large increase in energy prices,'' the memorandum says. "It is clear that the exchange rate has not overshot the long-run equilibrium value consistent with the current level of energy prices.''

Dodge and Finance Minister Jim Flaherty have repeatedly refused to comment on the value of the Canadian dollar, which is heading for a fourth straight annual advance against its U.S. counterpart. The Canadian dollar traded at an average of 86.6 cents during the first quarter and 89.1 cents in April to June.

"In Canada, the biggest factor in terms of the fundamental value is commodity prices,'' said Benoit Durocher, an economist in Montreal at Mouvement Desjardins, Quebec's biggest lender. He predicts the currency will reach 90 cents by the end of the year and 94 cents next year. The central bank would probably get a similar result if it did the same analysis today, Durocher said.

Even as Bailliu and Issa said the currency would benefit from higher energy prices, their equation predicted it would take time. The researchers found it historically took about five quarters for the currency to make 50 percent of the adjustment to "long-run determinants,'' which would have meant an 83-cent dollar in the first quarter.

The researchers updated the Bank of Canada's mathematical model of the Canada-U.S. exchange rate to better account for the effect of energy prices, according to the note.

"What underpins the dollar to a very large extent is the price of natural resources,'' said Jean-Francois Villeneuve, an economist in Montreal at Laurentian Bank, Canada's seventh- largest bank. He predicts the currency will trade between 87 cents and 91 cents over the next 12 months.

Bailliu and Issa dismissed explanations other than commodity-price gains for the currency's rise up to the first quarter, such as the expected discrepancy between the U.S. and Canadian interest rates or a ``multilateral depreciation'' of the U.S. dollar.
In a May 15 update to their memo, the researchers said the broad-based decline in the U.S. dollar against other major currencies had contributed to "part'' of the Canadian currency's surge in the previous six weeks.

The true cost of AIDS

A few days ago two economists from TD Economics released an interesting report: The Economic Cost of Aids: A Clear Case for Action. The paper stresses that not enough attention is being given to the cost of AIDS on labour force participation rates. Here is an excerpt from the 14-page paper:

So what are the costs? Some studies suggest a significant, but not devastating economic cost of just a few tenths of a percentage point lost from the annual GDP growth rate – even in the developing world. But these assessments appear to be incomplete. For one, they tend to attach little importance to a reduction in the labour force. For many of these studies, the starting point is an assumption that much of the developing world has an excess supply of labour, as evidenced by very high unemployment rates and low labour force participation rates. But once, as is generally projected, some of these countries lose as much as one-quarter of their labour force – and likely the youngest and most productive quarter — such a model is questionable.
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For the developed world, there is a clear economic case for attention and action outside of humanitarian motives. The potential collapse of some of these economies will deprive the world of future markets for both imports and exports. Already the world has been made worse off. Twenty years ago, Sub-Saharan Africa was a net exporter of agricultural products. The region’s share in world agricultural exports has fallen from eight per cent in the early 1960s to just two per cent currently.
The region must import more agricultural products than it exports, in spite of substantial international development assistance to date. Additionally, the developed world incurs all-too-real costs from failed states and the flow of refugees and disillusionment that emanate from them. Ultimately, the bill to provide assistance will be much greater if the human capital, government services, and infrastructure have been destroyed. Pay now or pay a LOT more later.

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International aid to support the fight against HIV in the developing world amounts to approximately $8 billion U.S. dollars per year, compared with $17.3 billion spent domestically in fiscal year 2005 by the U.S. federal government. However, $13.4 billion of this – nearly 80 per cent – is spent on the care and treatment of those already infected. Another 15 per cent is spent on research, leaving less than five per cent – just $788 million a year – spent on prevention. This amounts to $2.63 per person in the U.S.

Unions embracing foreign workers

As we know, an increased supply of workers will tend to put downward pressure on wages, all else being equal. Because of this, there was a time when a certain labour union in B.C., The Construction and Specialized Workers' Union, fought to keep foreigners from competing for jobs held by the domestic workers they represent.

Despite the union's concerns, foreign workers were brought in by SELI Canada Inc. and issued long-term contracts. Soon after their arrival the 42 Latin Americans issued a human rights complaint with the B.C. Human Rights Tribunal. Their complaint is that they're receiving a lower wage for the relatively riskier work they're doing on the Canada Line rapid-transit tunnel. In response, the union has done an about-face and decided to help the foreigners state their claim.

"This is all nonsense,” said the firm's lawyer. “The union didn't want these people coming in in the first place. It's part of this campaign to keep out foreign workers.” He added that the human rights complaint “is part of a political campaign” for the union.

Perhaps the campaign to keep out foreign workers is still going strong, yet in a less obvious way.

First, it could be the case that the union is truly concerned for the welfare of the foreign workers. Further, the foreigners have already arrived, so there's a possibility that the union wants to prove its credibility and perhaps increase union membership (thereby increasing its collection of membership dues).

A second possibility is that the union is protecting the jobs of high-paid union members. If the union can bargain for better wages for foreigners, the relative costs to employers will increase. If the cost of hiring foreigners increases, SELI will be less likely to use them as substitutes for domestic workers.

SELI claims that it hired the foreigners for their unique skills ("they know how to handle the company's special tunnel-boring equipment"). In other words, the firm is hiring them for their productivity. If it is able to pay less for labour by hiring foreigners, all else being equal, productivity growth could be in excess of wage growth, putting downward pressure on prices.

The union could feel that it has the slack to increase SELI's costs, which would cause the company to think twice about substituting foreigners for domestic workers again.

If the union were successful, the foreigners may win in the short-run (gain higher wages) but lose in the long-run (lose future work contracts). Then again, if they have no interest in working for the company again, SELI may have a payroll full of happy workers (much to their chagrin).

Media sources are providing inconsistent details on the foreigner's earnings and labour conditions, but the anecdotes are everywhere. One foreigner was quoted in the media complaining that he couldn't afford to buy a pop in Canada. He was apparently told that his employer would send him to Ethiopia -- “that way I could save money." In sum, they are not happy.

Mark Thoma recently pointed to an article in the WSJ which says that unions in the US are not only embracing foreign workers, they're embracing illegal foreign workers, too.

On a related note, it seems that high profits in the metal industry are being met with union strikes all over the world. The Globe and Mail has a good article on this subject and a list of recent stoppages.

Media, media, media

A couple things media-related things have caught my attention so I thought I would throw them into one post.

1. From Marginal Revolution:

Econospinning: How to Read Between the Lines When the Media Manipulate the Numbers, by Gene Epstein, economics editor at Barron's.

Imagine lengthy polemics against the use of numbers in the work of Paul Krugman (most of all), the Op-Ed page of The Wall Street Journal, Brad DeLong, Steve Levitt, and Barbara Ehrenreich, among others. Except the vehicle isn't the blogosphere, it is a book!

This one is guaranteed to ruffle feathers. Here is the book's home page.

2. Helpful writing guide at The Economist. h/t Greg Mankiw

3. Finally, what kind of blogger would I be if I didn't get in on the ballyhoo of recent media scandals? See here, here and here. Tisk, tisk on the NYT: once for this, and again for this. If I were a freelancer, I'd be concerned. I'm not quite as angered as others are, but I'd be less shy to blog about the drama if: i) the cynicism of the media were expressed in a clever fashion; and, ii) I had a television to get my fix of drama elsewhere.

On warfare theory, politics and economics

As a good-bye gesture when I left my pre-university tuition-saving job, a mentor of mine left me advice: “Never forget that 'war is a continuation of politics by other means is often misunderstood.' The sooner you understand that, the more time you'll save.” (I was working in the news industry and his comment was related to the content of our work) It's not often that I'm offered advice, so I took note of it. He was quoting Carl von Clausewitz from the book “On War,” a philosophical and political “treatise on the art of warfare.” I still wonder what to make of it.

The phrase “war is a continuation of politics” could be interpreted as a description or a prescription. As a description it's true; as a prescription it's subjective.

Von Clausewitz's treatise is scientific in nature, and throughout it a distinction can be made between normative analysis and positive analysis. In political science, anyone armed with a good newspaper and an interest in current events can offer a personal prescription to war. Von Clausewitz offers a description of war, although he stops short of using cryptic math-speak or complex formulas.

Normative analysis is as useful in “On War” as it is to any science. In political science/(economics) it's often been said that positive analysis should be accompanied by normative analysis, based on equity and efficiency, lest political scientists/(economists) appear detached from reality/(autistic). In warfare theory, positive analysis alone fails to sufficiently consider the welfare of civilians, militants, the rich or the poor. In von Clausewitz's words, “....talent and genius act beyond the law, and theory is in opposition to reality.”

On the other hand, normative analysis alone would have killed “On War,” so to speak. If Clausewitz had constructed “On War” with a reliance on prescriptions, he would have stunted his ability to brilliantly configure the science of war (not to say he wasn't biased, but this was no cheap manifesto either). It would be comparable to the case where scientific reasoning is crowded out of economics. When economists become push-overs to politicians, their ability to utilize positive economics as a scientific tool diminishes (a criticism that Milton Friedman has expressed on a few occasions). By overtly stressing normative analysis, an individual risks losing credibility (and perhaps a seat at the central bank), and does a disservice to society.

The complementary relationship between positive and normative analysis in economics is evident.

Faruk Gul and Wolfgang Pesendorfer (2005):

Normative statements (farm subsidies are inefficient) are used to define new positive questions (what makes farm subsidies persist?) that lead to better models of the underlying institution.

Although the two are sometimes treated as substitutes:

When economists or political scientists model the government, they do so either by endowing the government with certain objectives or by modeling government as an institution where conflicting incentives of various agents interact.

As it was suggested to me, the phrase “war is a continuation of politics” has saved me time. The phrase demonstrates how normative and positive analysis are omnipresent; they exist in economics, politics, warfare theory and elsewhere. They aren't always proportionally represented, but they should be distinguished from each other. The quicker this is understood, the more constructively individuals can interpret the works of people like von Clausewitz, and the lesser the likelihood of costly misunderstandings leading to greed, corruption, violence or painful sentimentalism.

I would like to think we can complement von Clausewitz's brilliant phrase with a normative statement. Perhaps, “war is a continuation of politics...only when the costs remain hidden to us.” I strongly suspect this isn't quite the lesson my mentor had in mind, but it's the one I prefer to take home.

RIP Raymond Arndt

Urban development: A case against subsidies

There is an interesting article by Jack Diamond in Saturday's Globe and Mail ($ subscription required). In it, Diamond explains how subsidies have a negative impact on urban development.
He first explains some of the weaknesses of current urban development trends in low density areas, including automobile dependency, exacerbation of social problems, urban poverty and the cost of providing services (which “exceeds the tax revenue derived from low-density development”).

Diamond says that “urban development has been made possible, and indeed encouraged, by two factors:”

The first is what amounts to subsidies that land speculators and low-density developers receive from provincial and federal governments in the form of highway construction, and the provision of trunk-line sewers, water supply and other services. The burden of this cost is not borne by the beneficiaries, but by all taxpayers.

The second factor is low gas prices in the past. They meant that transportation costs were often not a consideration in urban development.

Diamond offers two suggestions to change current development trends:

The means to make these changes is first to institute full-cost pricing. Let the market forces exert their logic: If each increment of suburban growth were to bear the full unit-cost of expressways, trunk water supply and other services, the market would adjust to more appropriate urban forms. That this would create densities capable of supporting public transit, creating a richer mix of land uses, would be an added benefit to affordable development.
Nowadays, development occurs at the extremes of density — either vast expanses of single or semi-detached housing (and low-density commercial uses), or high rise/high density condominiums. There is a wide variety of satisfying housing in between these two extremes, from town houses and duplex dwelling to low-rise apartment buildings of about six to eight storeys. Ingenuity, when confronted with necessity, will out.
The second means to bring about change is for governments to set performance standards for the infrastructure. Imagine a situation where, instead of distributing
infrastructure funds across the country, regardless of the effects of the funding or even the quality of the urban development, funds went to those who would build sustainable communities, effective in social, physical and economic dimensions. Imagine building on this excellence in a manner that would buttress our society in an inclusive manner, one that would plan for the inevitable change wrought by scarce and expensive fossil fuels, rather than belatedly reacting to crisis once it is upon us.

Such a system has been operating successfully elsewhere in Canada — consider the
Canada Foundation for Innovation that funds research infrastructure.

The global redistribution of income

From the PSD blog:

The actual distribution of world income across countries is extremely unequal, much higher than the within country inequality faced by most countries. The question studied in this paper is: How do international policies on aid, trade, and factor movements affect the international distribution of income?… In brief, there is a contradiction in international policies where aid's equality-enhancing effect is somewhat offset by protectionism.
From a new working paper by World Bank chief economist Francois Bourguignon, Victoria Levin, and David Rosenlatt.
Also, the most recent issue of the Journal of World Systems Research is out. It includes papers on global income disparities since 1800 and a review of the economics literature on the world distribution of income and income inequality.

More on equalization

In a previous post I applauded the idea of removing non-renewable resources from equalization. I stand by the opinion I expressed earlier, but, for anyone interested, there is a paper worth reading on an alternative model. Prof Paul Boothe from the University of Alberta (1998) writes:

...Provinces will not willingly accept the undoing of the decentralization that has occurred over the past three decades. If that is the ultimate federal goal, Canadians are in for a long war of attrition. The forces of global competition and the growth of north-south trade, both underlying causes of decentralization, show no signs of abating. Thus, the need to adapt our federation and its transfer system to these realities is unlikely to disappear, despite the fervent wishes of some for a return to the good old days of dominant central government.

Our proposed reform has four distinct parts:
1. Combine equalization, the CHST [Canada Health and Social Transfer], and regional differences in EI to arrive at total transfers.
2. Transfer the required PIT [personal income taxes] tax points to eliminate vertical fiscal imbalance.
3. Create a net interprovincial equalization pool that leaves all provinces deficit neutral at the outset.
4. Use a macro formula to calculate contributions and withdrawals from the pool in the future.

Prof Boothe's paper can be found here.

Thanks to Marc Lee for bringing this to my attention. Marc adds some interesting insight on this subject over at Relentlessly Progressive Economics.

Still, I stand by my earlier comment. Further, until I catch up on my reading I'll be quiet on this subject!

Advice to academics

Prof Greg Mankiw:

The truth is that producing bad papers is one of the costs of producing good papers. When you swing for a home run, you are more likely to strike out. The only way to avoid the occasional strike out is to quit the game.
Here is my advice to a young academic: You will be judged by your five to ten best papers.
Your bad papers will be mostly forgotten. So be willing take risks, if there is a reasonable chance of a big payoff.

From a blogger perspective: As a blogger and a klutz (see my last post - er, wait, no don't), I take great comfort in Prof. Mankiw's emphasis on risk. Then again, perhaps I take greatest comfort in my anonymity!

But wait! A reader offers to complete Mankiw's statement in the comment section:

Studies show that if you are typical even your good papers will be read by essentially no one -- and almost certainly will never be read again before the decade is out.

Women and productivity

Amendment: I noticed that I butchered my last effort on this post...so I'm going to try this one more time...

Popular literature tells us that when women are discriminated against in the labour market, it's often for one reason: the potential for interruption in a woman's career (for child-rearing etc.). This morning I heard a good reason to believe that this sort of discrimination can cost a firm in productivity.

The premise of the lecture I attended was this:

Assume that men and women are homogenous but the firm doesn't treat them so. Policy dictates that women should receive the wage that men receive, therefore men and women are both paid 'W'; however, the employer acts as if he is paying women too much. He does this by hiring less women then he otherwise would if he believed that the marginal revenue product of men and women were equal.

As a result, there is a potential for loss of productivity by the firm. Female workers can offer more than the employer is gaining. The cost of discrimination is therefore the productivity gained by the firm's competition if females are hired elsewhere. In sum, if a firm behaved discriminatorily against women, it will not maximize its productivity as long as this is a competitive market.

The question I asked is: Are you aware of any studies that show that the benefit of hiring women offsets the cost that a firm faces when women's work time is interrupted for such things as maternity leave?

Lecturer's response: Yes. There have been studies which show that the benefit of hiring is greater, holding constant age, education, location, marital status and wages.
The way I see it, this implies that we spend too much time saying: “See, look, maternity leave costs our firm.” Or, “See, menstruation explains the gender gap.” (Sadly, I'm not even making that last one up. Excerpt is here). The point we're missing is that discrimination causes hidden productivity. The benefits of hiring women are being lost by society in order to avoid the costs, which may be lesser. If a firm can tap into the benefits, they'll be ahead of the competition.

In my view, however, even if the study I heard about this morning is conclusive, there still remains a problem: How do you convince an employer that he/she is better off hiring talented women over less talented men when his/her utility was seriously diminished when the last woman hired took maternity leave? In this case statistical discrimination might continue to exist, if for no other reason but ignorance.

Addendum: A related note from The Economist (April 12, 2006), A guide to womenomics:

Making better use of women's skills is not just a matter of fairness. Plenty of studies suggest that it is good for business, too. Women account for only 7% of directors on the world's corporate boards—15% in America, but less than 1% in Japan. Yet a study by Catalyst, a consultancy, found that American companies with more women in senior management jobs earned a higher return on equity than those with fewer women at the top. This might be because mixed teams of men and women are better than single-sex groups at solving problems and spotting external threats. Studies have also suggested that women are often better than men at building teams and communicating.

To make men feel even worse, researchers have also concluded that women make better investors than they do. A survey by Digital Look, a British financial website, found that women consistently earn higher returns than men. A survey of American investors by Merrill Lynch examined why women were better at investing. Women were less likely to “churn” their investments; and men tended to commit too much money to single, risky ideas. Overconfidence and overtrading are a recipe for poor investment returns.

Despite their gains, women remain perhaps the world's most under-utilised resource. Many are still excluded from paid work; many do not make best use of their skills. Take Japan, where only 57% of women work, against 65% in America. Greater participation by women in the labour market could help to offset the effects of an ageing, shrinking population and hence support growth. Ms Matsui reckons that if Japan raised the share of working women to American levels, it would boost annual growth by 0.3 percentage points over 20 years.

How is Chihiro like the BoJ?

The best paragraph in last week's Economist magazine:

AT THE end of “Spirited Away”, Hayao Miyazaki's animated masterpiece, ten-year-old Chihiro uses her wits and her courage to escape from a nightmarish world of ogres and witches. Japan enjoyed a similar deliverance last week, when its central bank turned its back on an interest rate of zero for the first time in almost six years. The quarter-point increase marked an end to the rich world's longest economic stagnation since the Great Depression.

Now, what other news magazine would compare an economy to an anime film? Weird. But nice to see that The Economist recognizes the best film ever made.

I never liked 3-D anyway

Statistical Modeling, Causal Inference, and Social Science shares the gospel: you can't make friends with fancy-pants 3-D visuals.

They offer some good suggestions for designing visuals for your data (via another link).

Alberta's new labour strategy in action

Tyson Foods is the first company to take advantage of Alberta's new 10-year plan dubbed “Building and Educating Tomorrow's Workforce” to attract foreign workers. The international component of Alberta's strategy isn't getting much ink (actually, the entire thing seems to be getting overshadowed). It stresses recruitment, education and training, retention, and public information-sharing of labour force trends. Apparently it means relaxed requirements for immigrants seeking a short-term work visa . It was announced July 25th.

Addendum: Given that Tyson Foods is first up to plate to take advantage of Alberta's looser recruitment regulations, some people might be amused (?) to learn about Tyson Foods' controversial history.

Doug Cameron in today's Financial Times (also printed in The National Post):

Tyson Foods, the world's largest meat processor by sales, is recruiting workers from China and the Philippines in an effort to solve a labour shortage at its Canadian operation.
The US group is also targeting the Ukraine and El Salvador to fill gaps in its plants in the province of Alberta, where the boom in oil-sands exploration has driven economic growth to 6.6 per cent - twice the national average - and cut unemployment to 3.7 per cent.
The skills squeeze is causing energy groups such as Royal Dutch Shell to re-evaluate the economics of their oil-sands exploration, and led the province last week to announce a 10-year plan to attract more overseas workers.
Tyson is the first company to launch a recruitment drive under the plan, which would allow sponsored overseas workers to work in Canada for a year. The staff shortage has reduced productivity at its Alberta plants and worsened the problems caused by the strength of the Canadian dollar.