The sensitivity of industries to labour regulations

Don Boudreaux over at Café Hayek pointed to an article by Gary Becker and Richard Posner ($) published in yesterday’s Wall Street Journal. Here’s an excerpt:

An increase in the minimum wage raises the costs of fast foods and other goods produced with large inputs of unskilled labor. Producers adjust both by substituting capital inputs and/or high-skilled labor for minimum-wage workers and, because the substitutes are more costly (otherwise the substitutions would have been made already), by raising prices. The higher prices reduce the producers' output and thus their demand for labor. The adjustments to the hike in the minimum wage are inefficient because they are motivated not by a higher real cost of low-skilled labor but by a government-mandated increase in the price of that labor. That increase has the same misallocative effect as monopoly pricing.

Surely, just like the minimum wage, other regulations on labour also have a greater impact on certain industries relative to others. I started thinking about this when another commentator asked why the U.S. doesn’t adopt a 35-hour work week. Here’s most of what I posted in response on Café Hayek:

….regulations on hours worked can be just as painful to certain sectors as minimum wage requirements. First, it does seem odd that 40 hours is considered to be a "natural" and permanent level (although, I think the French have already proven what a failure the 35-hour week can be). Second, I can’t understand how an obligatory set of hours can be optimal for ALL industry sectors. Perhaps regulations on hours of work distorts the ability of each sector to find its own "natural" level through heuristic means, or whatever, thus hampering productivity and efficiency in certain sectors. I’ll explain.

Any strict regulation on hours worked, be it 40 hours or whatever, may not work for all sectors for at least two reasons: i) some sectors are productive in spurts (I’m reminded of a post on freexchange where a reader notes that "anyone building a house or undertaking a project that requires a number of diversified tasks comes up against the brick wall of inefficiency" when faced with regulations on hours worked); and ii) not all sectors have the same firm-size make-up. An IMF report shows that moving from a 40-hour to a 35-hour work week encouraged French workers in "large firms to take second jobs or to move to small firms where the 35-hour work week is not obligatory." In other words, while a 35-hour work week might be optimal for sectors comprised of small firms, it is likely not optimal for larger corporations, the backbone of our economy.

Another reader points out something that I didn’t add, but I should have:

I agree that it should be up to the company how many hours one should work - up to some maximum allowed under law under at-will labor. I mean, as long as you know the terms before you agree to the work, companies should have a lot of flexibility.

I just wanted to take note of the subject of work hour regulations here because I thought it might be interesting to sometime explore its impact on various industry sectors. Perhaps some industries have more to gain from a barrier-free labour market than others. Further, perhaps the existence of certain regulations on labour distorts the "natural" sectoral make-up of a nation's economy.

How the east contributes to wealth inequality

A fire might have been ignited under western Canada when policy makers implemented a business friendly tax structure, but positive investor sentiment is going to take it from campfire to bonfire before the rest of Canada (hereafter, TROC) even gets its matches out of the box. The combination of two recently released reports makes me believe this.

First, The Fraser Institute released its Canadian Provincial Investment Climate Report: 2007 Edition. In it, they publish something called the The Provincial Investment Climate Index, which has seven components: 1. Corporate income tax (CIT), 2. Fiscal prudence, 3. Personal income tax (PIT), 4. Transportation infrastructure, 5. Corporate capital tax (CCT), 6. Labour market regulation, and 7. Burden of regulation

Here’s an abstract from a press release:

The Provincial Investment Climate Index objectively evaluates the public policies that create and sustain a positive investment climate. It ranks each province on a scale of one to 10.

Alberta earned the highest score, 8.9 out of 10, and was clearly Canada's top province for policies that encourage and sustain a positive investment climate. BC followed in second position but some distance behind with a score of 6.0 out of 10. Saskatchewan is third with a score of 5.3 out of 10. The three western provinces were the only ones with an overall score above 5.0.

Ontario was fourth overall with a score of 5.0 while Quebec, with a score of 3.0, was ninth.

Jason Clemens, a co-author of the report, had this to say:

The low scores for Quebec and Ontario are among the most worrying aspects of this year's report. These two provinces are extremely important to the Canadian economy, yet they have chosen to implement policies that are not conducive to attracting investment.

As the west becomes more business friendly, wealth tends to blow that way. But then there's a multiplier effect that kicks in when wealthy westerners begin investing to a degree that surpasses that of individuals elsewhere across Canada.

Earlier this month TD Waterhouse released a report which claims that “…those living in the west are more aggressive investors with higher expectations and greater use of financial plans and advice than those living in Quebec and Atlantic Canada. Ontarian investors, in accordance with their geography, are somewhat in the middle.”

I would attempt to explain this two ways: i) as individuals in the west become more wealthy and more experienced in investing they become less risk averse in their investment strategies; and, ii) we’re seeing that individuals who have a higher propensity to invest also have it in their interest to move, or remain, where the business climate is most attractive: in the west (whether for wage or salary prospects, or for entrepreneurial incentives).

But studies in behavioural economics suggests that there's more here than simply the fact that wealthy westerners will be getting wealthier by putting their money to work. Westerners will also gain experience ahead of TROC. I'm reminded of a paper by Daniel Kahneman where he explains that experienced traders show less reluctance to trade, almost as if they learn to "base their choice on long-term value, rather than on the immediate emotions associated with getting or giving up options." The parallel to the west seems convincing.

Further, while propensity to invest is rocketing in western Canada, it's also the case that in TROC, it's really, really, not. The TD Waterhouse report tells us that “the most favoured type of investment in Quebec is savings held in a savings account (55%).” Talk about low expectations.

The bottom line is that the longer it takes TROC to become business-friendly (or ditch the welfare state sentiment, in the case of some regions), the greater the division of wealth will be across Canada. This will hurt TROC for obvious reasons, and it’ll hurt westerners who will be pressured into being good sports and promoting equality through transfer payments.

Addendum: Damn-it. My images always come out as good as dirt. I vow to work on that at some point.

Look at me, I read The Economist

I must be in a strange mood, because I nearly busted a rib laughing at this Onion piece. And yet,... should I have?

h/t The Healthcare Economist

The influence of values vs. remittance

From "Migrant Power," The Economist, Jan. 16

As migration changes, shorter-term movements will bring migrants home with wealth accumulated abroad and human capital in the form of knowledge and new institutional norms that can improve domestic life. The American experience suggests that, for all the fears that Mexican culture is overwhelming the domestic variety, the influence is more likely to go the other way. Tyler Cowen, an economist who does field work in Mexico, points out that American influences—whether consumer tastes, a greater inclination to give to charity or more enthusiasm for democracy—are stronger there than anywhere else in Latin America. The spread of values, in other words, may be just as influential as the remittance of cash.

Emphasis is my own. This is an interesting way to look at temporary labourers. I've never perceived them as being potential ambassadors of American goods and values.

FYI: did you know that if you use an RSS to access The Economist, you're a click away from free content -- including the premium content that isn't accessible to non-subscribers on the magazine's Web page? Perhaps this is a temporary glitch.

M&M's -- No!

"Numbers by painting," Forbes, Jan 14 2007:

What if you could auction off a logo at Christie's or Sotheby's (nyse: BID - news - people ) to determine the notoriously tough-to-measure market value of a brand?One prism through which to measure the perceived value of global brands is the contemporary art world, and in particular the sale prices of the works of Wang Guangyi, one of the leading lights of the post-1989 Political Pop Art movement in China ... Wang is the Andy Warhol of the Chinese art scene--at once criticizing commercialism and profiting by including famous brand names in his works.

The rest of the article can be found here.

My favourite Wang (only because I prefer Reese's):

M&M's ("The Great Criticism" series: M&M'S)
Oil on canvas, 1993, Sale price: $180,000 Estimate: $150,000-$180,000, Sotheby's New YorkSale: Contemporary Asian Art, Sept. 20, 2006

Big-box stores, food prices & the CPI

Abstract from The Impact of Big-Box Stores on Retail Food Prices and the Consumer Price Index, by Ephraim Leibtag (Economic Research Report No. (ERR-33) 41 pp, December 2006)

This report focuses on retail food market dynamics and how they affect food price variation across store formats. The differences in prices across store formats are especially noteworthy when compared with standard measures of food price inflation over time. Over the past 20 years, annual food price changes, as measured by the CPI, have averaged just 3 percent per year, while food prices for similar products can vary by more than 10 percent across store formats at any one point in time. Since the current CPI for food does not fully take into account the lower price option of nontraditional retailers, a gap exists between price changes as measured using scanner data versus the CPI estimate, even for the relatively low food inflation period of 1998-2003. This study estimates that the CPI for dairy products overstates food price change by 0.5 to 2.5 percentage points per year for dairy, eggs, and butter/margarine.

'Stock Markets Contract as M&A Overtakes Equity Sales'

While the contraction of the stock market due to mergers and acquisitions (M&A) isn’t an entirely new phenomenon, it’ll be interesting to see how Canada, the U.S. and Europe are individually affected in '07 by further M&A. The Bloomberg article I excerpt from below doesn’t mention Canada in specific, but I imagine that M&A will have a greater impact on Canadian investors relative to U.S. investors, as Canadian markets are smaller. This article suggests that companies could end up paying too much as the M&A "fad" jacks up prices.

To put things in context, the value of Canadian M&A deals doubled in 2006 to US$173.6 billion (the number of deals increased by 26%) and European country deals went from US$244 to US$266, while US deals went from US$229 to US$266 billion (Japan actually dropped).

Bloomberg, by Michael Tsang and Daniel Hauck (Jan 8) (Full article here)

Stock markets are shrinking as mergers and acquisitions take shares out of public hands faster than companies add them through equity sales. The value of U.S. shares dropped last year by the most since 1984 and the European market narrowed for the first time, according to Citigroup Inc. Last year's $3.68 trillion in takeovers, led by AT&T Inc.'s $86 billion purchase of BellSouth Corp., outweighed the biggest year for initial public offerings since at least 1999.

The contraction may continue in 2007 as dealmaking accelerates. M&A will rise by at least 10 percent this year, analysts at Deutsche Bank AG, JPMorgan Chase & Co. and Bank of America Corp. forecast. Private-equity investors alone have $1.6 trillion to spend, Morgan Stanley estimates.

"Corporations and the private-equity crowd both appear to still be on a buying spree," said Eric Bjorgen at Leuthold Weeden Capital Management in Minneapolis, which oversees $2.8 billion. "Less supply implies higher prices. That's bullish."
The reductions helped lift the Standard and Poor's 500 Index and the Dow Jones Stoxx 600 Index in Europe to the highest in six years. Stock buybacks also climbed to an all-time high. Last week, the S&P 500 fell 0.6 percent to 1409.71 and the Stoxx 600 gained 0.1 percent to 365.69.

Buyout funds and companies may wind up paying too much as they vie over acquisitions. It may "end badly" for stock investors later this year, said Jason Trennert, chief investment strategist at Strategas Research Partners LLC in New York.

Top Priority

"Given the sheer amount of money that's been raised, it seems to me that there's a chance that this could be taken to an extreme," he said. "Fads tend to take on a life of their own."

The underground economy and the poor

Neil Reynolds takes a look at the role that the poor play in the hidden economy.

The Globe and Mail (Jan. 5) ($):

How do poor families spend so much more money than they earn? By one measure — the National Council of Welfare — the average poor Canadian family spends $4,855 a year more than the $14,366 it receives as income, a difference of 33 per cent. By another measure — the Fraser Institute — the average poor Canadian family spends $9,370 more than the $9,114 it receives as income, a difference of more than 100 per cent.

* * * * * *

How does Statscan determine the income of the poor? It asks them. How does it determine the spending of the poor? It asks them. What's the source of the "bonus bucks" that the poor spend? Perhaps, in one of its surveys, Statscan should ask them. We can, meantime, only speculate.

Off-the-table earnings. Wanton use of credit cards. Gifts from more affluent family members. Academic scholarships. (Many postgraduate students are, by LICO logic, poverty-stricken.) But Canada's basic information on poverty remains dubious.

No one knows whether the poor, in their reports, minimize the money they either earn or otherwise get. It shouldn't be surprising if they do. Everyone else does it all the time.

I want to make two points. First, nobody is implying that the underground economy is strictly measuring income concealment, as some detractors seem to be charging. In a 1992 report published by Statistics Canada, "the underground economy" is defined as the mean economic activity that is not measured in the system of national accounts. In the past I may have failed to mention other sources of the "hidden economy" when referring to income concealment, but that’s because I was being sloppy and perhaps aiming for brevity.

Secondly I’ve read quite a few papers recently about different approaches to income concealment (ie. ignoring the rest of the hidden economy). The expenditure approach, developed by Pissarides and Weber (1989), seems to be the most well-received, at least according to the literature that I’ve read (please share your opinion here if you have one!). For example, Pissarides and Weber look at the relationship between income and food expenditures for salary and wage earners to evaluate the "normal" relationship between the two. They then compare this relationship to the income/food expenditure relationship of the self employed. If food expenditure appears to be incredibly high relative to the income level for the self employed, involvement in the hidden economy is assumed.

A major assumption is that the wage and salary earners (in comparison to the self employed) have very little ability to conceal their income (again, never mind their total involvement in the hidden economy), because employers document employees' earnings on their T4 slips. Thus, data from wage and salary earners is assumed to be actual. In relation to Reynold's article, this implies that poor families spend more money than they earn not because they are concealing income, but because of credit, loans, etc.

I have some criticisms of the expenditure approach, only one of which is relevant to Reynold’s article. The expenditure approach often depends on the use of surveys, for lack of other data. But to what extent can we rely on surveys? I have in mind a paper by Elffers, Weigel and Hessing (1987), who found zero correlation between survey results and audits for Dutch taxpayers. If there is zero correlation, even for wage and salary earners (this surprises me), this is a violation of a key assumption of the Pissarides and Weber model.

Further to Elffers et al’s findings, Andrew Jackson at the RPE blog has this to say:

Statistics Canada’s main surveys of consumption patterns are not very reliable, particularly when it comes to measuring the consumption of the very poor. Household surveys (formerly the SCF and the SLID) have been shown by Statistics Canada to produce significantly lower estimates of the incidence of low income than Census and tax data, likely because of under-sampling at the low end of the income distribution. (See Marc Frenette, David Green and Garnett Picot "Rising Income Inequality in the 1990s" in David Green and Jon Kesselman (Eds) Dimensions of Inequality in Canada, UBC Press, 2006.)

While this is a major blow to the expenditure approach (and there are others I won’t bore you with), I have to agree with Mr. Reynolds: i) the data simply does not tell what is hidden; and, ii)if other wage and salary earners are in some way involved in the hidden economy, why assume that the poor are an exception? Jackson’s critical piece on Reynold’s article can be found here.

By the way, if it's ever the case that you're itching to read an available-by-subscription-only article that I refer to, I don't mind emailing it by request.

Productivity and firm size in construction, pt2

A couple of posts back I asked why Canada’s construction sector is said to be more productive than the U.S. sector, despite having smaller establishment sizes. The gap isn’t huge, but it’s surprising. I don’t know if any single concept can answer this. Instead, I’ve broken it down to two questions: why are the Canadian firms small, and why are they more productive.

On being small…

Small establishments are unburdened from taxes on inventory
If one considers the high taxes that the construction sector faces on inventory, it seems reasonable that large companies wish to unburden themselves of this tax by contracting individuals to do certain services. Perhaps in Canada self employed contractors are more willing to take on the risk of being taxed on inventory (perhaps due to favourable tax scheme on Canada’s self employed, in comparison to the U.S.? I don’t know if this would justify the gap).

Variable taxes, in contrast to flat taxes, keep establishments small, even in Canada’s most populated areas where construction productivity is destined to be highest regardless of establishment size
B.C. has the lowest provincial tax rate in Canada up to a taxable income of $67,500 per annum. Above this income level, the rate rises rapidly and Alberta becomes the lowest personal tax jurisdiction at an income of $88,000 per annum. B.C. has the highest unincorporated self employment rate of all of Canada in the construction sector while Alberta has the highest incorporated self employment rate (see graphics below that I created using StatsCan CANSIM data Table282-0011). Perhaps Canadians are more sensitive to an un-level tax scheme than Americans.

Here's my colour scheme:
self employed unincorporated w/ no paid help,
self employed incorporated w/ paid help,
self employed incorporated w/ no paid help,
and the final pie in lime is self employed unincorporated with paid help.

On being more productive…

Economies of scale are relatively unimportant in the construction sector
Construction is highly labour-intensive, depends on a high proportion of low-skilled jobs and is not considered a high technology sector. Further, I would argue that where economies of scale do matter in the construction sector, they mean less than they once did. Thus, simply being big doesn’t give U.S. firms a greater advantage in this sector.

And yet this isn’t the case with other labour intensive industries. The U.S./Canada "productivity gap is large in other labour intensive industries such as textiles and clothing as well as in fabricated metals, the machinery and computers industry, and the electronic and electrical equipment industry." So maybe this idea is a dud.

The hidden economy
If labour inputs are somehow being underestimated, then productivity (measured in my last post as GDP divided by hours worked, by the way) could be distorted.

For example, John O’Grady (2001) estimated that, on average, the annual underground income in Ontario’s construction industry, in the period 1998-2000 increased to $2.395 billion. This is due to the "hidden economy" composed of self-employed individuals who wish to conceal their income, which we know is easier to do in the construction sector than nearly any other sector.

Also, I think dachisb made a good point in response to my first post: "I would wager that low cost labour (read mexican migrants) drives most of this difference."

Not all construction is made equal
I’m not sure what affect this would have, but I thought it was worth noting that heavy and civil engineer construction is much smaller in Canada then, say, the construction of buildings. Surely many modes of construction have their own unique productivity level, and the compilation differs across countries.

Am I missing anything? Any more ideas anyone?

The rise of necessity entrepreneurs?

December saw 62,000 new jobs, taking the jobless rate to a 30-year low.

Ahem. Who was it that defied just about every analyst that said the labour market would fall in Q4? I believe it was me. But perhaps I was just lucky. Anyway, I didn’t see it all coming...

Self employment is booming. BMO economist Douglas Porter says December’s job gains were spread across all sectors, except construction was up only slightly. Is there any good reason why all these people with jobs wouldn’t pump up residential construction? Perhaps, if they didn’t have the right jobs. The Globe and Mail reported today that 49,000 of the positions were characterized as self employed.

This reminds me of a previous post where I explored three reasons why individuals might become self employed:

a) self employment is a stepping stone to other work

b) self employment is a stepping stone to retirement

c) self employment persists in periods of poor job growth

As hiring slows down, it might be the case that a) and c) are coming true. Perhaps self employment really is an innate survival skill. I’ll return to this topic at some point.

Also, I haven’t forgotten about my last post on the construction sector. I’ll continue with that tomorrow. Or something.

Productivity and firm size in construction

Why would Canada's construction sector be more productive than the U.S. sector despite having smaller establishment sizes (ie. fewer employees in each establishment)?

If it’s the case that American construction firms, for whatever reason, have a greater ability/willingness to take advantage of economies of scale (an explanation for their larger establishment sizes), one might expect the U.S. construction sector to be more productive than Canada’s. Empirical evidence suggests otherwise. Canada’s construction sector, despite its smaller establishment sizes, is more productive, says several studies. It also has slightly more capital intensity, but this could mean a few things (ie. low economies of scale; high capital costs).

I have some ideas but I'll sit on this some more and come back to it in my next post.

Source of graphs: Don Drummond, TD economist (2005).

Canada's generous passport policy

Canadian policy-makers will soon be reviewing the subject of taxes on non-residents and citizenship options. Unlike in many countries, in Canada non-residents do not pay taxes, and yet they have the option to benefit from a number of social programs.

The CD Howe Institute recently published a paper by John Chant, a professor of economics at Simon Fraser University, titled The Passport Package. The passport package, says Chant, is the package of benefit options that non-residents receive. These include easy qualification to healthcare benefits, free entry and exit, resident tuition fees, financial assistance when enroled in postsecondary institutions, and more.

Chant suggests that all non-residents pay a flat passport renewal fee. He compares the "passport package" to financial options.

The theory of financial options provides guidance with respect to setting the level of the passport fee. The value to the holders of the passport package over any period equals the sum of the values of each option in the package. In turn, each option has a value equal to the probability it will be exercised in the period, times the value the holder gains from its exercise. Different holders of the passport package would attach different values to each element. A law abiding citizen who values avoiding a year in a foreign jail at $60,000 would be willing to pay $6 a year for the privilege of repatriation if they have a 1/100 percent chance of spending a year in a foreign jail. Someone more criminally inclined may be willing to pay much more.

Like financial options, the options in the passport package are exercised when they are "in the money"; that is, when the value of the object optioned exceeds the strike price at which the option can be exercised. In the same way, passport options are exercised only when their holders perceive that the benefits from exercising exceed the costs.

Often this will be dictated by events. The benefits from higher education become attractive when a student wants to come to Canada to study; the prisoner exchange becomes valuable to someone facing jail in a foreign land; and the option of evacuation and assured entry to Canada will be exercised in times of war and domestic upheaval. The parallel with financial options goes further: if people fail to renew their passport, the option expires out of the money. To make the package self-supporting, the fees would have to cover the cost of underwriting the exercise of the options. The revenues of the package would depend on the reaction of non-resident citizens. Some would judge that the value of the package exceeds the fee and opt to pay, while others would let their passports lapse and lose the benefits. If 20 percent of current non-resident citizens opted not to pay the fee, a $500 fee for five-year renewals would raise roughly $200 million per year.

This seems reasonable. If non-residents don’t find that the "passport package" is worthy of the price tag, they don’t need to renew their passport. It also seems simple. It’s far less complex than actually taxing non-residents.

Chant adds:

John F. Kennedy’s appeal, "ask not what your country can do for you — ask what you can do for your country" was a high mark for the rhetoric inspired by citizenship. Its message, however, is at odds with reality. People do weigh the benefits and costs of citizenship in deciding which and how many passports they carry. Some become and remain citizens of countries where they never intend to live.

Snickerdoodles and sea creatures

Tim Haab points to an interesting article:

Researchers at the University of Washington say all that holiday baking and eating has an environmental impact — Puget Sound is being flavored by cinnamon and vanilla.
[...]
So far, the research has turned up no evidence that snickerdoodles are harming sea creatures, but their research does lead to some serious environmental questions. Fish rely heavily on their sense of smell to locate food, for example, and, in the case of salmon, to find their way back to their home stream to spawn.

Tim’s environmental solution:

I propose a Christmas cookie cap and trade system. You are each hereby allocated one dozen cookie permits per month. These permits are fully bankable and tradeable and can be saved for the Christmas cookie season. I will monitor your consumption and be mandated to take any unpermitted cookies off your hands. I will dispose of them as I see fit.

I question Tim’s motives. Why stop at cookies? A true environmental martyr would be happy to monitor the giving of unwanted Christmas sweaters (see below) that are produced (and disposed of) every year.

Given that the textile industry uses toxic chemicals to bleach and dye yarn, perhaps the production of Christmas sweaters is worse for the environment than the vanilla and cinnamon inputs used in household kitchens. The tighter the cap on Christmas sweaters, the better, in my mind.