Tax evasion: lessons from Egypt

In my view, we should be taking a lesson from Egypt when it comes to dealing with tax evasion. I'll explain.

Studies claim that tax evasion among the self employed in Canada is common and the costs are high. What should be done? First, it depends if the government is concerned purely with inefficiency, or if its concern is inequality (which do not need to be trade-offs, as I've argued before here; and I'll point to my view on equality here). I'm going to address the aim of efficiency here, but I'll quickly explain why.

In a welfare state, the objective of an inequality-averse government would be to raise taxes to redistribute incomes, and thus auditing would be useful to protect the tax base. But there are drawbacks to making equality the only major priority. I won't get into the old equality debate again here, but here are a few thoughts: First, when are degrees of inequality aversion sufficient? And, how do we know if such a degree is attainable? Finally, it's worth repeating that, if efficiency is gained, equality does not need to be a trade-off.

My assumption henceforth is that efficiency is the government's concern when it comes to deterring tax evasion.

What actions can the government undertake to increase efficiency? Three possibilities: Do nothing, design an efficient auditing scheme, or cut taxes to a point where the self employed are more willing to pay (and, ultimately, adopt a low flat tax).

Do nothing

If efficiency is the major concern, nothing should be done, claims Simon C. Parker in The Economics of Self Employment and Entrepreneurship (2004: p. 248). Audits are expensive for the government and for the individuals who prepare the tax reports for audits. [edit: My hurried fingers pasted the wrong quote here. Sorry. Intended quote:] "These costs impose deadweight losses on the economy." Parker concludes that a government would be more efficient to not audit.

Design an efficient auditing scheme

Herb J. Schuetze (2002) disagrees. He finds that (at least in Canada) a discriminatory method of auditing would be most effective in reducing tax evasion.

Excerpt from Schuetze's paper "Profiles of Noncompliance Among the Self Employed" (2002, p 19-20) (The entire paper can be found here. Click on "research"):

Even though pre-tax wages will adjust to equalize after-tax wages, too many resources, in terms of efficiency, will be allocated to occupations which provide the greatest opportunities for noncompliance. This result also suggests an obvious strategy for the development of an effective tax audit system. One which targets the self-employed in construction and service occupations is likely to be more effective.

...A tax audit scheme targeting groups which have been found to conceal income the most (such as self employed households headed by younger males or those in the construction and service occupations) is likely to be an effective tool in reducing noncompliance.

He acknowledges a disadvantage:

Clearly, such a policy, if continued for a period of time, would lead to the misrepresentation of occupation and other characteristics by self-employed tax filers to avoid being audited. However, if the information from these audits is used effectively, policies can be designed to reduce noncompliance.

Such a well-designed auditing scheme might be attractive, but perhaps its major disadvantage (other than the one pointed out by Schuetze) is that it's not simplistic. Simplicity in self-employed tax treatment, or any tax treatment for that matter, should be an objective within any economy. By the way, The World Bank agrees with this sentiment (link via The Heritage Foundation) :

Complicated tax systems can lead to high evasion, even when rates are low. ... A better way to meet revenue targets is to encourage tax compliance by keeping rates moderate.

Lower taxes

In my mind, the best solution would be to take a lesson from Egypt. That is, lower taxes to a point where the self employed are willing to pay (zero would be the ultimate). By extension, if taxes for the self employed are to be lower, taxes for all business should be lower. A flat tax seems to be the most efficient, but I digress. Let's get back to Egypt.

Excerpt from "TAX: Abrupt halt to haggling." The Financial Times, Dec. 11:

"The existing culture as far as the tax authority was concerned was a story of predation." says Youssef Boutros Ghali, the finance minister. "Anything the tax authority could squeeze out, it did. But now we have affected a fundamental change of attitude. We have given up predation and established a partnership through a law that is transparent rather than fuzzy and through reducing the tax rate to what people would be willing to part with."

The new law set the top rate at 20 per cent for both individuals and companies, down from 42 per cent. It offered a total amnesty to those who had never filed a return in their lives, regardless of how long they had been earning, if they presented themselves before the end of March 2006.

The law also introduced self-assessment, changing at one fell swoop a system based on the assumption that the tax payer is always a liar, to one in which inspectors have to believe properly-maintained records presented to them, unless they can come up with evidence of wrongdoing.

At the same time penalties for tax evasion have been seriously stiffened. Mr Boutros Ghali says the impact in the first year has been dramatic, with 2.6m returns filed, up from 1.7m in 2005.

The finance ministry had been expecting receipts to drop by 12 per cent in the first year and by 7 per cent in the second before climbing back to their original level at the time the legislation was introduced. Instead, tax receipts have grown by 17 per cent - a reflection of both the wider tax base, and the buoyant economy.

....It is still not uncommon for middle class professionals to argue privately that they should not pay tax, citing examples of official corruption or waste, or to justify tax
evasion by saying that they make no use of the subsidized and generally bad health and education services provided by the government and that, instead, they pay exorbitant fees at private schools and hospitals.

Tax inspectors also say that under-reporting is still rife. One cited the example of a doctor who charged him personally $20 when he went for a consultation, but when he filed his return he listed his fee as less than $4.

No one has any doubts that it will take years for a new tax culture to take roots. But there is agreement that new law is definitely a start.

Now Mr Boutros Ghali says that, with an improved computerised system, and freed of the necessity to check the records of every single taxpayer, his 39,000 inspectors will have more time to chase evaders.

Perhaps we could do better to take our complex tax systems to the trash and keep an eye on Egypt.

Income Splitting Among the Self-Employed

Which system of taxation on the self employed evokes the greatest tax distortions?

I) An income-splitting system where individuals may appeal to tax non-compliance; or,

II) A system of individual taxation where individuals may simply not report income.

In an interesting paper forthcoming in The Canadian Journal of Economics, University of Victoria professor Herbert J. Schuetze estimates (with a few caveats) that in Canada’s income-splitting system “…approximately one half of a billion dollars in taxes were avoided in 1998 by more than 90,000 businesses.”

An abstract from “Income Splitting Among the Self-Employed:”

Whether the individual or the household should be the unit of taxation is a long-running debate in the economics literature. One potentially important cost associated with a switch to individual taxation, which has been overlooked in this debate, is the impact of such a move on tax non-compliance. In particular, under individual taxation with progressive marginal tax rates households in which the distribution of income among household members is unequal benefit from attributing income from the higher to thelower income household member. The absence of a third party reporting income enables self-employed households to "split" income among family members to reduce income tax liabilities. Using the Canadian experience as a case study this paper sheds light on the magnitude and nature of this activity by developing a unique estimator of the incidence of illegal income splitting among couples. These estimates provide evidence that the occurrence of income splitting is likely non-trivial and suggest that the costs associated with this activity are potentially significant.

Schuetze draws a comparison between the U.S. and Canada. “The current US tax code, which primarily treats the household as the unit of observation, is such that the distribution of income within the household does not affect household tax liabilities.”

His findings:

…the raw reported employment rates of wives of self-employed men in Canada are significantly higher than those of their US counterparts. …. No significant difference in employment rates are observed among husbands…. I find strong supporting evidence that the employment differential found among wives is indicative of Canadian self-employed men attributing income to their wives.

He concludes:

…the pattern of income splitting found above suggest that countries that have high marginal tax rates, unequal wages across men and women and high rates of self-employment may find a system of joint taxation optimal, while for those with low incentives for income splitting individual taxation may be more appropriate.

Perhaps as equally interesting as his findings (at least to me) is the methodology he uses. He attempts to identify hidden behaviours, taking a lesson from Duggan and Levitt (corruption in wrestling) and Jacob and Levitt (cheating among teachers), among others.

Santas and elves: skilled and unskilled?

Apparently the demand for skilled Santas in Alberta vastly exceeds supply. The problem, says Victor Nevada, headmaster of a Calgary-based Santa School, is that Santas are being paid as though they were unskilled workers. Gasp!

Malls should classify the Santa position as skilled labour, he said, given the job requires skills ranging from acting to psychology.

"Santas encounter stories that cause a lot of emotional distress for Santa and children generally are regarding Santa at that point as psychologist, I suppose," he said. "They're looking to Santa to provide some closure, some comfort and so forth and that's why I say it's a skilled position. If a personal shopper can make $50 an hour I would think that a skilled Santa should also make at least about $50 an hour."

I'm sure it's gruelling, but there must be plenty of elves willing to do the job for less than $50.

That would answer the problem from the supply side, but what about demand? No problem. If malls were to treat elves as subsitutes to Santa rather than complements, perhaps supply will create its own demand, as Says Law goes. After all, elves are small (less intimidating) and often more agile (exciting). They can sell themselves.

Perhaps any one of these small people pictured below would have prefered an elf if only the market existed.

If demand is as low as anecdotal evidence suggests, there's no reason for wages to be as high as $50/hour, and thus Alberta's Santas are right to go work on the oil rigs.

Plenty of anecdotal evidence of weak demand sweeping across North America can be found here.

Link fest

I've made a few discoveries.

1.Bill Goeff's Econ Search Engine (Google Trial III) is a customized search engine that "lets you use Google to search the contents of some 10,000 economics web sites (the URLs are from RFE and EDIRC)." The best part is that you can add his search engine directly to your Google homepage.

How useful is it? Very. For example, if you search for the word "toilet" using Google, you'll find The Home of Toilet Art, Humor, and Fun Facts. But use Bill's Econ Search Engine and you'll be led to worldwide portable toilet sales. Voila. No more humour, fun, and all that crap. Thanks Bill! Log into your Google account, click on Google Gadgets For Your Webpage, and run a search for "Econ Search Engine Google Trial III."

2. I'm really digging the Vancouver Housing blog. Don't let the name fool you. There's a lot to learn here. For example, here, he/she asks if immigration is driving the Vancouver housing boom. And here he/she looks at median family incomes in cities across Canada. And if you need more convincing, it won best Canadian business blog this year. Unfortunately, the author is on a holiday hiatus, but the archives are worth reading for now.

3. I often wish that Canada would catch up to the U.S. and the U.K. when it comes to the frequency in which (some) data is collected, as well as the accessibility of (some) data.

But now we have Swivel available to us, which could possibly, maybe, perhaps improve the data accessibility problem as long as people use it, and use it well. Tech Crunch has an explanation (h/t Statistical Modeling, Causal Inference, and Social Science).

Sources of inequality

Recently we saw the release of two interesting reports on household wealth: the Canadian household wealth figures for 2005 from Statistics Canada, and a report from the UN University's World Institute for Development and Economics (WIDE).

The WIDE release and the StatsCan release cover a lot of ground. Incidentally, the StatsCan release is the first of is kind to offer such detailed data on Canada's household wealth distribution since their last such release in 1995 (we're a bit behind the U.S. and the U.K. in the frequency in which we collect this particular type of data). An attempt is made to actually isolate the sources of inequality, which makes for a unique (as far as I know) opportunity for cross country comparisons of sources of inequality.

What can we learn about the sources of inequality of wealth in Canada?

One thing we know is that the middle class holds the majority of their wealth in the form of their principal residence .
Graph via TD
For comparison:

Graph source: WIDE

Secondly, the richest Canadians are likely to hold a greater portion of their wealth in stocks, relative to lower classes.

TD economists Don Drummond and David Tulk offer their analysis on this:

A distinguishing feature of the 1999 and 2005 wealth surveys is the decline in the real value of stock holdings. As the wealthy hold a disproportionate amount of stocks, the decline in the real value is the principal reason why the concentration of wealth in the highest quintile did not increase by more. If investment returns rise the trend towards growing wealth disparities will likely intensify. This could be compounded by sluggish wage gains in the low end and the financial challenge of immigrants – the main source of growth in the younger, less affluent population.

The National Post says tomato differently:

Net wealth -- non-financial and financial assets minus liabilities -- jumped to 640% of annual disposable income in 2005 from 527% in 2000 and just 370% in 1995, when the country was struggling to emerge from a recession.

The surge in wealth in 2005 reflects rising stock markets and once again the positive terms of trade shock where a stronger dollar is making imports cheaper while export prices surge.

That appears to more than offset total debt of 126% of disposable income in 2005.

The point is, the source of household wealth differs across classes in Canada.

I have two thoughts on this. First, equality varies across time and space. Placing countries on an ordinal scale seems bizarre (to me, anyway), likewise to drawing conclusions based on "trends." The richest Canadians hold a high portion their wealth in stocks, which vary in their returns across time, therefore "equality" is not a stationary measure. Further, there's of course often heterogenity in the data across regions. Perhaps one of the key benefits of these studies is that they allow us to examine the nature of sources of wealth, rather than pointing us to "trends," or forcing cross-sectional data into ordinal scales where both are inappropriate beyond very general terms.

Second, there are policy implications. By understanding the sources of inequality we can fight the impulse to redistribute wealth based on "trends." Further, it should be perfectly clear to policy makers that the needs of investors should be accommodated (since we know where household wealth is concentrated). Onay oremay orporatecay axestay. Right? Clear.

There's so much to explore on this subject, but I'll quickly note one of the many interesting aspects of equality: tax shifting, which neither study had anything to say about, unfortunately (but perhaps understandably so in the Canadian context). Alan Reynolds from yesterday's WSJ (h/t Greg Mankiw):

As was well-documented years ago by economists Roger Gordon and Joel Slemrod, a great deal of the apparent increase in reported high incomes has been due to "tax shifting." That is, lower individual tax rates induced thousands of businesses to shift from filing under the corporate tax system to filing under the individual tax system, often as limited liability companies or Subchapter S corporations.

As far as I can tell, this doesn't seem like a big problem in Canada. Jack Mintz and Michael Smart (2001):

Canada integrates corporate and personal taxes by providing a dividend tax credit and excluding a portion of capital gains from taxation. At the small business level, the combined corporate and personal tax rate on equity income is roughly equal to the personal rate on employment and interest income, while for large companies combined tax rates on equity income exceed that of other income. When the small corporate tax rate has been changed in the past, governments have typically adjusted dividend and capital gains tax rates to maintain integration at the small-business level, in order to minimize incentives for shifting between corporate and personal tax bases.

The subject of "equality" often makes me want to rip my hair out, but there are surely thousands of useful, interesting ways to look at it, as StatsCan and WIDE have proven. What a thick and intriguing subject. Please, let's stop dissing it.

Defaults and donations

It's been a news-heavy week on the personal front, but I'm attempting to get back into some kind of routine, which would include catching up with my reading (a futile task) and blogging more regularly.

Here's just a small thought I've been pondering: How can we encourage individuals to commit to donating, including the donation of their money to charity, or the donation of their organs when they die? Maybe we shouldn't. (edit: At least not on an individual level).

First, consider organ donation.

The Edmonton Journal reports, “Health Canada has identified a shortage of organ donors in Canada, noting Canada has one of the lowest rates of organ donation in the industrialized world.”

Consider the ways we can encourage organ donation.

The government can commit to ad campaigns to attract the so-called "altruistic donor." It could also offer a tax deduction of, say, $5,000 or $10,000 off the estate of an organ donator.

The first option can be costly and ineffective. And, a tax deduction? Well, I happen to think that there shouldn't be an estate tax, so I'm not quite on par with this solution either.

Then there are financial incentives beyond tax deduction. Alex Tabarrok explains (2004):

In the minds of many, financial incentives for organ donation means rich people buying up kidneys being hawked on eBay by the desperately poor...Two distinctions are especially important. First, financial compensation for cadaveric donation and for living donation are different ideas and it is quite possible to have one without the other. Indeed, the primary cause of so-called organ tourism—rich people flying to poor countries like India to undergo a transplant from a poor, living donor—is the shortage of organs in the West. By allowing compensation for cadaveric donations we’ll increase the domestic supply and reduce the demand for people to fly to poorer countries for living donation. Financial compensation for cadaveric donation, in other words, is a substitute for both paid and unpaid living donation.

Second, organs are currently allocated according to a point system which is based on factors such as the quality of the match between donor and recipient, the length of time the potential recipient has been on the waiting list, the health of the potential recipient and so forth. It is not necessary to change these criteria in order to make use of financial compensation. Financial incentives can be used to increase the supply of organs without using finance to determine who will receive an organ.

The solution that has my attention is this: change the default. Andrew from “Statistical Modeling, Causal Inference, and Social Science” explains:

Over 99% of Austrians and only 12% of Gernans consent to donate their organs after death. Are Austrians so much nicer than Germans? Maybe so, but a clue is that Austria has a "presumed consent" rule (the default is to donate) and Germany has an "explicit consent" rule (the default is to not donate). Johnson and Goldstein find huge effects of the default in organ donations, and others have found such default effects elsewhere.

What does this have to do with financial charity donations? Andrew goes on:

Lots of research shows that people are likely to take the default option (see here and here for some thoughts on the topic). The clearest examples are pension plans and organ donations, both of which show lots of variation and also show people's decisions strongly tracking the default options.

....My hypothesis, then, is that the groups that give more to charity, and that give more blood, have defaults that more strongly favor this giving. Such defaults are generally implicit (excepting situations such as religions that require tithing), but to the extent that the U.S. has different "subcultures," they could be real. We actually might be able to learn more about this with our new GSS questions, where we ask people how many Democrats and Republicans they know (in addition to asking their own political preferences).

Does this explanation add anything, or am I just pushing things back from "why to people vary in how much they give" to "why is there variation in defaults"? I think something is gained, actually, partly because, to the extent the default story is true, one could perhaps increase giving by working on the defaults, rather than trying directly to make people nicer. Just as, for organ donation, it would probably be more effective to change the default rather than to try to convince people individually, based on current defaults.

I'm not quite sure how changing a default would work with regards to giving money to charity, or giving blood, without infringing on people's freedoms (I don't consider Austria's "presumed consent" rule to be such an infringment), but I like how Andrew is thinking and I'll be pondering his idea more.

The Art of Controversy, Verizon style

Prof Greg Mankiw points to a recording that “takes a while, and it is not at all edifying.” Go ahead and laugh at the math skills held by a couple of Verizon call center employees, but notice the skill they present on other fronts. Namely, they are natural masters of controversy.

Unable (or unwilling) to see their mathematical error, they've wisely armed themselves with Stratagem XXII, Stratagem XV, and Stratagem XXXVI from Arthur Schopenhauer's Art of Controversy. That is, “Petitio principii,” “Use Seemingly Absurd Propositions,” and (the powerhouse) “Bewilder Your Opponent by Mere Bombast.” Their strategies are classic, and painful to listen to (their greatest strength perhaps). Real slick.

George, their opponent, was left with few options. He thus pulled out Stratagem XXVIII: “Persuade the Audience, Not The Opponent.” Brilliant counter attack. The public release of his phone conversation has surely left the blogosphere entirely persuaded (and amused).

A couple more days of hibernation and I'll be back (with less fluff).

To anyone who still returns this blog, I really appreciate you being so patient with my increasingly relaxed blogging habits. I'd prefer to be posting more often and I have a few ideas that I'm eager to run past anyone who will listen. The frequency will pick up here again in a week when I return to trying to earn your love (or at least your readership).

Sometimes I think Stanislaw Lec wasn't being so terribly peculiar when he said, "People find life entirely too time-consuming."

Economic growth or flat labour productivity?

I don't see sunshine and lollipops going into Q4, but November's labour figures make me slightly less bearish than Marc Lee. The fact is, hours worked increased by 1.6% since the end of the last quarter and labour growth still looks healthy (even though much of the net growth in employment was in lower-paying, part-time positions, unlike what we saw from October's net gain in employment of 51,000). Further, as we know, people with jobs spend money.

When October's employment figures came out, I asked why job growth is so out of sync with GDP growth. This still puzzles me, but I'm comforted to know that I'm in good company. TD Economist David Tulk asks a good question:

With just a single month yet to be revealed, 2006 is shaping up to deliver the labour market’s best performance in three years with the expected addition of near 300,000 net new jobs. This stands in contrast to yesterday’s GDP report which shows that economic growth has slowed markedly over the middle quarters of 2006. However, an encouraging development for the final quarter is the pick up in hours worked. Over the first two months of Q4, hours worked have increased by 1.6%, reversing the 0.1% fall observed in Q3. The puzzle is to sort out whether this indicates more economic growth momentum though the fourth quarter of 2006 than suggested by the 0.3% decline in September’s real GDP or a flattening of labour productivity.

Really, the increase in hours worked shouldn't be too surprising, nor should the fact that it hit the right regions in just the right sectors. In October we saw full-time employment rise by 50, 500, putting labour-starved Alberta out of its misery. Well, not quite -– demand is still there -- but Alberta and British Columbia did gain 70 per cent of those new jobs, and November's employment figures tell us that Alberta's woes continue to improve.

Perhaps a productive workforce throughout Q3 and Q4 will be enough to partly offset the economy's bleaker qualities (eg. our less than pretty exports choking on the strong dollar -- which has since improved), and give us less to be bleak about after we witnessed a Q3 GDP growth rate of 1.7%.

In fact, never mind the labour report, maybe the Q3 GDP figure isn't so bad on its own.
Tulk again:

...the details are not as discouraging as the headline number would suggest. While some of the weakness can be traced to the second consecutive quarterly decline in residential investment, the main cause of the deceleration in real GDP growth was a combination of more moderate government spending and falling inventory investment – two of the more volatile components of real GDP. For example, part of the deceleration in government spending from 4.9% in the second quarter to 0.7% in the third was due in part to the one-off effect of the conclusion of the 2006 Census. Meanwhile, the fall in inventory investment likely reflects some unwinding from the significant accumulation in the previous quarter.

As long as firms refuse to fire workers until a recession is in sight, labour growth is a poor indicator of things to come; however, in sum, here's my guesstimate: A slowdown is inevitable, but Q4 has a cushion of labour productivity that some aren't seeing.

Random notes

1.'The latest jobless rates and what's behind them.'
CBC has updated its nifty interactive tool to reflect November's employment figures.
The west wins again.

2. I'm burning to relieve myself of this. Why does at least one Canadian journalist insist on mirroring U.S. journalists by over-emphasizing the housing market figures when housing is such a smaller influence on Canada's CPI? I'm going by memory, but I believe that housing has a weight of 3.5% in Canada and 30% in the U.S.

Mary (Foley) Doyle, dead at 88

I thought I would try something new on this blog. After realizing how very few female role models I have, I became convinced that it's only because I'm unaware of the many successful women out there. In an effort to learn more about them, I'll be profiling female economists and business women, maybe once or twice a month, beginning today with Mary (Foley) Doyle.

My group of friends are some of the most magnificent people in the world (I just know it), but when I came across the obituary of Mary (Foley) Doyle, I wished I could have added her to my circle of friends. I want to share this piece, written by her children, which ran in The Globe and Mail last week. She seems like a spectacular woman (a chairwoman in 1956!), and this glimpse into her life is truly inspiring.

Mary (Foley) Doyle
Mother, businesswoman. Born July 5, 1917 in Point Mall, Placentia Bay, Nfld. Died May 23 in St. John's, of heart failure, aged 88. Mary Foley was raised in Corner Brook, far from her parents' native Placentia Bay. Work had lured them west. Her mother was a determined redhead whose genius was to feed and clothe seven daughters and a son on a mill-worker's wage.
Mary graduated from St. Henry's, narrowly missed a university scholarship, and took “commercial.” She soon became a private secretary. One day, offered the rare opportunity to make a long-distance call, she phoned a Water Street merchant in St. John's, replying to an ad. Impressed, he hired her.
Three years later, Mary married Gerald Doyle. He was a widower, 25 years older than she, and living on an eight-acre estate. She stepped into a household with maids, a cook and a gardener — and five young motherless boys. Dinner parties, New York business trips, cruises and summers sailing around Newfoundland: She'd been swept into a world of glamour, travel, and love. When he died in 1956, he left a bewildered 39-year-old with three more small children in the mix. She was thrown immediately into a man's world as “chairman” of her husband's manufacturer's agency, in charge of 50 employees.
Mary Doyle never felt at home with St. John's “society.” She sought company, and found it in the Redemptorist priests: intelligent, urbane men who posed no threat to her widowhood. The mother of our childhood was stunning, decisive, and slightly scary. She wore a sealskin jacket, drove a Land Rover and had two German Shepherds. If a man hesitated when approaching her, she'd exclaim: A man who's afraid of dogs! She was fearless, bought and sold property without advice, and travelled without reservations, including a three-month European tour with kids. Later, she drove around Morocco in an Austin Mini. Fearless, yet. . . she once opened the front door, and ordered a passing teenager to come in and catch a mouse. At 53, her family raised, Mary walked into a classroom of 17-year-olds and began university. She took notes in shorthand, asked smart questions, and wrote A papers. At 57, she crossed the stage to collect a history degree. The photo records a proud and defiant woman.
Mary was anti-Confederate. Returning Canadian? she'd be asked at a border. I carry a Canadian passport. Canadian citizen? I was born in Point Mall. Eventually, a frustrated guard would let her pass. Her rage against Canada dates from 1939 when an immigration officer on a Halifax dock looked down at her seven-year-old Down Syndrome sister. He removed the child to a holding cell and next day handed her back: Entry Denied.
Mary was a fighter. Stacks of yellow paper document responses to injustice. In 1969 she fumed in a church pew on Fogo Island while a priest “harangued his own good people.” She wrote him about what he had “flung with vituperation” to “a captive audience who could not speak back.” She copied the bishop.
Her independence strengthened as she aged. At 77 she was tough enough to cope with the blow of losing a leg. For months her car sat idle in the driveway; she couldn't relinquish this symbol of mobility. In time, she installed a lift which she rode to a waiting wheelchair downstairs. She'd open the garage door remotely and take a cab to the bank. She and her dog carried on through the Newfoundland winters for five years. She moved in briefly with her youngest son then, with courage and insight, made the inevitable move to a home.
She was a rebel, and fires of defiance continued to burn even as her world grew smaller. She hung a bold sign on the door: No admittance after 11:00 p.m.

John, Bill and Marjorie are Mary's children.

The BoC's big obstacle

The Canadian press is giving a lot of ink to the possibility of the Bank of Canada setting a lower inflation rate in the future and, further, the possibility that it may favour price targeting. Of course, no action would happen until 2011 if it happened at all, but with the next renewal due this December, the subject is a popular one.

If the public doesn't "get it" though, is price targeting worth pursuing? From The Toronto Star:

Inflation target under review (Nov.27)
[UWO prof David Laidler] acknowledged it would be “risky” to change the rules without careful preparation of the public, but proposed a one per cent target, stressing that “a two per cent inflation rate is a far cry from anyone’s (or at least any retiree’s) idea of price-level stability.”
The Bank of Canada raises another, more complex, possibility: targeting a price level. This would mean that periods of above-target inflation — which under the current policy are written off while the bank seeks merely to return to the two per cent level — would have to be offset by periods of inflation below the target to produce stable long-term prices. The bank’s document acknowledges “the difficulty that might be associated with explaining price-level targeting to the general public.”
Officials intend to complete their research “well before 2011 so as to ensure sufficient time for open discussion of the results and their implications.”

I'm beginning to think that one of the biggest obstacles associated with price targeting is the public's confusion over what it actually is and how it would work. Ben Bernanke and Allan S. Blinder could probably write a book or two on this subject by now after Bernanke proposed “the explicit numerical definition for the price stability objective” (I've blogged about the confusion they've both seen here). Bernanke's proposal is something like inflation targeting; still, I think his experience with proposing a new regime, as I wrote about in the link above, says a lot.

I'm short on time, but I thought I would share a few links that I find interesting.

1. Are husbands like potatoes? Bryan Caplan provides some food for thought in his latest post over at EconLog. His reasoning isn't compatible with my own, but it's laugh-out-loud funny. According to him,

"Once women can become financially independent of a man, they will choose to do so." This is theoretically possible, but only if husbands, like potatoes, are inferior goods.

He concludes that demand for husbands is at an all-time high.

A commentator points to a common survey outcome: “married men are the happiest people, followed by unmarried women, then married women, and the least happy people are unmarried men.” I don't know if I'd conclude that men are “inferior goods,” but they do seem to be heading that way. And yet, I can't manage to type this without laughing. Sorry, guys.

2. How do dietary norms affect the economy? I was somewhat surprised when I stumbled across a recently-published USDA report about the American national dietary guide. It explores what the impact would be on the U.S. agriculture sector if Americans changed their dietary habits to meet the dietary requirements suggested in the 2005 guide . Here's an excerpt:

For Americans to meet the fruit, vegetable, and whole-grain recommendations, domestic crop acreage would need to increase by an estimated 7.4 million harvested acres, or 1.7 percent of total U.S. cropland in 2002. To meet the dairy guidelines, consumption of milk and milk products would have to increase by 66 percent; an increase of that magnitude would likely require an increase in the number of dairy cows as well as increased feed grains and, possibly, increased acreage devoted to dairy production.

The way you do I.T.

Does the degree of success enjoyed by US firms operating in the UK imply that productivity growth may have more to do with superior management/organization rather than simply geographical or regulatory environment? H/t to D.R. for sending this along.

Excerpt from, It ain’t what you do it’s the way you do I.T. (2005), by Nick Bloom, Raffaella Sadun and John Van Reenen; London School of Economics:

Productivity growth in sectors that intensively use information and communication technologies (ICT) appears to have accelerated faster in the US than in Europe since 1995. If this was partly due to the superior management/organization of US firms (rather than simply the US geographical or regulatory environment) we would expect to see a stronger association of productivity with IT for US multinationals located Europe than for other firms. We examine a large panel of UK establishments from all business sectors and provide evidence that US owned establishments have a significantly higher productivity of IT capital than either non-US multinationals or domestically owned establishments. Indeed, the differential impact of IT appears to fully account for almost all the difference in total factor productivity between US-owned and all other establishments. Further, this finding is particularly strong in the sectors that intensively use information technologies: the very same ones that account for the US-European productivity growth differential since the mid 1990s.

Addendum

How comparable is Canada to the UK when it comes to the productivity levels of IT? A recent article from The Financial Times sheds some light on this. The article suggests that the bursting of the dot com bubble may worsen things for both countries.

'Perfect storm' could stifle IT (Nov.22)

In the UK, a report by Lancaster University School of Management and the British Computer Society revealed that applications for computer science degree courses have dropped by half in the past five years. Software engineering applications have fallen by 60 per cent.

In Canada, things are not much better, according to the council organised by the government to monitor and promote the development of IT skills. Canada will need 89,000 new IT professionals in the next three to five years, warns the Information and Communications Technology Council, "yet enrolments in IT courses have dropped by 50-70 per cent because of the negative view of the IT sector," explains Paul Swinwood, president of the ICTC.
****
In Canada, the ICTC is also co-opting private sector organisations and community colleges as close to the client base as possible. "We're bringing together the engineers, the technicians and the technologists; my council, the Canadian Information Processing Society, and your local IT associations," says the ICTC's Mr Swinwood. "We can have a national programme but we need feet on the ground, in the community." Creating a link between high-level policy and direct action is crucial if IT education is to be effective in schools. The difficulties the sector faces in terms of generating appropriate skills are inseparable from its own success.

For many teachers who advise young people, it moves too quickly and unpredictably for comfort. This is why the BCS's Mr Rodd has been horrified to see some teachers advising students against careers in IT, citing the uncertainty caused by the bursting of the dotcom bubble.

Spontaneous order

Sorry for the lack of posts. I've been ill and unproductive, but I have less to complain about this evening.

Moving on...

Where does spontaneous order exist?

In the response mechanisms of white blood cells?

In the market place? And, by extension, in flight patterns? (h/t Cafe Hayek)
Be sure to read Russell Roberts' explanation of this last video.

These two (short) clips are really remarkable, especially when watched one after another. Well, I think so. It doesn't hurt that they're both set to hot music.

ugh. I intended to delete a draft but I've deleted my last post as well. I'll have to blame my flu and chalk it up to that. Actually, I really didn't like that post anyway. Perhaps it was a subconscious decision.

'Put our TV bands to better use'

I'm slow to catch this, but Neil Reynolds had an interesting article in last Friday's Globe and Mail ($). Here's an excerpt.

Put our TV bands to better use: Sell them (Nov. 17):

Pssst. Here's a way to make Canadians a cool $6-billion, cut cellphone costs and simultaneously drive the wireless economy. Simply auction off the country's entire “TV band” — airwaves no longer needed for this redundant purpose.

When U.S. economist Thomas Hazlett looked at Canadian broadcast policy four years ago, he found an enormous waste of a scarce natural resource — the electromagnetic frequencies used by relatively few TV stations to transmit relatively few programs to relatively few people in relatively few cities. In allocating 67 TV channels, he said, Canada had “consumed valuable bandwidth while delivering very little service to the public.” Since federal regulators had given each channel six megahertz of frequency space, we were using up 402 MHz for TV signals alone, “a vast commitment of radio spectrum.” We're using freight trucks, in other words, to deliver carloads of TV programs.

With the same allocation of frequencies as Canada, the U.S. uses its band more efficiently by allowing 1,472 full-power TV stations (compared with 136 in Canada), 210 TV markets (compared with 43) and an average of 7.0 stations per market (compared with 3.1). This sparse use of the TV band meant that the typical Canadian market provided only three over-the-air channels. This didn't matter much to most Canadians — by 2002, 74 per cent of them had opted for cable TV, 7 per cent for Canadian satellite TV and 8 per cent for U.S. satellite TV.

Here is Mr. Hazlett at the University of Montreal in June, 2002: “It is not possible to argue that 67 channels of scarce radio spectrum are optimally used to deliver [only a very few] video channels. The typical Canadian market uses just 4.5 per cent of its allocated bandwidth. The TV band is underemployed throughout the country. There are no offsetting efficiency arguments. This waste produces no social dividend.” Worse still, Canadians had already abandoned over-the-air TV. Only 10 per cent of Canadians still used TV antennas. Four years on, the number must now be even less.

Canada's profligate dispersal of bandwidth for over-the-air delivery of TV programs, long after Canadians had switched to cable and satellite TV, necessitated the country's parsimonious hoarding of bandwidth for New Economy wireless technologies. This is one reason why only 50 per cent of Canadians are using wireless devices — compared with 70 per cent of Americans and 100 per cent of Europeans. It's one reason why cellular phone service in Canada costs much more than it needs to cost. Industry Minister Maxime Bernier will auction off more spectrum next year, specifically for cellular and wireless tasks, which doesn't go nearly far enough.

Once chief economist for the U.S. Federal Communications Commission, Mr. Hazlett is now a professor of law and economics at George Mason University in Virginia. Recognized internationally as an authority on the economics of broadcasting, he serves as director of the university's Information Economy Project, which — in its mission statement — recommends that governments get out of the way and permit the “wireless century” to develop without needless bureaucracy and anachronistic regulation.

In his analysis of Canadian airwave use, Mr. Hazlett cited Italy as an example of a country in which government did get out of the way — though inadvertently. Deregulation, Italian style, occurred in the mid-seventies when courts permitted unlicensed entry into cable TV. The Italians spontaneously extended this liberty to all TV broadcasting. At the time, the country had 90 TV stations. Within 10 years, it had 1,300 — the highest TV station density in the world. (Canada and the U.S. have 0.05 TV stations per 10,000 people; Italy has 1.0). Italian TV stations get 20 times as much use from bandwidth as Canadian or American stations. Cable TV scarcely exists; it was never needed and serves less than 1 per cent of households.

Mr. Hazlett calculated “the enormous economic benefits” that would result were Canada to sell at auction the country's entire TV bandwidth. The country's remaining roof-top antennas would need to be replaced with satellite dishes at a cost of $600-million. But the TV band auction (based on Canada's sale of 40 MHz for $1.5-billion in 2001) would clear almost $6-billion.

Self employment: an 'innate survival skill'?

Nobel Peace Prize Laureate Muhammad Yunus, Yale's Dr. Robert J. Shiller and others blew me away last week when I heard them speak on microcredit and financial innovation. My perception of poverty in developing countries has bloomed. One thing that struck me in particular from their lectures was the reoccurring theme of self employment.

It's often been repeated that one of the virtues of microcredit is that it's a 'hand up', not a 'hand out.' Essentially, the Grameen Bank offers loans to would-be entrepreneurs, or entrepreneurs who need a supportive push.

The Grameen solution: “...jump-starting self employment, providing the capital for poor women to use their innate ‘survival skills’ to pull themselves out of poverty” (Neff).

Innate survival skills. I like that. This survival concept surely isn't restricted to developing countries. At the risk of sounding like a monomaniac, I'll point out one last time that in periods of recession and poor job growth in Canada, self employment rises. More precisely, low productivity, unincorporated self employment rises.

So why then do we categorize all self employed individuals similarly? Why not group them in the same spirit of methodology that labour economist's use to draw a distinction between economic refugees (those who migrate for jobs), and war refugees (those who arrive only to flee from war and thus have a relatively lower likelihood of perseverance -- ie. if they are met with opportunities or choices which provide them a higher utility level, say, returning home after a war, they'll take it).

My new terminology (subject to change as brighter ideas hit me):

'Economic' entrepreneurs: individuals whose decision to enter business may be influenced by such things as taxes, IT, geography, etc. Such individuals demonstrate the self interest motive at work in the market place and are valued in developed countries.

'Spurious' entrepreneurs: individuals whose drive to be self employed is manufactured by recession or poverty. They tend to depend on heuristic means; they may have little business know-how. Further, after hearing Dr. Shiller speak I would also add (although this is not his idea) that these individuals don't tend to be lured by the profit motive to the extent that economic entrepreneurs are. Tax structures, for example, have little influence on them. Thus, market inefficiencies increase, ceteris paribus, as the ratio of spurious entrepreneurs to economic entrepreneurs increases.

While 'spurious' entrepreneurs offer promise in developing countries, we tend to ignore their potential in Canada because we see the market inefficiencies and low productivity that a high spurious-to-economic entrepreneurship ratio creates. Although, the ratio seems to be declining since the late 1990's and Canada's self employed are doing increasingly well.

I know, I know. It's awfully perverse of me to have absorbed the wisdom of Messrs. Yunus and Shiller with only my self styled ideas to show for it on this blog. For the record, both are doing amazing work and are having a profound impact on people all over the world.

For Dr. Shiller the proof is in the pudding. See here, and here for an interesting read on behavioural finance (Oh, D.R., I've crawled from my rock and I see that you really are on to something good with behavioural economics!).

For Dr. Yunus, the proof is in The Prize. See here and here (in the latter link he suggests that the term 'do-gooders' be replaced with 'social entrepreneurs').

Addendum:

More terminology:

Terms used by GEM (h/t D.R.): opportunity entre­preneurs, necessity entrepreneurs.

Terms used by CIBC economist Benjamin Tal: seniorpreneurs, lifestylers, superachievers

Friedman is gone

To blog about anything except Milton Friedman's death seems unthinkable today. And yet I have nothing new to contribute. I'll just mark this sad news by pointing to Friedman's obit in The Financial Times (h/t happyjuggler0).

Addendum

Milton Friedman is my hero. After some thought, I do have something to say.

In the comment section of this post I was asked, “So what should the Canadian government be doing, as per your idol Friedman, that it is not already doing?”

My response made me realize two things. I realized how much of an influence Friedman's ideologies have on me, even if some of my opinions aren't consistent with his. I also realized that it's only been over the past four months (since I began this blog) that I've become a libertarian (with the most un-libertarian moniker around). It may have taken even longer, or not at all, had it not been for Friedman's influence.

Despite all of his great contributions to economics, one thing that will continue to influence me is the assertiveness in which he defended his values. The sheer strength of Friedman's backbone gave courage to people to defend their freedom, or to do so more confidently. As George Shultz once said of Friedman when he found himself defending a freedom he felt strongly about, “It's as if he were there with me.”

Here's a post that I enjoyed from Tyler Cowen: When I think of Milton Friedman.

'Economic Liberalism at the Turn of the 21st Cent.'

This might be one of the most exciting book reviews I've ever read.
From EH.net:

Published by EH.NET (November 2006)
Mark Wynne, Harvey Rosenblum and Robert Formaini, editors, _TheLegacy of Milton and Rose Friedman's Free to Choose: Economic Liberalism at the Turn of the Twenty-First Century_. Dallas: Federal Reserve Bank of Dallas, 2004. vii + 251 pp. $ (hardback), ISBN: Info:0-9763494-1-8

Reviewed for EH.NET by Ranald Taylor and Robert Leeson, Department ofEconomics, Murdoch University.

This book is a collection of papers presented at a conference held at the Federal Reserve Bank of Dallas in October 2003. It is a tribute to Milton and Rose Friedman's _Free to Choose_. The papers have a dominant theme: competitive markets can solve many of the problems associated with education, environmental degradation, taxation, cultural diversity, globalization, financial markets and monetary stability. The book is organized into six sessions, each devoted to particular issues which the Friedmans have raised in _Free to Choose_.

Session one sets the tone of the book by revisiting Milton Friedman's organizing argument: that competition ensures economic freedom and that the appropriate role of a government in a free society is toensure that competitive markets function freely. Eric Hanushek andPaul Peterson examine the coexistence of what they believe to be the declining state of the public school system in the U.S. and risingreal spending per pupil. Hanushek argues for a competitive market-based funding system in the form of vouchers. Resistance to vouchers, he believes, derives from an old ideology. Hanushek arguesthat it is easier to defeat communism than to overcome the education establishment's resistance to meaningful reform of the public school system.

Advocates of 'sustainable development' advocate changes in virtually every aspect of
consumption and production. In session two Terry Anderson and Laura Huggins argue that sustainable development theory is vague and "operationally vacuous" (p. 58).

They challenge the two fundamental pillars of sustainable development: 'running out' of resources will leave future generation with less, and market processes are the causes of these depletions. According to Anderson, Huggins and Richard Stroup, the over consumption of natural resources is primarily linked to ill-defined property rights rather than the operation of the market system.

Property rights, they argue, provide the structures that are necessary for development, innovation, conservation and the discovery of new resources. They maintain that countries with greater economic freedom and rule of law tend to have higher environmental standards than countries where the rule of law is weak.

One of the themes of _Free to Choose_ was that government has grown far beyond the size necessary for the protection of liberty.

In session three, William Niskanen constructs a model to estimate the optimal level of expenditure for government services relative to GDP. His estimate (10 percent of GDP) provides support for smaller governments. Liqun Liu, Andrew J. Rettenmaier and Thomas R. Savingargue that falling birth rates and rising life expectancy have made the current social security system unsustainable. Their analysis ofthe costs and benefits of a transition to a privately-funded system, suggests that during the transition period there would be a costinvolved in the form of lower consumption. However, in the longer term, they argue, the transition would make the country as a whole better off by enhancing the nation's capital stock.

In session four, Tyler Cowen deals with the implications of _Free to Choose_ for culture, diversity and aesthetics. Globalization and free trade benefit both cultural diversity and the creative arts, Cowan argues: periods of greater freedom in international trade tend to beperiods of greater cultural diversity and creativity.

Peter J. Boettke examines the impact of _Free to Choose_ on global movement toward free markets during the period from 1979 to 2003. During this period, communism collapsed in the Second World, theThird World began to reject development planning, and many First World countries reformed their welfare states. Boettke notes thatmuch post-communist privatization was inspired by Friedman's writings.

Gregory Chow uses the central themes of _Free to Choose_ to examinepost-1978 reforms in China, sensing progress in all areas. With reference to education, Chow claims that there is probably a greater degree of freedom of choice in education in China than the U.S. (heargues that about 40 percent of all spending on education in China comes from private sources compared to an average of 12 percent inthe OECD countries).

Session five has a topical immediacy given that the Grameen Bank andits founder, Muhammad Yunus, were jointly awarded the 2006 Nobel Peace Prize. Luigi Zingales argues that access to finance is crucial to promote competition and economic freedom. Zingales describes thefate of two Bangladeshi women (one with access to finance, the other without). The second found it extremely difficult to develop her stool making business; the first obtained a small loan from the Grameen Bank to acquire a Nokia cellular phone. The phone made a huge difference in her life and the lives of her fellow villagers by bringing information at low cost to farmers and tradesman. The phone reduced business costs facilitating profits about twice the average national monthly income.

Zingales argues that although financing is a risky and complexactivity, riddled with adverse selection and moral hazard, it is government intervention that is the main obstacle: "In spite of theenormous challenges intrinsic to the financing activity, human ingenuity, when allowed to work freely, is able to devise many mechanisms to enlarge access to finance. It cannot, however, overcome the power of the government, when this is determined to block finance. Unfortunately, governments are too often captured by rich incumbents, who stand to gain very little and risk a lot from the development of finance" (p. 188).

Allan H. Meltzer itemizes twenty-five specific policy proposals initiated by Milton Friedman (some of which have been adopted and many of which have not) to minimize government intervention. He looks at some of the successes (ending the military draft, floating the dollar, the abolition of interest rate ceiling on bank deposits) and some partial successes (lowering tariff barriers, deregulation various industries in the U.S., the introduction of a school voucher system in certain U.S. states).

Ben S. Bernanke examines eleven of Friedman's key monetarist propositions. According to Bernanke, Friedman's counter-revolution isstill very much alive: "one can check to see if an economy has a stable monetary background only by looking at
macroeconomic indicators such as nominal GDP growth and inflation. On this criterion it appears that modern central bankers have taken Milton Friedman's advice to heart" (p. 213).

The last session traces the relationship between economic freedom and growth performance. The Friedmans believe that economically free countries would grow more rapidly and achieve higher income levelsthan less free countries. To test their hypothesis, they saw the need to develop a scientific instrument that could be used to quantify the degree of economic freedom across a large number of countries. James Gwartney pioneered the construction of indexes to proxy economic freedom. Based on the Economic Freedom of the World (EFW) index (taking into account of private ownership, voluntary exchange,personal choice, and free entry into markets), Gwartney and Robert Lawson report that a one-unit increase in the EFW index enhancedgrowth by 0.71 percentage points over the period 1980-2000: "Friedman was right" (p. 232).

As a conclusion to the book, Raghuram G. Rajan offers somereflections on whether the free market tide may retreat (in LatinAmerica, for example). Rajan argues that the growing backlash againstpro-market reforms is driven by elites who tend to undermine equalityof opportunities by opposing widespread access to markets.

This is a fascinating book -- a must read for Friedman fans. One of Friedman's strengths was (and is) his intense curiosity about the strengths and weaknesses of the arguments and unexamined assumptions of his opponents. Some of those who have documented the progress of his ideas have been struck by the initial lack of reciprocity in this respect (in the early days his ideas were often dismissed as Chicagoeccentricity). Friedman was a dominant figure among the first generation of post-war libertarians: this salute by some of thesecond generation provides an insight into the dynamics of the ideas that he developed and propagated.

Ranald Taylor is the author of "Can Labour-Savings, Capital-IntensiveProduction Techniques Reduce Unemployment Rates in DevelopingCountries?" _Australian Journal of Labour Economics_ (2004). He is currently working on a project tracing the evolution of technological progress since Adam Smith.

Robert Leeson is the co-author (with W.J. Darity and W. Young) of_Economics, Economists and Expectations: From Microfoundations to Macroapplications_ (Routledge: 2004) and is currently editing Milton Friedman's _Collected Writings_.

Hard-pressed manufacturers, realistic wish list

Extra, extra! Firms realize that government spending is not a solution to their economic woes! Today's Globe and Mail highlights the response from the manufacturing sector as it suffers a slowdown like no other sector of late:

Hard-pressed manufacturers seek Ottawa's help; Wish list calls for tax breaks, but sector says bailouts can't fix underlying woes

Canada's manufacturers are turning up the heat on Ottawa to help them out of their deep economic troubles, but the wish list is surprisingly timid given the extent of their woes.
That's probably because there's little that the federal government can do about the underlying cause of most of their troubles, economists say.
“Why aren't they asking for more? It may be the realization that a lot of their problems are way beyond the control of the Canadian government,” BMO Nesbitt Burns economist Doug Porter said.
The manufacturers will launch their lobbying effort today, publicizing a letter they recently sent to Prime Minister Stephen Harper that asks for lower corporate taxes, less red tape and better tax credits for research and skills training.
The hope is to win some commitment on manufacturing issues in next week's fiscal update, followed by concrete measures in next year's budget.
While lower corporate tax rates could be expensive for Ottawa, the manufacturers merely request the government keep its promise to reduce the corporate tax rate to 18.5 per cent by 2011, and then go a step further to 17 per cent by 2012.
As for tax credits, they want Ottawa to make its research and development regime more relevant, but not necessarily enrich it. And they want a new tax credit for training.
The most immediate and expensive request would have Ottawa allow capital investments to be written off over two years (instead of the eight to 10 years it now takes) — a proposal that would immediately improve the cash flow of companies investing in new technology, but one that would cost Ottawa about $1.5-billion in the first year.
The manufacturers have made no mention of handouts or lump sums of money, despite the painful restructuring the sector is enduring. So far, 83,000 jobs have disappeared in the sector this year, and about 200,000 since the end of 2002. Manufacturing output is flat compared with a year ago, and profit growth has slowed to a crawl. In Ontario, profits are falling.
“These are not issues that bailouts will fix,” said Jayson Myers, chief economist of the Canadian Manufacturers & Exporters.
Rather, the proposals would put Canadian manufacturers on a level playing field with other countries for taxes and investment incentives, he said.
Manufacturing in most developed countries has been under intense pressure for the past few years because of the rise of cheaper competition in China, but Canada faces some unique issues, Mr. Porter said. In the short term, Canada is particularly exposed to the slowdown in the U.S. economy, he said. In the medium term, the quick appreciation of the Canadian dollar is a serious issue other countries' manufacturers don't have, he added.
But manufacturers should probably not hold their breath for immediate action by the federal government. Next week, Finance Minister Jim Flaherty will unveil a Conservative economic road map aimed at making Canada a more powerful player in global markets. The economic agenda will not contain tax cuts or fiscal measures, but will lay out a direction for next year's budget and beyond, he said.
“This is a document that we hope will be a plan for the next 10 years or so,” Mr. Flaherty said Sunday.
“We are going to talk about, as part of the plan, about our direction in tax policy for our country, our direction in skills training and postsecondary education.”
The long-term economic plan will make the case for measures to boost Canada's productivity, although the Conservatives are expected to eschew the term in favour of Main Street friendly phrases such as “increasing opportunities” for Canadians. The agenda will argue for more investment in education, research and infrastructure, such as highways and border crossings, as well as a big role for the private sector in financing the latter.
In some respects, the Harper government is now moving closer to its Liberal predecessors in its economic focus. Sources have said the Tories are drawing on the 143-page “Plan for Growth and Prosperity” paper that former Liberal finance minister Ralph Goodale's department released just two weeks before his government was defeated.

A new inflation target?

With the expiry of the inflation-control agreement held between the Bank of Canada and the Government of Canada arising this December, people are talking.

Some background from the BoC:

In February 1991, the Government and the Bank introduced targets aimed at reducing the rate of inflation. The objective was to achieve a 3 per cent inflation rate by the end of 1992 (the lowest inflation rate in almost two decades) and to gradually reduce the rate of inflation to 2 per cent by the end of 1995. The targets were extended twice—first from the end of 1995 to the end of 1998 and then from the end of 1998 to the end of 2001. Both extensions involved maintaining a target range of 1 to 3 per cent with a midpoint of 2 per cent.

Graph Source: Government of Canada

Pierre Fortin, an advocate of the theory of downward nominal-wage rigidity, says it should be raised to three per cent (Fortin, P. 2001. "Inflation Targeting: The Three Percent Solution." Policy Matters 2: no.l, Institute for Research on Public Policy). This is unlikely to happen though. The BoC maintains that “the argument for the effects of downward nominal-wage rigidity is not a persuasive one in deciding on an appropriate inflation target.”

David Laidler of UWO says the rate should be lowered to one per cent.

This is more likely. In fact, there's been some speculation that the BoC is considering a target of zero. I found this to be surprising. Two things interest me in particular: the probability of hitting a zero floor on interest rates, and the impact of deflation.

An excerpt from a 2001 BoC document:

The Zero Floor on Nominal Interest Rates

A number of authors have argued that the zero floor on nominal interest rates prevents real (that is, inflation-adjusted) interest rates from falling far enough when inflation is below its target, thus leading to a prolonged period in which the economy is weak and inflation remains below its target. After reviewing the evidence, including importantly Black, Coletti, and Monier (1998), and the papers in Fuhrer and Sniderman (2000), Bank economists Amirault and O'Reilly (2001) conclude that most researchers would estimate the probability of hitting the zero floor as negligible for an inflation target of 2 per cent. Moreover, although this probability rises at an increasing rate as inflation falls, their evaluation of the empirical literature is that there would be only a slight increase in the probability as one moved down to a 1 per cent inflation target. This latter conclusion is less widely held. Some authors are more cautious regarding the proposition that the probability increases only slightly, in contrast to Parkin (2001). As well, Parkin notes that the work of Reifschneider and Williams (2000) shows that explicitly taking into account (in various ways) the zero floor in the central bank's reaction function for setting interest rates significantly lowers the cost of hitting the zero bound in the unlikely event that it is hit.

Potential Risk of a Costly Deflation

Mishkin (1997, 2001) has emphasized the importance of avoiding deflations because of their cost. It is important to distinguish at the outset, however, between an unexpected price decline (of, say, one year in duration) and a persistent deflation. It is also necessary to note that there are costs whenever consumers, firms, and financial institutions are adversely surprised. An unexpected price decline of, say, 2 per cent with an inflation target of zero is no more costly than a temporary drop in the inflation rate to zero for a year with an inflation target and expected rate of inflation of 2 per cent. On the other hand, a deflation with some persistence will be more costly than a reduction in inflation of the same size if it causes problems to arise either from hitting the zero floor on nominal interest rates or from downward nominal-wage rigidity. For example, persistent deflation at 2 per cent per year when the inflation target is zero would be more costly than inflation persisting at zero when the inflation target is 2 per cent only to the extent that its persistence becomes more prolonged because of those two problems. But it is important to note that central bank targeting of a specific inflation rate provides a high level of protection against persistent deflation.
We conclude from this analysis that the serious problems come from persistent deflation, that they stem from the first two factors discussed in this document, and that they are unlikely to arise under explicit inflation targeting.

Consumer rationality and Buy Nothing Day

Kalle Lasn, a Vancouverite and the founder of Adbusters magazine, believes that consumers are irrational precisely because they consume too much. He claims that over-consumption has consequences on the environment, the political atmosphere, and so on.

He proposed Buy Nothing Day (the last Friday in Nov.) as a course of action, and he's now taking things further with Buy Nothing Season, which would extend over the Christmas holiday season.

Wait a minute. How irrational are consumers?

Here's David Altig's view, which may be a popular one:

A great deal of individual behavior appears to be perfectly rational; Most of that which does not appear so rational has small consequences for the individual decision maker (with the "irrationality" tending to disappear over time); There are always some people who persist in making apparently irrational, and costly, choices.

Altig adds that there are “plenty of behavioral anomalies...And it may not be the case that small deviations in individual rationality add up to small consequences for collective actions.”

Kalle would wag his finger at Altig. He might say that a great deal of individual behavior is imperfectly irrational. A consumer may see the consequences of her actions (eg. environmental degradation) yet irrationally assume that her independent action will not bring her dis-utility. In effect, individuals discount their actions and consequently cheat themselves, so to speak. Further, when they witness other individuals cheating, they persist in making irrational, and costly, choices forever after. It's of no surprise then that Kalle is an advocate of individualism and responsibility.
But Kalle is an extremist, an anarchist even, and his ideas go much further (case in point: Buy Nothing Day/Season). Does he believe what he promulgates or does he overshoot his message to encourage individual thought?

I agree with Kalle much less than I once did; however, I have a big soft spot for the guy who gave me my first real work experience. His passion is contagious and his ideas are fun to entertain, even if they're economically unsound (ouch, it hurts to say).

Here's Kalle, cheery as ever, speaking about Buy Nothing Day/Season on CNN (scroll to bottom of link).

Altig points to some good reading by Richard Thaler et al on the subject of anomilies in rationality and choice models.

Kids and Canadian native reserves

There are very few things that outrage me, but watching kids grow up on squalid native reserves does the trick.

The costs for the kids are great and the benefits are few. Even when I was a kid I recognized that the youth being bussed to school from the neighbouring native reserves had a rougher life than the rest of us, as was evident from their bad diets, misappropriate clothing for the weather, and behavioural problems. The promotion of Attikamekw, Oji-Cree and other languages is the only benefit I can see.

I've highlighted some numbers from the Statistics Canada 2001 Consensus for the Cold Lake Indian Reserve #149. Cold Lake is not unique, as a quick browse around this link to StatsCanada shows.

1.
'The latest jobless rates and what's behind them.'
CBC has a nifty interactive tool offering a very general idea of what's going on with employment in each province.

2.
Q: What do you get when you mix obnoxious attitude, grammatical errors, anonymous hacks and a respectable news magazine?
A: The new blog from The Economist magazine. Hip hip!

Patterns in self employment

Addendum II: Et voila! Not only is this graph clearer, but it contains more data. (Thank you Ms. D.L.! I knew blogging would pay off!)

Addendum: I'm looking at this graph from a computer with less resolution than my own and it's fuzzier than I observed earlier. Double the apology! I'll have a clearer graph to post here in the coming days.

Many people dream of being their own boss, but is this why Canadians become self employed?

Some other possible reasons that have been theorized:
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

I produced the graph here using data from Stats Canada's Labour Force Survey. Clicking on the graph will take you to the raw data ($ or affiliation req'd). Sorry for the poor quality, but I'll have to leave it for now and learn my lesson for next time.

I was hoping that periods of recession would be observable, but no such luck.

One interesting observation is that the gap between the per cent of the total self employed and the nonfarming self employed (both unincorporated) is closing. I'm missing a stream of data prior to 1987, but when I plotted data calculated in accordance with the System of National Accounts, the pattern looked similar (with smaller percentile values) and it illustrated a progressively shrinking gap from 1976 to 1987 and onwards.

Notice also that the per cent of total unemployed bottoms out during Canada's great boom beginning in 1987. This is inconsistent with other booms though. Perhaps other factors are at play.

Nothing too exciting here I guess. Sorry for the lack of posts. School has been keeping me busy and uncreative.

The labour growth puzzle

Grrrr. I've switched to beta blogger and it's not being kind to me, hence the reason this post disappeared. One more time...

I'm stumped by this contradiction: October's net gain in employment was a whopping 51,000 (more than double expectations) despite poor GDP performance. What's up?

What analysts are saying isn't making sense. Here's CIBC's Avery Shefield:

Typically, employment growth lags the initial turn to slower economic activity, as businesses hoard labour for a while before bearing the costs of layoffs. That could be behind the stubbornly healthy trend in hiring of late, one that contrasts with poor GDP growth in Q2 and Q3.

Are we really seeing a case of job hoarding? Maybe in select businesses (construction), but elsewhere evidence suggests otherwise.

First, a quick backgrounder: 67,600 of the new jobs created were full-time jobs, while part-time employment fell by 17,100. Gains were both in goods (construction mostly) and services (educational services, business, building and other support services). The big dives occurred in manufacturing and the resource industry.

Here's why I can't understand how the 'job hoarding' reasoning stands.

1. The strongest reason (I think): A lot of the job gain in the service industry has been in educational services, support services and health services, resulting from an injection of provincial spending. It doesn't seem to me that these industries are hoarding labour.

2. We're seeing a sectoral shift to more productive sectors where hires seem long term. For example, the self-employed sector, typically made up of less productive low-wage earners in Canada, shrunk in the last two months as entrepreneurs joined other sectors.

3. The fabric of Canada, small and medium size enterprises (SME's), can sustain an economic downturn as cost burdens drop while incentives improve. SME's have reported their biggest burdens to be insurance premiums, less youth in the labour force, and the inability to find cheap part-time labour. Well, they must be cheering then. First, insurance is more favourable. Second, StatsCan says “full-time growth for youth was strong in October (+36,000)...” Third, downward pressure on wages will be a boon. Fourth, SME's have reported not being affected by external fluctuations, such as fluctuations in international trade. The businesses tied to external fluctuations (manufacturing) have already been cutting labour. In short, SME's are doing the hiring, and they're doing well.

5. Overall, firms are in a strong position. TD analysts in September:

One of the main reasons for this aggregate strength is that relative to previous periods of economic slack, the balance sheets of Canadian firms are extremely healthy and the level of operating profits remains near the record high set in the fourth quarter of 2005. As a result, the vast majority of firms are in a much better position to weather this economic downturn without resorting to layoffs or job cuts.

In sum, surely a small drop in labour can be expected (eg. in the construction industry), but not to the extent predicted in the next quarter or two. The problem is, if I'm right, and businesses aren't hoarding labour, why else would job growth be so out of whack with GDP growth? A new job growth equilibrium?

Anyone who regularly reads this blog knows that I break promises. I say I'll return to a subject and then I leave it for dead. I'll be coming back to this one when November's employment figures come out though. I promise.

Income trusts, optimism, AIC

This morning I blogged about the recently announced tax on income trusts. I've since been out running and a thought hit me that I can't shake from my mind.

I don't know much about investment or mutual funds, but optimism really does pay off some times. At least it did for Michael Lee-Chin of AIC, a mutal fund firm.

I remembered reading that Lee-Chin decided to avoid high yielding income trusts. This stumped me at the time. Bloomberg reported: “AIC plans to stick with its holding in Loblaw, Canada's biggest grocery chain, even after the stock dropped 30 percent in the past year....AIC also plans to keep its shares in Amvescap, the London- based owner of the Aim and Invesco mutual funds. The stock has lost more than 60 percent of its value in six years.”

His optimism served him well. I guess he wasn't enjoying himself too much though, because he stepped down as CEO of AIC shortly after. Here's Bloomberg's original file from Oct. 6.

Slapping a tax on income trusts

Surprise! Income trusts will be taxed. Minister of Finance Jim Flaherty made the announcement yesterday of a phase-in over four years. The plan includes an attempt to soften the blow to seniors by offering a tax break. Details on the MoF web site.

The economic benefits of income trusts that I explored in a previous post aren't popular with many, but this announcement is a surprise all the same.

Some individuals felt that the trusts were a Trojan horse for corporate tax cuts. Well, in a small way they are. The Liberal government previously dropped taxes on corporate dividends to entice individuals away from income trusts and into stocks. Now the Conservative government is coupling its tax on income trusts with the announcement of a ½ per cent drop in corporate tax in 2011.

Obviously some poor suckers felt that income trusts had a future.

From Reuters:

One of the largest Canadian trusts, CI Financial Income Fund (CIX_u.TO: Quote, Profile, Research), savaged the surprise move.

"This is the most bizarre, Third-World policy that I could imagine," CEO Bill Holland told Reuters. "It doesn't even make sense to me -- how can they keep changing the rules?"

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“I think this is a huge, huge surprise. Huge. I don't think they consulted with anyone," said Calgary lawyer John Brussa, considered the father of the income trust format.

"To do this seems quite troubling, and for a government that's supposed to be encouraging of business. This arbitrary action is not very conducive to business. This is going to cost a bunch of people a lot of money tomorrow."

I'm not going to try to predict what will happen at the bell, but I highly recommend that the loudspeakers play the beautiful 'Funerarius for Michael Wise Esquire' by Orlando Addleston, as can currently be heard on the NPR web site.

Some facts from Reuters:

- More than 220 income funds are now listed on the Toronto Stock Exchange and TSX Venture Exchange, with a total market capitalization of about C$200 billion ($180 billion).
- More than one million Canadians own units in income funds and several million more invest in income trusts through their mutual funds.
- Large institutional investors, such as the Canada Pension Plan and Ontario Teachers' Pension Plan Board, invest in income trusts on behalf of their clients.