It's The Economy, Stupid

I have been chatting off and on with an American economist, Kenneth Thomas, whose research is meant to point out the problems with business subsidies.  He has a good blog today contrasting the U.S. and European experience.

Dr. Thomas’ disgruntlement with the use of incentives to lure investment is well placed.

I have said it many times before but it is worth restating that my view on incentives is simple. It is very hard to unilaterally disarm.    Take the issue of digital tax credits.  These are widely used to incentivize digital media across North America.   NB doesn’t have a program and this is a main reason we have almost no video game and related development here.  The few firms that are here are threatening to leave (understandably) because in neighbouring provinces they can get 40 to 60 percent of their development labour costs covered by these programs.

Like nuclear weapons, if jurisdictions across North America got together and agreed on a framework to stop the spread of these incentive programs and eventually to reduce them, it would be a good thing.

I am not even sure companies would balk at this.   Most tell me the reason why they seek incentives is because their competitors receive them and they don’t want to be put at a competitive disadvantage.

In a world with no grants, low interest loans, tax breaks, etc. jurisdictions would have to compete on core value elements such as skilled labour, infrastructure, R&D environment, tax rates and others.

I think reducing or eliminating these incentives will be very hard but it is worth pursuing.  Dr. Thomas should petition the National Governors Association or other broader groups to get a dialog started.

If he can do a more comprehensive job of linking the incentive wars to the declining competitiveness of America for investment, he’ll have a stronger argument.

I’ll make one final point.  Many people say that the main reason why governments (at least in Canada) offer grants and loans to companies is the lack of access to traditional sources of capital. They claim banks are not interested in peripheral places and other sources of capital are also reluctant to invest in places like rural New Brunswick.  That may be so and, if so, I don’t see a problem with a government supported bank offering access to capital at normal market rates.

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I stumble across this issue yesterday.  The Department of Finance Canada tells us New Brunswick got $1.483 billion in Equalization this year while the NB government had budgeted for $1.632 billion.  I suspect there is a reason for this discrepancy.  It was probably covered in the media and I just missed but it is a whopper of a difference - roughly $150 million.   As the government goes about looking to chop a million here and a million there – $150 million looms large.  The last time the NB government received this amount of equalization was back in 2007-2008 (see page 220 of the 2007-2008 main estimates document).

In fact,a  quick scan of the last eight budget shows very little discrepancy between budgeted and actual equalization.  Then this year – $150 million.  Curious.

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Just finished that movie, The Company Men,  with Tommy Lee Jones and Ben with the last name repeated over and over by that duck in the insurance commercial.  It’s not a particularly good movie but it does hit on a point that I make here and many others make everywhere –  we gotta build stuff if we want to have a strong economy.    Not necessarily ships or cars or televisions – it can be software, new technologies, even services but it has to be something of value that we can see beyond our borders.

That’s the problem.  Just looking at the provincial trade balance – if you extract the oil coming into the SJ refinery and the refined petroleum products coming out we have gone from more than a $2 billion trade surplus a decade ago to a $700 million trade surplus today.  And, of course, much of what we export is lower value added commodities while we import all the higher value stuff – cars, trucks, buses, computers, engineering software, whatever.

The big caveat is that the Stats Can export data doesn’t include services which would help the NB statistics – all the call centre stuff is export-based, as is some of our engineering and IT sector work.

I think I’ll write a more detailed column on this later in the week.

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For those that missed it, the Daily Business Buzz site had an amusing picture associated with the story of the NB Throne Speech.  It said that Premier Shawn Graham was going to outline his government’s plans for 2012 in the Thrown Speech.   I had a little fun with that pic.

Anyway, I have a few thoughts on the Thrown Speech below for what they are worth.  I read the speech quickly last evening and picked out a few economic development-related sections:

“Your government has been working with industry to design a digital media incentive to help encourage economic growth and job creation in this important sector of the new economy. Details of this new program will be announced as part of the 2012-13 Budget.”

If you search this blog, you will see I make a huge distinction between a digital media tax credit and a film tax credit.  When I made this point after the last budget, I got pilloried by those who support the film industry but I continue to maintain there is a significant difference.

“It needs a pro-active, made-in-New Brunswick economic strategy that will invest in high-growth opportunities and ensure our labour force has the skills to match  industry’s needs so we can have more people working.”

Anyone who knows me will remember I really dislike this term ‘made in New Brunswick’.  I realize it is a political term that plays to a base of voters but I strenuously felt that Bernard Lord and his advisors saw this as a euphemism for “not Frank McKenna’s strategy” and I fundamentally disagreed with this.  New Brunswick needs to be more open than ever before.  We need a “made in the Globe” strategy – we need more investment, more immigration, more researchers – flooding into New Brunswick – all parts of New Brunswick.   So, if this term ‘made-in-New Brunswick’ is politics – fine.  If it means turning even more inward – not fine – but we have a hint below it may be the latter.

“The Department of Business New Brunswick will identify opportunities for growth and develop focused strategies for investment in sectors. These strategies will complement existing strategies in traditional sectors of the economy as well as charting a course for developing emerging, knowledge-based opportunities. This is not to suggest that projects in other sectors will be excluded from consideration, but rather, the focus will be on the potential for growth. This potential will be measured in terms of above-average paying job opportunities, higher-than-average investment in research and development, higher-than-average productivity, and higher-than-average value-added export potential.”

Standard boilerplate stuff but it does start to get us away from the watered down tea variety of economic development we have seen in the past.  We have something like 600 people in this province paid by government to do ‘economic development’ and they mostly provide banking services.  Forcing the system to think about how you grow sectors – the kind of investments that need to be made, the kind of alignment between industry and research, industry and workforce development, industry and investment attraction, etc. – is desperately needed.  If you don’t like ‘picking winners’, then let industry lead the process but ignoring the very real need for us to be competitive in specific industries would be a mistake.

“Working in partnership with the federal government, the other Atlantic provinces and private sector stakeholders, your government will continue to promote the strategic benefits the Atlantic Gateway and Trade Corridor can offer to international business and trading partners. New investment will ensure New Brunswick is poised to grow international air cargo and cruise passenger opportunities.”

How’s about working with Halifax on the Halifax-Detroit trade corridor?   In my experience, most of the ‘cooperation’ around the Atlantic Gateway has been each province jockeying to ensure they get as much of the pie as possible.  Drop that.   Just putting this region back on some serious trade footing – cargo coming in and going out – would be a longer term win even if the actual province on the coast got more of the short term benefit.

“In connection with, among other things, the objective of attracting out-of-province investments through trade missions and increasing the number of immigrants to New Brunswick, your government will make structured, targeted efforts to build on our international operations and networks for the benefit of our province.”

This, my friends, is genuinely new.  We have 600 people involved in economic development – we spend tens of millions of dollars – we have over a dozen different funding agencies and departments (in a province smaller than the city of Winnipeg) but we have nada – no resources – out there in the world where the actual investment, trade, research partnerships, immigrants, etc. is located.  I saw this as the strangest part of the system 20 years ago when I first moved back to New Brunswick.    Our idea of ‘market development’ is sending a few companies over to France for a week.

Even ACOA – the most logical of all agencies to be strengthening an international presence because of its cousin – DFAIT- seems to be pulling back the little work they did in investment attraction and international trade.

Anyway, this is about maturity in our systems and processes.  The big fear in development an international presence is that the people/resources will be far from home/far from oversight.  Well, we have 600 right here – close enough to touch and how’s that oversight thing working out for ya?  Deploy people.  Hire international experts.  Invest in targeted international markets.  Partner with ACOA.  Partner with the other Atl. Provinces.  Build relationships – university to university – industry association to industry association – Chamber to Chamber – diaspora group to diaspora group.  Be smart about it.  I’m not suggesting we move half the spending out of province – at least initially – but like just about every province west of New Brunswick – have a real international presence.

We’ll see.

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After describing my column as ‘a load of manure’, one of the commentators on my Economy Lab post today suggested that the Maritimes need more jobs in the $35,000-$60,000 range and not more in the $100,000 and up range.   I guess this is one point of view but if your objective is to become economically self-sufficient as a region, I don’t see how the numbers would work.    The following table shows the income taxes paid distribution in New Brunswick.   My manure-loving friend wants to create a lot of jobs in the second and third quintiles.  Again, not a bad thing but if you really want to drive tax revenue we need to see a little more job creation at the higher end of the distribution.  The fourth and highest income quintiles, even though they represent a fraction of total income earners, pay 84 percent of total income taxes in New Brunswick.

I know people don’t like the word ‘greed’  - it is a term with a very negative connotation – but if we understand where tax revenue is generated and if we want to keep taxes low on those in the lower and middle bands – we need to get more folks at the higher end.

It is certainly true that folks earning higher incomes have a range of tax avoidance opportunities but in the end they still get large tax bills.

Smell a little better now?

Share of total income taxes paid by quintile – New Brunswick (2009)

Source: Statistics Canada. Table 202-0501 – Income tax, by economic family type and after-tax income quintiles, 2009 constant dollars, annual (table), CANSIM (database)

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In my column in the TJ today I take another crack at this.

I have to reiterate my view that the real reason to try and reform EI is not to “get those lazy slackers” or the other statements made in the wake of the Mowat report but to strengthen the environment for business investment and job creation and to foster a stronger labour market.

I say in the piece that I don’t want to comment on the culture of work angle.   It could be true that a cohort of folks have gotten used to working part year and collecting EI part year (someone in the provincial government told me this is now in some cases second and third generation) but if folks that are more well off are piling on these folks it just starts to look a little to strident for me.

After all, the average EI take is around $7,500/year (total EI payout over total reporting EI income).  It’s impossible to calculate the average employment income of these folks because there are a wide variety of variables but just looking at a straight up calculation – to collect $7,500 worth of EI  an average person would only earn between $17k and maybe $25k per year.

Do you want to be the one trying to demand that $7,500 back because it is ‘unfair’?   And if you push many of those people into welfare where they can get at least as much, will you take that back too?

Look, you know my views – I’m not a left wing guy.  I have “The Road to Serfdom” on my bookshelf here in my office.

But I can see the consequences of decisions and I don’t like what would happen if we adopted whole cloth the Mowat recommendations.

I think we need to do a few things:

1. Test the hypothesis.  As fantastical as it may seem, I had some pretty well placed folks tell me this week they had no idea about this issue of employers not being able to find workers in many NB communities despite 20% unemployment rates.  We need to do a thorough study of this phenomenon to determine its extent.  We need to determine conclusively if EI has become a barrier to investment and job creation.

2. We need to come up with plausible solutions.  I would start by talking with the actual folks that are on the EI system – how novel an idea is that?   We have talked about job training, home-based work, help those that need to sell their homes to move to another NB community for work, offer joint fringe benefits to encourage people to work for one, two or even three different companies during the course of the year, etc.

3.   Implement any changes over time.  Maybe grandfather certain folks in where needed.

4. STOP giving government money to companies that create seasonal jobs and that includes tourism.  I know this will get me removed from Christmas card lists but it is true.  The government has done less of this in recent years but it still goes on.

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It’s a tongue in cheek reference, of course, but it is true that persons earning higher incomes pay far more taxes than those in the middle and lower end of the income distribution.  And it is also true that the Maritime Provinces are at the low end of the scale when it comes to those earning $100k or $250k per year.    I did a quick back of the napkin analysis and if New Brunswick had as many people earning $100k as Alberta (ie. 96.5 per 1,000 persons reporting income) it would eliminate the province’s need for fiscal equalization payments.

Of course that is easier said than done but if we at least understand this policy dynamic it should influence a lot of things in the public policy arena.

Persons with income of $100,000+ (per 1,000 reporting any income)

In 2009. Source: Statistics Canada. Table 111-0008 – Neighbourhood income and demographics, taxfilers and dependents with income by total income.

Persons with income of $250,000+ (per 1,000 reporting any income)

In 2009. Source: Statistics Canada. Table 111-0008 – Neighbourhood income and demographics, taxfilers and dependents with income by total income.

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I find this story about the NRC strange.  It seems like just yesterday the feds were talking about having the NRC centres at the centre of technology cluster development across Canada.    Now, they are talking about pulling the plug on their operations in the province where the feds spend less R&D than any other?

To the point of my blog heading, if they had some internal metrics that show the IIT has failed in NB, then let’s have it.  No one wants another deadweight federal institution not adding any value beyond paying a few salaries.  But most of the feedback from partners and industry would suggest the IIT has been successful in New Brunswick.

I realize the feds have to balance their books but it seems like a strange way to save a few bucks.

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I can’t remember the city but there was a place in the US back in the 1990s that just decided one day to attract chocolate and candy manufacturers from Europe.  The jurisdiction sent over delegations to Switzerland, Belgium, Denmark, etc. and ended up attracting a number of manufacturers.

There are some – probably not any in the economic development business directly – who think that economic development decisions done on some pure, scientific basis.  Warehouses are set up in cities at the centre of population areas.  Manufacturers make plant investments based on highly calibrated models that weigh cost, labour, political and geographic factors.  IT firms only cluster in certain locations with lots of Starbucks and VC.

The facts, of course, are far different.  One U.S. study found that CEOs of multinationals tend to be more friendly to the jurisdiction where they were born.   Concentrations of manufacturing, services, high tech – start up in the strangest places based on distinctly non-scientific factors such as luck (why was Bill Gates in Redmond anyway?) or – wait for it – politics.

I tell my clients that nothing is inevitable.    While it is not scientific, economic development is based partially on vague factors such as those above but also on real comparative advantage and jurisdictions need to relentlessly seek to foster comparative advantage.

It’s the magical intersection between a passionate leadership class – we will transform our community – entrepreneurs and the ability to catch the eye of multinationals that make things work.

I had a conversation this week where I suggested that a place like Moncton – in the medium to longer term – might attract more food manufacturers as the cost of transportation rises and people become more environmentally conscious.  The 100 mile diet is a currently a myth in the Maritimes but if Moncton was a hub for food production for Atlantic Canada, we could possibly foster the 150 mile diet for the whole region.

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Thought I would take another stab at this issue of the symbiotic relationship between the big biz and the small biz in a healthy economic ecosystem.   It’s a mostly an argument I have been losing.  From pundits to politicians to the CFIB, the more large businesses we lose, the more calls there are to put more money and focus into small business.  The number of business establishments in New Brunswick has dropped by 2,600 from 2003 to 2011.  Every time we lose a mill or mine or other large firm (such as Maple Leaf Foods in Moncton),  you can see a drop of dozens – even hundreds of small businesses.

The core issue is around exports.  If you could replace a lost paper mill (which was totally export-based and supporting $60 million worth of employment income) with 30 small IT firms all exporting their products (supporting $60 million worth of employment income) – fine.  Trouble is we haven’t been able to do that.

The government response to losing the paper mill is to put $50 million mostly into a variety of projects hoping to stimulate economic activity but we never seem to get back anywhere close to the $60 million in lost employment income and the cycle continues.

In my view, we need both.  We need to ensure we have the large anchor employers and we need to be a place that is fostering more and more Radian6es.

Of course I must restate that our large anchors need to be here with a good business model.  Ongoing, sustained subsidies -propping up an unprofitable business model is not my idea of good economic development.

The government needs to work on the fundamentals: competitive tax rates, excellent workforce pipeline, competitive energy costs, and industry-specific things such as royalties, silviculture, access to public land, R&D, etc.

In the end, just about all of the data I look at would suggest there is a floor – somewhere around 8-10 firms with 200 or more employees per 1,000 firms overall – that if you go much below you will struggle as a regional economy. There are exceptions – there may be a specific set of circumstances – but across the board I would argue this point.  More academic research should be done on this.

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