It's The Economy, Stupid

I have been saying for awhile now that the most important role of small business in a local economy is to foster competitive and dynamic local industries.     Professional services is an excellent example of this.  If a place like Fredericton or Moncton only had one or two architectural firms, over time the lack of competition could lead to higher prices, lower service and less innovation.  A healthy mix of large and small firms creates a competitive environment and consumers/residents end up better off.

Statistics Canada tells us that New Brunswick architectural firms have consistently higher operating profit margins (as an industry) than Canada as a whole.  This could mean there isn’t enough competition in that space.  It’s also interesting that the architectural services sector only generates about half the revenue per capita as Canada as a whole.  This most likely points to a few things such as the weaker overall economy and the unwillingness of firms/individuals to pay more for value added architectural work (such as green buildings).

I am talking mainly to local economic developers on this one.  It would be interesting to do a complete review of the local industrial mix to see where there are gaps/weaknesses/higher than average profits/lower than average profits, etc.   It may make sense for a local economic development agency to try and attract architectural firms in a situation where there was clearly not enough local competition.

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Did you know that New Brunswick is considerably more dependent on the old age security (OAS) program than Canada as a whole?  NB generates about 1.9 percent of national employment income but receives 2.7 percent of the national OAS distribution.

We are also more reliant on EI payments – double the national average.

We also have more demand on our health care system because of a) an older than average population and b) higher incidences of chronic health conditions, obesity, etc.

We are a major user of the federal equalization program.

What do all these have in common?

They are all targeted for cuts/modifications by the federal government in the near future.

I have said that the feds will need to balance their budget and any cuts will fall harder on provinces that are more reliant on federal transfers.  In the longer term, changes to health care funding and federally funded pension programs will also bite harder in places like New Brunswick.

Don’t misinterpret this.  It’s just data.  If we need to reform OAS, so be it.  If we need to reform EI, let’s get to the table.  Most people agree that the health care system cannot continue to chew up an increasing share of national tax dollars.

My point is these things will inevitable hit places like New Brunswick hardest and it would behoove the provincial government (and hopefully the feds) to think about this.

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I was struck by how many times David Alward used the term ‘rebuild’  in his SOTP address last week (reconstruction en française).    It seems to me that the Premier and his advisers are trying to impress upon people the scale of the challenge but I don’t know if the general public is really feeling it.   It’s different now than compared to the early 1990s or even the 1970s.   You have more than 40 the adult population that is or will be 65 within 10 years.  It’s just a fact they are not by in large thinking about growing their careers in New Brunswick.

You have an effective unemployment rate of well below 10 percent – this compares to 17 percent not that long ago in our history.

And, most of all, the folks that are in the positions of leadership – are mostly concentrated in areas of the province that are chugging along quite nicely – visibly they are doing fine.

So when the Premier talks of a huge demographic problem, a structural fiscal deficit, etc. – I don’t know how many people get it because I don’t know how many of them are impacted by it – particularly among those in positions of leadership in government and in our communities.

Some people that study the issues – get it.  Talking to folks in the health care system  - most of them get it.  They are bracing for a wave of boomers starting to need advanced health care services.

The primary and secondary education community gets it – they will be planning for wholesale decline in the coming years.

I don’t know if that trickles down to the average NBer, though.

Everyone loves the idea of ‘rebuilding’ unless that rebuilding impacts their lives personally.  Then, we shall see.

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During my visit to Freddy last week several people asked me about the Costco effect.  I also read about local gas retailers in the Freddy area demanding the government set a minimum price for gas as Costco had eaten into their business model.  I had blogged about this years ago but the subject is now on topic in the province’s capital city.

A while back I mentioned the grass roots campaign to attract Walmart to the Miramichi.  Before Walmart decided to move into small markets, there was a lady in the ‘chi who was adamant she was going to attract Walmart to her community.  There was a petition with thousands of names on it sent to Walmart – and she got her wish.  It was a remarkable display of public interest in attracting an industry and it made me wonder how we could possible leverage this kind of thing to attract other kinds of companies – manufacturers for example.

Anyway, Miramichi got its Walmart and has seen a fairly sharp rise in overall retail sales in the region since.  However, there has been a 15 percent decline in the number of retail business establishments (2003-2010).  That is a net lost of more than 50 small retailers even though retail sales overall are on the rise.

The same kind of effect happened in Moncton when Costco arrived in the 1990s.  That firm’s business model relies on enormous volume and that volume has to come from somewhere.

I am not a big fan of retail from the perspective of economic development.    It’s almost entirely reliant on local demand and relatively low paying (although Costco is said to pay the highest wages in the industry).    Some have argued that niche retail can attract people from outside the community – fair enough – but it’s not a major driver of economic growth.

And there are examples of smaller communities fighting fiercely against big box stores.  I remember battles in the early 2000s along the coast of Maine as certain residents were looking to keep Walmart out of their little communities of 4,000 or 5,000 people.

In the end, I think Costco is a positive influence.  People looking to move to Fredericton from any larger urban centre will expect Costco.  It’s not a huge deal but it matters.

And I categorically disagree with the government intervening in the retail market.    That is almost the last bastion of free market activity – I can point to very little government grants and loans or direct influence in the retail sector in New Brunswick – and that is a good thing.

I am sympathetic to those retailers in Freddy that have been hit by Costco and the nice little downtown core of shops might suffer but in the end the ‘greater good’ is what matters here.

Smaller retailers need to niche – find products/services the big guys don’t care about and pile on levels of service and other differentiation the big guys find hard to replicate.

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For anybody looking to take a strip off me for suggesting some kind of  provincial personal tax harmonization - put away the pitchfork – I am not calling for this.  What I am saying is that in my opinion the fiscal gap is going to widen in Canada and provincial governments in places like New Brunswick and PEI, for example, are going to be under increasing pressure to raise taxes to pay for boomer health care.  Of course, you will say the equalization program was set up to ‘equalize’ but in fact it is a set dollar amount each year and it is unlikely to be the vehicle to flow a pile of new money to pay for the public services needed by our aging population.   Harper has already ruled out any special funding for provinces with older populations like in the Maritimes and will be capping health transfers in line with GDP growth later on in this decade.

So, it is not completely crazy to think that provincial governments will have to raise taxes and further erode tax competitiveness between the provinces.

And, as I say in the piece, this didn’t matter as much when it was grumbling local populations but NB, NS, PEI, etc. will have to attract tens of thousands of workers from outside their borders in the coming years and the level of taxation matters.

So  I will reiterate my main point.  I am not calling for provincial tax harmonization across Canada.  My point is that in a fiscal union like Canada, all provinces have to understand that the economic trajectory in other provinces will impact their own fiscal situation and when Ontario joins the have-nots – it could start to get really interesting.

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There is a good article in the TJ today about the high debt load the average Canadian family faces these days.  This piled on top of public debt and it would take decades and decades of determined effort to pay it down.  Of course, some economists don’t mind debt – as long as your ability to service the debt (i.e. pay the interest) doesn’t become too onerous.

There is a small but growing group of economists suggesting that all this debt has far more pernicious effects and use the example of mortgage default in the U.S. as an example.  Apparently, the average U.S. household has deleveraged a lot faster than the average household in Britain because it is a lot easier to default on your mortgage in the U.S. so hundreds of thousands of American families are just walking away from their mortgage debt -because they can.  To those of us outside the U.S., it seems strange that the people can deleverage by walking away from debt with virtually no negative impacts.   It raises the question of what would happen if everyone who had an underwater mortgage across the world just walked away scott free.

Nassim Taleb says there is no way to predict black swan events and therefore we should try to keep debt to an absolute minimum.  Imagine a world where there was 95 percent less debt.   90 percent of the finance industry would disappear.  Virtually all of the growth in the finance sector in the past two decades has been in areas meant to manage the risk associated with leverage/debt.

It is an interesting thought experiment.  Commerce would still continue.  People would still buy houses.  Consider the example of Brazil.  Because of hyper-inflation until the mid 1990s, banks did not offer any kind of longer term mortgages because they were impossible to price.   People had to save up to buy houses.  Families would chip in/loan the money – people would just wait.  They still bought houses but they had to wait a little longer.  The same was the case with other major purchases as well.  Now, that is changing because of the stable inflation and Brazil is starting to see worrisome levels of household debt, too.

But it is interesting that many of my relations in Brazil – in my age group – have a house and no mortgage debt.  I, on the other hand, am sitting on a fairly large mortgage with 19 years left on it.

While my views on this are evolving, I am starting to think we should look seriously at this issue longer term.  Maybe we should set as a goal across society to limit debt across the board.  From Millken and LBOs in the 1990s to investment banking in the 1990s, financiers have used massive leverage to make enormous profits until the bubble burst.  Maybe the morality of debt should matter.

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Struggle for a dollar, scuffle for a dime
Step out from the past and try to hold the line
So how come history takes such a long, long time
When you’re waiting for a miracle

-Bruce Cockburn (Waiting for a Miracle)

For the first 120 years or so of New Brunswick’s post-Confederation history, provincial governments blamed Ottawa for all their ills.  In the 1944 New Brunswick Committee on Reconstruction, there was a stream of data showing how the NB economy had dramatically under-performed the rest of Canada since 1867.

I just read yesterday a speech given by Hugh John Flemming before the Royal Commission on Canada’s Economic Prospects in 1955.  He had some zingers.

“New Brunswick has not shared to a proper degree in this great Canadian economic advance”.

“For nearly 100 years the relative economic level of this province has been steadily declining”.

“Three weeks ago I drove down to beautiful Fundy Park.  For miles along the route, crews were busy tearing up rails – owned by the CN Railway.  And why this retrogressive step?  Because, I was told, the Railway did not pay.  And this at a time when rich mineral deposits are being uncovered in Albert County, which, if they are developed, will undoubtedly call for more and better railway service – rather than none at all.  this is the kind of thing that we in New Brunswick fail to comprehend.”

“We all know that the St. Lawrence Seaway must inevitably further reduce railway traffic, both passenger and cargo, in the Atlantic region.”

and my personal favourite:

“Though it is my firm conviction that the great economic experiment undertaken by Confederation to make trade flow artificially east and west instead of naturally north and south [italics in the original] was like trying to make water run up hill – it has turned out to be like our own famous Magnetic Hill in New Brunswick – a definite illusion.”

There are many more but I think you get the point.  As Donald Savoie chronicles superbly in his book Visiting Grandchildren this kind of grievance has helped ease the pain for a very long time.

And it may all be true.  I have talked about this enforced east-west trade flow that was summarily jettisoned when it made sense for Ontario and Quebec.  Certainly the St. Lawrence Seaway – paid for by Canadian taxpayers cut Atlantic Canada off as a principal trade route (I heard last week that all international mail into Canada used to come through the Port of Saint John – if so, amazing).

However, complaining about the past doesn’t fix the future.  Understanding the past does – I firmly believe the federal government should be a partner in a serious new effort to promote regional economic development (note – more than the banking services to industry they are providing now).   I talk about how the shale formation that holds shale gas extends all the way to the northeastern tip of New Brunswick.  But do you think any government would think about investing in a pipe to the north?  Outrageous waste of taxpayer money.  Spending $300 million or more each year on EI payments to mostly seasonal workers in Northern NB is a good investment, then?

I’m not suggesting the government put a natural gas pipeline to Northern NB willy nilly but they could incentivize a company to run a test program up there to see the potential.  If it made sense, maybe a joint public/private sector partnership might work.  Of course, the anti-frackers would be out in full force to scuttle it anyway so it is probably moot.

But you get my point, maybe.

Natural resources development – forests, fish, minerals, oil/gas – are an important part of the national economy and they are particularly relevant as economic drivers in rural areas.

I have been talking with dozens of politicians, bureaucrats, business leaders, journalists, etc. in the past few years and I think this historical grievance angle has just about run its course.  I rarely hear it now – except for in an historical setting.

We need new, big ideas for the economic renewal of New Brunswick.  The feds need to be partner in this but the leadership must come from New Brunswickers.

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How’s that for a provocative title?  We live in a 140 character world so have at it.

I just finished an Ideas podcast where the speaker argued that the fear of communism led to the green revolution in agriculture as the wealthy class didn’t want the hungry to rise up against them.

A couple of years ago I read a biography of FDR where he supposedly said to the wealthy class about his social reforms “I am the only thing standing between you and the angry masses”.

This thread – the threat of communism led the west to develop the modern, welfare state version of capitalism – is one that I read and hear repeatedly when discussing late 19th century and 20th century history.

If this theory is correct, what do we do in  a world where the Reds aren’t a threat anymore?

Maybe a little Rosa Luxemburg isn’t such a bad thing after all.

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I really like the economist Nassim Taleb who wrote two very popular books Fooled By Randomness and The Black Swan.  He has a new book coming out and he spoke on EconTalk recently about it.   There is a transcript of his discussion with Russ Roberts but I extracted a small piece on the subject of skin in the game because I found it to be interesting.  I am a big fan of the skin in the game concept – I feel that fewer and fewer people have skin in the game when it comes to New Brunswick economic development.   To win there needs to be the potential of loss.

Taleb: I present antifragility and the last one I call “Skin in the Game: The Ethics of Antifragility.” What happens is that some people in society have the option, namely the bankers, the managers of businesses, they have other people’s skin in the game, the left column. No skin in the game other than they keep the upside and transfer the downside to others.You can see this, the stock market has lost about $5 trillion over the past 10 years, comparatively because a lot of stocks were at a higher level compared to cost of funds. Managers of companies made $400 billion. Why? Because you have the upside and no downside. So they actually own the option and they benefit from volatility.

So, no skin in the game–in that category I put bureaucrats, journalists, corporate executives, bankers of course, and other people I call Fragilistas.

Now, people with skin in the game are citizens, people who have the upside and downside of their actions. If they don’t pay their mortgage, they lose their house. Or, if I make a mistake, then you have skin in the game. And of course my rule of ethic is what I write about, is to have the corresponding position in the market, so I don’t really care about right or wrong; what matters is the payoff. Anyway, so this is the middle column, people with skin in the game.

And of course the right column is an interesting column of people who actually don’t have upsides. They are there to take the downside of others. And they have the highest status in society, traditionally. Compare a banker who has upside and no downside, because they don’t have negative bonuses, to someone in the military. He doesn’t have a bonus and he has his life on the line.

Roberts: It’s a very beautiful insight. Honor is bestowed on those who take the bullet for others. Exactly. These don’t have to be a saint, a knight, a warrior, a soldier, a prophet, or a philosopher in the pre-modern sense. Or a maverick. You can be just like the babysitter who pushes herself and lost her life because she had a responsibility for the baby she was holding.  And you argue that modernity is pushing more and more people into the left column, the Fragilistas who impose their downside on others, and we don’t spend as much time on that right column. Our culture doesn’t do that. In fact, we look at those people sometimes as fools–they could have avoided that harm; they are idiots.

Taleb: Exactly. And in fact it’s the first time we have power for people who don’t have courage. It’s the first time in history in which the people on top have power without courage. First time. You cannot find that in any society. Take the knights. The knights were people who, their trade was that they were risking their lives. This is why they or lords were supposed to die first. And of course the United States was supposed to be first in battle. Not someone pushing a button. It changes the incentives. So, the only way you can have a safe society is by moving the first column, the left column, moving these people out of there, making it more accountable. It’s hard to get there, though. You can, with the legal system you can in various ways. But I think society will explode because then you start having a growing wedge between what is ethical and what is legal. And I name names in here; I don’t know if you want me to name them.

Roberts: It’s your choice. I’m willing to take a lawsuit. It’s your book. I name people who to me–for example, some academics can cherry-pick; they can give contradictory advice and retain the one, because they don’t have skin in the game; they don’t go bankrupt from the bad trade, so to speak. They are always going to be there. The problem is a Nobel Prize in economics. People are not penalized for being wrong. You cannot have a proper functioning. I just wrote a paper in a policy journal in which I show that without accountability, risks will keep going because people will hide them, and we had a system in ancient societies for that. That’s Hammurabi’s Law. Hammurabi understood risks very well. And it was as follows: if the house collapses and kills the owner of the house, the architect is put to death. Why? Not because to punish people. As a deterrent, because no inspector, no regulator, nobody will ever know more about what’s in a foundation than the architect himself. So, you can hide risks from society, you can cherry-pick, you can do a lot of things unless you have a direct responsibility for the results of your action.

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I have following the Occupy movement with interest – I wrote a couple of columns looking at its various contours – with a focus on New Brunswick but it is interesting to get the British view on this.  I have read a number of articles lately (most recently in the Economist) about the middle class frustration with the one percent and with the bottom 20 percent.  The exact theme of the narrative is that the only ones getting ahead in Britain are the one percent at the top and those in the social welfare system – and there were statistics galore about the the top and the bottom outpacing the middle for income growth.

That dynamic in the U.S. has bifurcated with the Tea Party taking it out on the bottom 20 and the Occupy movement taking it out on the top 1 percent.  The British thing about the middle being frustrated up and down the income scale is a new line of discourse – at least for me.

I’ve never been a big fan of this kind of sniping at those earning well below average incomes – even if much of their income comes from the state.  It’s always been distasteful for me but I do think societies need to craft labour market policies and income support programs in intelligent ways.

Unlike much of the research coming out of the think tanks, my view of the EI program is that we need changes because it seems to be the program has become a barrier to economic development.   However, I am very reluctant to recommend some kind of swift change that will move the whole country to some kind of standard.

There have been stories in the media about people that are waiting more than 10 weeks to get their EI cheques and not being able to provide Christmas presents for their kids.  One guy on PEI was carrying around a loaded shotgun out of frustration.

For many people – a higher concentration down here – EI is a relied about part of their annual income stream.  This isn’t a theoretical discussion about the impacts of a 2 percent rise in the HST.  If the government adopted the recommendations that came out a few months ago there would be tens of thousands of people in mostly rural Atlantic Canada that would see their incomes drop by 20, 30 and even 40 percent.

What we really need to do is get back to the point.  If we want to get more people working, how can we do that?   How can we evolve the EI program over time to encourage more work?

I guess some folks take a harder line – on the one percent and the 20 percent.  I prefer a nuanced view – at both ends.  We want people earning piles of cash to pay a reasonable portion of that income in taxes.  We want people to work if they can and contribute to society.  Having 100,000 New Brunswickers collecting EI at some point during the year – to me points to a labour market efficiency problem.   Having an 83 percent employment rate among 40 year olds drop to 40 percent among those aged 60 to 65 – is a problem.  In the modern world why are only two out of five people aged 60 in New Brunswick working?

I guess the conversation rolls on but if we could get our EI usage down – and employment income up – if we could see a gradual rise in employment rates among those 50 and older.  I think these would be a couple of good moves ahead.

Economists are having a good debate about how much of the national tax take should be used as direct transfers to individuals.  This has been rising steadily for 50 years.   In New Brunswick, there is something like 19 cents of government transfer income to individuals (all sources) for every dollar of employment income.  That will have to reach some kind of tipping point.  It’s not about kindness, fairness or justice.

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