The Public Service Bargain: Why "Protection" is a Pillar of Good Governance

 

In the first four weeks of PADM 112: Introduction to Public Administration, my students and I have been deconstructing the engine of the Canadian state. We’ve explored the Merit Principle vs. Political Patronage, and the delicate dance between elected officials and the professional bureaucracy.

Shortly after this discussion on administrative neutrality, I came across a post from a City Manager in Florida quoting an attorney speaking on City Manager contracts. His takeaway was a blunt reminder of a principle we often take for granted:

"If you want a [manager] to lead effectively, make tough calls, and act in the city’s best interest — the contract must also protect the manager. That protection isn’t a perk... It’s governance structure."

While the American system often leans on individual contracts, in the Canadian Westminster model, this protection is an institutionalized "Bargain."

The Anatomy of the Bargain

In the Booth and Rowley textbook, the relationship between the politician and the administrator is defined as a Public Service Bargain. While not explicitly written into the Constitution Act, it functions as a Constitutional Convention, one of the unwritten rules essential to the operation of Responsible Government.

The Administrator’s Commitment: They trade their right to public partisan expression and political ambition for permanence (tenure) and anonymity.

The Politician’s Commitment: They trade the "spoils of victory" (the right to hire/fire based on loyalty) for professionalism and institutional memory.

The "protection" mentioned by that City Attorney is exactly what allows for Fearless Advice. Without job security, advice becomes "survivalist." If an administrator knows that questioning a populist whim might lead to their termination, they cease to be a professional filter and become a "virtual yes-man." At that point, the merit principle is dead, and we have reverted to a system of patronage in all but name.

The Partisan Pressure Cooker

This bargain is more critical today than perhaps at any other point in Canadian history. We live in an increasingly partisan landscape where social media has effectively eroded the "Anonymity" portion of the bargain.

In the past, a senior official could challenge a policy in the privacy of a Minister's office. Today, that official’s identity, past social media posts, or even their perceived "body language" in a committee meeting can be weaponized by partisan actors online. When anonymity fades, the permanence of the role becomes the only remaining shield. If we weaken that protection now, we invite a "spoils system" where administrators are forced to perform for the digital mob rather than provide rigorous policy analysis.

The Tension, Who Watches the Watchmen?

A rigorous look at this bargain requires us to address the primary pushback, democratic supremacy. Many critics will argue that "too much protection" allows unelected bureaucrats to stymie the mandate of an elected government. This is the fear of Bureaucratic Sabotage, what we see with calls to end the ‘deep-state’.

The answer lies in the second half of the Westminster duty, Loyal Implementation. Protection exists to ensure the advice is honest and the trade-offs are clear. However, once the decision is legally made by the elected official, the administrator’s role is to execute that direction with the same professional rigor they used to critique it. Protection is a shield for integrity, not a license for obstruction.

From Clean Theory to the "Messy Reality"

For my PADM students, the theoretical honeymoon is over. We are now pivoting to the Application Phase. Over the next three weeks, we will be analyzing current issues at the Federal, Provincial, and Local levels.

The goal is to recognize a hard truth, very few problems have "solutions"; they have trade-offs. Whether it is housing density or carbon policy, these are not "simple" issues, despite how they are marketed. It is precisely because these issues are so complex that we require a protected, professional public service. We need experts who are empowered to weigh those difficult trade-offs without the looming fear of political retribution.

Recommended Reading List

To dig deeper into these themes, I recommend the following selections from our course text and key administrative literature:

• Booth, G. J., & Rowley, A. J. Canadian Political Structure and Public Administration (6th Ed.):
• Chapter 6: A Cog in the Machine: For the foundational definition of Bureaucracy and the Merit Principle.
• Chapter 7: Evolution of Public Administration: To understand the shift from 19th-century patronage to the professionalized service of today.
• Chapter 9: The Bureaucratic Machinery: Focus on the "Haldane" convention and the role of Deputy Ministers.
• Savoie, Donald J. Breaking the Bargain: Public Servants, Ministers, and Parliament. (2003). (LINK to the Policy Options Book Review)
• Kernaghan, Kenneth. The Politics of Public Administration.  Essential for understanding the "Neutrality" doctrine in the Canadian context and the shift and risks it faces (LINK).
• Values and Ethics Code for the Public Sector (Canada) (LINK)

 

Gender Income Gaps, Shelter costs, and equity

 

Source: https://blog.vantagecircle.com/gender-pay-gap/

               Time to be a little bit of a nerd and get excited about census data release day. Unfortunately, other than the data being released, there is little to get excited about.  In the below image we can see the income profile for men and women in Langford. What we see is, unfortunately, reminiscent of what is seen in many communities around Canada, Women tend to be over-represented in the lower incomes, while men tend to be over-represented in the higher incomes. Without getting into the causes, or some of the (terrible) justifications for a gender wage gap, I want to take a look at the impact this has on the security of housing.

               With highly inflated house prices and interest rates on the rise, I wanted to take a step away from the ownership discussion because i) the current carrying costs of qualifying for a new mortgage are so ridiculous that very few people possibly could unless they already have a sizeable amount of equity and ii) because the recent census release also included the housing tenure information which showed that, at just over 35%, an increasing number of Langford residents are renters.

               With ownership, the majority of owners are shielded by wild swings in the valuation of their property, and with most Canadians utilizing fixed-rate mortgages, many will continue to be shielded from interest rate fluctuations for up to the next 5 years.

               The same is not true for renters. Renters typically face annual rent increases up to the maximum as set by the provincial government. But as renters move due to changing housing needs, or to be closer to work, or due to eviction, their rent is re-negotiated at market prices. This means that renters are far more susceptible to paying the current market rent than homeowners are to the current market payment for housing. That is, Renters are more likely to be paying the current, high, market price of rent, well homeowners are more likely to be locked into a constant, lower, payment for their home.

               Thus, if we look at current market rents, versus current incomes, what we find is that only the top 19.85% of income earners are able to afford an average 1-bedroom rental at an affordable rate in Langford.

               Note: Affordability is determined as 30% or less of your before-tax income going towards shelter.

               What is exceptionally troubling is if you break this down by gender. Amongst those identified in the census as male, the top 26% of income earners are able to obtain the average 1-bedroom at an affordable rate.  While only the top 13.7% of female earners are able to obtain a 1 bedroom at an affordable rate.

               It is often presented that renting is a stage of life that you get through until you can obtain high enough income and wealth levels to afford to buy. What we are finding is that this is untrue, with all but the highest income earners being unable to rent a 1-bedroom in an affordable fashion.

               Many argue that this is an unfair verdict. The average household in Langford is 2.4 people, after all, thus most of the time these shelter costs are split between two income earners. We can similarly look to see what percentage of households are able to afford a 1-bedroom. The issue that then arises is that a 1-bedroom may not be suitable for a 2.4-person household – but we will overlook this to maintain a constant comparison.

               The further issue is social in nature and is that as housing becomes increasingly unaffordable for a single individual it encourages individuals to remain in relationships they may not otherwise remain in out of economic necessity. This creates understandable problems that I will not go into here.

               Just the same, we can see in the image below the distribution of household incomes, and from this determine that only the top earning 31.25% of households would be able to afford a 1-bedroom rental at an affordable rate. While this is better, it still signifies a huge problem in that only the top-income earners can afford to rent at an affordable rate.

          With homeownership becoming increasingly out of reach resulting in an increasing percentage of our residents being renters – we cannot afford to overlook this segment of the population. As a city, we need to ensure that rentals are being built and provided to residents at an affordable rate. It is through the initial years of renting that a household can build up the wealth needed to enter the housing market. If the rental market itself is closed off to all but the highest income earners then how can this happen?

This is clearly an issue that affects all members of society, even those in the top income brackets. What do you see as a potential solution? 

Feel free to comment below. 

New inflation values out today - be careful how you interpret this!

     

    TL;DR: When StatsCan measures changes in prices, they do so for a fixed basket of goods - this includes maintaining quality at a fixed level. When the quality of goods increases over time this creates problems - especially when consumers cannot choose to still purchase the lower quality good for a cheaper price - the result is that the actual inflation of this good, likely, is significantly more than the posted rate of inflation.     

    A common argument is that the average household today is better off than John D Rockefeller because we now have access to microwaves and the internet. Thus, this drastic increase in the quality and availability of new goods must mean that we live significantly better lives. The real question is, can we honestly compare the standard of living across such an expanse of time given drastically different goods, and the quality of goods available. 

    Just the same, an attempt at this adjustment is used in calculating the Consumer Price Index (CPI). recognizing that we have access to superior quality goods today Vs what we had 10, 20, or 30 years ago. This improvement in quality must be accounted for in computing the change in the price of a fixed basket of goods. 

    I talk about this a lot with my students - CPI inflation is intended to be a measure of the change in aggregate consumer price levels for a fixed basket of goods to provide information to policymakers regarding how consumer prices have changed year over year. This provides insight as to what has been happening with prices, but it is not the full story and it is not a good measure of the cost of living.

    But first, why is this problematic? This is problematic as the CPI measure of inflation is often used by employers, pensions, unions, and others to determine the change in the cost of living. This leads to the thinking "Oh, CPI inflation was 2% last year, so as long as I get a 2% pay raise I am no worse off". Unfortunately, as we will see - this may not be true. Specifically, your observed rate of inflation may be significantly higher than the reported CPI inflation - basically, the problem comes down to assumed substitutability.

    (This helps to explain why even though wage growth has been slightly higher than CPI inflation, the average wage earner today feels as if their purchasing power is less than it used to be)

    To evaluate this, let's focus on the aspect of CPI inflation, rented accommodation - while shelter costs on whole are weighted as 26.8% of the CPI basket of goods, rented accommodation accounts for only 6.4% of the total CPI weighting (because we assume that most households are owners - however, a similar problem exists for owned accommodation as the problem we discuss here).

    To begin, we can look at the Canadian Mortgage and Housing Corporation (CMHC) historical records showing the median rental price in the Capital Regional District (CRD) from October 2011 through to October 2021 (the latest available published data), this shows that average rental prices have increased by 4.97% on average over the last ten years (source).

    To compare this to the latest CPI inflation information, we see that over the last ten years the rental accommodation aspect of CPI inflation for the CRD has only increased by an average of 1.92% (source).

    So on one hand, we have the CMHC saying that rents have increased by 4.97% annually (on average), while we have Statistics Canada through the CPI saying that rents have only increased by 1.92% annually. Where does this large discrepancy come from? 

    While these two values are computed through different surveys, and over slightly different time periods, it is easy to presume that as both surveys sample from the same population, we should have approximately the same values given the large sample size - that is to say, sampling error does not explain this difference. 

    What does then? Partly it is in how Statistics Canada and all OECD countries compute the CPI. By definition, the CPI is measuring the change in the price of a fixed basket of goods. For some goods, this is not problematic. IE. The price of a litre of milk in 2011 was $X, then in 2021 the price of litre of milk is now $Y - in this case, milk is milk and has not significantly changed over the last ten years.

    But what about when measuring expenditure on other items? Cars, Computers, Cell Phones, Housing? All of these goods have had quality increases over the last decade (a 2021 computer is not the same as a 2011 computer!) As a result, Stats Canada needs to recognize that quality has increased, and thus needs to determine what would be the change in price for a constant quality (fixed basket) rather than the change in price due to the fact that it is a fundamentally new good being sold (again, it would be tough to argue that a 2021 computer is the same good as a 2011 computer). 

    Statistics Canada does this by using a matched-model method to measure pure price changes. That is, attempting to determine what the price of a good would be if we could somehow keep the quality constant.

    While the idea behind this fundamentally makes sense and is necessary - there are some major problems. Often as quality increases, the consumer no longer has the option to obtain the cheaper, original-quality option. For example, as cell phone speed, and features drastically increase each year, you are stuck paying for these features even if you do not want/need them because there are few if any phones on the market that do not include these new improved features. The same can be said for housing or vehicles. In fact, if features (quality) increase substantially while price only increases marginally, this matched-model method may actually report that the price for this good has decreased from year to year! 

    This becomes exceptionally problematic if the consumer does not actually differentiate based on quality. With respect to housing, what if the consumer is primarily concerned with access to shelter rather than access to different qualities of shelter. 

    If this is the case, then shelter becomes homogenous irrespective of quality - That is to say that the potential consumer does not significantly see a difference between low-quality shelter and high-quality shelter. Given the current tightness of the rental (and housing) market, this makes sense - and we would expect to witness similar market prices irrespective of quality. 

    If we take the year built to be a proxy of quality (IE, newer built homes have newer better quality features) we could test this hypothesis by comparing the two possible outcomes:

1. If we witness little if any price difference based on year built, then the consumer primarily cares about the availability of shelter, irrespective of quality. 
2. If we witness newer places renting for higher amounts, then consumers value quality and thus are willing to pay a premium to access higher quality shelter. (If this is the case, then we should be accounting for this change in quality when computing inflation!)

    Likely, we will witness a bit of both happening, so the real question is where are we sitting today Vs. where were we sitting in the past? Well, we find the following (Source)

    How do we interpret the above table? Initially, we find a large spread between old builds and new builds, this would signify that in 2011, there is a desire for quality - renters were willing to pay more for a quality (newer) unit over a lower quality (older) unit. 

    As we move forward to today (2021) we witness that this spread has flattened out. in 2011 the maximum rental price was 43% higher than the minimum, while in 2021 the maximum was only 9.7% higher.  

    This is signifying that renters are caring less about quality than they care about access to units, thus resulting in a reduction in the quality premium. That is to say, while StatsCan, through the CPI, still discounts higher rents to account for increased quality - the renters are not caring about the quality so much as they are caring about access to shelter.

    To summarize, CPI Inflation says that the cost of rental accommodation has only increased by 1.97%  Vs CMHC's reported 4.97%. The reason for the significantly lower CPI inflation increase is due to the fact that there has (on average) been an increase in the quality of rented accommodation. To account for this increase in quality, the price increase must take the quality increase into account in order to compare "apples to apples". This "apples to apples" comparison yields only a 1.97% increase in rental prices over the last ten years. 

    While this method of comparison is preferred to compute changes in prices from an economic and policymaker standpoint, this is problematic when these same metrics are used to compute changes in the cost of living as they will often under-estimate the true change in cost - this is especially true when the consumer does not have the option (or ability) to continue to choose the lower (original) quality option. 

    The crux of the argument is to use caution when interpreting CPI inflation as there are many assumptions that go into these calculations, and the recently reported annual inflation rate of 6.7% (source) may not be telling you what you think it is. 

    Any comments or questions please feel free to message me or comment below.

    

    

     

Canadian Wealth Lorenz Curve

 

    As promised, above is the Canadian Wealth Lorenz Curve showing the percentage of total national wealth held by each percentile of the population.

    The first thing to notice is that there is not really much movement in this over time. In fact, looking at this I don't find it too interesting and probably would not have posted on it on its own - but I promised in the income Lorenz curve post that I'd run this one too - so here it is. 

    Further, to recognize is that wealth can be negative as individuals can have a negative net wealth - this is specifically seen in the bottom 20 percentile of the population, the net worth of this set is around the -2% range. We see that 50% of the Canadian wealth is held by 90% of the population, with the top 50% of the wealth being held by the top 10th percentile (and the top 25% of the wealth being held by the top 1%). 

    Additionally, most of the movement in this curve takes place in the top 20th percentile. so zooming just on this area we witness the following - still not too exciting.

    So, provided out of a promise to provide, I find it a little interesting that there has not been much change in the wealth distribution over the last 15ish years, That is, a rather anti-climatic change in wealth.

    Further - to be honest - I struggled to find a definition of this data-set, so I am not 100% sure how wealth is determined and what sources of wealth go into this calculation - thus it may very well be that the unremarkability of the above data is due to the way in which wealth is measured and reported.

Canadian Lorenz Curve since 1950

 

    Working on this for a course - but I thought many would find it interesting. Above is the Lorenz Curve for Canada from 1950 to the present (2021). 

    To recall what a Lorenz Curve shows - A Lorenz Curve displays the population percentile to the income percentile. In a perfectly equal society, the bottom 50% of the nation would earn 50% of the nation's income, the bottom 25%, earn 25% of income, etc. etc (this is the 45 degree dotted line). 

    The further the curve shifts down to the right, the more unequal society is - for example, to compare and contrast the 1950 levels to the 2021 levels. 

    In 2021, the bottom 90% of Canadians account for almost 60% of all income, while the next 9% (90 to 99% of all Canadians) account for almost 26% of all income, Finally, the top 1% of Canadians account for almost 15% of all income. 

    In 1950, the bottom 90% of Canadians accounted for just over 65% of all income, while the next 9% (90 to 99% of all Canadians) accounted for just over 25% of all income, while finally to top 1% of Canadians accounted for just under 10% of all income. 

    That is to say, over the last 70 years, the bottom 90% have seen their share of income eroded, the next 9% (90 to 99%) have seen their share stay almost constant, while the top 1% have seen their share of income rise by over 5%. 

    Coming up I hope to create the same for the wealth distribution in Canada - we will see what that looks like! (Spoiler - it's not that interesting)

What does rising interest rates mean for homeowners?

 

    While I found it surprising that the Bank of Canada decided to keep rates steady yesterday (Jan 26th 22), especially in light of sustained inflation above their mandated target. 

    That being said, I also recognize that the Bank of Canada is between a rock and a hard place. On one hand, they have their mandate to maintain inflation between 1 and 3% (targeting 2%). On the other hand, Canadians have been amassing serious levels of debt, with some of the latest estimates pegging Canadian debt to disposable income at just over 177%.

    That is, Canadians tend to owe $1.77 for every dollar of income they earn -- but why does this cause trouble for the Bank of Canada?

    Well, as the Bank of Canada increases the overnight rate to combat inflation, this will also increase debt servicing costs for many Canadians, increasing the proportion of their income that goes towards interest costs. Depending on how rapidly the Bank of Canada acts - this could push certain Canadians into insolvency 

    According to an Ipsos survey from 2019, almost half of Canadians are $200 or less away from insolvency. One can imagine that since the pandemic, and increasing prices all around, this outlook has not improved. 

    Now, with the picture painted that Canadians are heavily indebted, with many on the verge of financial ruin - let's look at the housing market - That is, if the Bank of Canada were to increase interest rates, what impact will this have on the mortgage payments being made by Canadians? 

    First, important to differentiate between variable and fixed-rate mortgages. 

    Variable-rate mortgages are linked - somewhat - to the Bank of Canada's overnight rate. Speaking in generalities, if the Bank of Canada increases the overnight rate by 25 bps, then the variable rate mortgage also increases by 25bps -- meaning the debtor's payment will have to increase.

    Fixed-rate mortgages are a little different - with a fixed rate, the debtor is locked into a given rate for a certain term (say 5 years). With this arrangement, the debtor's payments are constant over the term of the mortgage but will be re-negotiated upon renewal (typically every 5 years).  That is, an increase in interest rates today will have no impact on the holder of a fixed-rate mortgage - until renewal.

    That is to say, a change in the overnight rate will impact variable rate holders immediately, but will impact fixed-rate holders over time - as they renew at new, potentially, higher rates.

    So let's see what the impact on monthly mortgage payments would be if we received a 100bps increase in interest rates (a conservative forecast).

    To do so, let's begin by determining the monthly payment on mortgages of various amounts if the current mortgage rate is 2.5% (a typical fixed-rate amount). 

    While not interesting on its own, let's re-work out what the monthly payment would be at a rate of 3.5%

    Here we see an increase in monthly payments, but what is the magnitude change in monthly payments?

    Thus we see that an increase of interest rates (from emergency lows) by 100bps, which still leaves at historic lows, causes drastic increases in the monthly mortgage payment for many Canadians. 

    Given, as we saw, that many Canadians are within $200 of insolvency we can now see why the Bank of Canada may be so hesitant to begin rapidly increasing interest rates. Even with this - this is just looking at the impact on mortgage payments, many will also be witnessing a potential increase in car loans, student loans, line of credit, etc. All together causing potential trouble for many Canadians.

    Of course - all this assumes that these payments (and prices) are rising, but incomes are staying constant - Of course, this is not true, as we witness inflation, there should also be increased pressure for wages to rise offsetting some of this pain - Although, we just showed a 100 bps increase in the lending rate would cause an 11.5% increase in monthly payments, unlikely that incomes will increase that much.

    Feel free to comment below with your thoughts 

COVID False positives.

 

Source: BCCDC

I have often been forwarded articles like this one here which is stating the large probability of receiving a false negative on a COVID-19 test.

This, at first light, appears to be a huge problem.

From the article, we have the reported probability of receiving a false positive based on how many days you have had this disease for:

Day 1 of disease: 100% chance of false positive.

Day 4 of disease: 67% chance

After symptoms begin to show (When you would likely then go to get a test) 

Day 5 of disease 38%

Day 8 of disease 20% 

As I said, this appears to be frightening. Of those getting the test (who have symptoms) something close to 2 out of 5 tests will say that the person is COVID negative when in fact they have the disease.  

So let's work through this. Let's say that you are sick (or someone in your family is sick) and you decide to get a COVID test. You go through the process, get your brain tickled, then get the phone call later that evening. Good News. The result is negative. 

But then you read this article. Are you actually COVID free? or did you just receive a false negative? What is the likelihood that you actually have COVID given that you received a negative test result?

Well, we can actually work this out quite easily. 

Let's first utilize our general multiplication rule for events that are not mutually exclusive:

This says that the probability that both events A and B occur is the probability of A occurring multiplied by the probability of event B occurring, given that, A has already occured. To put this into a more straight forward sense:

Let suppose you have a cooler of beverages. 3 colas and 4 rootbeers. The probability you reach in (without looking) and pull out a cola and a rootbeer is a probability you pull out a cola and then the probability you pull out a rootbeer, given that, you have already pulled out a cola.  

Now the important piece to remember is that this goes both ways.

The probability, P(Cola and Rootbeer) is identical to the opposite P(Rootbeer and Cola). that is, the order is not necessarily important, as long as we finish with one of each. 

Thus we have that:

Why is this helpful to us? 

Almost there - let's open this up, define (A) and (B), and then things should start to become clear.

Where if we set: (A) = "Covid" or (C) and (B) = "Negative test" or (N) we obtain:

From here we can work through what we know (or can find out) in order to answer our question.

What was our question again? 

What is the likelihood that you actually have COVID given that you received a negative test result?

Right, that is, we are looking for P(C|N) so we need to determine values for all the other variables:

• P(C)
• P(N)
• P(N|C)

So how do we go about solving all this?

Well, let's start out with P(C). Currently, there are just over 100k active cases in BC. Given a population of just over 5 million that puts you at about a 2.5% chance of having COVID.  Yes, exposures, or area in which you live/work/play is going to impact this, but we don't have that, so let's keep it simple. 

 

Let's then take a look at P(N). in total, just over 2 million tests have been done in BC (2 336 090), with just over 200K of those being a positive result (217 485) that is we can work out the P(+) to be 9.3%. Using our compliment rule, we can then obtain the P(N) to be 1-P(+) or 90.7%. 

Finally, we need to determine the P(N|C) That is, what is the probability you get a negative test result given that you have COVID. 

Hey, that is our false-negative rate as reported above. Let's start by using the 38% false negative. so summarizing all this we have:

• P(C) = 0.025
• P(N) = 0.907
• P(N|C) = 0.38

We can then re-arrange our above formula to solve for P(C|N) and then make the appropriate substitutions.

Making our substitutions:

What does this mean? it means that given the low rates of actual COVID occurrence in the province and despite the relatively high rates of false negatives. the probability that you actually have COVID given that you received a False-negative is only 1%. That is reasonably low. 

What about if you had a test on day 4 (Pre-symptoms) which when you think about it, is extremely quick for you to realize - notified of an exposure (X) days ago, feeling fine, but will book a test just the same:

Again, despite the alarmingly high false-negative rate. the probability that you actually have COVID given that you received the negative test result is exceptionally low (less than 2%) 

Okay; so what is the moral of the story.

Articles like this come out - and they end up breeding fear and distrust of the tests - potentially leading to people not taking the tests at all. They may think the test is not worth it, the results are meaningless. This of course is problematic in determining caseloads, tracking spread, and combating and turning the tides for this disease. 

Despite these high rates of false negatives. This is still an extremely useful tool and an extremely valuable resource to utilize in our fight against COVID. 

Now - if infection rates were to skyrocket. suppose that instead there was an 80% chance that you had COVID. At that time we would have to question whether or not this test was effective, as the false-negative rate would be extremely problematic. But with our current "low" relative caseloads and infection rates, this large of a false-negative is not a huge concern. 

USMCA: My brief thoughts and opinions

Source: https://www.iisd.org/blog/usmca-nafta-environment

As one the big headlines from the last week (The other, which ended up taking backstage was the subsequent announcement of a $40 billion dollar LNG pipeline and processing facility in northern BC ... for a province with an annual GDP of about $260 billion ... this is huge!) I feel that it is needed to discuss (briefly) USMCA including my thoughts and opinions as to how it will all shake out.

First, let me start off by saying I was surprised by the announcement. I had the opinion that the Canadian team was trying to stall negotiations till the US midterms in order to see how this would influence their negotiating position. I was wrong.  

From what I have seen there are the following notable outcomes from USMCA:

1. Increasing rules of origin for automobiles from 62.5 to 70%
2. 40-45% of auto must be produced by workers earning at least US $16/hr
3. Opening the dairy markets (allowing American Farmers access to 3.6% of Canadian markets)
4. Increasing drug patent lengths (longer time till generics can hit)
5. Increasing copyright lengths.

Let's start off by talking about the benefits:

Business confidence will (has) increased through this deal being struck. that is firms have greater certainty in the future dealings, especially as it relates to cross-border trade. 

Even talking generally with individuals, the view is this is a good thing ... all this seems to point to me that confidence across the board is up, but perhaps my sampling is biased. 

Across the board, I would say the agreement reached on the USMCA is a good thing. With this finalized, I will now be jumping on the band-wagon with the expectation of an interest rate hike on October 24th (especially with unemployment so low and inflation creeping high). 

What about the details. the notable outcomes listed above.

Increasing the rules of origin has been a sore spot for the Americans for a while, so in this case, I am not surprised by this outcome. I can then infer that the reason this is an issue is that we have been skirting around the lower threshold of the rules of origin, meaning that auto-parts are able to be produced cheaper in other parts than they could in the USMCA zone. If this is the case, higher rules of origin mean higher cost parts, means some of these higher costs will be passed on to the consumer (higher price of autos). 

The second attachment to this is that 40-45% of the vehicle must be manufactured with a wage of at least US $16 an hour. Again, not an expert in what the average hourly wage is in this industry, but one of two outcomes exist: 

(A) This is put into place as lip service, but in reality, this threshold has already been easily met or the more likely scenario. IMO.

(B) This is mentioned because, again, most of the production is being done in lower wage areas, and this is an attempt to shift production back to higher wage areas. Again in this sense, the impact of this will be higher costs, passed on to the consumer (higher price of autos).

Longer copyright and longer drug patents mean longer time periods for material to hit the public domain and generic drugs to become available. Again this translates into higher rent for those holding the copyright or patent and thus higher costs for Canadians. 

Finally the dairy industry - the big news item here (or so it seems). American dairy producer will be allowed access to 3.6% of the Canadian market, not a huge proportion, but not trivial either. 

On one side, this entrance (slight as it is) will erode (a tiny bit) of the supply management system and may begin to translate into lower costs of dairy products (although I find this unlikely). 

The caveat to all this though is that the federal government has promised to subsidize dairy farmers (who already earn higher than market prices due to the supply management system) as they had done following the CETA agreement which similarly caused a slight erosion of the supply management system. 

While I find it unlikely that we will be seeing dropping dairy prices, what we do know is that when the government spends (billions?) in subsidies, these have to come from somewhere, that is ultimately a drop in other social services or higher taxes.

Although I have not read the actual USMCA document (nor will I likely to be honest) I have come across several articles which point to a special clause that will prohibit any USMCA member from negotiating future Free Trade Agreements (FTA's) with "Non-Market Economies", IE China. 

If this is the case it is an interesting loss of sovereignty for Canada. Especially as it seems that Washington is the one who decides which economies would be classified as "Market" Vs "Non-Market" 

What are your thoughts on the new USMCA (personally NAFTA was easier to say)? feel free to comment below.  

Staring over the edge. As we try to repeal the carbon tax.

Source: https://www.strathcona.ca/agriculture-environment/environment-and-conservation/

Within an hour I came across the following two articles.

1. from the IPCC on a need for a carbon budget and the very real impacts of climate change, here.
2. from the CBC on Doug Ford (Ontario's Premier) holding a rally in Alberta to challenge the federal government's Carbon tax, here.

An amazing dichotomy of events within a few hours. 

On the one hand, we have the IPCC attempting to bring to light the need for climate reform. On the other hand, we see the political reality (or political appetite to address climate problems). That is once again, let's ignore the problem and hope it goes away! 

I have written before as to why a carbon tax (or cap and trade) will never be popular (here). 

As always my hope is that we will stop playing around with the politics of the issue and deal with the problems in front of us ... however as those who have heard me talk on this know ... I am not overly optimistic that we will have a timely response. 

The Impact of Changing House Prices on GDP in BC

Source: https://www.armstrongeconomics.com/markets-by-sector/real_estate/real-estate-in-decline/

Yesterday (11th of July 2018) the Bank of Canada continued to increase interest rates, as many expected. 

Since the increase in the interest rate, the media coverage has been flooded with conversation around the impact this will have on homeowners. Specifically, it is well presented that Canadian households currently have a pile of debt and will have trouble continuing to service their debt if their payments or obligations increased. you can read a Bank of Canada article on the subject here.

Building off of these discussions, although quite separate, I began to wonder. Here in BC the Finance, Insurance and Real Estate (FIRE) industry make up essentially 25% of our provincial GDP.

As governments continue to engage in policies which aim to make housing more affordable (decrease or slow price growth) and as the Bank of Canada continues its upward movement of interest rates (decreasing the demand and supply of real estate); we have some serious headwinds on house price growth. The question of interest then: Given the size of the FIRE industry in BC, for some change in the house price, how does this filter through to impact our provincial level of output?

To answer this I conducted a simple time-series analysis which allowed me to jointly model both house prices (Teranet national bank composite house price index for BC) as well as the provincial GDP (Statistics Canada).

In order to ensure stationarity, these variables have a log-difference transformation applied to them, giving them the interpretation of the annual percent change. Each can be viewed independently below:

With these variables, I then apply a one standard deviation shock to the transformed House Price Index (HPI), which works out to be about a 4.6% point annual change in the index. Observing how this shock filters itself through both the HPI and GDP over time we see the impact of this shock. This impact is presented below.

First, evaluating the impact of a 4.6 percentage point shock to the House Price Index (HPI) on itself. What we witness is no big surprise, the housing price index jumps in the shocked year (year 1) and then slowly returns to it's normal. With a 95% Confidence level, this shock to house prices has been fully absorbed within 2 and a half years.

Recall we are dealing with growth rates here. Imagine the HPI is doing its thing, then, out of the blue, it jumps by 4.6 percentage points. the effect is an immediate increase in the index, followed by 2 and a half years of additional (but slowing) growth before returning to its pre-shock level of growth. 

Looking at the impact of a shock to the HPI on GDP we witness an impact which was expected. Our shock happens in year one, however, this does not filter through to impact our level of GDP until the second year. At this point, the GDP jumps to an estimated increase of 2 percentage points (fairly large given average growth rates of GDP). However, this impact quickly subsides and is showing no statistical effect 2 and a half years after the shock.

Through this, we can determine the elasticity of GDP to the HPI (for some % change in HPI, what is the impact on the % change in GDP). Thus we can determine the elasticity of GDP to be 0.435, meaning that GDP is not overly sensitive to a change in the HPI, that is GDP would be inelastic. Just the same we can take this to mean that for a 1% point change in the HPI, we would expect to witness a 0.435% point change in the GDP.

So, if we do see a collapse of house prices, this may filter into a bad few years for the BC Economy. Keep in mind, in 2014 when oil prices collapsed causing Alberta's GDP to collapse, Oil and Gas (with support services) accounted for aproximately 8% of Alberta's GDP. Given BC's reliance on the FIRE industry (25% of GDP), a collapse in the price of real estate could very well have a major impact on our provincial economy.

What are your thoughts on this, feel free to comment below.

BC Budget - Housing

Source: https://www.facebook.com/homeiswhereitstarts/

As expected one of the big highlights of the recent BC Budget (yet to be passed in the legislature) is the focus on implementing new policies in order to deal with the housing affordability issues we have seen in BC over the last decade.

The full BC Budget can be found here, the highlights here, and finally the focus on the housing action plan here.

First some praises for the plan.

The plan, although not perfect, aims to deal with both demand and supply side problems currently being faced by the real-estate market. With these policies being aimed to cool demand and stimulate supply (Contrast this to previous policies such as 0% downpayment loans to help first time home buyers. A policy which further stimulated demand).

On the Demand side:

• Introduction of a speculation tax.
• Increasing the foreign buyers' tax from 15% to 20% and expanding this tax out of Metro Vancouver to include the Fraser Valley, CRD, and Okanagan.
• Increasing property taxes (school tax rate) for properties over $3 million. 
• Actions to prevent speculation and pre-sale condo re-assignments. 

On the Supply Side:

• Government $6 billion dollar investment in affordable housing
• 14,000 rental units for 'middle' working families.
• increasing student residences at universities and colleges.
• Providing changes to property taxes to encourage rentals. 

What does all this mean? Let's start working on the demand side followed by the supply. 

First the speculation tax, other than the announcement of the idea of a speculation tax, we know very little as to what this would entail, as a result, it is difficult to say what effect this may actually have on the market. Just the same, I am under the belief (normatively) that if effectively placed could have a significant impact on cooling the market. I have written several times on the role of speculation in the housing market, starting with this article here.

Second the Foreign Buyers Tax. I have written about this before as well. to be brief - I am not a fan of this policy. To read my reasons why you can find the previous post here.

Increasing property transfer taxes and school rate taxes for properties over $3 million: There is a part of this policy which seems satisfying. Ratchet up the taxes for those rich enough to afford a $3 million mansion, but keep in mind, many of the people who have found themselves owning multi-million dollar properties are seniors, on fixed incomes who have just always lived in their house and seen property values rise exponentially around them! 

I have witnessed several sad experiences where seniors have come into the bank, they had bought their property decades ago, out in the boonies, only to find that now their property has exploded in value, with the property taxes being so high that they can no longer afford to pay them through any method other than a reverse mortgage, or city lien on their property. 

Finally, actions to prevent speculative pre-sale re-assignments of condos. Again my belief is that this could be an effective policy, as with the speculation tax, however, the big question I have is what does this look like and how will it be enforced. 

To the supply side: 

A $6 billion dollar investment over the next ten years. Let me start by saying that a minority government releasing a spending plan over the next ten years is rather wishful and thus leaves me skeptical. 

I am not sure of the exact details or conditions of this $6 billion, so let's assume this money is available as financing, and funding for public institutions to increase rental housing and student residences. 

First, building 14,000 rental units for the 'middle'. This may be a great idea, but ultimately I feel it will fall into the slow molasses of municipality zoning and bylaw processes which many have argued to be the primary supply problem contributing to the current affordability crunch. Thus I am interested to see how this materializes.

If this does materialize and if this materializes as 14,000 new rental units, not just "14,000 rental units over the next 10 years" then this may have an effect of driving down rents in areas like the CRD and Metro Vancouver where rental affordability remains just as much of an issue as purchasing a home (near 0% vacancy rates in both regions). 

An increase in investment for student housing will also help to relieve the pressure on rental markets (again primarily in university towns such as Nanaimo, CRD, Lower Mainland and the Okanagan) by allowing students their own specific residence it frees up more rental units for the rest of the population, thus allowing an increasing vacancy rate and decreasing price pressure for rents. 

In conclusion, there are still a lot of unknowns with this housing action plan, but preliminary evaluation looks promising to slow (or temporarily) reverse the acceleration of home and rental prices through policies aimed at cooling the demand while stimulating the supply. 

In the coming weeks, I am sure the specifics of these policies will be revealed. Given the nature of politics, come that time I may have to retract the optimistic tone I have. 

What are your thoughts on this policy?  I have taken a rather one-sided approach in my discussion above, but all policies are going to have both winners and losers. Think about who the losers are following the imposition of these policies and what this means for them. 

Feel free to comment below. 

Rate Increase

Source: http://eldercarebroker.com/wp-content/uploads/2016/08/rateincrease.jpg

Old news by now, but if not aware, Bank of Canada increased the overnight rate by 25 basis points from a rate of 1.00% to 1.25%

I posted briefly about this as well as a link to an article by Don Pittis at the CBC outlining the headwinds the Canadian economy is facing.

Although I never commented ahead of time as to what I predicted would happen, I will say I was pleasantly surprised by the rate hike.

That is, my thought (with nothing but anecdotal evidence to support) was that interest rates would remain at 1.00% for the time being. The rationale for this was:

• There is a lot of uncertainty regarding the future of NAFTA, if this is at risk of being canceled, this could be a serious negative shock to Canada's Economy.
• Increase in the minimum wage may have a similar impact (however also may cause cost-push inflation).

On top of these two headwinds, we also have the effect that increasing interest rates have on consumption, and thus output. That is, an increasing interest rate acts as a negative shock to consumption, and thus to aggregate demand. Keep in mind, this is the big reason why the BoC wants to increase interest rates, as this effect cools inflationary pressures.

This is also the rationale I have when I state that I was pleasantly surprised by the interest rate hike. As we have watched Canadian debt levels explode over the last few years, it seems that an increase in interest rates is required to cool this growth in debt. 

What are your thoughts on the interest rate hike, with another expected 3 hikes this year, is this too much too fast or just what we need?

feel free to comment below.

Looming increase in rates?

Image Source: https://economictimes.indiatimes.com

Don Pittis has a decent article here on the role Bank of Canada has in the Canadian economy and how they have to temper their decisions based on the current political realities of the time. Primarily the increasing minimum wages (Ontario and Alberta) as well as considering a possible end of NAFTA.

The bank of Canada is mandated to maintain a stable inflation rate bound between 1% and 3%, the big politics of late have even bigger economic ramifications which will ultimately affect how the Bank of Canada responds.

Keep in mind when the Bank sets their interest rate we expect it to take 8 to 24 months for the monetary transmission mechanism to fully work through the effect the actual economy.

What are your thoughts, should we expect an increase in interest rates coming up?

Minimum Wage in BC

Source: http://www.motherjones.com/

With all the discussion around minimum wage - particularly the push for a $15 minimum wage. I was recently asked my opinions on the matter. 

Although I have many, which are two-sided and highly contingent on our basic assumptions of market structure in hiring minimum wage employees, the point here is not to make a bunch of normative statements. 

From my readings, much of the literature seems to be split on minimum wage, for every study I have read which supports raising minimum wage due to some list of net benefits, there is another study which is against minimum wage for some list of net costs. 

Rather here. I wanted to briefly evaluate the minimum wage condition here in BC. 

the following utilizes minimum wage data over the last 20 years which I obtained from here and utilizing the all-items Consumer Price Index for both BC and Canada from here. 

using these data sets I created two plots.

first, in BC minimum wage is not indexed to inflation, as a result, it is set intermittently based on the political pressure of the time. 

thus the first plot (below) shows the nominal minimum wage compared to what the minimum wage would have been if it had been indexed to inflation. Here I have indexed it to both the Canadian inflation rate as well as the BC inflation rate for comparison. 

What we witness is that in relation to 1997, the minimum wage today is higher than it would have been if the minimum wage had been inflation adjusted. Keep in mind this was definitely not true between 2005 and 2012. 

The next plot (below) demonstrates the real minimum wage (in 2017) dollars over the last 20 years. Again this real wage is constructed using both Canadian and BC CPI data, then compared to the nominal. 

Nothing too surprising from this graph, most the intuition could have been pulled out of the previous by comparing an inflation-adjusted wage to the true wage. But what we witness is a reinforcement of our previous statement that minimum wage in real terms is higher today than it was 20 years ago. 

Due to the nearly 10 years of constant wage at $8.00/hr we see the outcome that between roughly 2003 and 2012 the real minimum wage was lower than it was in 1997. That is those individuals earning minimum wage saw a steady erosion of their purchasing power over this almost 10 year period due to inflationary pressures. It took nearly 2 years of increasing minimum wage, from about 2010 to 2012 for the real minimum wage to match its 1997 level before continuing to increase. 

Keep in mind this is strictly observational - there are no statements being made that 1997 was the proper minimum wage, which subsequently saw years of erosion. Nor is today's minimum wage necessarily a correct minimum wage either. 

Depending on our assumptions of labour markets minimum wage can either help correct a market failure (in the case of monopsony or oligopsony) or in any other case minimum wage will cause a market failure. 

Final note, because all around we are seeing a big push for $15/hr minimum wage. My big response to this is what makes $15/hr so special? based on the market situation, perhaps no-minimum wage might be optimal, perhaps $16.26 might be optimal. 

The takeaway is that, as far as I can tell, there is nothing special or optimal about a $15/hr minimum wage, rather it is a convenient, round, rally cry - where $14.12/hr just does not have the same ring to it. 

What are your thoughts? feel free to comment below.