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.  

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?

On the loss of American Manufacturing jobs.

Just as the semester is wrapping up we have had the chance to cover the final two chapters in Micro and Macro.

In Micro we had the chance to briefly look at environmental economics -- which has been making some prominent headlines in the news with the discussion of a federal carbon emission tax ... but we will save these headlines for a follow-up post.

First, I bring attention to an interesting article I came across in "The Atlantic" by Jared Bernstein and Dean Baker titled "Why Trade Deficits Matter".

For those of you in my Macro class - to relate this to what we discussed, this article falls right along the line of the familiar, traditional, almost mercantilist argument of "Exports are good, imports are bad", that is the false underlying belief that trade is a zero-sum game.

The argument which Bernstein and Banker make is that the view held by us economists that current account deficits are harmless and no different in effect than current account surpluses are, in fact, wrong.

The argument which they are referring too ... as far as I could decipher at least, follows the basic premise:

1. Following trade liberalisation, industry in each country will align itself along the sectors with a comparative advantage (lowest opportunity cost of production). 
2. Thus industries in the export sector will expand, while industries in the importing sector will contract -- however given a basic premise of scarce resources, in order for the export sector to expand, it needs to utilise the released resources from the contracting import sector. 

Thus my interpretation of the argument being made is that because we have a prolonged trade deficit, (Imports are greater than exports) then this must mean that more jobs have been lost in the import sector (manufacturing) than have been gained in the export sector. 

Thus it is due to a prolonged trade deficit that we have weak demand (aggregate demand) resulting in a persistent recessionary output gap and high rates of overall unemployment. Thus to fix the problem Bernstein and Banker argues that we need to restore the trade balance and reduce the current account deficit. 

while it may be the case that there has been a correlation between the trade deficit and higher rates of unemployment in the states, I was extremely sceptical of the argument being made by Bernstein and Banker. I had a feeling that this was a case of correlation, not causation. (Remember just because A and B are correlated does not mean that A causes B or that B causes A, In fact, there could be a C that causes both!)

Specifically, I would have expected trade to have the effects mentioned above - regardless of trade surplus or deficit. 

As the US economy reallocates its resources to support its export industry (contracting the import industry) - jobs are created in the export industry, while jobs are lost in the import industry. The problem is, many of the skills or education held by the recently laid off labour (and capital) in the import industry may not be relevant for employment in the exporting industry. 

Although the exporting industry wants to hire more workers, the present labour force does not have the skills or education which is demanded by the export sector. As a result, we have a rising level of structural unemployment. I felt this would especially be the case given the exceptionally high cost faced by workers in the US to retrain due to the high cost of schooling.

This was at least my thoughts on the matter, however, these were based on some grand assumptions as I lacked (and lack) the actual data and information about the US economy, as well as other economies who may be experiencing the same thing, but with a current account surplus. 

Then by luck, I came across this article on Forbes by Tim Worstall "Memo for Trump...". Worstall does not comment on the rise of structural unemployment the same ways I hypothesised above, rather Worstall argues that manufacturing jobs are on the decline globally, and this holds for countries both with trade surpluses and deficits. 

Worstall makes the argument, which seems well founded from my view, that through the rise of new manufacturing technologies, productivity has risen, and as a result, there has been less demand for manufacturing jobs. Thus, the manufacturing worker has found themselves hard pressed for employment regardless of if they find themselves in a country where manufacturing is the export/import sector, or if they find themselves in a country with a trade surplus/deficit. 

With this bit of insight (and data) in mind, it would seem that the US manufacturing sector has two serious headwinds to face. 

1. The manufacturing industry in the US does not have a comparative advantage in relation to foreign countries, and thus finds itself in the position of the import sector - struggling to remain competitive. As a result, firms struggle to maintain a profit, and exit the industry, releasing their capital and labour for the export sector to utilise. however, realistically, we will first see a period of higher structural unemployment as the labour retrains and the capital is 're-purposed'.
2. Globally, manufacturing is shifting to capital intensive methods of production. this rise of technology, further displaces manufacturing workers, further adding to the structural unemployment. 

With these two headwinds in mind ... what can be done to save American manufacturing jobs? we could ignore the changing economy and put up protectionist measures in order to save these manufacturing jobs ... but this just delays the inevitable. (and , could potentially slow the shifting of scarce resources to the trying to expand export industry, thus limiting national income). 

Or alternatively, we could rethink the institutional makeup, and craft some forward thinking policies aimed at reducing the structural unemployment caused by these pressures. Specifically, subsidised education reduces the enormous cost of retraining, allowing laid off workers (who are already facing a cost of lost wages and uncertainty of future job prospects) to retrain, and reenter the job market at a much more rapid rate than we are potentially seeing. 

However this last point I make without any hard evidence, other than looking at other countries (Canada, Germany) which also have witnessed pains in their manufacturing sectors, but through subsidised education, have greatly reduced the cost of retraining, allowing these workers to upgrade their skills rather than be relegated to low-paying, low-skill jobs, which is what I am continually being told is happening to these manufacturing workers by the US media.

There is of course much more to this discussion! please feel free to continue the conversation in the comments below.