NORTHERN ECONOMIST 2.0

Monday, 25 January 2021

Governments betting on low interest rates may experience rude awakening

Governments in Canada and around the world have run large budget deficits and greatly added to their debt loads due to their pandemic response and the accompanying economic downturn. Moreover, they are poised to add even more debt in coming year to provide further stimulus to kickstart moribund economies.

Indeed, the new Biden administration plans a $1.9 trillion economic package on top of the $2 trillion relief bill in March and additional $900 billion in December. As for Canada, the Trudeau government is poised to spend $100 billion in stimulus on top of a record deficit approaching $400 billion.

Clearly, governments worldwide went into the pandemic with large debt loads and will emerge with even bigger ones. However, the large deficits are justified on the grounds that we need to kickstart the economy and it’s a good time to do so because interest rates are at historic lows, making debt-service costs extremely manageable. In many respects, there’s a great gamble underway. We’re rolling the fiscal dice, anticipating that interest rates will not rise anytime soon and will remain below the growth rate of the economy, thereby ensuring sustainable debt burdens.

On the surface, the grounds for such optimism are supported by economic history. The long-term trend for interest rates over the last few centuries has gradually been downward as economic development and capital-labour ratios have grown, raising the return to labour (wages) and reducing the return to capital (interest rates). Indeed, this process has been documented by Jorda, Singh and Taylor with medieval interest rates of about 10 per cent falling to four per cent by the 19th century and now approaching one per cent.

In the wake of pandemics such as the Black Death and the Spanish Flu, the long-term downward trend has been amplified by further short-term depression of interest rates. Essentially, pandemics increase mortality, making labour scarcer, and also increase savings rates as people hunker down and spend less. Both effects make capital more abundant relative to labour and lower the return to capital. If the COVID pandemic is true to form, one might expect the next decade to also feature ultra-low interest rates, justifying the current debt acquisition gamble.

Yet, there are reasons why this time may be different.

First, the current low inflation environment may soon end. The large budget deficits worldwide, competing for funds and resources, may eventually put upward pressure on prices and interest rates.

Moreover, the rise in trade barriers may lead to rising costs as global supply chains become less smooth, further adding to inflationary pressure. Indeed, some think Canada may be among the first countries to start raising interest rates due to stronger commodity prices as economies recover despite Bank of Canada positions to the contrary.

Second, in historical pandemics, the mortality impact has been on much younger populations and as a result the labour force impact has been more severe. Unlike the Spanish Flu, for example, COVID’s mortality impact has been disproportionately felt by seniors as opposed to prime working-age younger demographics more engaged with the labour force. Indeed, the labour force disruption and reductions of COVID are mainly the result of measures taken to reduce the spread of the virus. Once the virus is contained, these reductions should abate.

Taken together, governments around the world should not bet big by taking continued low interest rates for granted as they add to their debt pile. One year ago, nobody was thinking about COVID-19 and its economic effects. Today, few seem to be thinking about potential interest rate increases. Governments may feel lucky as they boost deficit-spending in a game of fiscal roulette. But the real question we must ask ourselves is: do I feel lucky?

This appeared in the Fraser Institute Blog on January 20th, 2021.

Friday, 22 January 2021

Why Can Ignace Get Nice Things and Not Thunder Bay?

It turns out that Ignace is getting its municipal snow grader outfitted with a “snowgate”. Essentially, the snow plough is going to have a gate on it that lowers at the end of the blade when in front of a driveway thereby preventing snow from blocking the driveway while snow on the street is removed. Needless to say, the thought of not having to deal with a foot high pile of crushed ice and snow at the end of a driveway after a major storm makes winter much more bearable. However, given it is budget season, one wonders how expensive this might be?

As noted in the CBC story: “The gate cost $15,000, and is easy to operate, Taylor-Hertz said. The operator of the grader flips a switch, and the gate lowers when going in front of a driveway. Once past the entrance, the gate comes up, pushing snow to the side of the road. ‘A couple of our department heads got together, and talked about getting a snowgate for the snowplow, or the grader attachment, and it has alleviated a lot of problems for our elderly residents in our community, by taking the windrow away at the end of the driveway’."

The “snowgate” is of course essentially a windrow prevention program as opposed to a windrow removal program but in Thunder Bay it is apparent our municipal government is capable of neither. The possibility of windrow removal in Thunder Bay is not a new issue. During the 2020 municipal budget season, this very idea was discussed in Northern Economist but to no avail. As noted on their web site by the City:

"No, windrows across driveways will not be cleared by City Crews. Residents are responsible for the maintenance associated with their driveway, including the portion that is on City property. It is that portion of the City property which has been designed to provide snow storage during the winter. The City does not give up the right to store snow in that area of the boulevard when it allows the residents’ driveway to encroach across City property. It is important to note City crews have the important task of plowing snow on all City streets as quickly as possible. Snow removal from driveways is not a program offered by the City. "

Apparently, our driveways over the boulevard to access the street are an "encroachment" on City property so they can do whatever they want with the land.

And of course, it is not just Ignace that seems to be adept enough to cater to the needs of its municipal ratepayers. Richmond Hill has the Cadillac of programs and now removes the windrows on all residential driveways. Richmond Hill windrow removal was implemented in 2019 for all 55,000 households for a total annual cost of $4.4 million dollars. Markham also does windrow removal but for qualified registered applicants who must either be over 60 years of age or if under 60 have a medical note saying they cannot shovel snow. Even Toronto has some windrow removal depending on where you live in the city.

While one does not expect the Richmond Hill program, it remains that when it comes to windrow removal, Thunder Bay is not even trying. Why? That is a good question. After all, when it comes to municipal spending, Thunder spends one of the highest amounts per capita across major Ontario municipalities. How onerous might the total cost of $15,000 per city plow be given a $200 million dollar tax levy supported budget?

The answer is it is all about priorities. While Thunder Bay does spend one of the highest per capita amounts of major Ontario cities, it has chosen to prioritize three things: general government, police, and fire services. Indeed, of 27 major Ontario municipalities, Thunder Bay spends the most dollars per capita (about $1,000) of its tax levy supported operating budget on these three things as illustrated in Figure 1. Indeed, nearly 60 percent of Thunder Bay’s operating tax levy is spent on these three items - again, the highest of these 27 major municipalities.

However, as we all learn in first year economics, given a fixed budget, more of one thing results in less of something else. As a result, as shown in Figure 2, once police, fire and general government are removed from its spending, Thunder Bay spends the second lowest amount of the same 27 major Ontario municipalities and the lowest of the five major northern Ontario municipalities. That means relative to other cities, less money is spent for snow removal, parks and recreation, public transit, environmental services and numerous other things.

How can this be? In the wake of my last colorful comparison using marine metaphors, think now of the City of Thunder Bay as a Roman war galley. The municipal taxpayers are the galley slaves at the bottom of the galley propelling the City forward with their property taxes while sloshing about in the cascading bilge water provided by innumerable leaky pipes. On the top deck, along with the municipal council gathered around their decision table sitting comfortably on their high chairs, are the neatly arrayed officers of the ship – police, fire and administration standing between the elevated stern of a new Turf Facility and a prow marked by a new police station. They are looking proudly forward as they steer the ship into the wild blue fiscal yonder. One can almost hear the beat of the budget drum as the municipal council intones to the ratepayers in their best imitation of Quintus Arrius that “We keep you alive to serve this ship. Row well and live.”

You would like a “snowgate” you say? Don’t be silly. The City of Thunder Bay has already decided what we need. Keep rowing.

Sunday, 17 January 2021

Thunder Bay Simply Spends More...A Lot More

Budget deliberations will continue this week at Thunder Bay City Council and the conversation to date suggests that there does seem to be some recognition that this year needs to recognize the financial hardship of the current pandemic. However, easing back on tax increases this year and expecting to get back to normal the year after is really also not the right strategy. This does seem to be the source of division right now on Council given the difference of opinion on just how serious future financial challenges are.

The summer saw talk of a tax levy in the 3-6 percent range as a result of increased costs due to COVID but it appears that the substantial amount of federal and provincial aid has dampened that talk to the point where the proposed increase is now 2 percent for 2021. However, many in City administration and on council feel that this is temporary, and we will be returning to business as usual with increases well over three percent in subsequent years.

The response at some of the budget presentations last week was that even the proposed two percent now needs to be reduced further. In response, the call by one councillor to accomplish that by simply taking the money out of City reserves or stabilization fund for this year again reflects the belief that the problems are short term and things will be better next year. This is a mistake given the long-term structural problems affecting City of Thunder Bay finances.

[As an aside, the councilor’s quote that “That stabilization fund is there for crises, like the [2012] flood,” was interesting comment given that the 2012 flood affected several thousand homeowners much like the current leaky pipe pandemic and apparently dipping into the reserves then now seems to be viewed a form of assistance to homeowners. The City has remained tight-lipped on the leaky pipe matter since the start and now especially since it is before the courts as a result of a class action lawsuit. However, the homeowners affected by the 2012 flood have also filed several large lawsuits so one wonders why the double standard in public commentary? Has some sort of self-imposed statute of limitations on discussions expired?]

Thunder Bay’s municipal finances are marked by a long term erosion of its property tax base due to industrial decline and a lack of population growth combined with above average spending and costs due to a higher cost structure acquired during a time when revenues were more abundant. There is a failure to recognize or deal with the problem. This higher cost structure is apparent when Thunder Bay is compared to major Ontario municipalities.

The following figures present municipal spending for Thunder Bay compared to 26 other major municipalities in Ontario for 2020 using data obtained from the BMA 2020 Municipal Report. Note that for municipalities with regional government, in the police and fire categories, spending per capita for the regional functions was included on top of their reported municipal spending. Figure 1 presents the per capita tax levy for all 27 cities as well as the average for them. Thunder Bay does have the fourth highest tax levy [municipal operating spending] of these 27 major municipalities. What is more interesting is when the composition of the spending is broken down a bit.

What emerges from Figure 2 to 6 is that Thunder Bay spends the most per capita on general government (administration), police and fire of these municipalities. Thunder Bay spends $241 per capita on general government compared to the 27-city average of $113 – more than double. It spends $317 per capita on fire protection compared to the average of $191 and $441 per capita on police protection compared to the average of $311. While in total, Thunder Bay only spends about 10 percent more per capita than the average, compared to the category averages it spends 116 percent more on general government, 66 percent more on fire and 42 percent more on police.

When these three expenditure categories are summed up, it turns out that Thunder Bay spends nearly $1,000 per capita on general government, police and fire compared to an average of $612 – that is 63 percent more than the average. While northern Ontario municipalities because of their larger urban areas and lower population densities have a tendency towards higher costs and spend more, we are head and shoulders above the rest of the North. Looking at Figure 5, after Thunder Bay at nearly $1,000 comes Sault St. Marie at $752 and North Bay at $736. Sudbury is only at $656.

As a share of the per capita tax levy (Figure 6), spending on general government, police and fire in Thunder Bay at 56 percent is approaching nearly 60 percent! The average across these cities is closer to 40 percent. One cannot simply blame arbitration costs for police and fire spending in Thunder Bay because all cities in Ontario are under the same system and salaries do not differ that much across jurisdictions. Based on what is being spent on administration, police and fire, we are spending an awful lot for government protection services which makes one wonder if in Thunder Bay we are living in some type of municipal public sector version of the Sopranos? The cost structure is a problem and require a concerted long term effort to bring costs and spending more in line with other jurisdictions.

Friday, 15 January 2021

Despite spending hundreds of billions during COVID, we seem to have little to show for it...

As the pandemic moves into 2021, it’s important to reflect on how Canada is dealing with its impact. After a summer that included a semblance of normality, the fall and winter have brought a resurgence that’s taxing our ability to cope. As the second wave unfolds, various new lockdowns (with substantial rates of non-compliance) have been imposed, testing international air travellers on their return has begun nearly 10 months after the start of the pandemic, the vaccine rollout appears to be unfolding in slow motion, hospitalizations are rising and death tolls are creeping upwards.

The current sentiment seems to be that while Canada may have made a few mistakes along the way, we’ve been doing relatively well and deserve a pat on the back. Yet despite spending hundreds of billions of dollars at the federal and provincial levels with combined budget deficits approaching $500 billion for 2020-21 and the largest deficit-to-GDP ratio of any developed IMF country, we seem to have little to show for it.

The virus is surging in our major cities, we lag behind in administering vaccines to the point where many spent a long time in freezers. And the virus still runs rampant through many long-term care homes.

One wonders if in the end, the disjointed, confused and slow response to the pandemic was partly the result of the current interpretation of Canada’s federal system by its leaders.

Federalism is a system of government where units are able to be both independent and coordinate and should accommodate regional preferences with the economies of scale and political direction of a larger country. The Canadian federation has been held up as a model for the world given our standard of living, the freedom of our population and the stability and diversity of our political system.

While Canada’s diversity has meant regional tensions between the federal and provincial governments and perpetual crises and tug of wars over jurisdiction, it’s managed to remarkably stay aloft for more than 150 years. Indeed, one pundit remarked how Canada is a “bumblebee nation” able to fly despite being aeronautically impossible. However, one wonders if the flight of the Canadian bumblebee is more attributable to luck than ability.

Given our high standard of living, we’ve come to think of ourselves as high-flyers, but it increasingly seems that we are mediocre flyers caught up in gusts of wind provided by the historic proximity to a relatively benign and wealthy southern neighbour and our abundant natural resources. Canada’s leaders seem increasingly unable to solve problems. Our governments are increasingly bureaucratic and adept at planning but not at implementation. While quite accomplished at spending large sums of money—especially at the federal level—our governments seem extraordinarily incapable of getting things done themselves or harnessing private initiative. Indeed, when it comes to the private sector, our governments are experts in imposing rules and regulations rather than incentives. When some private companies stepped up to produce masks and hand sanitizer early in the pandemic, their reward was to be bypassed by foreign suppliers when the real money was spent.

During COVID, governments across the country have issued inconsistent and contradictory statements about masks, the rules for gatherings and so on. Consequently, many Canadians increasingly don’t know what they’re supposed to do to stay safe and some may think they’re following the “rules” even when they’re not. We’re told these are unprecedented times—but obviously not unprecedented enough for politicians of all stripes who tell us to stay home while they gallop around the world demonstrating an appalling lack of leadership.

Our federal government intones that health is a provincial responsibility, but there are federal and provincial health ministries and public health agencies and federal health transfers. Health as a provincial responsibility should provide experimentation and flexibility in dealing with the pandemic. But there seems to be little learning going on given that the relative success of the Atlantic provinces has yet to rub off on other provinces.

While the discord of the U.S. experience has not marked Canadian intergovernmental relations, one cannot help but wonder how much “politics” has marked public exchanges. Take the premiers asking for more health transfers or the federal response to the provincial clamour for the federal government to provide vaccines, which was followed by the expression of federal “disappointment” over the lack of quick distribution by the provinces.

Finally, the federal government has used its spending power not to provide early testing and comprehensive quarantine facilities at international airports or ramp up domestic vaccine manufacturing and distribution, but to dispense poorly-targeted transfers. And again, Ottawa has chosen not to do more to tackle the pandemic directly by hiding behind a strict interpretation of provincial jurisdiction over health. This federal government seems to act is if health is a provincial responsibility when necessary, but not necessarily a provincial responsibility. Sadly, all Canadians will pay the price for the failure of our governments.

This was first published in the Fraser Institute Blog, January 8th, 2021.

Sunday, 10 January 2021

Thunder Bay Municipal Budget 2021: Overview

It is budget time at Thunder Bay City Council and this year’s discussion should be quite interesting given the coming together of the pandemic, numerous water issues that have affected residents directly in their pocket-books as well as the long-term effects of rising municipal expenditures combined with a flat population profile and an essentially stagnant property tax base.

The proposed 2021 municipal tax levy, which represents the total amount of dollars that needs to be raised from property taxpayers to fund City services, local boards and agencies and contribute to capital infrastructure programs, is $203,682,300 - an increase of 2.15% or $4.3 million over the 2020 approved municipal tax levy of $199,398,000. By comparison, in 2020 the municipal levy increase was $5.3 million, representing a 2.73% increase over 2019. Not included in the increase are costs associated with the COVID-19 pandemic, which are proposed to be funded from the Stabilization Reserve Fund in 2021 and one expects the millions of dollars in federal and provincial funds that have been provided for the purpose.

As well, there are numerous user fee increases not least of which is for water which comes in at 3.5 percent. The irony of a 3.5 percent increase for water given the epidemic of residential pinhole leaks affecting thousands of residents is notable. As well, the 2021 proposed capital budget is presented at $51,607,300 gross of which $16,525,700 is funded by the tax levy representing an increase of 8.6% compared to the 2020 budget. In terms of employment, the number of fulltime equivalent positions (FTEs) rises from 1724 to 1758 which we are assured is temporary because it has to do with cleaning costs associated with COVID. This increase of 34 FTEs in municipal employment comes on the heels of 9 FTEs in 2020 and 10.5 in 2019.

If one wants some comparisons, Figure 1 plots the total municipal tax levy from 1990 to the current forecast for 2021 with the trend readily apparent. As well, while we know that Thunder Bay in 2020 had the second highest property tax rate of 35 Ontario cities, Figure 2 looks at the per capita levy in 2020 for 27 Ontario cities. It turns out, that at $1783 per capita, Thunder Bay is the fourth highest. For those purists who say it is unfair to compare us with cities like Toronto, very well, let us just look at the five major northern Ontario ones. Here, Thunder Bay is ranked first – primus inter pares – above North Bay, Timmins, Sudbury and the Sault.

If City Council is to be guided on what to do this year it may want to heed the results of its own budget survey which had nearly 500 respondents though one expects that the expert statisticians resident on City Council will simply discount the results as based on a small and biased sample of negatively minded people not representing the true mind of the City of which only City Councillors have the divine power to ascertain. Still, the survey results were quite telling as the general tenor of the responses was to focus on core services.

As the report reads: “While there was a wide variety of topics covered, the strongest message and overarching theme centred around not spending money on extras considered ‘wants’ and instead focusing on essential ‘needs’. For example, not spending money on new capital projects such as the Multi-use Indoor Turf Facility, a waterfront sign, roundabout, or art gallery, and instead investing in existing City infrastructure (roads, facilities, fixing water pipes), and social services such as crime prevention and supporting vulnerable populations. It was also conveyed that citizens have experienced financial hardship because of the pandemic and do not want to see their taxes raised at this time – especially not to support new capital projects. Citizens outlined they would like to see the City invest in what we currently have and support the core needs without increases taxes – understanding this means giving up those items which would be nice to have but are not essential services.”

Indeed, based on a ranking of what is considered “very important or important,” the top programs and services in the city should be: emergency services, winter maintenance, drinking water, road maintenance and construction, garbage and recycling. Included at the bottom are transit, child-care, libraries, recreation programs and facilities, animal services, and economic development. There certainly does not seem to be a groundswell of support in this survey for new capital projects that do not reflect a core services mandate.

What should the City of Thunder Bay do this budget season? Well, that is the $203,682,300 question. First, it probably is time for Thunder Bay to visit the concept of core services in a more substantial manner. Given our tax base, running the expansive set of services that we have is increasingly difficult given the size of the tax base. If the province wants us to fund an expansive set of community and social services on a local and regional level perhaps, they should foot more of the bill. Second, the 2.15 percent proposed increase does represent a retreat from the 4 percent or more number that was being bandied about earlier in the year. While it may seem that City Councillors and administration have seen the light, it is unfortunately an oncoming freight train in a dark tunnel and more needs to be done.

While 2 percent does mirror the rule of keeping increases to the sum of the rate of inflation (approximately 2 percent) plus population growth (pretty much zero), it should represent an upper bound rather than a flexible target. There is more to be done to get levy growth even lower. Third, given that approximately 70 percent of costs are often associated with employment levels, there really needs to be a program of reduction via attrition and redeployment and retraining of staff. For the next three years, for every two municipal employees that retire or resign, there should only be one replaced. That FTE footprint needs to start coming down to where it was a few years back – say 1700 as in 2017. At 100,000 per employee – which is not an unreasonable estimate of what each municipal FTE costs when salaries and benefits are combined, that would eventually reduce spending by $5 million a year.

Of course, all this talk of numbers and reductions is probably a lot for more upbeat members of council and one certainly one would not wish to bore them to death as they are perfectly capable of doing that to themselves during their marathon five and six-hour meetings. A better way of framing all of this is via a simple analogy from the world of nature. Simple stories are often the best ones as they can reduce complicated issues to the essentials needed for understanding.

Picture if you will, our municipal government as a Physalia physalis – also known as a Portuguese Man O’ War – floating serenely in a large aquarium. It is essentially a large jelly like inflated bladder that in the end is rather brainless and feeds instinctively on the small fish and creatures in the aquarium via the lethal stingers in its tentacles. Along with being rather brainless, it also really has no anus so it is probably recycling its own waste matter which can eventually get monotonous and a little stale given the size of its environment.

As it sits in its limited environment and exhausts its food supply, it really is not capable of doing what needs to be done. The solution is either to expand the size of the aquarium and restock it with new prey or replace the current Physalia Phyalis with a new and much smaller one or perhaps even an entirely new creature. The current creature of course behaves by instinct and really is not capable of altering its size or its environment. It is not capable of expanding the size of its environment – economic growth and an expanded tax base – and it does not appear to be capable of shrinking on its own. I suppose that a solution has to be done by forces external to the situation. I guess that is where the voters will ultimately come into the picture.