Economic Climate for Bargaining

The December 2010 issue of the quarterly Economic Climate for Bargaining publication that I produce is now on CUPE’s website in both English and French.

In each issue I summarize developments and trends for the economy, labour markets, inflation and wages, and also include short pieces of 1-2 pages on related topical issues.  In this issue, the focus is very much on pre-budget issues, including:

• Confronting the notion that we can have “expansionary fiscal austerity”. This is a myth that has been peddled in particular by Harvard economist Alberto Alesina in various articles.  His work has been very influential, but it has serious problems (including ignoring the impact of monetary policy).  The IMF’s October World Economic Outlook included a decent chapter that demonstrated just how flawed these arguments are.  Dean Baker has also discredited a Goldman Sachs report that makes similar arguments.   The bigger problems are of course household debts, lack of demand and measures to reduce economic instability.
• Discussion of the benefits of public spending for the economy, summarizing the recent report from David Hall with various examples for Canada.
• Summary of a few fair tax measures for the federal government that could net over $20 billion a year, including a higher PIT tax bracket, elimination of preferential tax rates for stcok options and capital gains, freeze or restore corproate income tax rates, and a Financial Activities Tax, as proposed by the IMF.

A couple other points of note:

Underlying inflation appears to have become unhinged from the macro state of the economy and appears now very much tied to inflationary expectations (as an RBC report from May suggested).   Despite all the turbulence in the economy in the past few years, Canada’s core rate of inflation has barely budged, it’s been stuck at an annual rate of 1.7% or 1.8% (depending on rounding) for 2008, 2009 and 2010YTD during a time in which output gap has swollen.   In addition, there appears to be much less exchange rate pass-through impact on inflation.

In this context, the Bank of Canada’s debate over changes in Canada’s 2% inflation target (marginally lower rate or price level targetting) that commenced four years ago now seems misplaced and arcane, a bit like the fabled medieval religious debates over how many angels could fit on the end of a pin.   Recent years have shown that it is changes in asset prices–stock market and housing price booms and busts–that are much more damaging for the economy than slight changes in the consumer price index.   It’s true that the Bank of Canada doesn’t have all the tools necessary to control asset price inflation, but that’s why if there is an inflation control agreement, it should be a true agreement with the federal government.  It should of course include elimination of tax measures that help to fuel asset price booms.  The BoC should declare victory on its consumer price inflation control target and confront the much more damaging problem of asset price booms and busts.

Secondly, while much has been made of differences between public and private sector wage increases and average private sector wage increases are now outpacing those in the public sector, over the longer term there’s a stronger correlation between public and private sector wage increases , as a chart on page 11 of the Economic Climate document shows.   Public sector wage cuts and restraint will suppress wage increases for all workers.

This comes back to the expansionary fiscal austerity arguments.    While it was flawed in a number of ways, Alesina’s work found that public sector spending cuts had a positive impact on the economy not because it led to lower taxes (little impact), but because they also suppressed wage increases for private sector workers (leading to higher profits, supposedly higher investment, more growth, etc.)

This of course undermines the false private vs public sector argument that business groups, media and politicians have stoked.   The real issue is workers’ wages & labour shares vs capital & profit shares.