Of Planes, Ships and Misleading

F-35 Joint Strike Fighter

Canada’s order with the Joint Strike Fighter program for 65 Lockheed Martin F-35 Lightning II fifth generation fighter jet will be the country’s second largest procurement of goods ever. The decision to explore replacement of Canada’s aging fleet of 79 CF-18 Hornets (of the original 138 purchased) was taken in 1997. Agreement to fund development of  a plane to serve NATO fleets was taken in 2001. In 2007 the participating countries agreed on Lockheed Martin’s design. While Canada has participated on the financial funding of the F-35 development and has signed memoranda of understanding on the purchase of the planes, the government hasn’t actually penned any deals as of yet. The official governmental decision to purchase the planes was taken in 2010. The Auditor General praisedthe Department of National Defence and Industry Canada for their cooperation on obtaining partial commitments for economic spinoffs (local procurement and parts supply). The praise was tantamount to a proud clap on the back for not having brought back Mulroney-esque graft to Canadian national procurement (hrum…hrum Airbus…Shreiber…hrumph). The AG’s report than proceeded to admonish those very same departments for having done a lax job of informing their overseers about the potential costs of the planes. The subplot: bureaucrats at DND and Industry Canada got a little over excited about the F-35s and jump the gun on the costing and decision of the purchase.

Michael Ferguson Auditor General of Canada

With this update readers might be made to believe that the furor and outrage afoot in Ottawa has to do with bureaucrats lying to duly elected officials and ministers. So how his it that Peter Mackay, minister of defence is public enemy number one? According to Ferguson at some point before the campaign the minister was made aware that the numbers he had previously been given were probably low-ball estimates. The minister chose to stick to the script and reiterate the one number he was sure of and for which written documentation was available. “A purchase tag price of 9 Billion dollars”. Now that number is not being disputed (the number was re-confirmed at a congressional hearing this past week in D.C.), what is being disputed however, is whether it was misleading. The purchase price does not include operating, maintenance cost, nor the estimated 15 or so planes that may be purchased for purposes of replacement. The full purchase and maintenance costs as estimated by DND in 2010,  up to 14-16 Billion, depending on the value of the Canadian currency. The life cycle costs estimated by the Parliamentary Budget Officer Kevin Page including purchase, maintenance and operating ran the 14-16 Billion tab up to approximately 25 Billion.

Kevin Page Parliamentary Budget Officer

Now these numbers are all more or less irrelevant. A plethora of external factors out of the governments control or the PBO’s capacity to predict will raise or even drop the final costing of the entire program. The facts are that there are two kinds of variables here (as always in economics) exogenous and endogenous, that is in and out of the hands of the government respectively. What should be obvious to any assiduous political commentator is that the Conservatives are getting pounded politically and in the media for their reporting or non-reporting of the factors which are out of their hands and for which no estimates can be reasonably assumed to be correct. But what of those factors who’s outcome can be – if not guaranteed – at least affected?

Leaving aside the actual question of the necessity of the jets’ purchase (this is a blog on economics not international relations/war), there remains some important questions concerning the JSF program. Often military contracts provide the political and nationalist cover military industrial lobbyists use to wash politicians memories of the basic laws of economics. For example, the AG report celebrates DND and Industry Canada’s efforts to wrestle F-35 parts supply contracts towards Canada. South of the 49th Congressmen exert pressure on Pentagon and industry officials to manufacture jets, tanks and ships in this or that Congressional district. Much ink is spilled over the astronomical costs of the F-35 in Canada but what of the largest procurement contract in Canadian history? Little or no attention is given to the 33 Billion dollars or so being spent on ship building in Nova Scotia and British Colombia. As almost all know, the geographies to which the contracts are allocated are for the most part chosen politically.

Peter Mackay Minister of Defence

A case can always be made for the necessity to protect national security and guarantee the reliability of military hardware. Everyone would recognize the stupidity of building NATO’s next fighter jets or tanks in China or Russia. However, when Canada awarded the shipbuilding contracts, one key requirement in the bidding was for Canadian content and jobs to be maximized. When South Korea, a NATO dependent ally, has some of the most cost efficient shipyards in the World why does the government not try to maximize the military bang for the taxpayers buck? How can the government accept to participate in the developing of the F-35 when it is de-facto an American controlled program. Why is it that the purchasing of military hardware must be operated through the Pentagon and not directly with the manufacturer? America’s NATO allies should demand an end to the discriminatory practices of the American industrial-military-complex. When it comes to that sticky number that is the cost of maintenance of the F-35’s, why is the government promising to do all the work in Canada. If the Canadian dollar is high the government should be sending the planes to the cheapest maintenance operations throughout NATO and inversely the debt plagued nations of NATO should send their repair work to the lowest bidder.

If the point of purchasing military equipment is to protect a nations sovereignty and citizens , why is it that countries are willing to trade more military capability for a few more jobs? Or in the case of the US get a lot more jobs but disproportionally more deficit and debt. If Italy is good at manufacturing and Australia is good at producing commodities both countries are poorer for trying to muscle in on the others specialty. At the end of the day military procurement is a game of intra-alliance attrition which makes us all that much poorer and less safe. Enough with the petty demagoguery of military jobs. If we really need strong armed forces to protect us let’s make sure servicemen are equipped with the best hardware and make sure our economies are competitive and strong enough to support those armed forces.

A Conservative Budget

Minister Flaherty scratching his shoe instead of his head

This was probably one of the more tame federal budgets in decades. Although it may be spilling a lot of ink now, expect the upheaval to be very short lived. While the Opposition may pay a little more attention than most to the budget, it is so unremarkable that they will probably return to criticizing such bills as C-10 and C-30 and keep the focus on the Robocalls scandal. As unremarkable as this budget may be, like all budgets it deserves much scrutiny for what was in it, what wasn’t and why its measures are so incremental.

Before we begin scrutinizing the budgets fine print, it must be said that the budget speech had one element in it deserving much praise. Rising up in the house of Commons to deliver his budget, Finance Minister Jim Flaherty spoke often of Canada’s fiscal leadership among industrialized nations. He noted recurring that Canada led the G7 in some manner or form when it came to public finance. Something in the rhetoric changed. After lavishing his government with much praise he proceeded to explain that Canada could not only benchmark itself against the wealthiest nations of the World, but should also compare itself with the ‘fastest’ and most dynamic growing nations of the World. It seems that if anything the conservatives have at least learned that comparing oneself to the wealthiest is no sign of merit when they are the economies that are the most stagnant in the World. This kind of talk can only lead to policy better aligned with the realities of the 21st century World dynamic.

Moving on to some of the less praise worthy moments of yesterday, let’s look at some of the new policies introduced and their short comings. In an effort to fill the glut of job openings in the western provinces the federal government will move to enhance immigration matching. The intentions of the action are praise worthy, the means may also be effective and fair, however one solution has not been explored. Employment insurance in Canada is atomized. While the program is national in scope and the premiums equal in all provinces, the hours contributed necessary for eligibility vary widely across regions, payout lengths are also regionally discriminatory. The result of this is while unemployment remains elevated in eastern Canada, job openings go unfilled in the west. Canada’s EI system encourages Canadians not to move to seek employment it encourages regional structural unemployment. So while the Premier of Saskatchewan is off in Ireland to go recruit that countries skilled unemployed labourers Newfies sit at home cashing in the dole waiting for the fishing season to start again. With standardization of EI across Canada the government could have hit two birds with one stone: reduce lost output in the west because of labour shortages and reduced unemployment in the east because of -job shortages. Than economist say they are puzzled with Canada’s international un-competitiveness, simply shameful.

Another issue Minister Flaherty often raises is the problem of an over heating real-estate market. No signs of cooling down the next Canadian Bubble. While almost all agree Vancouver and Toronto’s markets are over heating and the country is building condos at a breakneck pace, the minister choses to do nothing about it in his budget. The simplest and most efficient way to calm down the real estate market AND reduce the deficit would have been to phase out interest deductibility. This would in a sense incentivise the deleveraging of the entire Canadian economy which could have adverse effects on output if implemented too fast. A measured and gradual elimination of interest deductibility would reduce the tax incentive to speculate with borrowed money hence reducing leverage (bad), speculation, (bad), bubbles (bad) and the deficit (bad). So in fact this could have been a 4 birds 1 stone kind of solution.

One categorically adverse proposition in the budget has to do with the new R&D regime. The current plethora of R&D programs cost Canada $3 Billion or so. The Jenkins Report submitted to the federal government essentially called the money wasteful. The report stated that the money wasn’t helping to foster technology or competitive improvements. While a simple solution would have been to scrap this corporate welfare all together and just drop the corporate tax rate proportionally to the savings, the government decided to go down another path. The Conservatives chose to transform the R&D tax credits into direct subsidies. Completely reprehensible and irresponsible. Not only will bureaucrats start picking winners and losers. The R&D programs will now be open to graft, bribery or political interference as has been seen in other jurisdictions. Canadians often admonish Americans for not emulating their successful policies. Well I think it appropriate for Americans to admonish Canadians for emulating their failures. That the federal government hasn’t heard of Solyndra, a near household name down south, is a testament to narrow vision. At least government intervention, interference and market distortion seems to stop there in this budget.

Corporate and personal taxes not part of the plan, eh? No new corporate tax rate reductions planned. This is probably the Conservatives not adding salt to their unions wounds. Why unions love corporate taxes is still beyond me, but in any case no drops in personal and corporate taxes are envisioned. This is objectionable. The corporate tax remains one of the largest sources of economic inefficiencies  and a double tax on the wealthy and middle class. Any lack of effort on this front is meritorious of its own lambasting post. Canada remains middle of the pack in the OECD in terms of corporate taxes, as the Finance Minister said himself we need to compete aggressively with the up and coming economic powers of tomorrow not the stale economies of the yesterday.

The cuts to government departments’ operating budgets are mild and inconsequential to say the least. As has been mentioned by other commentators, the cuts in civil service employment levels do not even match the Conservatives hirings since 2006. Canada will still be saddled with more bureaucrats than before the Conservatives took office. The planned yearly operating efficiencies of $5.2 Billion. When Canadians were being fed numbers between 4 and 10 Billion dollars the actual number is only conservative in its timidity and aversion too splashiness. In terms of defining themselves as fiscal conservatives, the governments efforts are halfhearted at best. Some of the long term efforts at spending consolidation deserve applause: OAS change from 65 to 67, enhanced OAS benefits after 70 and all civil servants increased pension plan contribution. The short term efforts leave many, including the Canadian Taxpayers Association, short of admiration.

One important announcement, although not budgetary in nature, will surely get greeno Mulcair riled up. The government’s plan to cap all environmental reviews to 24 months (thats two whole years for those not paying attention) is a great boon to Canada. Let’s just admit it their is no reason (even for environmentalists) to want businesses to expand resources, government bureaucrats to waste time and the Canadian economy to lose steam just so that great business projects get merely slowed down by our overly stringent and public review system. That’s not to say that when talking about Canada’s pristine Wild we should all be environmentalist, but when an energy project is good and going to get approved anyway why waste everybody’s time. Seriously Green Peace, the Oil Sands may be bad (I didn’t say are, I said maybe) they’re a bleep in the environments radar, you should be scared of China’s industrialization, not northern Alberta’s botox gone awry.

The bottom line is that this is a timid, non-game changer budget. This is not how to win fiscal conservatives votes. This is not how to improve fiscal or macro-prudential policy. None the less it’s not a terrible budget, there is more good than bad. Let’s hope this budget is popular enough to convince people to let the Conservatives do what they got elected to do: Make government smaller!

Shout out to our Malaysian readers,

Cius

Drummond to Ontarians with Love

Don Drummond ex chief economist at the Toronto Dominion bank, the second largest in Canada, came out this week with a report this week on how Canada’s most populous province could tackle its mounting deficit. since most of my friends are neither Ontarians nor Canadian economic history buffs I feel that the significance of this past week’s event merits a little historical context.

Now this context starts somewhere around the 1800’s but bear with me for a while it won’t be that long. At the inception of Canadian confederacy political and economic clout were concentrated mostly into the two most populous provinces, Quebec and Ontario. These provinces were the bedrock on which Canadian economic growth rested and the springboard for much of Canadian political development. Around the mid 20th century Quebec relinquished its place as a driver for Canadian development leaving Ontario as the sole anvil on which the expansion of Canada could be forged. Business and industry migrated from Montreal to Toronto leading the latter to surpass the former in terms of population, economic output and general clout around the 70’s. As Ontario’s population soared the province became the capital for the financial industry and the center of canadian manufacturing. With its growing presence Ontario played the part of the peace broker in Canadian politics funding welfare programs across the country. 

That’s when things started changing. In the 90’s the cut in transfer payments from the federal government coupled with the pan-Canadian drive for budgetary surplus led to the Harris Year’s at Queen’s Park (unofficial name of the seat of Ontarian government). These years were marked by fiscal consolidation and labour wars with unions. Although mostly recognized as sensible policy actions by most non-union circles, the Harris years created a backlash which ushered in the McGuinty years. This conciliatory leader brought in accrued social spending, bought labour peace and spent his way to three election victories from 2003 till present. This unloosening of the public purse however led to a gaping deficit following the recession of 2009-10. So in 2011 facing an upcoming election and with plenty of deficit and debt accumulation to justify McGuinty called on Don Drummond a well respected economist to propose ways of reforming government expenditure and services to enable the province to return to budget balance by 2017-18 without raising taxes.

A year later here we are, and with the McGunity in government reduced to minority status the Drummond reports has just hit the shelves weighting in at ~320 proposals and 540 pages. To most observers the report while impartially worded comes in as a heavy rebuke to the years of government largess. The headline proposals are to get rid of some of the Premier’s pet projects like supporting alternative energies, all day daycare reform if not get rid of most forms of corporate welfare and finally to steal a page from the Harris playbook and start playing hard ball with the Province’s largest unions.

Unfortunately this is not Italy and the credit markets have not yet come for McGuinty’s profligate head… yet. Hence This technocratic gem of a report will certainly not become law. The government has already announced it will preserve the expensive all day daycare program. Most observers agree the prescription no matter how impartial, how well crafted or how sensible are politically unpalatable for the Liberal Government. So don’t expect Ontario to resume its role of Canadian growth engine anytime soon, much to the contrary expect Ontario to continue to be the drag on confederation it has been for the last 3-4 years, eating up equalization payments instead of funding them.

The picture is gloomy the report itself states that economic growth will not exceed the 2% mark for the foreseeable future and has also stated the deficit isn’t expected to shrink before reaching an all time high and federally comparable 30 Billion C$. So here’s my prediction McGuinty doesn’t fix the finances but let’s them continue on their gradual slide into PIIGS style irresponsibility. So expect to see a Montiesque kind of technocratic government coming in within the next decade to fix Ontario’s rivalry with Quebec for the most shoddily run provinces in Canada prize.