Paul Romer and innovation

Back on October 19, I said that in the coming months I would

advocate for the following policies:
1) cut the provincial corporate tax rate from 10% to 3% and income tax rate from 10% to 5%, making up the difference in revenue loss with a VAT that excludes all capital inputs. ...
2) adopt an innovation agenda that draws on endogenous growth theory
3) adopt a hedging program for natural resource related revenues

I haven't yet said much of anything about (2) yet, never mind (3). (1) and (2) both address the issue of economic growth, with (1) being concerned with incentives to add to the capital stock. If I own a warehouse but don't own any forklifts, if I go out and buy one that's investment since it adds to the physical stock of plant and equipment. But higher levels of investment are the not the only way to stimulate economic growth, and moreover they can only get one so far.

Stanford economist Paul Romer is generally considered to be one of the most prominent and pioneering contributors to endogenous growth theory. Rather than get overly involved in what "endogenous growth" means, I'll just emphasize the idea that with respect to trying to realize growth by only adding to the capital stock, there is a problem of diminishing returns. Professor Romer gives a 77 minute podcast here on his new growth theory, but I'd note one excerpt in particular where Romer explains this diminishing returns problem:

Think of an activity like moving goods around in a distribution center. Goods come in from manufacturers, and then the distribution center gets them on different trucks and sends them out to stores. You could run a distribution center with 100 workers and just one forklift, and the first forklift would be really valuable for moving the heavy things.

Then you could add a second forklift and that would still add real value. You'd get a lot more done in that distribution center. But by the time you've added the 30th or the 40th or the 50th forklift, each additional forklift is really not helping you very much. So with fixed recipes for how you arrange things while you're adding more and more physical capital, you do run into diminishing returns.

Economies which try to grow by just adding more and more forklifts eventually do run into serious trouble. The Soviet Union tried to grow like that for a while with essentially no innovation but very heavy investment in physical capital. And they grew for a bit because they started out short on capital, but they rapidly ran into diminishing returns from accumulating capital.

So you have to keep discovering ideas.

Ideas are the critical ingredient here. The ideas of interest here are innovations that allow businesses to produce more output per unit of input.

The upshot of Romer's work is an enormous emphasis on education in general and innovation in particular. The Alberta Research Council, the U of A's Technology Commercialization Centre, TEC Edmonton, the Ingenuity Fund, UTI, and Calgary Technologies would all be generously funded if I were in control of the purse strings, and just not because I worked for ARC in the past and "specialization in technology commercialization" is printed on my U of A MBA parchment. It is sound economics, as there are huge positive externalities here.

But there is more that government can do than just provide funding and tax incentives. Governments can facilitate the creation of innovation "clusters." One of Romer's many interesting proposals is for Canada to create a "charter city" in Cuba. Bilateral US-Cuban relations being what they are, the US and Cuba could agree to a third party's proposal to administer Guantanamo Bay, with the idea being that the third party could do for Cuba what Britain did for China by administering Hong Kong. After Alberta gets its own policies reformed such that they are truly investment, business, and trade-friendly, the province could cooperate with Ottawa to negotiate the acquisition of rights from the US and make the territory subject to Alberta tax and regulatory policy. A half-baked idea? Maybe. But it might also be a great opportunity for both Alberta and Cuba to advance economically, with the pace determined in part by what Cuba is comfortable with.

Alberta's ministry of Advanced Education and Technology is already well-placed to a do a lot of good things, it just doesn't have the attention it needs relative to competing ministries and there is an inclination on this government's part to set the stage for "picking winners" instead of focusing on the macro policy environment. "Theme 1" of "Alberta's Action Plan", for example, is "Enhancing an already strong tax environment." It is not, in fact, already strong, as tax policy experts have noted. Reference is made to the federal Scientific Research & Experimental Development credits that Alberta also offers, but as the CD Howe Institute observed in 2006,

the federal and provincial governments preoccupation with tax credits targeted at research and development, and relative inattention to the competitiveness of the overall tax regime, is misguided. In effect, the Canadian approach has been to give with one hand, by providing generous tax credits targeted at R&D, and to take with the other, by imposing high taxes on the fruits of innovative activity and entrepreneurship.

The 1998 Technical Committee on Business Taxation even recommended that SR&ED credits be reduced, in conjunction with other reforms.

An innovation agenda that acknowledges the work of people like Paul Romer, who is widely expected to eventually be awarded the Nobel in economics for his ideas about growth, is both supplementary and complementary to investment friendly tax reform.

carbon tax in the news

To continue from a VAT to an even more politically challenging tax reform, I note a post of mine from June:

...Had the Stelmach government understood the situation, they would have gotten ahead of this by signing on to a national carbon tax (something I've long advocated, as readers of this blog would know). A carbon tax would be bourne by Canadians in proportion to consumption, and therefore far more regionally equitable than by production. As an aside to those who believe climate change is a hoax, support for a carbon tax does not necessarily mean support for the idea that climate change requires fiscal action. We have to get taxes from somewhere, right? Why not get it by taxing consumption like on sales of SUVs instead of taxing everyone's personal income? We should be taxing consumption instead of income and investment anyway. Whenever I say I support a carbon tax I mean a revenue-neutral tax.

... Stelmach has tried to impress environmentalists by throwing billions of Alberta taxpayer dollars at the boondoggle of carbon capture. Needless to say, no one has been much impressed...

From Jeffrey Simpson's G&M column of this week:

The best way to spread the burden would have been a carbon tax, applied on both producers and consumers. The tax could have been collected regionally and recycled into the regions where it was collected, thereby easing Alberta's and Saskatchewan's pain.

But those governments had their heads in the sands, hoping the whole issue would subside. So they did nothing in the one area that really counts: putting a price on carbon. ...

Both are big supporters of carbon sequestration, an unproven, expensive method of lowering emissions. In Alberta's case, the taxpayers will spend $2-billion to reduce emissions by perhaps five million tonnes, which is about 2 per cent of the province's total emissions. The world sees this policy for what it is – expensive and inadequate...

no government anywhere, from authoritarian China to semi-authoritarian Russia through all the democracies of the world, believes the climate-change deniers.

Here's a quote lifted from testimony to Congress by Ted Gayer (a former Deputy Assistant Secretary at the Treasury, equivalent to an Assistant Deputy Minister at Finance Canada):

The most frequent criticism of a carbon tax is that it would be politically unpopular. But to quote Milton Friedman, I think my role is to “prescribe what should be done in light of what can be done, politics aside, and not to predict what is ‘politically feasible’ and then to recommend it.”

Economists like fiscal measures like the GST, and most other consumption taxes which would include a carbon tax, in no small part because they are simple and transparent. Yet these are the very qualities that make politicians hate them. Politicians prefer complicated and opaque taxes as those can be hiked in the future with minimal political penalty.

VAT in the news

The New York Times has an article devoted to a discussion of value-added taxes:

... economists across the political spectrum say a consumption tax may be inevitable once the economy fully recovers. ...

Like universal health care, every other industrialized country in the world already has a value-added tax (as do about 100 emerging countries). And also like universal health care, this once-taboo policy option has recently been invoked, at times begrudgingly, by many prominent Washingtonians, including ... two former Federal Reserve chairmen, Alan Greenspan and Paul A. Volcker....

“[Today] there are many more deductions and credits, which can often encourage inefficient behavior such as tax shelters,” said Leonard E. Burman, a public affairs professor at Syracuse University, about the changes to the tax system since the 1986 reform. “The ideal tax system has a broad base — few deductions or exemptions — and low rates.”

Most of the rest of the industrialized world — including, most recently, Australia — has already taken this lesson to heart by imposing value-added taxes. Unlike income taxes, which are often front-loaded on the rich, then subsequently diluted, a value-added tax is paid by almost everybody. That broad base is one of its major advantages, and why the International Monetary Fund frequently recommends it...

The value-added tax is also the darling of many economists for its bounce-a-quarter-off-its-abs efficiency. Its administrative costs to the government are generally low. It is also considered less of a drag on the economy over the long run than raising income taxes, which discourage people from saving money and thereby making capital available to businesses.

The article goes on to explain how a VAT would work.

For a more fulsome treatment, see this paper by the Tax Policy Center.

Unfortunately, the background to these US discussions is raising more revenue for the government, which is not what the object should be in Alberta. Revenue neutrality could and should be maintained in Alberta, and indeed the "left-leaning" Canadian Centre for Policy Alternatives says Ontario's HST is "virtually revenue neutral."

"Assertions that this is a tax grab have no foundation in reality," Lightman said.
...
"My hope would be that (this report) forces the debate away from the knee-jerk, uninformed charges we've been having towards a discussion of what is really at stake, which is a shift from income tax to consumption tax and from business to consumers."

acting like a government

Yesterday's provincial poll results were not just a wake-up call to the governing party but to the Wildrose Alliance as well.

Wildrosers need to be able to adopt the stance of a government as opposed to a factional opposition. What do governments do? I think the HST is a good example of what governments propose and protest parties oppose. The only party in the House of Commons to oppose the federal HST enabling legislation is the NDP, a party that Canadians in general do not see as a government in waiting. John Manley, a former deputy prime minister of Canada, president-designate of the Canadian Council of Chief Executives, and my favorite of the 4 ministers I wrote memos to during the years I worked at Finance Canada, penned an op-ed in the Globe and Mail saying Liberal leader Michael "Ignatieff made the right call on the HST." What if Wildrosers called for a 7 point cut in Alberta's corporate tax rate and a 3 point cut in the income tax rate, funded by the introduction of a provincial 8 point harmonized VAT (i.e. a 13% HST)? The cries would sound about what elitist chamber-of-commerce types the Wildrosers are. But to make that charge is to imply that the Wildrose Alliance is not amateur, and right now the PC Party's biggest problem is the perception that they are amateurs. The contrast alone would be enough to preclude this line of criticism.

For an alternative, consider a call for a national securities regulator. The John Manleys of the country would waste no time indicating their support for a measure that both the executives of corporate issuers and professional asset managers have been calling for for years. It would be putting sound policy ahead of the vacuous spectacle of playing the anti-Ottawa card.

If Wildrosers are serious about going down the populist road, then why not just call for the elimination of all the civil service positions that provide policy support to the government? I mean, who needs them when we can make policy just fine without professional input? In reality the analysts in various government departments can explain how a lot of simple, easy to understand policy ideas may not produce simple, straightforward results because of a whole legion of factors that are difficult if not impossible to appreciate absent a large staff of researchers and analysts like those available to the ministers of various departments.

The Wildrose Alliance cannot just sit and wait indefinitely as a populist protest party for government proposals to appear that can be denounced. I would also note that Wildrosers need to give the media something to digest. Telling the media that the party will do something simple and popular that requires no explanation or expert defence is not giving the media something to chew on, which they see as their job. Telling them that Wildrose will do something that requires an expert verdict, on the other hand, does give the media something to do and will give the pundits something to defend. If these pundits are not defending you, they will be attacking you.

Before Wildrosers adopt the stance that global warming is a hoax or that base MLA salaries are the province's biggest problem, the question should be asked are these the sort of things a protest party would come up with or an actual government? Governments do things on the basis of industry or consultant advice that ordinary people have a hard time appreciating all the time. But that's what ordinary people elected them to do: make unspecified-in-advance detail decisions within a specified-in-advance philosophical framework. Wildrosers and Liberals could both propose identical tax reforms in detail but the electorate would receive them entirely differently because of primary interest to voters is the philosophical stance of the party, the context in which the detailed proposals are arising.

Having established a philosophical framework around fiscal conservatism, the Wildrose Alliance needs to a plank or two that is superficially unpopular but sound upon explanation, argument, and evidence. This is the ticket to being taken seriously.

new poll: in Edmonton Wildrose 36%, Lib 26%, PC 25%, NDP 12%

Angus Reid has released a poll of 1000 Albertans, the same size as the Environics poll released on November 5. A possible issue with this new poll is that it was a survey of Angus Reid Forum participants, and there may be some self-selection involved there. But leaving that aside, comparing these two polls is somewhat problematic, because while the pollster enumerated 5 options in both cases, Environics listed the Greens as the fifth option and Angus Reid (more correctly in my view since no Green party is currently recognized by Elections Alberta) listed the fifth option as "Other." Nonetheless, it appears that support for the PCs continued to slump across the province from late October to late November, with much of the drop in PC support in Calgary going to the Liberals and with the drop in Edmonton going pretty much entirely to Wildrose. The appearance of PC support bleeding to the Liberals in Calgary nonetheless strikes me as possibly just appearance, as the more likely explanation is that the Environics poll understated Liberal support in Calgary. Fact is, the Liberals took a greater share of the vote in Calgary in 2008 than within Edmonton city limits (33.9% vs 33.5%). Given that the Alberta Liberals have since proceeded to replace an Edmonton leader with a Calgary leader, the idea that the Liberals are at 30% in Calgary and 26% in Edmonton, as Angus Reid reckons it, strikes me as a lot more plausible then the Environics verdict that just 20% of Calgarians are inclined to vote for the red team.

It is also worth noting that Angus Reid confirms Environics' finding that NDP support in the capital city is down from the March 2008 election. Where have the 6 or 7 points the NDP appear to have lost from their 18% election share gone? Presumably to David Swann's Liberals, yet Edmonton Liberal support is also down 6 or 7 points relative to 2008 which means there may be a lot of Edmontonians who voted for Kevin Taft's team who are nonplussed with David Swann's group. That's something that makes a lot of sense to me, since while Kevin Taft and his talk about excessive PC spending led me to view him rather positively, I don't identify with David Swann at all.

The crosstabs are often the most interesting part of a poll. The province-wide breakdown for those in the $100K+ household income bracket is Wildrose 46%, PC 30%, and Liberal 16%. Given that the average household income in Edmonton Whitemud is $132K (and that is back in 2005), this may explain why our organizing in Whitemud has been so successful. I mean, look at this, Angus Reid has the Liberals in 2nd place after Wildrose in all demographics in Edmonton and for the six figure crowd (albeit province-wide for this tab) it is a 30 point gap, 46 to 16. The Edmonton Whitemud nomination for Wildrose is going to be hotly contested!

Besides Wildrose doing especially well in the rural south while the Alberta Liberals are quite weak in the rural north, the other crosstab of note is that Wildrose support skews noticeably older, with the Liberals skewing the other way (the PCs are inbetween on this tab, as on many). This is consistent with my experience on the ground and I have to admit I have been wearing out my welcome with a few older Wildrosers as I try to shove young, university educated people (uni grads being another demographic where Wildrose is weak and the Libs strong, with the Liberals running 8 points ahead across the province in this group according to this poll) to the front of the line. The mentality of the people on constituency association boards, on the provincial executive, and surrounding the leader is going to set the tone for the party as a whole, and accordingly I think the party needs to actively work to avoid adopting stances that preach to the choir. Environmentalism is a lot more popular with people of Danielle Smith's age and younger than those older, and I hope that older Wildrosers understand that there may be more to gain by expanding our foothold with 20 and 30-somethings than by messaging to older Albertans whom Wildrose has already won over by an absolute majority according to Angus Reid.

While I appreciate the idea of running up the score on favourable ground, my experience of politics has been that returns on investment decline after a certain point such that, for example, trying to shake the third round of votes off a tree is tough going because we are talking about fruit here that doesn't give up on the old branch easily. Find another tree and give it a first time shake. An effective shake means understanding what the tree is about and what makes it grow. I believe older Wildrosers are more than willing to cooperate so long as younger ones explain themselves (and the strategic value of bringing in their colleagues to positions whereby they could influence the party's stance) instead of just getting pushy and demanding with the old guard. In any case, whether new to the party or old, I would think most Wildrose Alliance members understand that the party is in the position it presently is because of one reason above all others.

benefits of carbon capture projects unproven

A media story about climate change and carbon emissions is always good for a lot of comments and a Calgary Herald story citing Wildrose leader Danielle Smith is no exception.

The facts are that the benefits of spending billions on carbon emission mitigation are unproven. Responsible fiscal policy means conducting a cost/benefit analysis with respect to programs and why spending on carbon capture and sequestration (CCS) gets a free pass here is beyond me. By how many fractions of a degree will the average temperature in Alberta be lower in 2050 for every billion of taxpayer dollars spent on CCS and how is that better for Albertans? If this is about helping Maldivians why are there no studies comparing the cost effectiveness of spending billions on CCS with spending billions on foreign aid to the Maldivians to help them adjust to climate change? Of course, there is a good chance we have not seen a cost/benefit analysis because climate cannot be reliably predicted.

As the BBC observes, "for the last 11 years we have not observed any increase in global temperatures." Climate scientists are acknowledging that their models have failed to predict the stability in temperatures that the planet has seen over the last decade. One wonders if this outcome should really be so very surprising when, as a writer in the UK Telegraph points out, "world-ranking physicists such as Professor Richard Lindzen of MIT and Professor Will Happer of Princeton have been arguing... that the models are fatally flawed because they do not take proper account of all sorts of other factors which play a key part in shaping the world’s climate..." Britain's Met Office estimates the odds of a 10 year global temperature stall happening by chance variation amidst a genuine warming trend to be 1 out of 8. Especially telling is this conclusion by the Met authors: "The simulations rule out (at the 95% level) zero trends for intervals of 15 yr or more." In layman speak, this means that unless temperatures move up by 2013, the hypothesis of global warming should be REJECTED by those whose approach to the subject is evidence and science-based as opposed to faith-based.

The head of the IPCC, Rajendra Pachauri, says that the Alberta oil sands should be shut down. Alberta politicians cannot have it both ways here. If they are going to take Danielle Smith to task for not accepting the IPCC's work uncritically, then they should either accept this call to close down the oil sands or explain why they are cherry picking recommendations.

From an economist's perspective, people should be focusing on stopping methane leaks from refinery equipment since methane has a much greater greenhouse effect than CO2.

The real problem here is not the consumption of carbon products but consumption in general. Hence my advocacy of general consumption taxes. There are a legion of strains on the environment, of which carbon levels in the atmosphere are just one, and one whose harm to the environment is dubious. As I've noted before, according to Nature magazine,

The Palaeocene/Eocene thermal maximum, 55 million years ago, was a brief period of widespread, extreme climatic warming that was associated with massive atmospheric greenhouse gas input. We show that sea surface temperatures near the North Pole increased from 18°C to over 23°C during this event.

That's right: more than 23 degrees above Celsius at the north pole. Yet the world kept on turning.

"Hancock's musings don't make sense"

I had been preparing a response to Edmonton Whitemud MLA Dave Hancock's support for blocking bitumen exports, but Deborah Yedlin says much of what I would say and says it more succinctly.

Shouldn't the emphasis be on creating a better environment for companies to take the risks they need to develop the resource as cost-effectively as possible? This is what would benefit Albertans in the long run.
...
Once again, the musings of the Alberta government smack more of populist politics than they do of robust, long-term economic policy.