The Very Shaky Math claiming Free Trade within Canada will generate $200-billion in Benefits

The Bank of Canada estimated $2-billion in benefits or $55 per Canadian, while think tanks are estimating $200-billion. They can't both be right.

In John Ibbitson’s latest piece in the Globe and Mail, he expressed his concern that Conservative Leader Pierre Poilievre might turn off voters but continuing to act like anti-woke insult comic who doesn’t tell any jokes.

Ibbitson’s complaints about the Liberals being “tired” but it’s not clear that the frothing hatred for the Liberals displayed by the Conservatives is really justified by the issues that Ibbitson mentions.

One he singles out is why we’re not seeing the supposed massive financial benefits of tearing down internal trade barriers between Canada’s provinces.

“A government that has been promising for nine years to jump-start a massive new housing program offered a clutch of federally owned properties that might, somehow, one day, be used for housing.

A government that faces the chronic challenge of internal trade barriers and the increasingly acute problem of lagging productivity has plans to convene a working group to study the situation.”

The thing is, we already have free trade in Canada. There are no tariffs between provinces. We have labour mobility. So what, exactly, are we supposed to do to make it freer?

The issue of lagging productivity and housing shortages is not unique to Canada. The U.S., UK and other countries like New Zealand and Australia are all facing housing shortages, as well as productivity challenges.

• From the US in 2022: There's a massive housing shortage across the U.S. Here's how bad it is where you live

• From Australia, 2021: Experts say this is what Australia needs to do to solve the housing crisis

• From New Zealand, 2022 (which experienced a housing crash in 2023): New Zealand’s housing crisis is worsening

• From the UK, 2024: 'We need more homes to ease the housing crisis'

This is not to dismiss the issue - quite the opposite. The fact that it is occurring in many countries suggests that there is a policy at a larger scale since despite being on multiple different continents, these countries are experiencing the same problem.

That common problem is the way central bank’s policies of ultra-low interest rates to create more debt in response to economic shocks and crises, when the appropriate response required fiscal investments and adjustments, not monetary.

I have spent a lot of time writing about this problem, starting with the very first post I wrote for this substack, citing Edward Chancellor, a former financial executive and economic historian, who argued that decades of bad monetary policy by central banks has created oceans of debt, arguing that

throughout the history of mankind, speculative bubbles and ugly consequences have always occurred when interest rates were kept too low for too long.

«After years of ultra-low interest rates, central banks created a bubble in pretty much every asset class, they facilitated a misallocation of capital of epic proportions, they allowed an over-financialization of the economy and a rise in indebtedness», he says.

“By aggressively pursuing an inflation target of 2% and constantly living in horror of even the mildest form of deflation, they not only gave us the ultra-low interest rates with their unintended consequences in terms of the Everything Bubble. They also facilitated a misallocation of capital of epic proportions, they created an over-financialization of the economy and a rise in indebtedness. Putting all this together, they created and abetted an environment of low productivity growth.”

So, that is what we have to deal with, and in Canada, there’s no one really discussing how to deal with this.

What would not be effective would be to try keep tearing down imaginary trade barriers that don’t exist in Canada, for economic benefits that could be marginal at best.

The Canada Free Trade Agreement (CFTA) was presented as a “win for everyone” and by the Canadian Federation of Independent Business as a “celebration of economic freedom” for Canada’s 150^th birthday.

There are some areas where clear improvements could be achieved – especially in trucking and transport (which vary from province to province). Having a national financial regulator.

When it comes to the CFTA, the benefits are being seriously overstated while the costs are totally ignored. It should be extremely clear that there are costs to trade deals, because cheap imports from China have wiped out jobs across the developed world. Often, the work has been transferred by companies to factories overseas, hugely reducing costs and increasing profits.

It should be clear that when you change the rules of the game, you change the odds of who is going to win it.

The free-market economist two-step

There’s a “joke” that I pulled off a now-forgotten website, which accurately describes the dilemma, as well as the behaviour of “free market” economists who are really engaged more in investor protection deals than trade deals.

Free Market Economist: Trade policy X will make us richer on aggregate
Other: What about winners and losers?
FME: Policy can be created to compensate the loser.
Other: Sounds good, here’s a policy we could use?
FME: Redistribution is distortionary, this cannot be allowed!

All trade deals have winners and losers. The benefit is supposed to be that with free trade, the gains of the winners outstrip losses, so, in aggregate, everyone is better off.

Being better off on average is not the same as everyone actually being better off, because concentrated gains by a few can, and do, outstrip the total losses of the many.

This is the fallacy of the average, and it really should be an essential part of all critical thinking.

The term “average” is mathematical, not factual. It takes a population of unique individuals by pooling their qualities then dividing those qualities equally and pretending that everyone is the same. It creates a fictional person who is mathematically average whose qualities may not represent anyone.

If the rich are getting richer with as much money as the poor are losing, as far as averages are concerned, it’s a wash. The reality is that the benefits can be thinly spread, and the benefits can be highly concentrated.

If we want to talk about someone who is more likely to have an experience like yours, that is the “typical” person - not the average.

Where’s the “average” here? While the numbers have changed since 2013, the shape of the curve has not- and the chart has to be cut off. To accurately show the top incomes, the chart would go to about $50-million in 2013 - and $150-million in 2023.

The CFTA’s own documents cite a Bank of Canada report that estimates removing trade barriers could increase Canada’s output by 0.1-0.2%, which, if it were equally shared, would be $55 per person per year.

This is stark contrast to estimates by economists Trevor Tombe and Lukas Albrecht, who in 2016 “calculated the benefits of eliminating trade barriers among the provinces at between $50-billion and $130-billion,” and that number has now expanded to a hard-to-believe $200-billion.

The difference between a low estimate by the Bank of Canada of $2-billion just a few years ago and $200-billion from think tanks on the other is so colossal that anyone taking this seriously should ask why experts have a plus-minus variation of pretty much the entire $200-billion in projected benefits.

One reason is that the economic models that are being used are useless at predicting anything. They rely on “inferred” data by using predictive models to promote policy that backfires. The promised gains never materialize, and they frequently backfire.

These models have failed to predict or deal with supernova level crises like the Global Financial Crisis. The policies imposed on Greece that were supposed to help its economy bounce back cost it 30% of its GDP.

The comparison between Canadian and U.S. productivity ignores two things. For one thing, the U.S. has the world’s global reserve currency. When most of the world has to deal in U.S. dollars, that makes things cheaper for the U.S. and more expensive for the rest of the world, including Canada.

It’s common today when people discuss trade deals that their magnitude is described by adding together the individual GDP of countries, and not what the estimated gains under new deals would be. Depending on what model is being used to calculate benefits may vary from slim, to none, to a loss.

Under new deals, some businesses will go broke and people will be put out of work. The benefits may be thinly spread but the losses may be highly concentrated.

Economists and politicians should all know this, and it’s why if people insist on deals, we should build meaningful compensation into trade deals, but we don’t. Cheap gadgets don’t make up for a lifetime of lower income.

Trevor Tombe, an economist at the University of Calgary wrote a detailed study of the potential of reducing Canada’s trade barriers which suggested that all provinces would benefit, but that poorer provinces would benefit the most, with specific areas seeing major gains.

Now, there are important assumptions that are built into Tombe’s analysis about the way money flows in the economy, which is that it suffers from the fallacy of “begging the question.”

While people say “it begs the question…” and then go on to ask something they want answered, “begging the question” means assuming the answer before you’ve started.

This is clear enough when you actually read Tombe’s paper.

“Canada’s overall productivity is also harmed by interprovincial trade barriers. The reason is straightforward: allowing regions to specialize in what they are relatively good at, and import what they are not, boosts economic productivity. Barriers to trade inhibit this specialization and therefore lower productivity.”

This is based, quite literally, on the 19th century propaganda of David Ricardo. It’s a just-so story of how trade works that doesn’t stand up to scrutiny, because it assumes there will be no change.

Modern analyses of trade show that its benefits come from large, closely integrated industries working across a border, with can and truck manufacturing between the U.S. and Canada being an obvious example.

In Tombe’s analysis, retail and wholesale were at the top for gains, while public services were at the bottom – yet discussion of the the Canada Free Trade deal is mostly focused on letting companies across Canada access government procurement, since European companies will be able to under CETA.

Neither of these measures add to economic growth at all: it is about European and larger corporations making money off the government dime, so that our local taxes will flow out of our communities and into (likely) a billionaire’s pocket. It’s people who say they don’t want government to run things because they want the government to pay them to do it.

It is not about “growing the pie”. It’s not about investment in new capital or new growth. It is mostly about wiping out or buying up smaller competitors, or having private companies bid on government contracts, where for the savings that come with a lower bid, all profits will leave the jurisdiction where they are earned.

For Manitobans, it’s about companies in Ontario or Alberta (or France or Germany) being able to bid for taxpayer funded contracts in Winnipeg or Quebec, and working towards dismantling public liquor monopolies.

The claim is “efficiency” or convenience, but the reality is that “good” public jobs may be lost and replaced by more less-secure, lower-paying private jobs, while increasing profits to a handful of owners. This is not about growth: it is about further consolidation.

That is because the economic analysis by Albrecht & Tombe has other unrealistic assumptions about markets. One is that they are “perfectly competitive”. That has a specific meaning, which is that there are many businesses of similar size competing with one another. That does not describe Canada’s market, or almost any market in the world today. We have massive consolidation of ownership, and the difference in business size is colossal.

Another is that “aggregate trade balances in all regions.” This is an assumption that is not backed up by evidence - because it is based on the idea that there is an internal mechanism within the economy that makes it perfect self-balancing, when it is not.

In the real world, value is destroyed, markets crash and people lose all their money, because they bet more than they could pay. Markets collapse under their own weight because of financial crises.

Albrecht and Tombe claim that “poorer provinces” would benefit the most. This is based on creating a “counterfactual” imaginary model of Canada. They imagine a Canada where those imaginary trade barriers will be removed, and then compare that imaginary Canada to the real one.

It is assumed that the problem with Canada related to productivity are internal trade barriers that cannot be measured, and have to be inferred.

However, the actual gains from trade are often not from increased exports, new businesses or new jobs. One of the areas for areas that are benefit are lower-cost imports.

There’s also an important assumption about how the benefits will flow. We’re told that lower income provinces like Manitoba, Prince Edward Island and Newfoundland will all benefit. These are all different provinces far apart from each other, and one of the defining characteristics of each is that they are harder to reach. PEI is an island (with a bridge) Newfoundland can only be reached by plane or by boat. Within Canada, the closest large city to the west of Manitoba is Calgary, which is hundreds of kilometers away, and to the east it is Toronto, which is thousands of kilometers away.

The assumption that these economists make is that economic activity in these areas are being blocked from flowing in due to barriers - on the premise that economic activity will “flow” from “hot” areas to “cold” areas.

To say this is a counterintuitive is an understatement. There’s a saying, that if you’re going hunting, you go where the ducks are. People leave areas with less economic activity for areas with more economic activity. As Dick Cavett once said, “How are you going to keep them down on the farm, once they’ve seen the farm?”

What is actually required for economic growth in areas that are underdeveloped is capital for creating and scaling up local businesses. Capitalism requires capital.

That’s the reason for the my joke about “I was promised $200-billion and all I got was this lousy T-shirt,” because one of the major benefits predicted for provinces like Manitoba is a reduction in the cost of retail - not the creation of new productive businesses.

That’s why CFIB’s position is genuinely interesting. They represent a large number of small businesses, but odds are it’s small and medium-sized businesses will struggle to compete.

Having forgotten that trade creates winners and losers, when politicians and orthodox economists calculate benefits at all, they use “supply-side” mathematical models which deny that losses can occur, and have a bundle of unrealistic assumptions aside. They assume households are equal, and so are businesses. In a country with growing inequality and huge variations in firm size, neither are reasonable or accurate assumptions to make.

The other thing that people are ignoring about trade within Canada, is that for big swaths of the country, the U.S. is much closer than the nearest big Canadian city.

Tombes recognizes that a major reason there is so much Canada-US trade, instead of trade within Canada, is that major U.S. cities and customers are often closer than the nearest Canadian cities are. Greater distance and small population is a challenge.

Here’s another significant part of the report that directly addresses the issue of productivity, saying that “businesses are not investing in productivity-boosting equipment because their customers aren’t demanding enough to ensure that the existing productive capacity will be fully used.”

Here again, inequality and financial distress matter. The lack of demand is because with crushing personal debt loads - and many of the most crushing debts are those taken on to pay for the necessities of life. Food, medication, shelter, education.

Hoyes Michalos in Ontario, Canada is a major licensed insolvency trustee, and they do amazing work crunching numbers on just who is facing problem debt.

The debt is too damn high. And it’s personal, private debt that is the problem.

We have to remember that one person’s debt is always someone else’s investment. They expect back everything they put in, and then some. Government debts and deficits mean that people are investing in the government.

An unserious question: Why not get rid of provinces entirely?

There is an interesting aspect to the arguments made about what are considered barriers to employment. Provincial regulation of professions, for example, like law.

What’s interesting is that the same people who talk about breaking down non-existent barriers to internal free trade, are often the strongest defenders of provincial rights - when the whole problem in many areas is precisely that we do not have national standards, because the standards are constitutionally set by provinces.

So, if we’re really concerned about these barriers and we really want to streamline things, why don’t we consider something different.

I want to make this clear - I’m not serieous about this at all.

But what if, to deal with these supposed barriers, we get rid of the root of the problem - provincial borders. In fact, we could cut out the middle man entirely and just have a federal government and municipal governments, and get rid of provinces altogether. There would be just two levels of government. One income tax. One corpirate tax. Municipalities get a sales tax as well as property taxes. The federal government could make sure we have national standards in education and health care. We could habe a national heritage fund, like Norway does.

Now, despite my criticism of provinces, I don’t agree with this idea. Some of that is practicality - I don’t think it’s politically achievable, and unless that were to drastically change, there’s no point in discussing it except for fun.

Actual solutions

I have also written many times of the potential solutions to this, and we already have historic evidence of its success in both Canada and the U.S. One possibility is to aim to recreate a period of economic activity similar to what was known as the “Great Compression” between 1938-1945, which the only time in recent history that inequality improved. Government working together with private enterprise ran what today would be called a “high-pressure economy.” The tool stock of the U.S. doubled at public expense, unemployment went down to 2%, and while inflation was high, wages were higher, and as a consequence the average American had paid down their debt and was saving 20% of their income a year, when the programs ended in 1945. Taxes were higher and regulations were required, in order to sure that nothing was wasted - food, energy, rubber, metal.

That is what created the foundation for post-war prosperity in North America. Wealthy and powerful countries become wealthy and powerful first through protectionism, then turn to free trade when they want more markets for their goods. At the peak of the British Empire, 50% of the manufactured goods in the world were made in Great Britain. After the Second World War, 50% of the manufactured goods in the world were made in the USA. Japan’s development of its auto industry involved banning American automakers, and a bailout of Toyota by the Japanese Central Bank. Its first exports were a flop.

What’s happened is that Canada’s economy - like those of other developed nations - all have massive asset bubbles, which is to say that stocks and real estate are all overpriced, and the reason for that for 40 years, central banks, government policy and economists have asked consumers - individuals to pay for economic growth with their personal debt.

If you talk to entrepreneurs and businesspeople, they will tell you they need access to capital. It should be equity, not debt. That’s what the Business Development Bank of Canada (BDC) should do, and what it is supposed to do. We also need public investment in infrastructure and the environment and into Canadians’s education and training to address labour shortages both present and future. That will address productivity. And if all sorts of jobs are going to be lost to AI, we should make sure that people will have access to capital and access to training so they can start businesses and build a new economy, and that we’re investing in R & D and putting money into making the change. You know, capital. There’s a whole -ism named after it. To create jobs, especially ones that are better paying.

The biggest threat in all of this is private mortages. Canada’s personal debt is higher than most other countries, and it is not an exaggerration to say, it is the single greatest threat to Canada’s stability and prosperity. It is ruining people now and destabilizing the country now.

And if we allowed for the restructuring of mortgages, we could help people stay in their houses and increase their equity in their home. This would make people more secure and make it easier for them to sell at a lower price. This is 100% within the power of the Bank of Canada and the Federal Government to do. This is what the Bank of Canada exists to do.

These would all be incredibly effective ways to deal with many of Canada’s pressing issues.

-30

DFL