Thursday, October 21, 2010

Air Canada and Corporate Welfare

The regulation of the Canadian air industry is supposed to ensure that the public has access to safe, reliable flights at the lowest cost. This mandate has been perverted. The regulatory regime now subsidizes the employees and owners of Air Canada at the expense of the taxpayer and travelling public. Nothing drives home this point better than the current dispute with the United Arab Emirates over landing rights in Canada for its two national airlines, Emirates and Etihat.

These two airlines requested the right to service Toronto more often and to offer flights to Vancouver and Calgary. If these requests had been granted, Canadians would have saved money, benefited from greater convenience, or both.

These benefits are evident from the fact that the Emirates Airbus 380 (the largest passenger plane in existence) flying now twice a week between Toronto and Dubai is nearly always sold out. The large number of Canadians of Indian and Pakistani origin find Dubai a very convenient gate way, offering many daily flights from there to the Indian subcontinent.

Dubai also has good connections to other countries in the Mideast and Africa, which are the destination of many tourists and business travellers from Western Canada and especially oil experts from Alberta. All of these flyers would be able to avoid stopovers in Toronto and enjoy shorter travel times in the air.

The reason for the refusal by the government to grant these UAE airlines
more landing rights in Canada is that it would cause Air Canada to lose millions of dollars in revenues and profits because, to keep its current passengers from flying with these airlines, it would have to lower fares, improve service and offer schedules more convenient for customers. These costs reflect the value of the benefits, which Canadians would have enjoyed if regulators had decided to allow UAE airlines access to Canada. The value of these lost benefits represents a subsidy to Air Canada.

This subsidy is a clear case of corporate welfare, even if it does not show up in any government budgets. It violates the spirit of free trade and is equivalent to prohibiting the import of any good just because it would cause Canadian producers to lose money. It therefore is a violation of existing international free trade agreements.

International relations are a game of tit for tat. The government of the UAE has just done the tat. It has cancelled Canada’s privilege to use the Camp Mirage airport near Dubai as a staging area for the war in Afghanistan. The shift of these military flights to other locations will cost taxpayers millions, all because regulators protected the interest of Air Canada.

Air Canada is likely to have argued against the landing rights for the UAE airlines on the grounds that they benefit from unfair government subsidies. If this is true, Canadian consumers should rejoice in receiving these subsidies from the taxpayers of the UAE. However, since such subsidies are illegal under international agreements, a complaint lodged with the World Trade Organization would lead to their elimination.

But it is not clear that these airlines are subsidized. They may just be more efficient and less burdened than Air Canada with pensions, wages and work rules extracted by unionized labour in the past. Dealing with the financial problems caused by these conditions should not be the responsibility of Canada’s travelling public or taxpayers in general.

How can we explain the regulatory decisions that provide subsidies to Air Canada at the expense of the Canadian public? Research has shown that the design and operation of regulation often is hijacked by the regulated industry to serve its own interests rather than those of the public. One of the reasons for this result is that advice to the regulators predominantly comes from the people in the industry, who are the best experts available but who also know what the industry’s coveted interests are.

Politicians also influence regulatory rules and decisions since they know that any policies that affect adversely the interests of Air Canada result in the loss of votes from the employees and other beneficiaries of Air Canada while the public is either ignorant of or not interested in casting their votes in opposition to these policies.

It is high time that Ottawa stops corporate welfare going to Air Canada through its regulatory decisions, allows full international competition and limits the use of its powers to ensure the safety of passengers. Air Canada has an excellent brand name, management and staff. It can and will survive, if not prosper, without government protection.

Herbert Grubel
Professor of Economics (Emeritus), Simon Fraser University
Senior Fellow, The Fraser Institute

Friday, October 15, 2010

Cancel the Obituaries for the Euro

When Greece faced a serious financial crisis in 2010, many Euro-sceptics rubbed their hands in glee and wrote obituaries for the currency union. It now looks as if these obituaries have been premature. The Greek government adopted policies that are returning the country to economic stability. Domestic protests against these policies appear to have run their course.

The value of the Euro reflects the confidence the worlds’ investors have in the currency. While it was worth 1.51 US dollars before the crisis in December 2009 and had fallen to 1.19 at the height of the crisis in June 2010, it has since then climbed steadily and reached 1.40 in the middle of October.

The writers of the obituaries for the Euro based their views on the premise that the people of countries like Greece would suffer unnecessarily because its government could no longer use monetary, exchange rate and fiscal policies to deal with unemployment and other economic calamities. In response to these sufferings, they would flee the yoke of the Euro, adopt their own currencies and quickly eliminate these problems.

The main reason why the Euro-sceptics were wrong is that the problems of Greece and other countries like Italy and Spain have not been caused by the traditional business cycles and economic shocks. They have been caused by persistent economic mismanagement rooted in social-democratic ideology, which cannot be cured by Keynesian monetary and fiscal policies but require external pressures on politicians to mend their ways.

The driving force behind Greece’s economic mismanagement during the postwar years has been a belief in the idea that governments can do better than free markets and create a socialist utopia. It resulted in many unsustainable policies. One of these was that the government protected workers and firms from the impact of shifts in international comparative advantage. When Greek shipyards and the producers of textiles could no longer compete with foreign producers, the government bought the firms in trouble. It kept most of the workers or induced them into early retirement.

At the same time, Greece expanded public sector employment to deal with high levels of unemployment, which to a large extent were caused by its own misguided industrial policies. It used economic and financial regulation intensively to advance its ideological goals. It used tax and social spending policies to offer security from cradle to grave and equalize incomes.

The consequences of these policies were unavoidable. They resulted in large fiscal deficits due to bloated public sector employment and the fiscally irresponsible operation of public enterprises; low average retirement age for Greek workers; high levels of corruption and tax evasion; and most important for the longer run, slow productivity growth.

While most of these consequences worked slowly and were hidden from public scrutiny, the fiscal deficits were not. To finance them, Greek governments forced the Greek Central Bank into buying its bonds and paying for them by printing money. As a result, between 1971 and 1994 inflation averaged 17.7 percent annually. The inflation in turn caused the value of the drachma to fall to about 10 percent of its initial trade weighted average value between 1964 and 1999.

When Greece adopted the Euro in 1999, the inflationary financing of deficits through its central bank ended because the central bank lost its ability to print money. For some years, inexplicably, private sector investors continued to buy Greek bonds without asking for risk premiums commensurate with the unsustainable growth in the public debt. However, the global financial and economic crisis that started in 2008 changed all that. There were predictions that Greece would be unable to sell its bonds and declare bankruptcy.

That was the time when Euro sceptics had their day and the currency was under attack. But instead of resulting in a crumbling of the Euro, the attack produced international commitments to buy Greek bonds under the condition that the government adopt policies that would restore fiscal balance and modify the social democratic policies discussed above.

The beneficiaries of government programs demonstrated and rioted against the implementation of changes that would damage their interests. However, the Greek government had no choice but to make the needed changes and resisted their blandishments. Chances are that politicians welcomed the external pressures for policy changes that they knew were needed but which under normal conditions would have guaranteed electoral defeat. Doing so is perfectly consistent with publicly blaming outside forces for the problems suffered by interest groups.

There is no doubt that the newly adopted policies will benefit all Greeks. The ability to run fiscal deficits will be constrained more than ever before. The resources spent in the past by interest groups lobbying the government for more benefits and regulation will go into productive efforts in the private sector. Inflation will continue to be limited to rates in the rest of Europe.

The Euro system has proven sceptics wrong. Criteria for membership in an optimum currency have turned out to have been endogenous, just as some academics had predicted.

Tuesday, October 5, 2010

The real cost of the Canadian Long Gun Registry

In 1994, when Liberal Minister Allan Rock introduced legislation for the long gun registry, I sat a few feet from him in the House of Commons, serving as a member of the Reform Party caucus. Before question period one day I asked him privately for information that I required to assess the merit of the bill. He promised that he would provide it to me. He never did. Nor was it produced or considered in the public debates the preceded the vote in parliament that decided to continue the gun registry.

The information that I had requested of the Minister was: “What will be the cost per life saved as a result of the existence of the registry?” Knowing this cost does not imply a callous disregard for lives. To the contrary. It allows one to judge whether this cost is higher or lower than that of other ways in which lives could be saved through government spending programs.

The economic issue is clear. Resources used for one deserving cause are not available for other deserving causes. Economic benefit – cost calculations rationally should be used in the evaluation of all proposed government programs.

For example, if it costs $10 million to save one life through the registry but it costs only $5 million to save one life by improvements to road intersections or the provision of better medical equipment in hospitals, an enlightened government should spend that money of the improvement of roads and health services, not on the gun registry. More lives would be served through spending of a given sum of money, a result everyone would welcome.

With the resources available to the federal government, reasonably reliable estimates of such costs and benefits could be made by civil servants and academic specialists. In fact, after I had my conversation with Allan Rock, I asked a colleague in the Criminology Department of Simon Fraser University about the feasibility of such a study. He assured me that it would be possible to do one.

The arguments presented by gun owners on one side and by defenders of the registry like police chiefs on the other, basically are about costs and benefits presented with much emotion but virtually no empirical content.

Gun owners deplore the costs incurred by the government in setting up the registry, the fees they have to pay, the time lost completing registration forms and the inconvenience and cost of meeting the registry’s requirements for the storage and safe keeping of guns.

The police chiefs defend the registry on the grounds that it saves the lives of law enforcement officers, potential victims of crime and domestic violence and that it saves time in responding to emergency calls. Some Canadians argue that the registry prevents a repeat of massacres like the one at Montreal's École Polytechnique in December 1989 that lead to the death of 24 women.

In principle and in the final analysis, the costs borne by the gun owners and the general tax payer can be expressed in terms of dollars with relative ease. The benefits of the registry are more difficult, but not impossible to estimate. Needed is, for example the comparison of the number of police officers and private citizens killed before and after the registry, adjusted for the secular downward trend observed in recent years.

Similarly, it would be possible to estimate the number of innocent people killed by long guns used by emotionally disturbed persons and what effect the registry would have on this number. The needed calculation would be difficult since Montreal-style mass murders are very rare in Canada, but some estimates could be based on comparisons of such incidents in US states and other countries that have and do not have strict long-gun registration systems.

The recent vote in parliament will not make the issue of registry go away. It would be most helpful to all Canadians if future discussions would be based on the kind of information suggested above and lead to voting decisions based on real facts and much less on emotion.