Canadian Politics from Canada's Centre

Sunday, May 28, 2006

NAFTA, Canadian Purchasing Power, and Canadian Households' Savings Rates

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Update: Purchasing Power's actual definition is different than what is written here. To avoid confusion, it is necessary to read the correction post (linked above) that discusses criticisms of this post that my economics professor wrote me when I asked him for feedback. Savings' rates definition remain unchallenged, however remuneration may also be different than what is stated below; my prof has cited different groups who may have different methods of calculation.

In previous articles on NAFTA, I pointed out that the savings rate of Canadian households was down significantly since the implementation of NAFTA, from a rate above 10% in 1993, to -0.4% in 2005 (according to the OECD's most recent stats; the OECD is an organization that compiles statistics from most of the developped world's national stats agencies, such as Statistics Canada).

At the time, I argued that a likely cause for the drop in the household savings rate was the series of cuts in spending that the Liberal government made in the 90s. This, according to my argument at that time, likely caused Canadians to pick up the tab for much of what government used to pay for.

More recently, I have been thinking about purchasing power and I believe I have found another possible cause for the extreme reduction of the Canadian Household Savings Rate since NAFTA came into place. My new hypothesis explaining the decrease in private savings suggests that Canadians purchasing power has declined, causing them to use up savings and go into debt.

GDP's Disconnect With Wages
Since NAFTA was implemented, Canadian GDP has been increasing at a rate of approximately 3% annually, after adjustments for inflation. In principle, this means Canadians ought to be wealthier.

In practice, however, Canadian remuneration has only been growing at the pace of 1% annually, after adjustments (according to data from the OECD's Economic Outlook No. 78). Furthermore, the term remuneration refers to more than just salary, or hourly wages; remuneration includes benefits such as health care insurance and all the other costs a company has for an employee. Wages themselves have only increased 10 cents/hour in the past 10 years, or about 150$/year, according to a Vanier Institute of the Family study published in February.

Effect on Purchasing Power

What this means for purchasing power is that Canadians can now purchase a lesser percentage of their GDP. The result is a decrease in purchasing power, if we accept to measure purchasing power as the percentage of GDP that Canadians can buy. Consider the following example.

In year one, Joe Canadian earns $10.
Canadian GDP is $10.
Joe can buy 100% of GDP (10/10).

In year two, Joe Canadian earns $11 (I'm looking at it as though the 1% increase in remuneration mentioned above was a 1% increase in salary).
GDP has grown 3% to $13, however.
This means Joe can only buy about 85% of his GDP (11/13).

In year 3, Joe's remuneration is up another 1% to $12.01 (101% multiplied by 11).
GDP is up to $16.09 (103% multiplied by 13).
Joe can buy 75% of GDP.

The percentage of our GDP that Canadians can buy is decreasing, because of the disconnect between the growth in GDP and the slower growth in remuneration (let alone wages and salaries!).

Resulting effect on Household Savings Rates

Since Canadians can purchase a lesser percentage of GDP using their wages, I suggest that the Canadian Household Savings Rate has been decreasing because people are dipping into savings or going into debt to maintain their purchasing levels.

If Joe had $10 saved in the bank, he would have taken $2 out in year 2 to make up the difference between his earnings and the increase in GDP (13-11=2). The following year, he would have taken out $4.08 (16.09-12.01=4.08). So Joe would have used up about 60% of his savings (6.08/10).

Caveat
The Canadian Household Savings Rate hasn't decreased that rapidly, though. There are two explanations that I can see for the discrepancy between the speed of the savings cuts according to the OECD, and the speed in my example. The first is that my gross simplification of the data explains the difference. The second is that my theory is nonsense. I'll ask my economics professor to consider this and get back to you.

So...
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Related articles are archived in the categories of: , , , :

Salaries and wages since NAFTA
1% Wages Growth Commentary
Unemployment since NAFTA

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