Canadian Politics from Canada's Centre

Saturday, June 10, 2006

Purchasing Power of Canadians - Correction

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I recently published a theory of mine as to why I considered purchasing power to be declining in Canadian households. I showed the post to my economics professor who corrected me. I'm a bit embarassed about the corrections actually, since I should have known these things from his class... Oh well! Anyways, here are corrections to my opinion and theory on Canadians' declining purchasing power, as measured by the declining percentage of GDP I thought we could buy.

I've copy pasted the text of my professor's email. The smart, helpful man in question is Mr. Philippe Ghayad of the Dawson College economics department. Generally, he points out problems with my non-standard definition of purchasing power, shows that Canadians' incomes have been rising by other measures than the ones I referenced (another question of definitions then, I suppose), and discusses the federal government's fiscal policy.

Here's what Mr. Ghayad wrote:

1) The following websites have numbers on quarterly and yearly hourly
compensation changes and weekly average salary. You'll notice that the
numbers are almost always above the annual inflation rate (2%). I think
another report by Statcan should be out on June 8th to update these numbers
with more detail.

2) Purchasing Power is usually defined as the amount of goods and services a
given amount of money can buy (ex: 100$). It does not really deal with how
much the average Canadian can purchase of the GDP given his/her income [ed's note: in the theory mentioned above, I defined purchasing power as the percentage of GDP Canadians could purchase given their income].

Even though that is an interesting indicator it can cause issues:
  1. consumers do not consume or cannot consume some of the Canadian GDP (ex:
    production of coal, asbestos, international services...). So the indicator
    would be biased downward.

  2. imports are subtracted from the GDP but Canadian consumers definitely
    want to consume imports (computers, cars, clothes...).

  3. If the Canadian Government decides to provide less services to its
    citizens, then GDP would fall (GDP = Private Consumption + Business Investment + and Government Spending) and this this would raise your Purchasing Power indicator.
    (ex: Period 1: income = 50 GDP= 100. Your PP indicator would be 50/100 or
    50%. If the Government decides to cut back in Period 2 and we'll assume
    there is not change to income we could now have income = 50 and GDP = 75.
    Your PP indicator is now 67%. That is, we can now purchase 67% of all
    goods and services produced where as before it was 50%. Are we better off
    even though the government cut back on services?)

  4. If the Government is cutting back are we gaining somewhere else?
    [For example, do we have] a lower tax level, which increases our disposable income and possibly our savings rate?
    [Is the government] lowering the deficit or getting out of a deficit (which would lower thenational debt and possibly decrease future taxes or increase future
    government spending)? Note: this is why the federal government did cut back
    in the 1990's. Our debt to GDP ratio was close to 70%!

  5. Finally, the government cutting back in certain services might create room
    for private enterprises. They might be more efficient than the public
    sector at providing certain goods and services (Jean Charest is trying or
    tried to steer Quebec towards this...not an easy thing to do!).

Remember, a government is not like a firm. Its goal is not to maximize profits (or surpluses) but to maximize strategic votes. If a government decides to cut back on services it is not to maximize surpluses but to probably get out of a difficult situation. [However,] if a reduction in spending is not agreed [to] by the general public, then the political opponents (left: NDP and right: Conservative [ed's note: the time period in question is the 90s; the Conservatives, under various party banners, were in opposition at the time]) can rule for a vote of non-confidence on the budget in order to bring down the party in power. This did not occur in the 1990s since the parties probably realized that the Canadian economy was struggling.

While I agree with most of the criticisms, I can't say I accept them without reservation.

First, even if Canadians' income has been increasing at 2%, this still leaves a difference of 1% annual growth with GDP.

Second, GDP can be calculated by summing up Canadians' incomes, and this is theoretically supposed to be equal to other measures. Therefore, though Canadians do want to purchase imports, by considering GDPi (the formula that calculates GDP by summing everyone's income) it becomes evident that Canadians ought to be able to purchase 100% of GDP, since they earned an equivalent amount.

I think that the problem here is an issue of what is associated to the term "purchasing power". In Professor Ghayad's case, it is the purchasing power of money, of currency. As I see things, my definition considers the purchasing power of people. Of course, I don't see one as superior to the other. Lacking a compelling argument to the contrary, though, I stand by my initial definition.

Third, income couldn't be 50 when GDP is 100 to begin with, unless we agree that there is a strange disconnect between GDP and wages. As to government spending, if it were to fall 25$, Canadians may have had a tax break worth 25$, the government may have had a surplus of 25$ that it will spend in the future, or perhaps something else explains the drop in services. I think that's what my prof said, but his paragraph concluded with "are we better off with fewer services," so I'm answering: "We could be." At any rate, as the possible scenarios I've just suggested show, we aren't necessarily worse off with fewer government services. Indeed, Libertarians argue that less government is better.

That said, I do think we're better off if we can purchase a greater percentage of GDP, because that suggests we're dealing with the disconnect problem.

Finally, though consumers might not be able to directly consume things such as coal, we pay for them indirectly as firms include them in the prices of finished goods they sell us. Consider for example how the price of oil affects the price of anything requiring transport.

To conclude, my economics professor has shown that there are problems with what I wrote about the disconnect between GDP and Canadians wages. It may not be as big as I initially asserted. My definition of purchasing power in the context of GDP's disconnect with wages doesn't correspond with what most people consider purchasing power, so arguing that 'purchasing power' is declining is something of a misnomer. I should say rather than "GDP purchasing power of incomes" is declining.

It's an interesting debate, at any rate, and you can expect me to follow up with Mr. Ghayad about the questions his reply has fuelled.

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