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With the prospect of a PQ Government in Quebec after next Tuesday’s election and a third referendum (a syndrome called the “neverendum”) on the horizon, I will reflect a bit on how global capital markets – the bond vigilantes – might respond.

There is some relevant historical precedent. In the run-up to the too-close-to-call 1995 referendum, international capital markets refused to buy new Canadian public sector debt. At the time, I was on the board of the Ontario Transportation Capital Corporation, then responsible for building Highway 407. We wanted to replace the provincial treasury bills that were funding the project with long term debt, and were given that alarming news by the Ontario Ministry of Finance.

Since 1995, Canada’s fiscal position has become much more secure relative to that of other countries. On the other hand, the bond vigilantes are much faster to pounce on countries whose finances are at all suspect.

Quebec’s public sector debt now stands at about 50 percent of gross provincial product. Debt service costs approximately $10 billion and consumes 11 percent of the government budget. The critical question is what will happen to the federal debt in the event Quebeckers were to vote for sovereignty in a future referendum. Sovereigntists will ignore the question or obfuscate. The federal government will argue that the debt was incurred by the entire nation, that federal assets in Quebec (the St. Lawrence Seaway, airports, federal buildings, national parks) will remain in situ and would thus become the property of a sovereign state of Quebec, and that therefore an independent Quebec must assume its fair share of the federal debt.

If we assume that a fair division of federal debt results in Quebec assuming its per capita share of the debt (24 percent, based on the 2011 Census), then an independent Quebec’s debt would increase to approximately 90 percent of gross domestic product (as shown in a recent briefing note entitled Quebec Election: Handle with Care posted on the Pimco Canada website). If we then assume that Quebec would be able to pay the same interest rate on its additional debt as on its current debt, then debt service costs would increase to close to 20 percent of the government budget.

Enter the bond vigilantes. Public debt of 90 percent of GDP is close to the situation in Greece, Italy, or Spain. If the bond vigilantes are skeptical about the long-term viability of the public finances of a sovereign Quebec, they would demand a substantially greater risk premium for debt issued by a sovereign Quebec than by the Canadian province of Quebec. The downward financial spiral faced by Greece or Italy could become a reality for Quebec. So virtually the first action of a sovereign Quebec government would be to seek a bailout.

If the sovereigntists’ Achilles heel is therefore public debt, then the federal government could exploit it. As soon as a sovereigntist government begins to prepare for a referendum, the federal government should enact a Fiscal Responsibility Act that would be parallel to the Clarity Act. (Recall that the latter requires a clear referendum question passed by a supermajority as a prerequisite for negotiating Quebec sovereignty.) The Fiscal Responsibility Act would stipulate that a sovereign Quebec would have to accept its per capita share of the federal debt. The Fiscal Responsibility Act would be intended to so substantially increase the economic cost of sovereignty for Quebeckers that it would dissuade them from voting for it in a referendum.

What I have outlined here is one of the key sticks the Harper Government could use to keep Quebec in confederation. But what carrots could it provide? It is a majority government with minimal representation from Quebec. Prime Minister Harper, to his credit, has achieved a level of fluency in French that, unfortunately, few members of his Cabinet or caucus can match. On a host of issues – for example social policy, cultural policy, and the long-gun registry – the Conservatives are completely out of step with Quebec. The Harper Government will have to do some serious thinking about how it can present a more welcoming face to Quebeckers if it is still in power during another referendum. Threatening to saddle Quebec with an unsustainable debt burden may be necessary to preserving the Canadian confederation, but it will not be sufficient.

On final exams I always try to challenge students by including one or two questions that require them to apply what they have learned in new and different contexts. I had two such questions in this year’s public management class. The first began with Industry Canada’s recent termination of the Community Access Program that provided funding for rural Internet access. A small town that had benefited from the program must decide if it should attempt to keep the public use computer room at the local library open using its own resources. The second imagined that one of Canada’s chartered banks had “bet the bank” on Spanish Euro-denominated bonds and, as a result of a fictitious Spanish decision to leave the Euro zone and resume using the peseta, the bank would have to write down more than half of its capital base, and could no longer meet its reserve requirements.

The first question dealt specifically with a township in Ontario cottage country. The township was funding a public access computer room in the local library with a $60,000 grant from CAP and $20,000 in user fees, assessed at $ 1 per hour. The township’s year-round residents have income and education levels below the Ontario average, while its cottagers are much wealthier and more highly educated. The $60,000 grant represented less than 1 percent of the township’s budget. The alternative to library-based Internet is relatively expense satellite-based service, provided by either Rogers or Bell. The student is to imagine him/herself as a recent MPA graduate who works as township manager, and is asked to do a policy analysis for township council as well as design a public consultation process.

My first question of the students was what the objective of the program should be. A limited objective – essentially that of the CAP program – would be to provide Internet service for rural residents who have no other broadband access. The existence of satellite service would justify the township confirming Industry Canada’s decision by not replacing CAP with its own resources. A more ambitious objective would be to contribute to the quality of life in the township by ensuring that it maintained broadband Internet access. The latter objective is comparable to the justification some larger cities have given for putting in place infrastructure making the entire city a wi-fi zone. The essential point is that how you envisage the goals of public policy will influence your solution.

While some students were explicit in setting out the more ambitious objective, almost all the students chose to try to keep the computer room open with municipal resources. The facts of the case made that relatively easy. One alternative would be to pay for it with a small increase in property taxes. Because cottage properties are major contributors to the tax base, cottagers as well as locals would be paying for the computer room. A second alternative would be by increasing user fees. That could be done through a form of price discrimination, for instance selling low-price annual or seasonal passes (say $ 50 for the year) and increasing the single visit fee from $1 per hour. A third approach would be to look for a private sector partner who might be willing to pay some of the cost in return for the marketing opportunity.

The consultation question mentioned that the township manager’s report would be discussed and recommendation voted on at the township council meeting, but left open other forms of consultation, making clear that cottagers, as property owners, had the right to vote in municipal elections. I was disappointed that most of my social media-savvy students didn’t suggest posting the report on the township website well in advance of the meeting, encouraging online discussion, or facilitating an online town hall meeting.

The financial crisis question assumed that the Spanish government made a dramatic announcement of the currency conversion on New Year’s Eve, which happened to fall on a Friday. It froze all Euro deposits in Spanish banks and would convert them to pesetas when business reopened the following Tuesday. It also suspended payment of interest on Euro-denominated Spanish bonds and intended that, when the bonds were converted to pesetas and payment resumed, bondholders would take a 75 per cent haircut. The one Canadian chartered bank that had invested so heavily in Spanish bonds was National Bank, which has traditionally had a stronger regional Quebec focus than the others. The facts of the case were presented in a New Year’s Eve phone call from Bank of Canada Governor Mark Carney to Prime Minister Harper. The student, cast as an adviser to the Prime Minister, was asked whom the Prime Minister should consult in formulating a response and posed three options: extending massive loans to keep National Bank afloat, temporarily nationalizing it, or trying to find another chartered bank to take it over. Finally, the student adviser was asked to outline how a decision would be announced and write the first paragraph of the speech or media release.

I expected that the Prime Minister would initiate secret but widespread consultation with the Government’s economic advisers (Bank of Canada, Department of Finance, Superintendant of Financial Institutions); with the banking industry and with National Bank itself; with knowledgeable sources on the ground in Spain, say the Canadian ambassador; and, given National Bank’s profile in Quebec, with the premier or Finance Minister of Quebec.

All the options are unpleasant. Bailing out the bank will be very expensive, even if the Bank of Canada monetizes the debt. Clearly, the management of this bank has made some major mistakes and deserves to be replaced or closely watched. Micro-management of business is not something that would appeal to the Harper Government, whether exercised as part of a temporary nationalization effected through purchase of equity or as conditions for a loan. A merger raises the question of which other bank would want to merge with the now-crippled National Bank. It might well be that the only way a merger could be achieved is if the federal government assumed the toxic assets. A merger also poses the problem of reducing competition as well as eliminating a Quebec-based financial institution, which the Government of Quebec would oppose. In effect, National Bank’s bet on Spanish bonds has given the Canadian financial system a gift of a huge lump of burning coal that, one way or another, will come to rest in the federal government’s lap. From the Harper Government’s viewpoint, a loan with numerous conditions attached is probably the least bad alternative.

Given the consequences major investments by Canadian banks in toxic overseas assets would have for the Canadian financial system and indeed Canadian society, one wonders about the Bank of Canada’s ongoing closed-door consultations with, and moral suasion upon, the banking system.

Because the matter is not yet a national crisis, an announcement would best come from the Government’s high profile financial spokesmen, Finance Minister Flaherty and Bank of Canada Governor Mark Carney. It would have to be made on Monday, before markets open on Tuesday. The media would undoubtedly have questions, so a press conference would be preferable to a press release. Finally, the statement should begin with the context and then move to the course of action the Government has decided upon.

To some extent, the question is posed in what economists would call partial equilibrium rather than general equilibrium. Spain’ sudden exit from the Euro zone would have consequences for the viability of the Euro itself and for the European economies as well. Better to reserve the Prime Minister for a response to the next phase of the financial crisis.

As the Chinese say, we live in “interesting times.” Surely, public management exams should be no less interesting.

I was asked by iPolitics.ca to put myself in Premier McGuinty’s shoes to think about priorities and problems at the start of his new mandate. While the iPolitics article, with contributions from a variety of pundits, will be coming out early in January, here are my un-media-ted views now.

The leadership of the federal Liberals is McGuinty’s for the asking. While leading the third party in opposition is always a hard grind, after this overview, the conclusion might be that it is preferable to governing Ontario now.

The province is running a substantial deficit in an economy that is not rebounding as quickly as anticipated a few months ago, and the debt ratings agencies are watching carefully, with the possibility of a downgrade looming. In addition, the generosity of the federal government, for example in constantly increasing transfers for health care, can no longer be taken for granted. It has its own fiscal concerns.

The province has little, if any room, for tax increases as a way to achieving fiscal balance. Economically, higher taxes decrease growth. Politically, higher taxes would confirm the “taxman” image the Conservatives, with at least some success, stuck on McGuinty. The alternative – spending cuts – militates against two key components of McGuinty’s style and substance of government.

First, he has taken pride in improvements in the quality of public service, for example decreases in hospital waiting times, reduction in class sizes, and better student performance in province-wide tests. All of these have required increases in spending. Second, after the public sector turmoil of both the Rae and Harris governments, McGuinty has brought a measure of stability and cordiality to the public sector, achieved through generosity in labour settlements, within both the OPS and the broader public sector. In addition, the McGuinty government has directed considerable spending towards key priorities, such as green energy. Spending cuts will make it very difficult to extend all these components of an activist agenda into the next mandate.

The McGuinty government may face two microeconomic challenges, the worsening situation at RIM and a possible collapse of the high-rise condo market in Toronto. RIM’s troubles may be the result of better strategizing and implementation by its competitors. Or they may be the consequence of co-CEO’s who, instead of sticking to their kitting, were attempting in one case to emulate Albert Einstein and in the other Larry Tannenbaum. A turnaround seems increasingly unlikely, so the best-case scenario would be takeover by a competitor and the worst-case bankruptcy. RIM has spawned an agglomeration of technological and entrepreneurial expertise in the Waterloo-area, and losing it would be very damaging to the Ontario economy. Just as the McGuinty Government intervened to prop up the auto industry in 2008, it can be expected to intervene to ensure a transition that maintains Waterloo’s technological and intellectual capital.

If Toronto’s high-rise condo market collapses, one implication will be major layoffs in the construction industry. The collapse of Toronto’s housing market in the early Nineties is a precedent, as the slack was taken up by the construction of Highway 407. The debt rating agencies were cooperative, agreeing not to add spending on the highway to the Rae government’s debt because of the prospect of cost recovery through tolling. The expansion of the Toronto subway system may play a similar role now, though the financial model and the likely reaction of the rating agencies would be different this time.

Politically, while McGuinty no longer has a majority, the Liberals have the advantage of straddling the political centre, making it hard for the Conservatives and NDP to find common cause and bring down the government. Furthermore, McGuinty has an advantage over the Conservatives in that leader Tim Hudak still chooses to wear the mantle of Mike Harris’s common sense revolution. McGuinty’s response would be that, if austerity is inevitable, it would be better to have it delivered by a leader who will do his best to mitigate the damage than by a leader who relishes it.

Ultimately McGuinty’s challenge will be to find some way to both recast himself and maintain continuity with a self-definition that has worked.

This will be my last post of the calendar year. I wish my readers a relaxing holiday season and healthy and happy new year.

At the end of “Wall Street and Vine,” his essay published in 2005 attempting to explain why he feels Hollywood is critical of business, University of Illinois law professor Larry Ribstein concludes that “the best way to counteract [Hollywood] films’ misleading message about business is to let business speak for itself.” The Acton Institute, a Michigan-based think tank that attempts to enlist the religious community in support of a free market agenda, has done just that in its 2007 documentary The Call of the Entrepreneur.

In this post, I point out some gaps and contradictions in the Acton Institute’s documentary and also show how Prof. Ribstein’s equally warm embrace of free market principles leads him to a dubious hypothesis about the motivations of the creators of films. Thus, this post will be a critique of two defenders of the free market faith.

The Call of the Entrepreneur is a documentary that blends profiles of three entrepreneurs with pontification by a variety of faith-based free market advocates, including Acton Institute president Rev. Robert Sirico, George Gilder, and Michael Novak. The three entrepreneurs are Brad Morgan, a Michigan dairy farmer who has built a business on high-quality compost; Frank Hanna III CEO of Hanna Capital, a privately-held financial services firm; and Jimmy Lai, a Hong Kong-based clothing and media mogul. All three, as far as I can tell from the movie as well as from online searches, have built companies that have prospered. But there are aspects of Hanna’s and Lai’s stories that set off alarms.

Frank Hanna described the essence of his entrepreneurship as the use of financial engineering to pool, minimize, and transfer risk. Even though he didn’t use the term, it is clear from the description that his firm was creating collateralized debt obligations (CDOs) such as mortgage-backed securities (MBS’s). Of course, it was these instruments that blew up during the financial crisis of 2008, when it turned out that the bursting of the housing bubble meant that virtually all the mortgages in a typical MBS tanked at the same time. The film was made in 2007, before the financial crisis. The Hanna Capital website even today tells us only that the value of its portfolio at the end of 2007 exceeded $ 4 billion. The unanswered question is what happened since then. Quite likely $4 billion was Hanna Capital’s high-water mark.

In The Call of the Entrepreneur, Hanna triumphantly proclaims, “but for financial engineering the US would not be what it is today.” Post-financial crisis, we can say exactly the same words but, ironically, with an entirely different meaning.

Jimmy Lai tells us about how he escaped from Guangdong Province in Communist China in 1960 to make his fortune in Hong Kong. At the age of 12, he immediately went to work in a factory from 7 am to 10 pm. The obvious question is whether Hong Kong had any child labor laws at the time. Either it had no such laws or it did and Lai’s employer was violating them. Rev. Sirico interprets Lai’s story with the comment that the wealthiest places on earth have the least regulation and the least taxation. Does the absence of regulation include either openly permitting or failing to detect and prosecute child labor?

Lai moved from clothing to the media out of anger at the brutal Chinese suppression of the Tiananmen Square protests in 1999. While that is an entirely appropriate reaction, and while I admire the determination and imagination that characterize Lai’s story, I would feel a bit more comfortable with his role as press baron if he had some formal education.

The talking heads in the movie go far beyond the three entrepreneurial stories to proselytize for the minimalist state advocated by von Hayek. While city-states with minimalist government have grown rapidly, there have been more than a few economic success stories of nations with more interventionist government (the four Nordic countries, Australia, Canada, and Germany, for example).

Perhaps the most amusing bit of commentary was by Rev. Sirico arguing, with an orchestra playing the Jupiter movement of Holst’s The Planets, that entrepreneurs, like impresarios [sic], coordinate the creativity of others so that they produce pleasing melody rather than cacophony. While the linguistic roots of the term (“carry between”) are consistent with that idea, the true creator in Rev. Sirico’s example is the composer. This leads to the much more complicated issue of the encouragement and protection of intellectual property, something that requires a state that is more than minimalist. Indeed, the minimalist states that Rev. Sirico praises have often permitted the piracy of intellectual property.

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Prof. Ribstein made the unusual argument that Hollywood’s creative class is anti-capitalist because of intrinsic nature of the film enterprise. Film production requires large pools of capital and films are made with an intention of earning a return on that capital. This means catering to audience tastes. Thus constraints are placed on the creatives (screenwriters, producers, directors) and it is these constraints that they face in their working life that have made them resentful of capitalists and capitalism.

An alternative explanation might of course be that capitalism is a flawed economic system and that at least some films give voice to a critique of capitalism. Another alternative explanation is that narrative requires conflict and that one of the dominant fables of conflict in social realism is between heroic individuals and large institutions. In this fable the large institutions could be located in either the public or private sectors.

On reading Ribstein it becomes clear that he idealizes capitalism. Thus he writes “Firms have powerful incentives to build reputations as good corporate citizens in order to encourage people to buy their products” (p. 64, online version), “real firms will not invite, and in fact try to prevent, the unethical or irresponsible corporate behavior films portray,” (p. 65), “the capital markets thrive on truth, and would have no interest in cover-ups,” (p. 66), “Markets penalize the antisocial and the bigoted,” (p. 66), “competitive firms are great social levelers that bypass entrenched classes, castes, and ranks,” (p. 66), “firms create wealth in the long run by inventing and selling better products rather than by chance,” (p. 68), and “the stock markets, far from the perverse gods of film fiction, fairly accurate reflect firms’ value,” (p. 68). In short, if capitalism is the best of all possible economic systems, then the film-makers’ criticism must be a result of their perverse experience with that system, rather than its failings.

Ribstein never seems to imagine a counter-narrative in which people who have done very well in the capitalist system could nonetheless be critical of its failings. The most prominent examples that come to mind are George Soros, Warren Buffet, and Bill Gates (the latter in the sense of using his wealth through his foundation to solve social problems the free market has ignored).

The most recent example of Ribstein’s thinking about the capitalist system is a 2009 paper, “How Movies Created the Financial Crisis,” published in the Michigan State Law Review. Ribstein argues that there are a variety of narratives explaining – that is, finding fault for – the financial crisis. These include no one’s fault, government’s fault, speculators’ fault, the banks’ fault, capitalists’ fault, and the fault of financiers who created CDOs and CDSs.

Ribstein speculates about which of these narratives will ultimately be incorporated into films about the financial crisis. Ribstein prefers a film with a heroic narrative about the contrarian investors who had the foresight to anticipate the crisis and made large and winning bets by shorting CDOs and buying CDSs. This would demonstrate that “competitive markets ultimately reward anybody with a good idea, industry incumbents often attempt to ally with government to squelch the innovator, free markets triumph in the end against all odds, and this outcome helps everybody.” However, because “films are less about the actual evils of capitalism than about filmmakers’ resentment of capitalists,” he predicts we are not likely to get such a film.

Michael Lewis’s book The Big Short told the story Ribstein wanted to see in the cinema, but without the free market triumphalism he was hoping for. Ribstein quotes one of the shorts, James Chanos, who urged Oliver Stone in making Wall Street 2 not to focus on the hedge fund managers – advice Stone rejected – and instead focus on the banking system. Chanos had it right, however.

In his documentary Inside Job, producer-director-writer-interviewer Charles Ferguson (whose IT-based fortune enabled him to escape budget constraints on realizing his vision), told a much more complicated and nuanced story about the financial crisis, apportioning blame broadly across the financial sector, its academic apologists, and its public sector regulators. I found Ferguson’s story, while difficult to summarize in a sound-bite or a tweet, much more compelling than Ribstein’s free market fundamentalism.

When the true believers in the idealized free market – Ribstein as critic of Hollywood’s supposed bias and the Acton Institute using the stories of three entrepreneurs as the point of departure for proselytizing – do have their say, I find much to challenge in the stories they tell.

The tributes that have been paid Allan Blakeney have focused on his achievements as minister of health when the Douglas Government introduced comprehensive public health insurance and as premier of Saskatchewan from 1971 to 1982. Blakeney, however, had three careers, first as a public servant; then as a politician, serving as minister, MLA, Opposition Leader, Premier, and again as Opposition leader; and for the last two decades of his life as teacher and writer. The third career received the least attention in the Canadian Press obituary, only a short concluding paragraph. Since my relationship with Allan Blakeney was entirely within that third period, I will focus on it.

Blakeney and I met when he came to Osgoode Hall Law School at York University, and wanted to teach a public administration course. I was already doing that at the Faculty of Administrative Studies (now Schulich School of Business), and we decided to combine our efforts. From our first conversations, it was clear to me that he had thought deeply about statecraft, the practice of government, at both the political and public service levels. In our preparations for each class, I would provide a set of questions and he would take them away, and come back with well-thought-out answers, written in clear, flowing hand writing – a marker of his generation – on a yellow legal pad.

I thought it was essential to preserve his ideas, and he came to agree, and so we had the classes taped and transcribed. This was the origin of our book Political Management in Canada. In it, Blakeney did something unique at the time, recounting how he managed his government and why he did it that way. Thus he took us inside the cabinet room, not to recount particular decisions, but to explain how his cabinet made decisions. In the years since our book, Jean Chretien, in My Years as Prime Minister (2008), and Eddie Goldenberg, in The Way it Works: Inside Ottawa (2006) have, to an extent, applied Blakeney’s approach to the Chretien Government. Students of government will benefit if other ministers and first ministers follow Blakeney’s lead.

I recently donated the audio tapes of our classes to the Saskatchewan Archives. The better to preserve Blakeney’s voice, I hope the Saskatchewan Archieves will digitize them.

The middle of a federal election campaign is an appropriate time to revisit Blakeney’s views on politics and policy. He titled his political memoirs An Honourable Calling because he believed politics IS an honourable calling. In this view, politicians regard one another as people of principle and integrity who differ over policy and base their campaigns on these differences in policy.

Discussing his electoral defeats in Political Management in Canada (p. 237), he wrote “Ideally an election defeat would be regarded as a rejection of one group of policies in favour of another, and there should be little sense of personal rejection. But if this was ever true, it isn’t now in today’s climate of personalized politics. … [the media] regard politics as a contest of salesmanship rather than a comparison of products. [Elections] are increasingly becoming contests of personalities rather than policies. Canadian politics is poorer for this.”

Blakeney was a strong advocate of public enterprise and critic of the privatization of the potash and uranium industries in Saskatchewan. He saw Crown corporations as making a social as well as economic contribution to the province. Thus, he supported SaskPower keeping its rates down for local curling rinks during the winter because “they were almost always the heart of village life in January” (Political Management in Canada, p. 138). This was a classic example of reducing the cost of living in rural areas.

Blakeney warned that if Crown corporations were privatized, the head office would de facto move outside Saskatchewan and senior management would be paid as private sector executives rather than as public servants.

And his view of public enterprise was part of a broader commitment to equality, a belief that society as a whole would be better off if the state helped those most in need and reallocated some of the wealth the economy produced.

At the end of An Honourable Calling (p. 250), he wrote: “Our challenge in the future will not be primarily to produce more goods, but rather to distribute the goods more fairly. … When governments have intervened to distribute education, health, and many other services at low or reduced cost, society has been better for it. .. A look around the world tells me that where able and active governments (and there are many) intervene on behalf of people with special needs or lower incomes, society works best.”

Blakeney’s views on political campaign, Crown corporations, and the distribution of income are certainly contested, and likely he was in the minority in all three areas. But Blakeney did not despair, and maintained to the very end both an optimism and willingness to advocate for his vision of Canada. Thus his advocacy after leaving office is just as much part of his legacy as the decisions he made while in power.