Friday, July 23, 2021

This week's interesting finds

This week’s charts 

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Market corrections by decade 

Social media 

Canada’s fiscal reality

It’s imperative that Canadians distinguish between convenient political rhetoric and reality when it comes to the country’s finances. The Trudeau government continues to promulgate three assertions that must be clarified. 

• First, that the government lowered personal income taxes for the middle-class. It simultaneously eliminated a number of tax credits such as children’s fitness, public transit and income-splitting for couples with young children. A 2017 analysis of these tax changes, which included both the tax rate reduction and the elimination of the tax credits, found that 81 per cent of middle-income families paid on average $840 more in income taxes. And a follow-up study found that 61 per cent of low-income families faced higher personal income taxes due to these tax changes. 

• Second, the Trudeau government continues to use Canada’s comparative government debt position as a rationale for more debt-financed spending. Using net debt, however, turns out to favour Canada in a way that fundamentally misrepresents our indebtedness because it includes the assets of the Canada and Quebec Pension Plans to adjust total debt when calculating net debt. Those assets are required to finance the promised benefits to current and future retirees. Therefore, it’s misleading to offset government debt with these pension assets. This is one of the main reasons why Canada’s total debt ranking is so different from its ranking on net debt. When we compare total government indebtedness as a share of the economy among 29 industrialized countries, Canada falls to 25th with only Japan, Italy, Portugal and the United States having higher levels of indebtedness. 

• The third and final clarification relates to rates of economic growth. The government continues to reiterate its commitment to improving the economy, the inference being that their policies—namely higher taxes, higher debt-financed spending and more regulation of the economy—have led to stronger economic growth. But if we compare the four years prior to the 2020 COVID recession (2016-2019) to similar periods in the past, the Trudeau government experiences the lowest annual average rates of economic growth (2.1 per cent) dating back to Brian Mulroney.

The private equity backlash against ESG

Call it Newton’s law of corporate ownership. As listed companies come under increasing investor pressure to act on everything from executive pay to carbon emissions, a reaction against those constraints seems to be fueling a spate of buyouts by private equity firms. 

The first half of 2021 was a boom period for the sector with $500bn-plus of deals, the highest level since records began four decades ago. 

Done well, private equity has a crucial role to play in modernizing economies, helping companies to restructure efficiently away from the short-termist glare of public markets. Buyout firms rightly pounce on listed companies that they deem undervalued or bloated. In so doing, they keep capitalism efficient and act as a positive reactionary force.

But is private equity also reactionary in the conservative backlash sense of the word — facilitating a rebellion against some of the progressive constraints of public company existence, particularly the growing demands of complying with standards on environmental, social and governance issues? The evidence is mounting. 

More freedom on governance has long been seen as a plus for private companies. As listed company governance has become stricter, so the advantage of private company status has increased. Heads at private equity owned companies relish diminished bureaucracy and the ability to earn more money without critical scrutiny from public company shareholders. Fortress’s agreed £9.5bn buyout of Morrisons this month came with a strong hint that management “incentives structures” would be boosted, only weeks after the listed UK supermarket suffered a shareholder revolt over pay.

The fact remains, though, that ESG is a fringe topic in the private equity industry. That in turn risks undermining the whole drive to embed ESG in global business. First, the steady switch towards private ownership and away from public markets neutralises progress made in public company ESG standards. Second, private equity is under little pressure to change. Buyout firms claim that their “limited partner” end investors, such as right-thinking pension funds and endowments, are demanding more focus on ESG. However, those LPs have little genuine influence, given the wall of return-hungry money clamouring for access to the best private equity funds.

Can the nuclear industry power Canada’s future?  

Governments encourage electrification of cars, buildings and nearly everything else. Those efforts could double, even triple, electricity demand in the coming decades. But renewable forms of generation – hydro, wind, solar and biomass – have become preferred tools for decarbonizing electricity grids. And utilities can buy inexpensive wind turbines and solar panels today.

Seeking to catch up, dozens of nuclear vendors sprung up just in the past few years, promoting a dizzying assortment of next-generation models that have collectively been dubbed “small modular reactors” (SMRs)

Though the characteristics of individual designs vary widely, in brief, these compact new reactors promise to retain the main selling points of nuclear power generation – namely, low carbon emissions and predictable electricity output, rather than the intermittent power generated by wind and solar. The makers also hope to ditch the nuclear industry’s considerable baggage, which includes a long history of cost overruns and construction delays.

Senior government officials regard SMRs as indispensable tools for meeting Canada’s greenhouse gas emissions targets, by replacing coal-fired plants and by electrifying mining and oil and gas facilities. U.S. President Joe Biden and U.K. Prime Minister Boris Johnson have also indicated they will also support SMR development, as have some prominent investors, notably Bill Gates.