How Canada Can Avoid "Hitting the Wall" in 1995: Two Views

Highlights from the presentations to the House of Commons Standing Committee on Finance by Michael Walker and Robin Richardson.

  Let's learn from other countries' debt crises

Robin Richardson

Canada's major challenge is to reduce its government debt burden, and that we must do it soon if we are to avoid "hitting the wall."

Last May the International Centre for the Study of Public Debt, a division of The Fraser Institute, presented "The Fraser Institute's SIC List 1994 (Worldwide All-Government debt--Severely Indebted Category)" to a sub-committee of this finance committee in Ottawa. It showed that Canada has joined the Third World in terms of its all-government indebtedness problem. Since then, I've updated "The Fraser Institute SIC List" to show the public debt of an independent Quebec and how it would compare with Quebec remaining as a Canadian province.

Excluding the unfunded liabilities of the Canada and Quebec Pension Plans, Canada's all-government net debt-to-GDP ratio was 120.6 percent as of March 31, 1994. It has been showing a worsening trend for many years.

The government of Canada accounts for 83.8 percent of Canada's all-government debt. The main problem therefore lies with the government of Canada. The government's target of a federal deficit of 3 percent of GDP by fiscal 1996-97 will do nothing to stop the federal debt from rising. It simply is not enough to prevent a financial disaster from happening.

The consequences of having yet another federal deficit in fiscal 1996-97 when we should be moving into surplus in the federal budget and beginning to reduce the federal debt, are potentially disastrous. A financial crisis of the "hit the wall" type that has hurt so many countries in recent years could happen at any time. The key event that bond investors are looking at is the next federal budget.

Let's learn from other countries' debt crises

What happens when a country "hits the wall"? Can we learn from the experience of other countries?

The Fraser Institute is organizing an international conference on this subject for Toronto on November 30 and December 1 The House of Commons Standing Committee on Finance met on October 31, 1994, one month prior to this conference  at which we have lined up a group of world class speakers, including senior people from Italy, New Zealand, Sweden, Mexico, Chile and Argentina to tell us about their "hit-the-wall" experiences. In addition, we have very knowledgable domestic and foreign fixed income investors, a well known bondrater and foreign financial journalists to give their perspective on Canada's government debt crisis.

Canada is not immune to "hitting the wall." It doesn't happen just to Third World countries. Some examples of OECD countries that experienced foreign exchange crises related to large government and current account deficits are Italy (1974), the United Kingdom (1976), Denmark (1980), Italy (1981), Ireland (1981), Belgium (1982), New Zealand (1984), Australia (1985), Sweden (1992) and Italy (1992). The typical response was a devaluation of the country's currency, rising interest rates, fiscal austerity, and rising unemployment.

Italy's recent experience (1992) and New Zealand's crisis of a decade ago (1984) and its aftermath may provide some insight into what Canada can expect if its governments are unwilling to take the necessary actions to reduce the debt burden.

Italy

Italy has had recurring currency crises since 1974, in part related to its excessive government debt burden but also reflecting internal political difficulties and, more recently, the problem of maintaining the lire within the European exchange rate mechanism. The chronology of main economic events in Italy in 1991 and 1992 leading to the Italian exchange crisis of September 1992 shows a typical pattern--restrictive fiscal and monetary policies leading to high interest rates, economic slowdown and rising unemployment.

It is of particular interest that Italy's September 1992 crisis was preceded by a sizeable downgrade from AA1 to AA3 of Italy's foreign currency denominated public debt by the U.S. rating agency, Moody's Investors Service. One significant consequence of the Italian crisis was that the Italian government sought and received special powers to cut public spending in four main areas: pensions, health, transfer to local authorities and public employment. When government debt becomes excessive the unfortunate consequence is that spending may have to be cut on social programs previously regarded as untouchable.

The May 1993 Italian budget announced an increase in the retirement age of five years and a reduction of entitlements to the state pension plan. The budget also contained further substantial cuts in government spending, lower transfers to local authorities, continued public pay restraint and stricter control of health spending.

New Zealand

The New Zealand crisis in 1984 provides an interesting example of what happens when a country "hits the wall" and its government has the political will to take longer-term corrective action. For a short time investors refused to buy New Zealand government bonds. The New Zealand dollar was devalued and a strict fiscal austerity program was introduced. The government removed subsidies from all sectors and virtually abolished quantitative import controls. State business enterprises were "corporatised" and, in many cases, sold off. Monopoly rights were removed from all government departments and internal product markets were significantly deregulated. Over a number of years, the New Zealand tax system was overhauled.

New Zealand still qualifies as a severely indebted country because it had to take a great deal of the debt of its state business enterprises onto the books of the central government to "clean up" the balance sheets of these enterprises in order to sell them. New Zealand's indebtedness trends, however, are improving and it is now close to qualifying for the moderately indebted category.

How much spending control is enough?

With such a huge debt burden, it is not enough for the government of Canada to merely "nibble around the edges" as far as its expenditure control plans are concerned. A clear signal needs to go out in the February budget to investors in government bonds whether they live in Toronto or Tokyo.

The specific recommendations I would like to make follows.

Sell off self-supporting Crown corporations

The Minister of Finance should announce a clearly defined program for the sale of all self-supporting crown corporations. All of the proceeds should be used to reduce the national debt and there should be legislation to this effect.

The Fraser Institute's International Centre for the Study of Public Debt is currently doing a major study on a "privatization shopping list" for government of Canada crown corporations. Two prime candidates for you to look at are the Canadian National Railway and Canada Post, but there are many others.

The Minister should set out a list and timetable of crown corporations to be privatized, with estimates of the amount of money expected to be raised for debt reduction over, say, a three-year period. This would give confidence to government of Canada bondholders.

Transfers to persons

What bond investors are looking for is a big reduction in the federal deficit, a quick move to balance and application of surpluses thereafter to reduce the federal debt. The area of biggest potential savings is federal transfers to persons.

My colleagues at The Fraser Institute have done research which concludes that the government of Canada should adopt the principle that no person who is a member of a household unit with income above their provincial or territorial average should be eligible for any payments from the federal government for the Canada Pension Plan, Unemployment Insurance, Old Age Security, Family and Youth Allowance and other personal transfers. The Fraser Institute's tax-back proposal would result in a deficit reduction of $24.6 billion for all federal programs and would begin to tax-back benefits at an average income, excluding transfers, of $45,816.

It is a major saving of this type--one in which the government of Canada could cut its deficit by more than half in one fiscal year--that would impress bond investors with Ottawa's commitment to solve its deficit and debt problem.

Health care

Require that high income earners add their health care expenditures to their taxable income as a benefit. A recent Fraser Institute calculation shows that a medical care tax scheme with a lower income cutoff of $20,000--that is that no family earning less than $20,000 would be taxed in any way by this provision, and with a ceiling of 10 percent of income, would retrieve about $1.2 billion in total tax revenue. In addition, there would be savings of an estimated $867 million as current users of the system are deterred by the knowledge that they will have to pay a "co-insurance" fee in the form of the increased taxation.

Education

Require that all universities that receive federal funding adopt a full tuition schedule and provide support only to those students whose family incomes are below a certain cut-off level.

Subsides to business

Eliminate subsidies to business for a 1995-96 savings of $3.1 billion.

Privatization of services

Studies conducted by The Fraser Institute and by others unambiguously suggest that public services are expensive services largely because most of them are not produced under competitive conditions.

The federal government could enjoy considerable savings by the simple expedient of subjecting its service supplies to effective competition by contracting these services out to competing suppliers. Experience within the federal government itself suggests that the savings to taxpayers, with no loss in service levels, could simply be staggering. The size of the savings available in a wide range of services has been established in thousands of privatizations in Canada and the United States. The recent Fraser Institute book, The Supply of Government Services, provides a catalogue of such services. They indicate savings ranging from 12 to 83 percent. Taking advantage of these savings could play a significant role in reducing the level of federal spending.

Government operations

During the past three years, The Fraser Institute has conducted a contest encouraging Canadians to submit ideas about how the costs of government might be reduced without reducing the level of services provided by the program involved. This contest, "The Fraser Institute Prize for Economy in Government," has had an extraordinary outpouring of ideas--some 2,304 in total, of which 114 have made it through the strenuous judging process to become finalists in the contest. These finalists' proposals have been provided to the federal Department of Finance each year, and the ideas have been circulated among government departments for their consideration.

The Minister of Finance should list in his forthcoming budget all of these excellent proposals which pertain to controlling government of Canada operations and insist that his cabinet colleagues implement them in fiscal 1995-96.

Conclusion

Already in the few minutes that I have spent talking to you this afternoon, the interest on the federal debt has gone up by $1,020,000 according to the $85,000 per minute estimate of the Department of Finance.

Canadian taxpayers cannot afford further delay in their quest for federal budget restraint. They want you to solve our horrendous government debt problem without further increases in fees and taxes. It is important to begin the process of recovery now before a "hit-the-wall" financial crisis happens. A disciplined and orderly approach to eliminating the federal deficit and reducing the federal debt is much needed.

Construct prudent assumptions for budget calculations

Michael Walker

The force of interest acting on the rising stock of public debt is shutting off options at an increasing rate. Even the currently planned additions to the public debt on the way to the 3 percent of GDP target may require elimination of whole programs if the future course of interest rates and economic growth follow the pessimistic path.

Assessing the assumptions and the contingency reserve

The Finance Minister has asked this committee to indicate which economic assumptions and what level of contingency reserve should be contained in the next budget. His analysis lays out the impact of different assumptions in a range leading away from the average of the forecasts of the private sector. He adds to the private sector average forecast a number of adjustments in order to be prudent. In our opinion, he does not go far enough in this regard.

In preparing the revenue forecast and the associated contingency reserve, the Ministry ought to calculate the past maximum errors encountered in forecasting revenues as a percentage of actual revenues. (In setting the height of a dyke to protect citizens against flooding, it is typical to aim to contain the highest level of water which has been experienced in 75 or 100 years. A similar approach ought to be employed in the setting of the contingency reserve.) We did not have all the information that would be required to make such a calculation. A potential illustration of the findings can be had by observing the budget shortfall of the last budget of the preceding government. Ministry projections in that budget were 11.7 percent or 15.5 billion dollars too high for 1996--the third year of the projection. (Use of the private sector average forecast as the base of the calculation takes no account of the likelihood that the average will be incorrect nor of the revenue errors that may ensue even if it is correct. The Ministry has recently been more accurate than the private sector in making GDP forecasts, but has had a dismal record of revenue forecasts as the figure cited demonstrates.)

Second, the Ministry ought to calculate the past maximum error in projecting the rates of interest payable on the public debt since most of the variation in spending from the budget has been due to interest rate forecasting errors. In addition, the government should, in setting its prudent course, take due account of the effect that holding a referendum on the future of Quebec will have on capital markets. Interest rates and the value of the dollar have recovered somewhat from their point of maximum uncertainty over the Quebec election. As the referendum campaign mounts, uncertainty will also increase and interest rates will reflect this. It would not be surprising if short term interest rates were pushed up by two percentage points, and they will certainly be pushed up by at least one percent as the referendum rhetoric heats up. As I understand the "prudent scenario" suggested in the Minister's brief, it involves an interest rate assumption which is only half of one percent above the current consensus forecast--one which does not take into account the effect of the referendum. Under the circumstances, this scenario does not constitute a prudent set of assumptions.

In general, maximum errors, not the average, ought to be used to construct the "prudent path" assumptions for the budget calculations. The reason for being guided by the maximum error paths is the asymmetry of the consequences of making a significant error. If revenues are higher and interest expenses are lower than expected, the result will be beneficial. If revenue and interest rate errors replicate the worst of historical experience, the consequences would be catastrophic as the government might find lenders unwilling to accommodate it at anything near market interest rates with a corresponding impact on the interest cost of servicing the debt and the deficit. In other words, a failure of revenues to materialize would be magnified in its impact on the debt as interest rates faced by the government would increase.

At the very least, in asking the public to choose assumptions, the Ministry ought to indicate the past success of its forecasting efforts and show the budgetary implications of past maximum errors. For example, the most recent error of 11.7 percent revenue short-fall for 1996 would imply a revenue shortfall of $16.26 billion from the "prudent" scenario suggested by the Minister. Such a short-fall would produce a budget deficit of $47.5 billion in 1996--a level which would undoubtedly trigger a very negative response on the part of those holding government of Canada bonds.

The upshot of the foregoing comments is that prudence requires a much more jaundiced view of the likely course of events than is implied in the government's current presumption. My own preference would be for a contingency in the planned-for deficit of $15 billion in 1996 and $7.5 billion in 1995 to account for the unforeseen difficulties mentioned. This would require a much more difficult set of effective spending cuts than are currently anticipated but in my opinion are required to properly contain the risks associated with the budget forecast projection.

Establishing the principles for spending cuts

The main criticism I have of the government's approach to the current difficulties is its failure to effectively involve the general public in the discussion. In fact, the complexity of the approach taken by the government has ensured that the general public can neither understand nor participate in the process of deficit control. The great volumes of analysis that have been released in conjunction with the social policy review and the budget consultation documents are a nearly impenetrable barrier keeping ordinary Canadians away from the most important fiscal policy debate in the country's history. The result is that the debate will once again be dominated by special interest groups and others who are expert in the analysis and the rhetoric of complicated budget discussion and who, in many instances, have a vested interest in protecting their program and their incomes.

The key to getting public discussion and involvement is to suggest and debate a few simple principles which will guide the deficit cutting exercise. The general public can grasp and debate general principles and will support a process which can be seen to be fair. What principles should be adopted? In my opinion there are just a few important ones and they are the sort that could in principle be the subject of a referendum. I am not suggesting that they be put to a referendum, but they should be able to pass that test.

The first principle is that spending cuts and not general tax increases should be the main route by which the deficit is cut. The second principle is that all spending be cut in proportion to its contribution to the total. So, for example, transfers to persons are 35 percent of total program spending. Therefore, transfers to persons must yield 35 percent of the program spending cuts. Subsidies--including $3.3 billion in business subsidies--are 11.7 percent of total spending and they would have to make an 11.7 percent contribution to the total spending cut, and so on.

The third principle is that irrespective of the other principles, in restructuring the social programs, families whose incomes are below the national average income should not be called upon to bear the brunt of the spending cuts.

The fourth principle is that spending cuts should attempt to preserve the traditional functions of government. For example, securing people and property from internal and external threats; providing services for citizens that they cannot provide for themselves; maintaining a minimum safety net to protect the incomes of citizens from unforeseeable and unavoidable events; conducting functions, such as negotiating international treaties. All other activities are expendable. The flip side of the fourth principle is the rule that all activities of the federal government which can be privatized or contracted out should be. (This will require changes to the federal labour code and changes to federal government labour contracts.)

These principles are understandable by the ordinary citizen. It is possible to conceive, therefore, of a process by which ordinary Canadians might actually endorse them and thus the budget setting process which would follow from them. It is not possible to conceive of any process which could lead to consensus about the great screed which the government has produced thus far in its policy and program review. It is even doubtful if the members of this committee, dedicated and resourceful though you are, are capable of forming a coherent view of the budgetary process itself. But, like the rest of the population, you could and should agree on a set of fairly straightforward principles of action which, if followed, could lead to an approach to the budget deficit problem that would work and which would be supported by the vast majority of citizens.

The Obvious Solution for Unemployment Insurance

Michael Walker

The voluminous reports associated with the Axworthy social policy review have missed the most important and obvious fact about Canada's social welfare web. The consequence is a complex and exhausting search for solutions when the cure for our ills is obvious. The reason the reviewers have missed it is because they literally haven't looked in the right place.

The first thing that strikes the reader of the social policy review summary document is its preoccupation with Canada's position in a--surprise--European-relative world. Canada's current difficulties are relentlessly reflected against the basket cases of Europe to reassure us that our situation is not as bad as it might be. And of course, since it's a universal disease we don't have to accept all the blame either. Canadian workers are the victims of global restructuring or the vast changes in the industrial structure or some other nicely distant force. Canadian workers therefore have continuing need of the system of supports and rescue teams which are the stuff of both the new and old social welfare apparatus. What we need, according to this view, is a refurbished social welfare web.

There was another comparison the reviewers might have selected, and one would have thought it was a much more natural comparison to make. Canada's largest trading partner (80 percent of trade) is the United States. We have much the same economic structure as that country, have been going through almost identical economic restructuring, have the same emergence of the service sector, the same cultural background, the same industries, and in many cases, the same firms. Moreover, with minor exceptions, we have very similar source populations and both of us, unlike the Europeans, have been enjoying a one percent annual average increase in our population. Finally, Canadians are, on average, about the same age as Americans while Europeans are distinctly older.

The consequence is, of course, that our economies are very much intermingled and entwined. It was the case in the 1950s and 1960s that one could forecast the rate of unemployment in Canada with great accuracy by simply looking at the figure in the U.S. The reason is evident from the attached figure which shows the rate of unemployment in the two countries over the period from 1950 to the present day. What is also obvious is the fact that this historical relationship no longer exists. Something happened to cause the two series to diverge. And it started in the mid 1970s.

Click here to view Figure: Unemployment Rates in Canada and the US., 1950-1994

Click here to view Figure: Average Weekly Unemployment Benefits, 1950-1994 Adjusted for inflation

Before addressing what caused that divergence, it is interesting to note another thing about the two charts--something that the social policy reviewers did point out. That is that the unemployment problem in Canada has become steadily worse. Each time the unemployment rate cycled up, it settled down to a higher shelf before cycling up again in the next recession. Curiously, this pattern is not repeated in the U.S. where current unemployment rates have fallen to their 1970s level once again.

The average rates of unemployment in Canada and the United States from 1950 to 1970 were the same, at 4.6 percent in each case. In the U.S., the average rate increased in the 1971-1994 period to 6.7 percent, whereas in Canada, the rate jumped to 8.5 percent. This nearly two percentage point difference disguises the fact that in the most recent period the gap has widened much more significantly. For example, the 1981-94 rates were 10.4 percent in Canada and 7.5 percent in the United States, while in the last five years, the U.S. average has actually fallen to 6.5 percent while the Canadian rate has stayed the same at 10.4 percent in the 1989-94 period.

Why didn't Dr. Axworthy's sleuths think to look at this puzzling development? Why didn't they ask: "I wonder how the U.S. does it? I wonder how they have escaped the ravages of world economic developments which have plagued Canada and Europe? What did the U.S. do that we did not do that protected them from rising unemployment? I wonder if we could learn something from looking at the U.S. situation?" The Fraser Institute has asked such questions and in 1986 we published a study entitled, "Why is Canada's Unemployment Rate so High?" This study examined all of the major factors that might have caused Canada to have a higher unemployment rate and found that only two were relevant. The first was our generous system of Unemployment compensation and the second was the extent of unionization in our economy.

There are two major differences between the U.I. systems in Canada and the U.S. The first is that unemployment insurance is operated at a state level in the U.S., and second that in most cases the insurance premium employers must pay is related to the extent to which their employees experience bouts of unemployment. In other words, there is an explicit insurance, or experience rating feature, built into the U.S. system.

One of Canada's most distinguished labour economists said of this situation that it was not evident in considering the provisions of unemployment insurance in the two countries why it should be the case, but Americans were much less likely to actually receive unemployment compensation in spite of the fact that their entitlement looks about the same. David A. Green and Craig Riddell, "The Economic Effects of Unemployment Insurance in Canada: An Empirical Analysis of UI Disentitlement," Journal of Labour Economics, Vol. II, No. 1, Part 2, Jan. 1993, p. S114 The upshot of the situation is that Canada currently spends 70 percent as much on U.I. in dollar terms as the U.S. does in spite of the fact that their total labour force is about 11 times the size of Canada's. The result is that at a time in the recent past when our unemployment rates were about the same, Canada spent nearly four times more as a percent of GDP on U.I. payments than did the U.S.

But it was not always this way. The second chart shows the evolution of the U.I. system in terms of the amount, in inflation adjusted terms, the average recipient of unemployment benefits was paid. As can be seen, the system underwent a very large change in the 1970s as the impact of the 1971 U.I. legislation became effective.

If I were Mr. Axworthy, I'd be pretty annoyed to find that while millions of dollars have been spent on the social policy review, the reviewers have missed the obvious questions and a potentially obvious answer. Moreover, as a result, they have spun a yarn which is completely misleading. Their story is one of harsh worldwide realities and unsuspecting domestic victims. The real story is one of a home-grown policy mistake and the adaptation of Canadian workers and Canadian firms to take advantage of it.

The solution is to follow the U.S. example. Make U.I. a provincial responsibility. Set differing premiums according to the unemployment experience of the employers. Don't use U.I. as means to give a lolly to special interests for maternity, paternity, fraternity, collegiality or regionality.

Dr. Axworthy, this is not a complex problem. It is a simple problem. "The problem," as Harry Johnson, a founding member of The Fraser Institute, used to say, "is to recognize simplicity when you see it."

One Solution for Reducing Smog--Congestion Pricing

Fazil Mihlar

Traffic and air quality are firmly and inextricably intertwined. And in Vancouver in recent times, traffic volumes are demonstrably worse--and so is the level of smog. The greatest proportion of pollutants in British Columbia comes from vehicles. When automobiles crawl forward to work, inches at a time, they emit more pollutants than they would if they travelled at normal speeds.

Obviously the regulatory controls presently in place are not working. But there is an alternative which has been used with success elsewhere--pricing! In this article, we explore pricing as a solution to auto pollution.

Sources of emission

More than 95 percent of Nitrogen Oxide (NOx) emissions in Canada originate from the combustion of fossil fuel in all sectors of the economy. The major source of NOx emissions, however, is the transportation sector, which accounted for 62 percent of emissions in 1985. In addition, in urban areas with smog problems, such as Vancouver, emissions of Volatile Organic Compounds (VOCs) from human-made sources is several times larger than that from natural sources. The major source of human-made VOCs in Canada is the transportation sector, contributing 42 percent of VOC emissions in 1985. The secondary and combined effects of NOx and VOC pollutants in the form of ground level ozone, a component of urban smog, is also a concern. In 1988 Canada and 24 other countries signed the Sofia Protocol to freeze NOx emissions at 1987 levels. Interim emission targets for NOx and VOC--the pollutants that cause ground-level ozone, are presently not being met, especially in B.C.'s Lower Fraser Valley.

Markets versus government regulations

The intensity of public opinion in support of stronger environmental action cannot be denied. Canadians are, in fact, demanding political leadership on this issue, which is an enormous asset since, without support for the underlying values, little progress is possible. At the same time, however, the public lacks understanding as to how to implement environmental policy. This situation has led to an enormous gap between the myth and the reality regarding two central points in the environmental debate. The first point concerns the notion that governments are superior to markets in taking a longer-term view of environmental problems. The evidence suggests that this notion is not true. If the profit motive and the market are the root cause of environmental degradation, one would not expect to find much pollution in the former communist countries in Eastern and Central Europe. But exactly the opposite is true: the former communist countries suffer from the worst air and water pollution in the world. In short, people pollute, usually because the government has weakened or eliminated the normal incentives of property rights and prices to limit pollution. Therefore, government leadership is needed to establish a framework of laws, but price mechanisms are needed for the actual implementation of environmental policy.

The Canadian regulatory experience

Governments in Canada, like those in Eastern Europe, have traditionally used the regulatory or "command and control" approach to achieve environmental goals. The federal government, for example, sets emission standards for automobiles; its regulations set maximum automotive emission levels on a grams-per-mile basis. Moreover, in 1971 the Clean Air Act was passed. Between 1971 and 1988, the Clean Air Act was used to prescribe national air pollution regulations for most sources of air pollutants.

In 1988, the Canadian Council of Ministers of the Environment (CCME) ordered that a management plan be drawn up specifying how NOx and VOC emissions were to be controlled. In November 1990, the CCME approved a plan in principle and established a target for the concentration of ground-level ozone of no more than 82 parts per billion for all regions of Canada by the year 2005. The targets, however, are not being met in the Lower Fraser Valley, the Quebec-Windsor Corridor, and the Southern Atlantic Region. Government regulations have not resolved the air pollution problem significantly. In spite of the evidence to the contrary, B.C. Energy Minister Anne Edwards promised that emission targets would be met through regulatory steps if voluntary compliance fails to yield results. Pricing as a policy instrument, however, is not being considered, but it should be.

Instrument choice: congestion pricing

Pricing the use of a common pool of resources holds two major advantages. First, if applied properly, pricing is a more effective way to regulate than the command and control method. If we charge for emissions, those who produce them get a clear signal, and they can adjust to that signal. If the charges are moderate, equally levied per amount of pollution produced, and directly applied to the one responsible for the emissions, then the efficiencies are, in principle, much greater than with command and control measures. The endless process of hearings and workshops, permits, waivers, fines and penalties are eliminated. Second, pricing helps build markets. It is the mechanism that brings producers and consumers together so that they may engage in mutually beneficial transactions.

The mechanics of congestion pricing

The logic of congestion pricing is simple and compelling. People who drive during rush hours inflict more delays than if they drive at non-peak periods, and consequently create more emissions. The incentives they receive to not overload the roads (and the air) are too weak to keep them from driving. Some peak-hour drivers will continue to drive at peak hours unless there is an additional cost imposed through the pricing system. Only if the costs of pollution-creating activities are imposed directly, so that individuals can clearly see the connection between an activity and its cost, can we hope to significantly reduce the occurrence of those activities.

Preventing traffic spillover

Significant smog emission reductions can be achieved only through a synchronous congestion pricing scheme that fosters time shifting, not route shifting. A coordinated congestion pricing network of tollways would discourage traffic spillovers from route shifting, which would transfer and not relieve congestion. According to a Brookings Institution study, a widespread change in the timing of commutes would relieve traffic congestion by as much as 25 percent and lead to a decrease in emissions. Time shifting can be encouraged most strongly by introducing pricing systems on analogous routes.

Specific benefits of congestion pricing

That congestion pricing will improve air quality is certain. By how much it will improve air quality is, admittedly, uncertain. Michael Cameron of the Environmental Defense Fund estimates that in California by the year 2000, congestion pricing would decrease vehicle trips by 12 percent, increase average vehicle occupancy to over 1.5 people per car, decrease daily travel times, and reduce carbon monoxide emissions by 23 percent.

Congestion pricing promises to increase mobility significantly by means of market incentives. Charging the true cost of road use will result in increased ride sharing, time shifting, and freeing up main arteries during peak hours. Congestion pricing will also foster more frequent use of public transit and will encourage transit firms to extend their services to new areas. Therefore, considered from the dual perspective of transportation and air quality, congestion pricing offers definite advantages.

The evidence and conclusion

Empirical studies of congestion pricing indicate reductions in traffic of between 10 percent and 25 percent in major U.S. and British cities. Peak period traffic reduction projections for Hong Kong range from 9 percent to 20 percent with a $2.00 a day charge for a typical commute. And in Singapore, a $2.50 toll per day was followed by a 69 percent reduction in peak traffic over four years. Thus, both analyses and test cases show that congestion pricing significantly diminishes congestion during peak hours and reduces air pollution. In short, congestion pricing is a "win-win" compromise between economic development and environmental interests.

Bibliography

"Warming up to a green initiative," B.C. Report, October, 31, 1994, p. 20.

Cameron, Michael, Efficiency and Fairness on the Road: Strategies for Unsnarling Traffic in Southern California (Oakland, California: The Environmental Defense Fund, 1994), p. 16.

Cameron, Michael, Improving Transportation Efficiency in the South Coast Basin: Alternative Strategies for Restoring Air Quality and Mobility (Oakland, California: The Environmental Defense Fund, 1994), pp. 16-17.

Claremont Institute, The, Prices or Bureaucracy: A Plan for Mobility and Air Quality, (Claremont, California: The Claremont Institute, 1994), pp. 1-8.

Doern, Bruce. ed., Green Diplomacy: How Environmental Policy Decisions Are Made, (Toronto: The C.D. Howe Institute, 1993).

DiLorenzo, Thomas, "Does Free Enterprise Cause Pollution?" Across the Board, January/February, 1991, pp. 34-41.

Environment Canada, Canada's Green Plan: The Second Year (Ottawa: Ministry of Supply and Services, 1992).

Hilborn, T.H. and M. Still, A State of the Environment Report: Canadian Perspectives on Air Pollution (Ottawa: Ministry of Supply and Services, 1990).

Small, Kenneth et al., Road Work: A New Highway Pricing and Investment Policy (Washington D.C.: The Brookings Institution, 1989), p. 94.

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