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Booms, busts, and mantra about bitumen

Andrew Leach on a new report from the Pembina Institute and Equiterre


 

On Wednesday, the Pembina Institute and Equiterre released a report entitled Booms, busts, and bitumen: The economic implications of Canadian oil sands development.  The goal of the report, according to its authors, is to offer a broader view than the GDP and jobs numbers often found in reports from groups such as the Canada Energy Research Institute (PDF). Instead, the report succeeds in confounding the interests of Canadians with the interests of the manufacturing sector, re-establishing the debate over the Dutch Disease and aesthetic preferences for economic sectors (the Staples trap), before finally getting to really important issues like the volatility of the industry, the risks imposed by future GHG policy, and the combination of fiscal and regulatory policy leading to significant losses in realized value.

The report opens with a foreword from University of Ottawa economics professor Serge Coulombe. His opening paragraph states that, “Environmentalists don’t accept gross domestic product (GDP) as a complete measure of well-being in the same way that economists do.”  This statement is astounding. I don’t know of a single economist who thinks this way.  In fact, in Greg Mankiw’s Principles of Economics, there is a muti-page section which begins, “GDP is not, however, a perfect measure of wellbeing…” The section goes on to discuss things such as the value of leisure, the costs of pollution, the value of home production, etc. Consider the following quote: “Another thing that GDP excludes is the quality of the environment. Imagine that the government eliminated all environmental regulations. Firms could then produce goods and services without considering the pollution they create, and GDP might rise. Yet, well-being would most likely fall. The deterioration in the quality of air and water would more than offset the gains from greater production.” Including this quote, from an economist no less, in the Foreward to their piece immediately sets the tone for a paper more based on mantra than evidence.

The reliance on mantra continues with the focus on the Dutch Disease.  The Dutch Disease concept is very simple—oil and gas discoveries (or, for that matter, rapid growth in any industry) can cause resources to shift from other sectors, can increase net inflows of capital and net outflows of goods, and thus lead to exchange rate appreciations, and that these effects may combine to hurt other sectors of the economy such as manufacturing. Unfortunately, the Pembina/Equiterre report continues a tradition in this country of equating the welfare of the manufacturing sector with the welfare of Canadians.  The section of the report characterizing Quebec’s economy begins with, “Quebec has always had a strong manufacturing base, which has played an important role in the economies of both Quebec and Canada.” The entire first paragraph is not about Quebec’s economy as a whole, but solely about its manufacturing sector. For a report concerned with accurately measuring the benefits and costs to Canadians, this is an odd approach. As discussed above, GDP is by no means a perfect measure of welfare, but it’s likely a better measure of welfare than the manufacturing share of GDP or the profit margins of manufacturers.

I had the opportunity to comment on the Pembina piece before it was published, and one of my comments pointed the authors back to the original Economist article which they reference extensively. On the second page of that article, there’s an offhand statement which tells you all you need to know: “So, Dutch consumers are roughly 10% better off than they would have been, but companies have been able to compete only by paring their profit margins.”  Consumers being better off while profit margins shrink in industrial production does not seem like a traditional source of concern for environmental groups, but it permeates the report.

The Dutch, it turns out, also experienced some of the impacts Canadians are experiencing today. If you read a little further in the Economist article, it talks about Dutch average wages growing faster than those elsewhere, and about the impact of exchange rates on Dutch citizens’ purchasing power.  Of course, when they talk about higher wages, they’re framed as higher labour costs, and increased purchasing power is framed as more competitive imports.  If we’re concerned about the welfare of Canadians, perhaps citing an article which treats wages as a cost not a benefit isn’t the right place to start.

Image from Economist article on the Dutch Disease, November 26, 1977.

In the 1977 Economist article, the magazine worried that after the gas boom fizzled, the Dutch would, “again have to live on their wits.” This issue – the degree to which we can rely on the resource sector in the long term – permeates the last half of the report and raises some important questions.  Sadly, this section too is permeated with catch-phrases like the staples trap or the China syndrome, each of which again carry an aesthetic undertone of preference for manufacturing. We’re told to worry about the contraction of the manufacturing sector, the drag on non-commodity exports, the loss of US market share for Canadian manufacturing, and the like. Why?  We’re not really told why we should worry but we’re certainly to be upset that the downturn is hurting Ontario and Quebec while the new activity is predominantly in Alberta.

The report looks at provincial revenue volatility–an issue which we have come to know all too well in Alberta—which comes with volatility of resource industries. As the report notes, the C.D. Howe institute has shown that the volatility of Alberta’s government revenues was twice that of B.C., Saskatchewan or Ontario over the past 10 years. This presents important budgeting challenges, but is made needlessly catastrophic by poor management.  For a provincial government with a AAA credit rating, smoothing resource revenues through saving or borrowing should not be an issue. Unfortunately, the government’s approach has been to spend in the booms, exacerbating the inflationary pressures, and to cut in the downturns, again leading to a negative feedback loop.

The report highlights the impacts of resource sector cost inflation due to unconstrained development. As Albertans, we should be pressuring the regulator to perform more extensive analysis with respect to the cumulative economic impacts of new projects. With over 2 million barrels per day of production today, an increase in average operating costs of $1 per barrel across the sector could have an impact of $200-300 million per year on Alberta government taxes and royalties. We will get to a point where the inflation externalities imposed by new projects will lead to an overall loss of value of the resource to Albertans, and that should be front and centre in the regulatory process, but it isn’t.

Finally, the report addresses the so-called carbon bubble. The carbon bubble premise holds that approximately half of the worlds known hydrocarbon reserves will remain in the ground if we take world leaders at their word that they will act to keep global climate change below 2 degrees Celsius. This is an important issue for oil sands production, as oil sands remains at the top of the global supply curve for oil, with some of the highest operating and capital costs. If global GHG policies evolve in ways which disadvantage Canada, that impact would be borne disproportionately by our oil sands industry.  The International Energy Agency (IEA) released a report this week which shows that, under their chosen set of policies to reach this goal, global oil production (including natural gas liquids) would drop to 75 million barrels per day by 2035, a drop of 10% from current levels. Natural Resources Minister Joe Oliver and others frequently cite IEA reports citing oil production growth to 110 million barrels per day, but those forecasts are not consistent with statements from global governments including our own on meeting climate change goals.  Something has to give, and the Pembina/Equiterre report is right to highlight the risks this brings about for the oil sands industry’s future.

Overall, I think this report raises some important issues, but does not give those issues pride-of-place. Instead, it chooses to give a voice to mantra which confounds the interests of manufacturers and existing industries with the interests of Canadians and to unsubstantiated attacks on economists, all the while relying largely on reports produced by economists. We should be having a higher-level conversation about the costs of economic transitions, the potential impacts of carbon policies on important sectors of Canada’s economy and about how to manage resource revenue than we are. Let’s have those conversations. You’ll find a good starting points in the back half of this report, so I hope you make it that far.


 

Booms, busts, and mantra about bitumen

  1. “Environmentalists don’t accept gross domestic product (GDP) as a complete measure of well-being in the same way that economists do.” This statement is astounding. I don’t know of a single economist who thinks this way.

    How about instead of “in the same way” he wrote “to the same degree” ? Still offensive?

    Personally, I would EXPECT differences because you are dealing with two differing disciplines/areas of study. The real question being – how big is the overlap in the Venn diagram of economists and environmentalists? In both disciplines, some portion will operate outside of the common area, notwithstanding pronouncements, or writings of prominent individuals in each discipline.

    Btw, it doesn’t strike me that the debate about Dutch Disease is over, despite your links to a SG blog (where I commented as “Double Dutch”). Or references to a 36 year old Economist article. It seems to me, after Stephen Gordon published a paper in September 2013 at the U of C School of Public Policy (headed by tax specialist Jack Mintz) the same University of Ottawa economics professor Serge Coulombe published a paper the next month, October, 2013: The Canadian dollar and the Dutch and Canadian diseases http://aix1.uottawa.ca/~scoulomb/pages/Coulombe-Calgary%202013.pdf

    And I do seem to recall another subsequent paper by some think tank (can’t find it right now) that included a citation of the Gordon paper, suggesting his observations (during the run up or boom/transitional period) were entirely consistent with what would be expected with Dutch Disease. So, it seems to me the issue is not at all resolved, or a consensus has been reached, despite the fact that it has largely dropped off the political radar screen.

    Otherwise, very good blog highlighting some important issues, worthy of followup discussion.

  2. Anyone has a reference for this statement? “With over 2 million barrels per day of production today, an increase in average operating costs of $1 per barrel across the sector could have an impact of $200-300 million per year on Alberta government taxes and royalties. “

    • Simple math – 2 million barrels per day, so an increase in costs to each barrel would be $730 million per year in decrease to net revenue, which forms the basis for corporate taxes and (post-payout) royalties. At today’s oil prices, Alberta tax and royalty share of net revenue is about 40-45%, which I low-balled a little bit as $200-300 million.

  3. Canada needs an economic action plan for the 21st century. Going all in on resources is something out of the 19th. We need to be able to compete with developed countries in order to remain one. That means fostering a contemporary value-added economy. Competing with Russia and other developing nations for resource exports is a race to the bottom.

    The resource sector is not only a terrible performer in productivity (which according to the Conference Board of Canada is another threat to living standards,) the jobs they offer suck. They turn Canadians into migrant workers. The bread winners get shipped off to remote parts of the country to work in open pit mines, sending their paychecks back home to support the family.

    Canadians want and deserve good job and business opportunities close to home. We are much more than hewers of wood and drawers of bitumen. Let’s put our talents to good use!

    • The “media” who increasingly rely upon social media and twitter feed from some economists for their lede. The latter who are often slaves for more followers, and having views RT’d, and/or appearing as talking heads in the same media.

      Symbiotic.

      • Given your diligent reading of economists’ work, I guess the media might be on to something. We certainly seem to have commanded your attention, and appreciate your faithful following of our work.

        • Actually, it’s the other way around. The more the media followed certain economists, the more the need to study closer what they were saying, and attempt to show where the analysis may fall short using a different perspective. Often unwelcomed.

          • All clicks are good clicks. Thanks for reading.

        • “and appreciate your faithful following of our work”

          It’s a fallacy to suggest all economists are on the same page. Or what they do is a science. Economists, like everyone else, gravitate towards a particular position in the left/right economic political spectrum. That makes the economic debate more about politics than facts.

          Economists spin economic data the way pundits spin political stories. They can be just as agenda-driven. The debate between the Keynesians and free-market ideologues in the US is certainly mired in rhetoric. Unlike scientists, there’s little that can be agreed upon or established as an undeniable fact. The debate can devolve into personal attacks. Zombie hypotheses that should’ve been killed by the facts lumber along invincible to all reason.

          • You’re making the error of assuming that the entire discipline is represented by the small proportion you see on TV discussing GDP, jobs, and economic policy. It’s a common misconception. Regardless, glad to see you take the time to read my “agenda-driven spin”.

          • I’m talking about the debate on macroeconomic policy among economists. I read blogs like Krugman’s and Economist’s View as well as the business section of various news media. Not sure why economists at Maclean’s try to pretend all economists are of the same opinion on macro. It is clearly ridiculous given all the economic schools of thought…

            In any case, there is a wide divergence of opinion among economists on many Canadian economic issues as well: Dutch Disease, anemic productivity growth, the hollowing out of the middle class, etc.

          • Ron, I am not sure where you get the idea that I (or anyone else blogging at Macleans) think that all economists agree on everything. I can tell you that they will almost all agree on some things, including the notion that external costs reduce welfare and that GDP is an incomplete measure of welfare in part for that reason.

            There is also less divergence of opinion on the positive (as opposed to normative) aspects of the so-called Dutch Disease – has manufacturing share decreased? yes. Has the dollar appreciated as a result of commodity prices? yes. Has this exacerbated the decline of the manufacturing sector? likely. Most will agree on these. Where they disagree is on the way in which the manufacturing share of GDP translates into a good measure of welfare, and whether we should or should not undertake measures to correct this “disease”. They will also likely disagree on the costs associated with a so-called hollowing out of the manufacturing sector. The same is true in other debates. Economists have different preferences over what policies should be adopted, and might even have different views on what the impacts of certain policy interventions would be.

            Any other canards to throw our way today?

          • All of the above pretzel twisting is exactly what I was talking about in my original comment.

            Perhaps you are not familiar with the left/right economic spectrum. I shall spell it out to support my original point. 100% left is communism or full government control over the economy. 100% right is libertarianism; no government involvement in the economy. In the center is the mixed-market system created by Keynes during the Great Depression.

            In the post-war era, Keynesian macroeconomics dominated. As Nixon said, “we are all Keynesians now.” The past 30 years were founded on free-market reforms: trade liberalization, deregulation, tax cuts, spending cuts, “starving the beast.” (Financial deregulation caused the 2008 global economic meltdown we have yet to recover from.)

            So to say there is this “entire discipline” where all economists are essentially in agreement is patently absurd. Macroeconomics is so mired in politics, heated differences of opinion — and blunders — it can only be described as pre-Copernican. Unlike physics and medicine, macroeconomics has not evolved because it is a form of politics, not science. The worst economists are the ones who think their primitive ideological models describe reality.

          • Gee, thanks for the refresher on the history of economic thought. If you actually took the time to read my comments, rather than assuming what’s written and responding to that, you’ll see that I have never said that economics (or even macroeconomics) is a discipline where everyone agrees about everything. Also, keep in mind that the most important disagreements are not necessarily the ones you see in the blogosphere. Keep reading (or not reading) as you see fit.

  4. I may be wrong, but i think you’ve used the verb confound at least twice, when you were probably looking for conflate. English is hard for economists at times i guess.[ just my little joke]

    • I was using confound in an appropriate (although not its unique) sense: to mix up (something) with something else. If you prefer the Webster’s version, it’s described as, “to fail to discern differences between.”

      • Thx. I guess you [i] learn something new every day. I’ll have to get up a little earlier then i thought i might to catch you out.

  5. Of course the Pembina Institute is completely unbiased. LOL

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