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To Diversify Alberta’s Economy, Start With Fiscal Policy

July 20, 2015
Pedro Antunes Pedro Antunes
Deputy Chief Economist and Executive Director
Forecasting and Analysis

Alberta’s economy is getting hit hard this year—we’re expecting a decline in economic activity and a softening in labour markets. Given the collapse in oil prices and severe cutbacks in energy-related capital spending budgets, a recession in Alberta comes as no surprise. It is also not surprising to see renewed interest in diversifying Alberta’s economy to reduce its reliance on the volatile energy sector.

Diversification talk comes in waves, especially when energy prices collapse. Proposals to encourage diversification, both in Alberta and other jurisdictions, usually take the form of tax breaks or subsidies. Targeting specific private sector industries in the hopes of significantly buffeting the effects of oil price shocks is possible in theory, but much harder to do in practice.

One immediate and practical approach is to turn to government. The provincial government could craft its fiscal policy to directly counter the cyclical nature of the oil and gas sector—be lean when times are good, and spend when times are bad. Unfortunately, history shows that policy often runs in the opposite direction.

During the late 1970s, mineral-fuel extraction directly contributed 44 per cent to provincial GDP. Today, that share is down to just under 25 per cent. But the real question is: Has the economy actually reduced its exposure to volatile oil prices? The answer: Not nearly as much as the shift in share of GDP would suggest.

The province’s oil industry has transformed over the years. Conventional drilling is being replaced by oil sands projects, which generate much more activity outside the extraction segment. Industries such as construction, business services, and some manufacturing have expanded in the province to help service the profitable energy sector and its high-earning workers. In many ways, the province has become even more integrated in the energy sector.

In comparison with energy and its supply chain, other industries in Alberta are minuscule. Agriculture, forestry, and their associated services collectively contribute less than 1.5 per cent to the province’s real GDP. The arts, entertainment, and recreation industry accounts for less than 0.5 per cent of GDP, while information and culture (which includes film production, among the highest-profile beneficiaries of tax incentives) contributes about 2.3 per cent. If oil prices firm up as expected, and if the world does not stop using fossil fuels, it’s hard to envision these non-energy industries (or others) growing faster than the energy sector—especially not enough to significantly alter the province’s economic structure.

Nevertheless, the provincial government can take a role in dampening the business cycle and promoting a more stable economy. First, royalty revenues and land lease sales should be taken out of the regular provincial revenue stream and placed in a sovereign wealth fund. Yes, Alberta does have a sovereign wealth fund, but not enough has been put aside. Given the expected impact of the recession on the government’s books, Alberta’s accumulated surplus—a paltry $17.9 billion—will be completely eroded over the next two years. This is disappointing from a province that has earned a cumulative $144 billion in non-renewable resource revenues since 2000. Alaska and Texas have amassed much more sizable sovereign wealth funds (each just shy of US$50 billion), not to mention Norway’s US$836 billion fund. Even North Dakota has put aside US$2 billion since fracking became viable in the Bakken field around 2007.

Adopting the approach of other jurisdictions would discourage the government from splurging potential excesses during prosperous times. Since 1980, the provincial government has generally acted in a pro-cyclical manner—spending above its trend levels at the same time as the economy was above its trend levels.1

A prime example of this pro-cyclical behaviour is the prosperity bonus—a payment of $400 per person that was made to every person in Alberta in 2006 ($1.4 billion in total, or 0.5 per cent of provincial GDP), at a time when the economy was already red-hot and inflation was accelerating. Those amounts aren’t available today.

It’s always easier to see what might have been done better in the past. And it is much more difficult to start a counter-cyclical policy when the economy is down. Spending now will mean bigger deficits in the short run, and more difficulty to return to balance down the road.

However, with economic conditions suggesting leaner times to come, the government should refrain from cutting back on programs or transfers; cuts would only deepen the downward cycle. Moreover, perhaps now is an opportune time to catch up on public infrastructure spending, given that private sector construction will likely take a hit.

While it’s useful to encourage diversification, Albertans should realize that their economic fate will continue to be tied to energy production and prices. A practical solution would be better fiscal policy.

Related Webinar

Reversal of Fortunes: Calgary and Edmonton 2015 Business Outlook Webinar
The Conference Board of Canada, September 15, 2015 at 3:00 p.m. EDT

1    There is a strong positive correlation between deviations from trend in provincial government spending and deviations from trend in nominal GDP.

 


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