Is Newfoundland a Petrostate? Part Two

It is instructive to use gross domestic product (GDP) as a means of evaluating whether Newfoundland and Labrador (NL) has become a rentier state. Let us compare across countries with firmly established rentier economies and analyze what share of GDP oil development constitutes: Saudi Arabia and Oman with 55 and 42 per cent, Venezuela at roughly 30 per cent, and Russia with close to 20 per cent. In NL, oil production accounts for 37 per cent of GDP. One additional characteristic of rentier economies is the small proportion of the labour force involved in the rent-generating industry, which, in NL, accounts for 5.4 per cent of all jobs.

Revenue derived from a particular rent-generating industry is another metric that one might use to analyze whether rentierisme has afflicted a particular jurisdiction: rentier governments depend heavily on resource revenues to fund programs and institutions. Indeed, the rapid influx of revenue from the rent-generating industry often encourages governments to adopt generous policy platforms. In the four rentier economies listed above, oil royalties as a share of total government revenue is 93, 45, 45, and 52 per cent, respectively. In NL, the provincial government derives 37 per cent of its revenue from oil royalties, reflecting the provincial government’s dependence on natural resource royalties.

These metrics seem to suggest that NL has become a rentier state, however, there are other elements that help determine whether that is the case.

The most common economic phenomenon associated with rentierisme is the deleterious “Dutch Disease,” which I described in an earlier blog post about NL’s experience with resource extraction. According to Kimble Ainslie, however, NL is not necessarily experiencing a “crowding out” of other industries or a decline in manufacturing employment. “Dutch Disease” typically occurs in an economy with a large non-resource sector, but NL’s agricultural and manufacturing industries are relatively small, and much too small in scale to export in significant quantities. (Non-resource sectors in NL account for 15.7 per cent of all provincial exports and 3 per cent of GDP.) Nevertheless, one could argue that NL’s persistent dependence on singular, direct sources of rent has suppressed non-resource growth in the first place.

If NL is suffering not from “Dutch Disease,” it could be suffering from a “resource curse,”–chronic political underdevelopment and corruption associated with resource dependency–which has retarded the province’s political environment over the years. Although the “resource curse” typically affects poor, developing countries, some aspects of it appear in NL. One consequence of lucrative resource rents, for example, is excessive, irresponsible government spending and NL is no exception: government after government in the province is guilty of increased spending habits and expensive social programs, not to mention public sector wage increases, etc. Furthermore, rentier states will earmark large, often dubious, public projects (read: Muskrat Falls).

Crowd-pleasing spending policies are commonplace in populist, single-party resource-rich states. Although a far cry from the petro-populism of Venezuela, the continuous rule of the NL Progressive Conservative Party, whose electoral victory roughly coincides with the beginning of the province’s oil boom, is intriguing. According to Reid and Collins, for example, former Premier Danny Williams used the oil issue in NL for political grandstanding and the demonization of his opponents.

Further to the aforementioned aspects of rentierisme, the most important long-term consequence of a rentier economy is a lack of incentive for diversification and long-term thinking, both of which result in economic vulnerability. Many Gulf countries have found it difficult to diversify away from the oil and gas industry, and with dwindling supplies in many of these states, in addition to the plummeting price of oil, the future looks grim. Thankfully, NL is less dependent on oil revenues, but, in the words of Finance Minister Ross Wiseman, recent budget shortfalls have one reason “… and that reason is oil.” Moreover, the provincial government has paid little attention to establishing a sturdier, more diversified source of revenue and it has had to make serious spending cutbacks.

In essence, although NL is heavily dependent on oil, and historically, single sources of revenue, it is not quite a textbook petrostate. The share of revenue and GDP resulting from resource rents is very high, but the effects of “Dutch Disease,” high levels of corruption and (serious) mismanagement, dysfunctional or authoritarian politics, and other ills commonly found in less-developed countries are less apparent.

Yet, the provincial government walks a fine line. The economy, albeit growing, does not seem to be diversifying. In addition, spending fell to reflecting falling oil prices, but per capita public debt remains the highest in Atlantic Canada, and as soon as rents begin flowing anew, spending will likely rise. In that case, and if government fails to encourage economic diversification–thereby continuing to place all of its proverbial eggs into one oil-slicked basket–the provincial economy faces the serious risk of economic decline.

As a matter of common economic sense, establishing a form of sovereign wealth fund (SWF) would benefit the provincial government in NL, and most importantly, the taxpayers who reside there. Liberalizing certain industries would also help them diversify and a more reserved approach to the oil and gas industry would eliminate the excessive emphasis on offshore oil. Finally, and perhaps most importantly, fiscal discipline is necessary and the provincial government must adopt measures that embrace it.

The future of NL’s aging population, and the younger generation there to support them, depends on the long term sustainability of NL’s economy. There is a lot to learn from the experiences of other countries with undiversified economies and the provincial government should take them seriously.

Leo Plumer is an AIMS on Campus Student Fellow who is pursuing an undergraduate degree in economics and political science at McGill University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies

Is Newfoundland and Labrador a “Petrostate?”

Falling oil prices have directed attention towards Canada’s oil-producing provinces, including Newfoundland and Labrador (NL). While lower gas prices should be a boon to most Canadians, Newfoundlanders look warily to oil’s plunging market price as a sign of harder economic times. In fact, the provincial government recently forecasted $916 million in the red–much higher than previously anticipated.

The provincial government in NL projected 2015 to feature surpluses and fiscal expansion. NL has been benefiting from oil exploitation for the better part of the last decade and has joined Canada’s club of “have” provinces in the wake of a veritable economic boom. Resource extraction can confidently be identified as the sole cause of this boom–as is the case in other provinces such as Saskatchewan–and with it comprising close to 37 per cent of provincial GDP, one may wonder if NL is a “rentier” province and victim to the associated “resource curse” that often plagues naturally abundant states.

Terry Lynn Karl’s influential work on the ideas of rentier states and the “paradox of plenty” provides insight into the case of NL. The former refers to a polity that derives a substantial portion of its revenues from indigenous resource extraction and sale, while the latter refers to the paradoxical effect of resource abundance: weak economic development and overspecialization in extractive industries, corrupt state institutions, and poor governance. Rentier states often suffer from “Dutch Disease,” i.e. when the manufacturing or agricultural sector in a particular country (or jurisdiction) declines in the face of rising natural resource exports, which results in rising wages and currency appreciation. Ultimately, this phenomenon makes exports from other sectors more expensive, weakening their competitive advantage. States like these are often awash with cheap money, encouraging patronage politics, populism and voter apathy à la “no taxation, no representation.” Dependent polities are much at the mercy of global markets, and their dependence on energy exports can exacerbate economic shocks. Moreover, governments in petrostates have little incentive to invest in long-term growth plans or economic diversification.

In Nigeria, for instance, oil wealth has often led to widespread corruption and nepotism, in addition to deterioration of institutional strength. In Russia, it has aided in authoritarian consolidation by Vladimir Putin, while the country is facing a recession as oil prices fall precipitously. Gulf Cooperation Council states also have massive youth unemployment and unsustainable entitlement schemes plague young monarchies struggling to diversify their economies.

Newfoundland has had a long history of dependence on singular sources of income. The fishery, for example, had long dominated the Island’s economy and continued to do so until the 1990s when it suffered a veritable collapse that devastated the province. Much like oil, global seafood markets were subject to flux and rested on global fish prices. Nonetheless, it laid the foundation for Newfoundland’s consistent dependency on external forces for prosperity, which reduces the incentive to develop human capital and diversify the economy. More damaging is that patronage and nepotism in the province became widespread. Eventually, NL began receiving large amounts of federal assistance and, as Kimble Ainslie argues, a distinct political culture of dependency developed in the province.

Dependence shifted from federal money to oil rents as the wells began operating in the early 2000s. Under Danny Williams’ leadership, Newfoundland and Labrador’s coffers filled quickly–and public spending rose in sync–as the province’s economy began to boom. Infrastructural investments under Premier Dunderdale and social spending under Premier Davis did not slow as oil prices began plummeting. In response, the Davis government has abruptly cancelled proposed spending and the future is uncertain, but not necessarily dire.

The legacy and conditions for rentierisme are certainly there, but can one be sure that contemporary Newfoundland and Labrador really fits the petrostate bill? I will explore this question in Part Two.

Leo Plumer is an AIMS on Campus Student Fellow who is pursuing an undergraduate degree in economics and political science at McGill University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies

Atlantic Canada must make tough energy decisions

Over the course of the past decade, energy issues have become louder and louder in Atlantic Canada; today, energy policy has recently often been the single biggest file for governments in the region. With the Muskrat Falls megaproject, shale gas exploration, and the Energy East pipeline have come a number of decisions Easterners must make—these decisions will play a large part in shaping the region’s economic future.

Let’s first examine the Lower Churchill Project. The project is often simply referred to as “Muskrat Falls,” the waterfall that is being developed for electiricty generation. Muskrat Falls will be owned by Nalcor, which the NL government created in 2007 as a publically-owned electricity-market monopolist. Through its subsidiary NL Hydro, Nalcor has the sole right to supply and sell electricity in the province. And despite the fact that government’s Lower Churchill development plan includes the construction of a Maritime link that connects NL’s electric grid to the mainland’s without passing through Quebec, the NL government has severely restricted interprovincial trade.

By denying Newfoundlanders and Labradorians other electricity options, the province’s government has given Nalcor the power to raise its rates at a whim. This power allows for the construction of the Muskrat Falls project, which will cost $7.7-billion.Without its monopoly, Nalcor would not be able to pay for the project: many economists think the project in uneconomical. In fact, NL’s Public Utilities Board (PUB) could not conclude that the project was the province’s least-cost energy option, stating that there were “gaps in Nalcor’s information and analysis.”

Because of the project’s high costs, the NL government will have to borrow $5-billion—that is, nearly $10,000 for each of its of its residents. With these potential consequences for the both the province’s debt and its electrical rates and output, the NL government’s management of Muskrat Falls will have serious ramifications for the province far into the future.

Muskrat Falls also has ramifications for Nova Scotian energy markets. Emera, Nova Scotia’s publically traded energy corporation will cover 20 per cent of the Maritime link’s cost in exchange for 20 per cent of the electricity produced at Muskrat Falls. Further, Nalcor will be able to use Emera’s transmission rights to sell electricity in the Maritimes and New England.

New Brunswick (NB) faces an equally dramatic energy situation. Two issues dominate energy discussions in the province: hydraulic fracturing (or fracking) and TransCanada’s Energy East pipeline. Tests for shale gas, which NB Premier David Alward hopes will be extracted through fracking, have prompted locals to (often violently) protest. Fiscally, however, potential fracking revenues seem to be the NB government’s only way to pay for its current level of services without raising taxes or adding to the provincial debt, which is approaching $12-billion.

Although New Brunswick’s fracking debate has been Atlantic Canada’s loudest, shale-gas extraction proposals have also provoked argument in NL and Nova Scotia. Recently, the NL government imposed a moratorium on fracking until it has consulted the public and conducted reviews. Nova Scotia has had a fracking moratorium for about two years, though it is set to expire this summer.

New Brunswick can also expect to benefit from the construction of the Energy East pipeline, which will bring Albertan oil to Saint John’s Irving Oil refinery. The most noticeable gains from project will take place during its development and construction: a report by Deloitte found that the pipeline will boost New Brunswick’s GDP by $1.1-billion in this period. And during its 40-year operations phase, the pipeline project will add $1.6-billion to the province’s economy, though it will only directly create 121 permanent jobs.

With Muskrat Falls, NL is taking a significant fiscal risk and trapping consumers with the hope of becoming an energy power. Any jurisdiction that allows fracking must balance the benefits of increased economic activity and royalties with potential environmental harm and local frustrations. And the Energy East pipeline could give NB the sort of economic and fiscal boost it needs. Energy may enrich Atlantic Canada, but squandering it may breed regret.

Michael Sullivan is a 2013-2014 Atlantic Institute for Market Studies’ Student Fellow. The views expressed are the opinion of the author and not necessarily the Institute