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

Limits to Growth?

In studying economics, I encountered the “Limits to Growth Theory” (LGT), which offers an alternative perspective to mainstream economic theories dealing with development, growth, and financial behaviour. The theory suggests there are limited resources available and, without recognizing this, serious environmental degradation will occur. Following this logic, at current growth rates, and under current economic models, the planet will face grave problems unless there are changes to the status quo.

LGT is concerning for obvious reasons, however, it has flaws that are easily overlooked. It suggests that human behaviour is static, for instance, as opposed to dynamic. In addition, it assumes that current models cannot account for negative externalities, not to mention a failure to recognize the advent of environmentally friendly technology.

New developments, such as the hybrid vehicle, are an excellent example of how technological development responds to, and fights against, environmental harm. To offset rising fuel costs, for example, firms introduced automobiles that achieve higher mile-per-gallon ratios. Indeed, much of the increase in their popularity is also attributable to the substitution effect, whereby consumers seeks substitutes that save them money and align with their preferences.

In addition, LGT suggests that societies will deplete natural resources if growth continues at current rates. The Club of Rome, who was integral in the development of LGT in the 1970s, argued that society was nearing the end of its oil reserves. Citing “peak oil,” they asserted that declining reserves validated LGT. However, decreases in the supply of oil, combined with a global increase in the demand of oil, gas, and petroleum products, spurred natural resource development in areas that were once uneconomical to develop, such as the Alberta Oil Sands (not to mention that technological innovation made the extraction process more efficient).

The Club of Rome addressed the discovery of new oil reserves in a recent report, stating that, despite flaws in their earlier assumptions, natural resources are ultimately finite. While it is true that resources are finite, there is no shortage of examples where markets responded efficiently. In fact, economists proposed similar theories about copper and iron-ore to no avail. Competition, coupled with property rights, will compel individuals and firms to maximize the use of natural resources. Technological innovation can also bolster this process. In cases where consumers are unwilling to pay higher prices, they will seek substitutes, reducing the demand for petroleum products and stabilizing the supply. Furthermore, the “environmental Kuznet’s curve” hypothesizes a relationship between economic growth and environmental sustainability reinforced through demands for cleaner technologies, institutions that internalize externalities, and consumer willingness to support higher prices in favor of safer environments. This phenomenon is identifiable in developed countries, where the demand for cleaner technology is visible.

Ultimately, LGT merits consideration–everyone wants a clean and liveable environment. Despite this, however, the theory does not seriously challenge current economic growth models. It is true that resource depletion is a real risk, yet, due to technological innovation and the way in which markets respond to scarcity, the economy will continue moving along.

Randy Kaye 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

The Energy-East Pipeline: An Opportunity to Turn a Province Around

New Brunswick has been making a rare appearance in the national editorial pages and the prospect of natural resource development through the Energy East Pipeline has been the principal topic of debate. Some observers argue that this could be the province’s opportunity to turn around its fortunes, but, as always, there is opposition citing environmental problems, among others.

That opposition generally stems from the argument that Canada must end its reliance on fossil fuels and fears of possible oil spills in the future.

While environmental concerns are particularly important in all natural resource development cases, it would be irresponsible for any government (of any political stripe) to ignore the possibility for serious economic gains. This fact becomes very clear from an examination of the state of the New Brunswick’s economy and the stimulus the project could provide.

It is no secret that New Brunswick has faced serious economic problems since the 2008 global economic meltdown. In September 2013, Statistics Canada reported that the province faced a 10.7% unemployment rate, which is one of the highest rates in the country. In conjunction with this report, CBC reported in the same month that the province lost approximately a net 2,944 individuals to other provinces in 2012.

Although these are only two indicators of economic performance, they tell a story that New Brunswick is facing a major economic problem.

This brings forward the next level of discussion: How can the Energy East Pipeline help build the New Brunswick economy?

TransCanada, the company who wishes to build the pipeline, employed Deloitte to explore the economic benefits of the pipeline for Canada. Deloitte found that the pipeline would add the following figures to New Brunswick’s economy:

  • $2,799 million to GDP
  • S266 million in tax revenues during construction (6 years)
  • $428 million in tax revenues during the operation phase (40 years)
  • 868 jobs in development (3 years)
  • 2866 jobs in construction (3 years)
  • 385 jobs per year in the operations phase (40 years)

These large amounts of tax revenues could mean balanced budgets for New Brunswick and extra money to spend in other areas of government, such as education and healthcare. Balanced budgets will also restore investor faith in New Brunswick.

The pipeline would create jobs that would not only reduce unemployment, but also increase consumption. That will lead to more economic spin-off, meaning that individuals will be able to afford more and, therefore, will buy more goods and services creating even more jobs in turn.

In conclusion, considering the state of the New Brunswick economy, it would be reckless for the government not to consider the opportunities that could be afforded to the province through natural resource development: the numbers show clearly that there is an extreme potential for growth and the Energy East Pipeline could have serious economic benefits for the province.

Randy Kaye 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