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The Staple Theory at 50: Why linkages matter

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Photo: Mel Watkins

Winter is now officially upon us, and so it is time to conclude our autumn-long series of special commentaries marking the 50th anniversary of Mel Watkins' classic article, "A Staple Theory of Economic Development." To wrap up the series, I would like to throw my own views into the brew. I argue here that Watkins' identification of the importance of fostering stronger backward and forward linkages (or, in modern terminology, input-output spin-offs) is still a valid and important tool for Canadians to escape the renewed staples dependence which marks our economic trajectory since the turn of the century.

Stay tuned for a rejoinder to this series from Mel himself. And the CCPA will be publishing the entire set of commentaries as a stand-alone publication early in 2014. In a separate post I will also compile (for ease of future reference) links to all of the contributions to the series. Thank you for your interest in this project!

Mel Watkins' pioneering work on staples theory continues to help Canadians understand both the opportunities and the risks of our staples-dependant economic trajectory. After Mel's 1963 article, and his subsequent policy advocacy (on Walter Gordon's task force and other initiatives), it seemed for a while that Canada was gradually escaping its staples trap. We experienced decades of uneven but important progress in diversifying our sectoral mix, reducing reliance on incoming foreign direct investment, and building significant and globally successful clusters of tradable value-added industries (including auto, aerospace, telecommunications equipment, and some tradable services). By the turn of the century, raw and barely processed resources accounted for well under half of Canada's total merchandise exports -- the lowest in our history (Stanford, 2008).

Early in the new century, however, the logic of staples dependence reasserted itself. Inflated global commodity prices (especially for oil, some minerals, and agriculture) sparked major inflows of capital into expanded staples production in Canada. Exports of raw staples grew substantially (driven mostly by higher prices, and less so by higher quantities); profits in staples industries were enormous but volatile. At the same time, many value-added industries went into a long decline -- and that slide was not independent from the renewed staples boom. In particular, the petro-fueled 65-per cent appreciation of the Canadian currency (taking it from well below, to well above, its fair value within 5 years -- according to the Organization for Economic Cooperation and Development, the PPP value of the Canadian dollar (reflecting the exchange rate that perfectly offsets nominal price differentials) is 81 cents (U.S.) (OECD, 2013)), was a major cause of the decline that is still being experienced in all other trade-sensitive industries (including manufacturing, tourism, and tradable services). NAFTA and its still-unprecedented energy-sharing provision reinforced Canada's pigeonhole as energy supplier to the U.S.

By 2012, raw and barely-processed resources once again accounted for two-thirds of total exports. Yet, perversely, Canada's total exports declined by one-third as a share of GDP from 2000 through 2012 (with the decline in non-energy exports far outweighing the increase in energy exports). Incoming FDI doubled as a share of GDP compared to the mid-1980s -- reaching a higher level (34 per cent) by 2009 than when Watkins published his original 1963 article. The current account balance shifted from surplus to large, chronic deficit (adding an amount equal to over 3 percent of GDP each year to Canada's foreign debt). Even with high commodity prices, it seems, Canada cannot extract and export staples fast enough to pay for its imports of more sophisticated (and more expensive) goods and services. Productivity suffered from both the unplanned, boom-time nature of new investments (Stanford, 2011), and the inevitable decline in productivity that is normally experienced in resource extraction (as the most easily tapped deposits of non-renewable minerals are exhausted). The helter-skelter boom in staples industries (experienced most dramatically in bitumen) created economic opportunities in some regions, but many problems, too: including regional crises in housing, infrastructure, and labour supply; immense strains in our system of fiscal federalism; and a spate of environmental problems, both localized and global.

The most important of these, of course, has been the growth of greenhouse gas emissions from bitumen production. The industry trumpets important reductions in the emissions intensity of each barrel of produced bitumen, but those savings are overwhelmed by the rapid expansion of total bitumen output -- and the biggest growth in output is yet to come, according to forecasts which expect a tripling of bitumen production (to 4.5 million barrels per day) in the next two decades. GHG emissions from new bitumen production have blown the lid off Canada's Copenhagen targets (which were grudgingly accepted by the Harper government, even as it became the first government in the world to withdraw from the Kyoto Protocol). They have also squandered the GHG reductions achieved elsewhere in Canada's economy (such as through the expensive phase-out of coal-fired electricity generation in Ontario).

In short, the key features of the staples trap first identified by Watkins are all visible again in Canada today: A cozy compact between government and the staples-exporting industry (described in detail in Clarke et. al, 2013). Enormous, publicly subsidized investments in export-oriented infrastructure. Pressure to extract and export the staple in ever-larger volumes to amortize development and infrastructure costs faster. A cumulative reinforcement of the dominance of the staple as seemingly the only path to economic progress -- even as the risks of staples-reliance become increasingly obvious. Regional inequalities and tensions between staples-producing regions and the rest of the country. And weak spin-off effects (forward and backward linkages, to use Watkins' 1963 terminology) from the staples industries for investment, innovation, and capacity building in other parts of the economy.

One dimension of the modern staples problem that is clearly more important today than in 1963, is the environmental constraints and consequences of staples production. Resource industries have always confronted the natural environment more directly than other sectors of the economy, and a legacy of environmental degradation has always been a major downside of unthinking, unmanaged staples extraction. But the growing challenge of climate change means this dimension must be considered more centrally in our analysis of staples -- as Brendan Haley, for example, has done in this collection (and in his important 2011 article).

Watkins' 1963 article argued that pro-active policy interventions were required to break the self-reinforcing logic of the staples trap, and set the economy on course toward a more diversified and self-directed form of development. This strategy focused on carefully regulating the pace and character of staples development. Key planks in this policy strategy included:

- Recognizing and enhancing the forward and backward linkages of resource production, through which staples activity could translate into a more fulsome and well-rounded form of development (both quantitatively and qualitatively).

- Regulating foreign investment, foreign ownership, and foreign trade in the staple industry, for all the well-known reasons.

- Acting to foster investment and capacity-building in other value-added sectors of the economy (including manufacturing and services), so as to reduce the entire economy's vulnerability to future staple cycles and attain a more self-sustaining, well-rounded prosperity.

Watkins also explored the political economy of fighting for those kinds of reforms, recognizing in particular the confluence of power between staples producers, foreign capital, and a staples-beholden government that would pose a formidable (but not insurmountable) barrier to change.

I believe this reform agenda is largely valid in its application to today's most recent manifestation of staples-dependence in Canada. In particular, taking pro-active measures to strengthen linkages and spillovers from resource projects and other staples industries (at the same time as regulating foreign investment, and fostering a broad slate of other value-added industries) would be a powerful remedy for the current deindustrialization which is a devastating side-effect of Canada's 21st-century staples resurgence.

For example, in the petroleum sector, input-output analysis has indicated that the supply chain feeding oil and gas producers (including bitumen) runs mostly north-south (not east-west), stimulating huge business for U.S.-based manufacturers and other suppliers who provide the lion's share of inputs (equipment, supplies, and services) to Canada's petroleum industry. According to the Canadian Energy Research Institute, the spin-off economic benefits from bitumen production in Alberta are 5 times larger in the U.S., than they are in Canadian provinces outside of Alberta (see Clarke et al., 2013, pp. 80-81; and Honarvar et al., 2011). No better symbol of the weaknesses of the domestic linkages (and the failure of domestic policy to strengthen those linkages) could be provided than the case of Caterpillar. This U.S. machinery giant sells billions of dollars of equipment to Canadian resource projects (including bitumen mines), but closed its only Canadian manufacturing operations in 2012 and 2013. One was the ruthless closure of its London, Ont., locomotive plant (following a failed attempt to destroy the union there); the other was the less reported, but equally ruthless, closing of its non-union equipment plant in Toronto (where the workers were never even presented with a phony ultimatum to cut their wages in half -- the factory was simply closed). The expansion of resource investments, without a strategy to develop made-in-Canada supplies, inputs, and services, inevitably translates into a large and growing trade deficit in inputs. In mining equipment alone, that deficit now equals almost $8 billion per year.

Downstream, too, the expansion of raw petroleum production and export has not been matched by an expansion of Canadian capacity and production in value-added stages of petroleum upgrading, refining, and manufacturing (including petrochemicals). To the contrary, 10 Canadian refineries have closed since 1990 (two since the turn of the century), and others (including remaining refineries in B.C., Quebec, and Newfoundland) risk a similar fate. Integrated foreign producers would rather ship raw Canadian petroleum to their own refineries in the U.S. Industrial policy interventions in earlier decades (led by figures such as Peter Lougheed) tried to foster Canadian value-added activity in petroleum refining and petrochemicals; these ideas seem downright radical by today's standards. In contrast, federal and provincial policy-makers today mostly ignore the importance of Canadian upgrading, refining, and petrochemical manufacturing, claiming these decisions are best left to the cost-minimizing decisions of private companies (even if those companies are foreign-owned, and have a private vested interest in processing Canadian crude in their own foreign facilities. One exception to that trend has been the Alberta government's fiscal support for the new Sturgeon upgrader and refinery, scheduled to be completed in 2017.). The result is an unsustainable flood of unprocessed exports (including raw bitumen) that has depressed prices in regional export markets. The flip side of the coin is growing Canadian imports of refined petroleum products: incredibly, Canadian refined product imports now almost equal our own exports of refined products (which have stagnated in the wake of refinery closures, a stark contrast to booming upstream production).

In short, as a major petroleum producer, Canada is squandering the opportunity to generate additional jobs, incomes and exports from whatever amount of petroleum production we determine is appropriate (in light of both economic and environmental considerations). We need a pro-active strategy not just to closely manage resource extraction (for many reasons: including greenhouse gases, efficiency, macroeconomic stability, and economic inclusion), but also to maximize forward and backward linkages so that resource production can support (rather than undermine) broader economic development goals. "Less extraction and more value-added" is the motto that summarizes this effort. Applied to the petroleum industry, this approach would involve efforts to support Canadian machinery and service industries (and hence increase upstream inputs to resource projects), limit exports of raw petroleum, and mandate more made-in-Canada upgrading, refining, and petrochemical activity. This vision is consistent with the approaches that Canadian trade unionists and nationalists have taken to other resource industries in the past: such as demanding restrictions on exports of raw logs, in favour of Canadian wood manufacturing, or supporting requirements that fish caught in Canadian waters must be landed and processed in Canada, or requiring domestic milling and refining of minerals (like nickel and copper). The theme of maximizing Canadian value-added from our own resources, both to enhance the economic spin-offs from those resources, and to support the development of a broader range of economic capacities, is a progressive idea in Canada with a long pedigree -- and continuing relevance.

Some worry we should not increase our economic dependence on natural resource industries at any stage of the value-added chain. They are uncomfortable with efforts to maximize Canadian linkages (including secondary industry) related to resource production. They propose shrinking or even eliminating staple industries entirely (as in the case of demands from some organizations to shut down bitumen production altogether), rather than trying to regulate them and enhance their net benefits. I am skeptical of this approach for both economic and political reasons.

It is certainly true that the total scale of resource extraction needs to be carefully managed in line with environmental constraints. In the case of climate change, this requires Canada to adopt meaningful, binding greenhouse gas targets, and then to manage all resource extraction in line with those targets. (In that context, we obviously cannot allow the dramatic expansion of bitumen production currently imagined by the petroleum industry.) Once we accept that some resource extraction will occur, and that the resulting activity will be economically important, then we should endeavour to extract the maximum possible employment, income, and fiscal benefits from whatever level of extraction is permitted. Harvesting necessary inputs from nature is the first step of all economic activity (including services). We cannot imagine an economy without resource industries, and we certainly don't want to simply "outsource" that work to other jurisdictions (following NIMBY logic). We must conserve our use of natural resources; pursue sustainable resource stewardship; and build an economy in which primary production plays an appropriate, controlled role.

Emphasizing the economic benefits from closer regulation of resource industries (including initiatives to strengthen upstream and downstream linkages) will also be important in building political support (including in resource-producing regions, and from workers in resource industries) for a stronger regulatory agenda. We can rebut the claims of petroleum lobbyists and others that regulating resource industries would destroy jobs, by highlighting the opportunities associated with more made-in-Canada inputs, refining, and manufacturing. For example, Unifor (which represents 30,000 energy workers) emphasized this dimension (as well as environmental and First Nations concerns) in its strong opposition to the proposed Northern Gateway bitumen export pipeline -- which its estimates suggest would result in the net loss of 26,000 direct and indirect jobs in Canada (compared to upgrading and refining production domestically). That net job loss would be amplified many times over, if the full slate of export pipelines currently proposed by the industry (and opposed by environmentalists, First Nations advocates, and many trade unions) were to be approved. Considering the employment and production opportunities of stronger made-in-Canada upstream linkages (machinery, equipment, services, and other inputs to resource projects) would add even more jobs.

Arguing for "less extraction and more value-added" opens political space to win broader support for a progressive approach to managing our resources. To this end, Unifor is campaigning for a national energy and environmental strategy: a progressive vision that would combine binding caps on greenhouse gas emissions, close management of future production, respect for the legal and economic rights of First Nations, limits on foreign investment and export of raw resources, and deliberate strategies to maximize Canadian value-added at all stages of the supply chain. Norway's successful experience shows it is possible to manage resource wealth in a manner which enhances, rather than undermines, long-run economic and social well-being (see Campbell, 2013). Building a political coalition to fight for and win closer regulations on resource extraction, and active measures to maximize the benefits of resource industries, will require careful dialogue, activism, and trust-building between unions, environmentalists, First Nations, energy consumers, and other stakeholders.

My work as a Canadian union economist has been strongly influenced by the work of Mel Watkins, and those he schooled in the staple theory. The worrisome structural U-turn which Canada's economy has experienced since the turn of the century, and the resulting economic and environmental consequences of our renewed staples dependence, convinces me that those teachings are as relevant and insightful as ever.

A list of references cited in this article is available here.

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