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Failing grades: The Canadian resource economy -- Part 1

Many Canadians understandably chafe under the designation of "hewers of wood and drawers of water." Yet geography it what it is and our country is blessed with energy resources, minerals, forests, arable land, and fisheries. This richness of natural resources should and does not constrain the developmental vision of Canada. For instance, counter to any expectation or intuition, the Canadian based Cirque du Soleil has become one of the world's foremost exemplars of nouveau cirque, almost single-handedly transforming the fast-vanishing circus tradition from a fading and tawdry showcase to a leading vehicle for the imaginative performing arts -- who would have imagined it? Properly employed natural resources can not only be an enormous asset, but can also pave the way for a robust, diverse, and resilient Canadian economy.

Onto the scene arrives a striking new study entitled The nine habits of highly effective resource economies: Lessons for Canada published by the Canadian International Council (CIC). Well-researched and clearly and effectively written by Madeline Drohan, the Canadian correspondent for The Economist, it points out what Drohan feels are nine key opportunities to leverage the resource economy of Canada to become a resource superpower. A closer reading of these also reveals that in almost all instances federal and provincial governments are largely missing the boat to a sustainable resource economy and attendant prosperity, if not paddling hard against the current of what other successful countries have learned.

In this, the first of several articles that examine the implications of CIC report, I'll focus on Habit # 1: Save Your Money (Think Sovereign Wealth Fund).

The first concept to understand about natural resources is that that they ought not to 'belong' to anyone, or rather that they belong to everyone. And properly speaking not, just to humans, who have acquired the power and hence assumed the responsibility for managing them, but to all sentient beings. The living creatures of this earth are our co-denizens and we should (if we are moral beings) acknowledge that they have a right to their own existence in the natural world, quite apart from human desires to employ and exploit it. As such we should consider ourselves stewards of the natural world.

The second point to grasp about non-renewable natural resources (and this CIC report draws examples principally from the energy, mining, and forestry sectors) is that they don't, properly speaking, belong to the contemporaneous "us" at all. Fossil fuels and minerals are a one-time special. When they have been exploited, that's it, they're gone. As such, they are part of a trust that we need to use sparingly and wisely, bequeathing as much as possible to future generations. To make a run on this bank today leaving nothing for our children's children's children would be the height of intergenerational irresponsibility.

Yet these two fundamental ethical principles of natural resource management are routinely and wantonly ignored -- if they are even acknowledged at all -- by political administrations in Canada (and in other jurisdictions as well). Their natural and logical corollary should be to regard natural resources as capital assets, and when such assets are monetized through extraction and processing, they should then be invested rather than spent. Drohan quotes former Liberal industry, international trade, and foreign affairs minister David Emerson on this point: "We are mismanaging our fiscal position because we're using the monetization of an asset, which should be an intergenerational asset, to maintain a high-level of ongoing permanent expenditure."

What's wrong with this? Just about everything. In the case of petroleum revenues in Canada (chiefly from Alberta), this has certainly made a substantial contribution (54 percent of the manufacturing employment loss) to the development of Dutch Disease [the appreciation of a currency based on revenues from one economic sector (usually a natural resource) so as to undermine the international competitiveness of other aspects of the economy (for example manufacturing and tourism)], a situation I discussed in some detail in Dutch disease denial: Inflation, politics, and tar. It squanders what should be a wisely invested asset, appreciating in value, available for strategic initiatives (see below), on economically distorting and useless measures such as (in the case of Alberta) the elimination of a provincial sales tax. And all of this is given salience by the inescapable fact that non-renewable resources will eventually -- by definition -- run out. If you have not saved for the rainy day when boom turns to bust (and there are many reasons this may come to pass, from resource depletion, to market fluctuations, to technological change that diminishes the demand for the resource) then you are up the proverbial creek without a financial paddle.

The CIC report points out that every Canadian province and territory (save for Prince Edward Island) derives significant revenues from energy, mining, and forestry resources (a sizeable proportion of which are non-renewable in the case of energy and minerals). So how does Canada rate internationally in terms of establishing sovereign wealth funds? Drohan quotes Jock Finlayson of the Business Council of British Columbia: "Most economists would argue that at least a portion of non-renewable resource revenues should be saved. Here, Canada's record can only be described as lamentable."

Sovereign Wealth Funds

A comparison with Norway is particularly germane for Canada. The Petroleum Fund of Norway (now called the Government Pension Fund of Norway) was established in 1990 as a financial vehicle for oil revenues from its North Sea oil reserves. All the countries oil revenues flow into the fund and the only permitted expenses are financial transactions related to petroleum activities. The only draw on the account is to balance the state's non-oil budget deficit which can be no more than 4 percent of the fund's return on investment. By making sizeable investments outside the country (and there is an Ethical Council which determines what such investments will be, excluding, for example, companies that manufacture arms and sell tobacco), currency appreciation has been kept to a minimum and the country has avoided Dutch Disease. The government has resisted raiding the fund for short-term objectives and despite the name "pension fund" no political decisions have been made as to how its assets may be used in the future and it has no formal pension liabilities. With a current (2012) value of US $617 billion (one percent of global equity markets) the Government Pension Fund of Norway is now one of the largest of its kind in the world, and the largest stock owner in Europe.

The parallels with Alberta are striking. In 1976 the Alberta provincial government established the Heritage Savings Trust Fund, and for a decade 30 per cent of province's oil and gas revenues went to the fund. Contributions, however, ceased in 1987. Since then the province has been a) spending oil revenues like a drunken sailor on infrastructure and other programs; b) has been drawing interest out of the fund and plowing it into general revenues; and c) has no policy directed at investing resource revenues in foreign assets.  In other words, the Alberta government has done everything in its power to inflate the value of the Canadian currency, and the fund's current value is only $15 billion, 2.4 percent the value of Norway's, which was established 14 years later. Rather than a colossal nest egg, the Alberta government has scarcely more than a goose egg.

The province of Quebec has also made a modest step in this direction with its Generations Fund established in 2006 into which funds drawn from hydroelectric royalties, sales of electricity outside of Quebec, and hydraulic power leases have been deposited. Its current value is $4.3 billion. No other province has a sovereign wealth fund, nor does the Canadian government. Drohan points out that non-renewable resources such as potash and uranium on Saskatchewan, offshore oil and gas in Newfoundland and Nova Scotia, coal in British Columbia, and nickel in Manitoba make substantial contributions to the economies of those provinces, but none have bothered to save for a rainy day.

Rick van der Ploeg, the Research Director of the Centre for the Analysis of Resource Rich Economies at Oxford University in the UK has investigated economic mechanisms of managing the windfall profits of natural resources, most notably the failures of many governments to save a sufficiently high proportion of such revenues, and the impact this has had to their economies. The "resource curse" (a wide-ranging set of economic, social, and environmental problems beyond simple Dutch Disease) is a well-known affliction that affects many jurisdictions that develop natural resources. The resource curse causes a strong and significant negative effect on the per capita growth of the GDP of jurisdictions that have a booming resource sector. This malady is so well investigated that it is quantifiable: if the ratio of resource exports to GDP increases by 10 percent, the per capita GDP shrinks by 0.77-1.1 percent annually. The key here is that nations with a good institutional infrastructure benefit from resource exports, whereas those with poor infrastructure are adversely affected.

Indeed, van der Ploeg recommends that jurisdictions create not one, but three sovereign wealth funds to help address issues associated with the resource curse:

1. A Generational Fund which is untouchable in the short and medium term and saves for the proverbial rainy day after resources have been depleted;

2. A Stabilization Fund that can be drawn on when commodity prices drop and is topped up when prices soar, thus smoothing the economic (and social) volatility frequently associated with natural resource prices. Given the many global macroeconomic instabilities that the world currently faces, such stabilization funds are apt to be even more important in the future than they are at present;

3. A Parking or Absorption Fund is an economic vessel into which funds that one would like to target for investment or development can be "parked" until such time as economic or other infrastructure can be developed to intelligently "absorb" the funds. This is like a sponge that can hold funds on a pro tem basis so as not to rush an expenditure beyond the ability of the economy to wisely absorb it.

The CIC report recommends that the Canadian federal government (remember that the Canadian constitution specifies that provincial governments have jurisdiction over resources), "end the practice it began in 2007 of allowing resource firms to deduct for federal income tax purposes the monies paid to provincial governments in the form of resource royalties and set those funds aside for a national [sovereignty] fund."

What's the response been?

On October 12, 2012 Natural Resources Minister Joe Oliver simply nixed the suggestion (No sovereign wealth fund for Canada’s resources, says Oliver) maintaining, "If we aren't receiving those hundreds of billions of dollars, we would not be able to afford the same level of health care and same level of education and other programs. This is a crucial issue and to the extent that money is diverted from those programs, it's not available for those programs." This is, however, a transparent shell game, since the Harper Conservative government has gouged huge income streams out of federal revenues in corporate income tax cuts and cuts to the GST. Thus, rather than employing the sound economic measures proposed by Drohan, van der Ploeg, and others to deal with the fallout of Dutch Disease and the resources curse, Harper, Oliver, and company do just the opposite -- a situation guaranteed to exacerbate current economic imbalances.

The CIC report maintains that "the political will is lacking" in Canada to implement sound economic measures related to the management of resource revenues. However, as is clear from Oliver's response, the situation is even worse. A political will exists -- to do precisely the wrong thing.

[Part 2 in this series,is Raw deal: The Canadian resource economy.]

Christopher Majka is an ecologist, environmentalist, policy analyst, and writer. He is the director of Natural History Resources and Democracy: Vox Populi.

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