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The Progressive Economics Forum

Going to the Wall in Defence of Mulcair

I have the following op-ed in today’s Saskatoon StarPhoenix:

Royalty hike cure for Dutch disease

Premier Brad Wall calls federal NDP Leader Tom Mulcair “very, very divisive” for expressing concern that Canada’s overvalued petro-dollar is eliminating manufacturing jobs.

In reality, Wall is being divisive by exploiting this legitimate concern to fan the flames of western alienation. Saskatchewan and other provinces would benefit by collecting more revenue from non-renewable resources, as suggested by Mulcair.

Wall and others are correct that the exchange rate is not the only factor reducing manufacturing employment. However, as noted by The SP’s May 9 editorial and Les MacPherson’s May 10 column, economic analyses from universities, banks and international organizations indicate that “Dutch disease” caused much of the particularly sharp decline in Canadian manufacturing employment over the past decade.

Much like the Netherlands in the 1960s, Canada’s currency has surged due to a fossil fuel boom. Between 2002 and 2011, the loonie’s average exchange rate skyrocketed to 101 American cents from 64 cents.

But while Canadian-based exporters are consequently receiving much less for their output, they are paying the same amount for their inputs. The Organization for Economic Co-operation and Development calculates that, in both 2002 and 2011, the loonie’s purchasing power in Canada (including imported products) equalled 81 American cents in the U.S.

Saskatchewan has itself suffered from this Dutch disease. Statistics Canada reports that, since Wall took office in November 2007, manufacturing employment has declined by 14 per cent in this province, compared to 12 per cent nationally.

Specifically, Saskatchewan lost 4,600 manufacturing jobs, including the closure of sawmills and pulp mills harmed by the overvalued exchange rate. Other provinces lost a further 231,300 manufacturing jobs during the same period.

MacPherson is correct that judicious saving and investment of resource income could alleviate upward pressure on our currency. However, provincial governments must collect the income before they can save or invest it.

The Saskatchewan Ministry of Energy and Resources’ most recent annual report indicates that it collected only $2.2 billion of revenue from $17.6 billion of non-renewable resource sales in 2010. Such low royalties allow private companies to reap super-profits by extracting publicly-owned resources.

The Canadian Association of Petroleum Producers’ most recent Statistical Handbook indicates that the industry sold $11.1 billion of Saskatchewan oil and gas in 2010, but paid only $1.8 billion in royalties and spent a further $6.5 billion on exploration, development and operations.

In other words, oil and gas companies made enough in Saskatchewan to immediately pay off all of their investments, with $2.8 billion of extra profit left over.

Foreign investors eager to get in on the action have been buying loonies in order to take over, or acquire shares of, Canadian resource companies. This inflow of foreign funds drives up the exchange rate, to the detriment of manufacturing and other Canadian-based export industries.

Ironically, since resources are priced in American dollars, the higher exchange rate further reduces provincial resource revenues in Canadian dollars. Saskatchewan’s recent budget estimates that each U.S. cent of appreciation in the loonie reduces non-renewable resource revenue by $34 million.

The solution is to increase royalty rates, which would moderate the flow of foreign funds into our resource industries and collect the public revenue needed for the provincial savings funds that MacPherson advocates.

Of course, if Saskatchewan did so alone, it would have relatively little impact on the national exchange rate. That is why Mulcair’s comments were directed at the unbalanced development of Alberta’s oilsands – a larger-scale giveaway of public resources.

But Wall is defensive because he has mimicked and even undercut Alberta by guaranteeing ultra-low royalties to the private corporations that extract Saskatchewan’s non-renewable resources. This policy would be short-sighted even if it had no effect on the exchange rate. Dutch disease, including a proportionally larger loss of manufacturing jobs in Saskatchewan than in the rest of Canada, is just another negative consequence.

Mulcair has articulated a balanced approach to resource development that would generate more public revenue, a more competitive exchange rate, and more manufacturing jobs. Saskatchewan is well positioned to help implement and benefit from this approach by raising provincial resource royalties.

Erin Weir is an economist with the United Steelworkers union, which represents workers in Saskatchewan’s mining and manufacturing industries.

Comments

Comment from Francis Fuller
Time: May 11, 2012, 4:57 am

There is a deeper irony here.

High exchange rates also have a negative impact on the earnings of the energy.

They purchase their inputs in CDN dollars but are forced to sell into a market priced in USD. During any period in which the fx differential favours the CDN $ the oil industry faces margin compression.

Add to this the fact that WCS sells at a discount to WTI of around $6 and WTI is itself priced at a discount to Brent (which represents the global market traded price).

Tar sands oil is the worlds most expensive oil. Recent tar sands developments have a marginal cost per bbl of around $80. Today’s WTI price is $96 per bbl. Add in the WTI – WCS discount and the producer margin is around $10 a bbl. And we need to remember that most AB producers are paying a negligible provincial royalty of 1%.

To re-frame all of this in short sound bite – the AB tar sands operations are marginally profitable and would likely be unable to support 1) a realistic provincial royalty rate (typically around 25%); 2) An fx rate in which the CDN $ is priced at a significant premium to the USD; 3) An increase in the Federal royalty as proposed by Mulcair.

What you are looking at in AB is socialism on a grand scale. The province has done everything in its power to bend over backward to attract FDI in order to see the development of the resource. The province benefits indirectly through the incredibly large volume of labour and other required inputs. The rest of Canada suffers due to the resultant distortions in the Canadian economy (my employer shut down our group and moved our work offshore due to the high CDN $. This was in the Ontario IT sector) and, to add insult to injury, the people of AB are constantly crowing about “capitalism” and how they are freewheeling entrepreneurs and so, so, much better than the rest of us.

They are not. Alberta has simply managed to create the largest industrial subsidy system in Canadian history. And, worse than that, they have managed to elect their own puppet as Prime Minister.

On a related matter, the IMF has a new working paper on “The Future of Oil.”

Comment from Michael Boudreau
Time: May 11, 2012, 5:58 am

Why are there not more Canadians pissed off about how much wealth is being extracted from under our feet with so little benefit to Canadians. Has there ever been a national analysis that looks at how much wealth was generated by our natural resources and how it was distributed. I’m guessing that might be a pie chart that could get some attention. I humbly suggest that as long as we remain ‘me’ focused (and this is a global issue) then little will change.

Comment from Darwin O’Connor
Time: May 11, 2012, 6:20 am

“Why are there not more Canadians pissed off about how much wealth is being extracted from under our feet with so little benefit to Canadians.”

That’s capitalism. Everyone knows that the only possible alternative is Stalinism.

Comment from Francis Fuller
Time: May 11, 2012, 6:49 am

Email to Dr James E. Hansen in response to his recent op-ed in the NYT:
http://www.nytimes.com/2012/05/10/opinion/game-over-for-the-climate.html


Dear Dr. Hansen:

Thank you for having raised the first warning over AGW. And thank you again for your recent comments in the NYT.

What seems poorly understood is the economic basis of tar sands extraction.

These resources are only marginally profitable. To encourage development the province of Alberta has reduced their royalty rate on tar sands production from the 25% rate in effect on conventional oil production to a 1% rate.

This lower royalty rate remains in effect until the producing company achieves full capital cost recovery.

In addition to this reduced royalty, producers have also been able to charge a carrying cost equal to the rate of return on the Canadian long bond. Many of these agreements were signed a decade or more ago when the Canadian long bond was returning 7% per annum.

What this implies is that the producing companies are able to generate a risk free rate of return on their capital investments of 7% a year, an excessive rate of return that is not available anywhere else in the world today.

In essence, what is taking place in Alberta is socialization for the benefit of the rich. The people of Alberta are in effect paying the oil industry an interest rate premium in order to ensure the development of a economically marginal resource. The province benefits indirectly through the excessive demand for labour and other inputs associated with a high level of foreign direct investment.

But the province fails to account for the myriad externalities associated with tar sands development. In addition to the global AGW effects these externalities include the destruction of regional habitat and deleterious health impacts on the native aboriginal population.

I recognize that these economic issues are peripheral to your concerns but I believe it important that they be made known.

I strongly suspect that there may be grounds to challenge tar sands development under the terms of the NAFTA treaty. This treaty prohibits selective government subsidy of industrial activity.

In the case of the tar sands, this subsidy permits the development of resource which is then sold into US markets where it is in competition with US oil produced domestically without benefit of subsidy. The producers in the province of Alberta benefit from an unfair competitive advantage derived from government subsidy. Producers in the US suffer from unfair competition due to foreign government subsidy.

As I am sure you will agree, all fossil fuel consumption makes a contribution to AGW. Based on your remarks in the NYT you will also agree that tar sands production makes a far greater contribution to AGW due to the amount of energy that must be consumed in the production process.

For the sake of clarity, I will declare my own interest in this topic. After 12 years with the largest global IT firm, my group was disbanded and our jobs offshored due to the rise of the Canadian dollar. This rise in the Canadian dollar is due to Canada’s emergent status as a “Petro State” and this rise has caused significant distortions in the Canadian economy and resulted in job loss in many sectors outside of the oil industry. Prior to this employment I worked in the oil industry.

Warm regards,

Comment from Alvin Finkel
Time: May 11, 2012, 11:12 am

The focus on oil extraction without any pacing of the projects (by now no political party in Alberta dares to call for staging of such projects)also makes the maintenance of a balanced manufacturing sector in Alberta impossible. In the last decade we’ve lost most of our packinghouses, Celanese, GWG, and Molson’s Brewery in Edmonton, among other employers. The uncontrolled exploitation of the oilsands creates short-term jobs but the long-term economic and environmental impacts get short shrift in Alberta despite the good work of the Parkland Institute, the Pembina Institute and others in doing excellent research on the subject and ringing warning bells. Unsurprisingly, even the provincial NDP was not willing to defend Mulcair’s statement though it could be reconciled in part with their call for more refining of oilsands oil within the province. We’ve just had a provincial election where the media and to a large degree the political parties did not want to raise issues about the fossil fuel industry. Big Oil rules here and it’s not surprising that Mulcair’s comments received only negative attention from Big Oil Premier Redford and the local media.

Comment from Purple Library Guy
Time: May 11, 2012, 12:54 pm

Increasingly I’m thinking a federal royalty floor would be feasible and cut the legs out from under race-to-the-bottom competition on royalties. I was just looking at the BNA act, which everyone says reserves all resource-related stuff to the provinces. But it doesn’t exactly. The section on taxation says

“92A . . .
(4) In each province, the legislature may make laws in relation to the raising of money by any mode or system of taxation in respect of
(a) non-renewable natural resources and forestry resources in the province and the primary production therefrom”

So it says provincial legislatures may make such laws. Which presumably means the feds can’t stop them or interfere with them doing so. But it doesn’t say the federal government can’t do it. And earlier it makes it clear that in general the federal government can tax whatever it wants; listed among federal government powers:

“91 . . .
3. The raising of Money by any Mode or System of Taxation. ”

So it seems to me that if the federal government legislated a floor to royalties such that the federal government didn’t interfere with provincial royalties but collected any extra left by the province up to the floor, that would be legal. And provide some much needed revenue . . . to somebody. If the provinces all respond by upping their rates to match (or exceed) the federal floor, then great. Those provinces are in a position to provide more services, make more equalization payments, invest . . .

It might be objected that it bypasses the spirit of the BNA act. Too bad. The spirit of the BNA act on resources gives the provinces too much power. We’d have fixed it long ago if constitutional change weren’t such a pain.

Comment from Dan Tan
Time: May 12, 2012, 6:57 am

Erin,

Are you on Twitter?
I put your name in and could not find you. If you’re not, please do get on. For good or ill, that’s where the press are.

I won’t go into it here, but I tracked this stuff during the last election…and you progressive economists were nowhere to be found. Anytime some important economic discussion came up, Mintz & Gordon were the only loudmouths reaching out to economically illiterate press.

Give the Twitterverse factoids & one-liners on a constant basis. Progressives need more than links to long reports & press releases.

Best,
Dan Tan

Comment from Ronnyjoejimbob
Time: May 14, 2012, 3:04 am

That is why there is now a conspiracy for depopulation of the planet. Check out Jesse Ventura and Alex Jones on utube.

Comment from Erin Weir
Time: May 14, 2012, 6:57 pm

Thanks for the encouragement, Dan. I’m @Erin_Weir

Despite being absent from Canada and from Twitter, I had an op-ed in The Toronto Star and got into The Globe and Mail a couple of times during the last federal election campaign.

PLG, I think the constitutional way to achieve your goal is through the federal corporate tax. Since royalties are deductible from taxable profits, lower royalties mean higher corporate tax payments.

But with a federal rate of just 15%, this dynamic is pretty weak. A higher corporate tax rate would increase the incentive for provincial governments to raise royalties to take advantage of deductibility.

Comment from Dan Tan
Time: May 14, 2012, 9:43 pm

Erin,

Sorry for the late reply…

I meant “nowhere to be found” on Twitter, not newspapers.

That’s where a lot of politically engaged folks are. These are the nerds & activists who are most likely to vote & influence the intentions of those in their immediate circles.

They can’t articulate strong economic positions on their own. So they rely on the declarations, charts, & fancy numbers only economists like yourself can generate. Folks latch onto those kinds of tweets like it’s currency.

The problem last election was that only worthless Mintz & Gordon bills were in circulation. It was like Zimbabwe, progressives really had no choice in the matter.

By having all you progressive economists on Twitter, the broader progressive community has easy access to positions/info when hot-button economic issues arise. They don’t have to wait for countless slanted editorials & wire reports before getting the straight goods.

Thanks for the effort,
Dan Tan

Comment from Larry Kazdan
Time: May 16, 2012, 4:37 pm

Letter to Editor, Edmonton Journal, May 16, 2012

http://www.edmontonjournal.com/news/exports+kill+jobs/6628677/story.html

Oil exports kill jobs

Re: “B.C. premier blasts NDP’s stance on resource sector; Mulcair can’t have it both ways: Clark,” the Journal, May 13.

Between 2002 and 2011, the Canadian dollar’s average exchange rate skyrocketed to 101 American cents from 64 cents. The loonie gained value largely because of a greater foreign appetite for Canadian assets, profitable due to the high price of oil and a boost from corporate tax cuts.

Canada is unique among major oil-exporting countries in having virtually no limits on foreign ownership of the non-renewable resource.

Today, manufacturing represents just 10 per cent of all employment in Canada, down from a peak of 16 per cent in 2000. Economic analyses from universities, banks and international organizations indicate that non-competitiveness as a result of higher exchange rates, dubbed “Dutch disease,” caused much of the sharp decline in Canadian manufacturing jobs over the past decade. From 2004-08, more than one in seven of those jobs, nearly 322,000, disappeared.

B.C. Premier Christy Clark and Prime Minister Stephen Harper purport to be good economic managers, but their rash promotion of unsustainable raw exports has greatly damaged our economy at the expense of workers across Canada.

Larry Kazdan , Vancouver, B.C.
© Copyright (c) The Edmonton Journal

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