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The Progressive Economics Forum

Dutch Disease on the Rideau

The following is another guest post by Robyn Allan:

A report recently released by the Macdonald-Laurier Institute claims Canada does not suffer from the Dutch disease. Unfortunately, the studies the authors draw on for this conclusion are riddled by it.

The Dutch disease is a situation where rapid export of a nation’s raw resources along with rising commodity prices inflates the domestic currency leading to a burden on other export sectors. The term was coined to describe the less desirable impacts associated with the development of the Netherlands’ North Sea resources in the 1970s.

Claim Based on Three Reports

The authors of the Macdonald-Laurier report rely on three papers purporting to model the impact of oil sands development and claim economic resource benefits trickle down to all provinces.

The papers are the Canadian Energy Research Institute’s Studies (CERI) No. 120 and No. 125 and the Wright Mansell Report filed by Enbridge with the National Energy Board as part of its application for the Northern Gateway pipeline project.

The Macdonald-Laurier Institute fails to mention CERI forecasts more benefits for the U.S. economy from oil sands development than for all regions in Canada outside of Alberta – 77 per cent more. It says “Ontario alone is projected to enjoy $64.9 billion” over 25 years, but compare that with a gain for the U.S. of $210.5 billion.

Macdonald-Laurier identifies the Wright Mansell prediction of higher prices for crude oil with Northern Gateway than without it, but fails to address the impact this will have on the Canadian economy when those higher prices are passed onto consumers and non-oil producing businesses – every year, for 30 years.

CERI and Wright Mansell make heroic assumptions about the value of the Canadian dollar and then, arriving at inflated projections, use an Input-Output model to further exaggerate benefits. When you dig a bit deeper, in fact, CERI is very clear it has the same concerns about the rapid expansion of oil sands production as do NDP leader Thomas Mulcair and Ontario premier Dalton McGuinty, who have both recently expressed concern about the Dutch disease.

CERI No. 125 relies on another CERI Study, No. 122, which states “there is a negative and statistically significant relationship between the Canadian-U.S. exchange rate and the price of crude oil . . . 78 per cent of the variations in the exchange rate can be explained by changes in the price of crude oil . . . Canadian goods and services become relatively more expensive to purchase with U.S. dollars, and Canadian exports to the U.S. decline correspondingly.” CERI says that, between 2004 and 2009, exports to the U.S. declined 23 per cent while the Canadian dollar appreciated 14 per cent.

CERI predicts by 2030 the Canadian dollar will be US$1.23 and by 2044 it will be two for one – yes a 50 cent U.S. dollar. CERI anticipates oil prices will rise to US$200 per barrel by 2044. When the price of oil goes up, so does the value of our petro-dollar.

The way CERI deals with the undesirable outcome is fascinating – it doesn’t. It assumes the Canadian dollar stays fixed while the price of oil rises. This overstates the industry’s ability to expand because it inflates oil sector profits. It also inflates the calculation prepared for use in the Input-Output model.

By stating almost 80 per cent of our currency is determined by our petro-dollar, CERI has overstated the severity of the Dutch disease, but if they are going to use rising oil price projections to force the benefits, they also need to use their exchange rate projections – they can’t have it both ways.

Wright Mansell go a step further. It assumes the Canadian dollar falls to 85 cents U.S. and stays there for 30 years, while letting the price of oil rise.

Flawed Model

Not only is the input developed for the economic model falsely inflated by unreasonable exchange rate assumptions, the model is incapable of dealing with an appreciating dollar. Whatever the underlying economic conditions that existed when the tables were derived, those are erroneously assumed to continue for the time horizon of the projections – 35 years for CERI and 30 years for Wright Mansell.

For example, CERI Study No. 125 uses Input-Output tables from 2006 when the price of oil was about US$58 a barrel and the value of the Canadian dollar was 88 cents. Wright Mansell relies on tables from 2005 when the price of oil was about US$50 a barrel and the value of the Canadian dollar was 83 cents U.S.

The Macdonald-Laurier Institute has failed to address the issue of oil prices and their impact on the dollar. The vast resource wealth of Alberta benefits all of Canada, but rapid expansion and export of raw bitumen with complete disregard to any downside, is hiding your head in the oil sands.

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Comments

Comment from Rod Smelser
Time: June 18, 2012, 9:04 pm

An interesting contribution to the public discussion around this issue.

A quite different viewpoint is published at Stephen F Gordon’s blog, where the basic bottom line is this:

Mr Mulcair wouldn’t be the first politician to reach the top of the greasy pole by exploiting interprovincial rivalries. But it seems to me that this is a remarkably irresponsible strategy for those concerned with climate change. The biggest asset that environmentalists have is their intellectual integrity, and they simply cannot afford to fritter that credibility away by cheerfully adopting an economic analysis they know to be wrong in order to advance their agenda.

http://worthwhile.typepad.com/worthwhile_canadian_initi/2012/06/blame-alberta.html#more

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