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The Progressive Economics Forum

Low Oil Prices, Good or Bad for Canada?

Unless you’ve been hiding under a rock somewhere, you’re probably well aware that the price of oil has fallen dramatically, to less than $50 / barrel. What this means for Canada’s economic output & labour markets is not yet clear. But Stephen Poloz at the Bank of Canada has said that he expects the effect to be “not trivial”, and suggested that it might lower the Bank’s GDP expectations by around 0.3 percentage points. Deputy Governor Timothy Lane’s talk on January 13th is good background reading on this topic, and overall he suggested that the effect will be at least somewhat negative for the Canadian economy. Other commentators have suggested that the lower dollar and the US economy’s pick-up will swamp any negative effects, leading to an overall positive effect nationally.

There are several reasons why I would side with the more pessimistic predictions. I also think that the policy response to a more pessimistic outlook is consistent with the policy response to medium and long term global constraints, such as climate change. Let me tell you why.

I’ve commented earlier on the Bank of Canada’s review of manufacturing capacity lost during the past recession, and the CIBC has put out a note on this as well. Avery Shenfeld and Andrew Grantham point out that significant capacity loss has been centred in manufacturing sectors that are sensitive to changes in the Canadian dollar (and therefore might be poised for a period of expansion). It takes much longer for business to respond to exchange rate signals when they don’t have existing excess capacity. Shenfeld and Grantham suggest that it could take several years of an 80 – 85 cent dollar before we saw a return to a vibrant manufacturing sector in southern Ontario. This is different than previous recessions, where Ontario had excess manufacturing capacity that could quickly respond to price signals.

Also, communities in Ontario and Atlantic Canada have depended on remittances from workers who either commute or move to Alberta for high -wage jobs in the tar sands or construction. These workers are likely to be laid off first, creating a drag on the economy that will be felt far outside Fort McMurray.

The other fear is that Alberta and the federal government will respond to lower revenues with more cuts, that will act as a further drag on economic growth. This would be the least effective response, but given current provincial and federal leadership, is also the most likely.

Rather than cross our fingers and hope for a manufacturing led recovery, I think that all levels of government, unions, and business need to think about what kinds of infrastructure we need to put in place to be ready for long term challenges. Governments especially should think about what kind of infrastructure would encourage new economic growth, rather than simply handing out funds to existing business.

A recent Nature paper suggests that negative economic impacts can be mitigated by taking early action on climate change. I think we’ve missed the boat on ‘early’, but sooner is always better than later. The earlier a jurisdiction can introduce a carbon pricing scheme (such as the one Ontario is expected to announce this year), the sooner businesses and individuals can adjust. This would give them a competitive advantage against firms in jurisdictions that are slower to respond to what is arguably an inevitable reality.

Let’s look forward to new challenges with new thinking. We’ll never dig ourselves out of the hole we’re in by using the tools that got us here in the first place.

Enjoy and share:

Comments

Comment from Larry Kazdan
Time: January 14, 2015, 7:40 pm

Talking about Australia’s loss of coal exports, economist Bill Mitchell comes to similar conclusions:

When fiscal policy is misrepresented
http://bilbo.economicoutlook.net/blog/?p=29477

“Peter Martin concludes that:

China’s coal use will have to decline in order for its greenhouse gas emissions to stabilise … [and] … Australia’s budget will be hit whatever China does. Less demand for coal will mean a lower price and lower tax revenue.

Aah – linking back to the fiscal discussion – in case you were wondering.

Using terms like “hit” are neo-liberal in bias. A ‘hit’ is a punch or a collision – and the underpinning metaphors are that it is bad – something we don’t want to happen.

A rise in the fiscal balance is not bad per se. It might reflect a deteriorating economy if unemployment is rising etc.

But the US-China deal has not detrimental implications for fiscal policy. It just means that the external deficit is likely to be higher and that means that the fiscal deficit will have to rise too to bridge the gap in spending that is lost as China stops buying our filthy polluting coal exports.

Simple as that.

It gives the Government the chance to really craft a new coal-free era where they invest in public renewable energy schemes to generate power and jobs and skill development and invest more in research and development and urban infrastructure and public transport and all sorts of other green initiatives.”

Comment from Paul Tulloch
Time: January 14, 2015, 10:29 pm

A follow up from out facebook chat today. There are several great unknowns at this point in the economy to know which way to call it- what is happening with the US economy, where will oil prices go, what is going on in other commodity markets, coppper had a major sell off today, what is happening in China, will the Eurozone be able to fend off the deflation that has set in, all these will have some impact on the exports we ride to economic health upon.

I am not sure Avery has the rational right- but he reaches the correct ends- that is we most likely will not see a similar rebound in manufacturing that we did in the 90’s with the low dollar beggar thy neighbour strategy economic growth. It is not that it will take years to set in- it more like there is not a lot of faith in the current government to intervene at any point with any kind of policy intervention with the dollar. And if as many think that the price of oil will rise soon- there will be even more risk on investors not to take advantage of the low dollar and layout some longer term investments. Mind you- we may see some short term go ahead in investments.

The other wild card is the housing market- can we manage this housing market and some of the expectations and market pressures that have built up. I for one blame a lot of this on the CMHC for not coming out with full disclosure in the public interest to bring in some factuals on these markets. How much of these markets are demographic shifts and housing needs changes, how much of the demand in these markets related to foreign investors or domestic investors who are speculating versus real demand and several other information issues that I do believe the CMHC has fallen down on and not displayed enough leadership with information and easing the angst out there. The last thing you want is a spooked herd and we are getting to a frenzy right now.

And lastly – I do not think the labour markets outside of the west have recovered as much as the headlines let on- from the recession- at least that is what some research is showing.

Also adding into this equation is the price of imports with a low dollar- I know we get savings in energy, but we trade that off with the lower dollar and the cost of imports rising. So potentially the consumer boon that many state with the lowering dollar is not as significant increase in demand.

Overall I think it is a positive for the long run of the economy to get off this dirty oil, resource extraction economy.

Comment from Angella MacEwen
Time: January 15, 2015, 9:58 am

Great comments. Sometimes I think I’ve said something clearly, and I re-read it and realize that I haven’t. Even though I’m pessimistic about manufacturing, I do think that low oil presents a clear opportunity to motivate Canada to build a new, better, non-oil based economic future. I don’t think the conservatives will do that, but they won’t be in power forever (right?).

Comment from Ron Waller
Time: January 15, 2015, 3:39 pm

Both the housing and bitumen bubbles had to pop sooner or later. Sooner is certainly better than later.

Hopefully this storm will be too long to ride out and northern Alberta is turned into a subterranean rust belt.

It’s absurd how the tarsands turned Canada into a petrostate with a petrodollar. Before 2003, the price of oil had no effect on the dollar. But since then the dollar has risen (by 60%) and fallen along with the price of crude. Given the proper value of the dollar is 81 cents based on PPP (according to the OECD,) the “weak” 84-cent dollar is still overvalued.

My prediction: even if the dollar dropped back to 65 cents we still wouldn’t see a big export boom like in the latter half of the 1990s. That’s because the US economy is in the midst of a very long-term slump like Japan.

The Great Moderation, brought about by heavy handed 2% inflation targeting, brought back boom-to-bust business cycles. The first one was the dot com bubble, which required 1% interest rates after it burst. That was followed by the housing/derivatives bubble, which required 6 years of 0.25% interest rates plus trickle-down helicopter money on the heads of crooked investment bankers.

So the US economy is running on nothing more than faint hope and copious amounts of borrowed money. Soon as the Fed raises interest rates another bout of illusory prosperity will be rudely awakened. (Not that the New Classical and New Keynesian monetarists who caused the mess will even think to question their economic models.)

The US desperately needs another FDR. Hopefully someone like him will emerge after the next meltdown. One can only shake their heads at the utter lack of leadership on the economy from pretend liberals. After 35 years of disastrous free-market ideology, they are moving further right.

Comment from Darwin O’Connor
Time: January 15, 2015, 3:51 pm

“So the US economy is running on nothing more than faint hope and copious amounts of borrowed money.”

Don’t all countries with a fiat currency run entirely on borrowed money and the economic slump is caused by people not borrowing enough money?

Comment from Ron Waller
Time: January 16, 2015, 9:33 am

“Don’t all countries with a fiat currency run entirely on borrowed money and the economic slump is caused by people not borrowing enough money?”

True. The process of borrowing money creates money, economic activity and jobs in a virtuous cycle. Over time, wealth, productivity and economic development grow at an exponential rate.

People want to borrow money to buy things like houses and cars. People in business need money to develop new goods and services that benefit the public.

Banks (including credit unions) are in the business of holding illiquid assets (hard to convert to cash) in exchange for cash in the form of loans. When someone borrows money from a bank, the bank creates the money. Of course, the bank is on the hook for the loan. If the loan defaults, the bank loses the money from its profits.

That’s how a market economy works. It may not be ideal, but like democracy, it’s the best of all worse alternatives.

The problems we are facing now are unrelated to the system itself. The problem is growing income and wealth inequality over the past 35 years due to failed right-wing free-market reforms. These allowed a small minority of people to hog up all the benefits of economic and productivity growth.

Declining real wages and benefits for most people meant people had to eventually borrow to maintain living standards in decline.

All these policy failures brought about another economic collapse. (The first happened during the Great Depression in the 1930s.)

The solution, then as now, is a return to the centrist Keynesian mixed-market economy that created modern living standards in the post-war era.

Comment from Pearce Tournier
Time: January 16, 2015, 2:29 pm

Good stuff all round! I should be interested to hear opinions on:

1) To what extent, looking back “after the fact”, can one say that the lack/hollowing out of central Canadian manufacturing capacity that we have long been warned of was a) due to a resource trap due to overexploitation of the oil resource, or b) the Great Recession and weak (especially US) demand for Canadian exports; or c) low-cost Asian competition, a more global supply chain and stiffer competition from U.S. rivals?

2) The effects on different Canadian regions of the collapse in copper prices, along with declines in Chinese demand for iron ore, food and other goods. It looks like, for Ontario, that, on top of the challenges to ramping up manufacturing, investments in the Ring of Fire might be put on hold, and similarly, in Quebec, that Plan Nord investments may be affected.

Comment from Mike McCracken
Time: January 25, 2015, 1:50 pm

Over many years, we have simulated oil price changes and their effect on the Canadian economy.
Without exception we have found positive increases as a result of lower oil prices.
The channel often ignored is the effect of lower oil prices on our major trading partners. The US, Europe, Japan, and China will all benefit from lower oil prices. Canada’s exports will do well, aided by the lower Canadian dollar.

Comment from Angella MacEwen
Time: January 25, 2015, 8:23 pm

I didn’t ignore exports, I think the situation has changed dramatically from previous recessions. See, for example: http://www.cme-mec.ca/?lid=JCKNC-E742G-1W6JA&comaction=show&cid=V6YP9-SYJK8-R4MBH

Comment from fjf
Time: February 11, 2015, 5:43 am

I am always late to comment but I wanted to throw in my 2 cents as I have experience in the oil industry.

First, I believe we have not yet seen an oil price bottom. In the oil industry all the capital costs are upfront. Once you develop the well the oil flows of its own accord as the Deepwater Horizon blowout clearly demonstrates.

What this implies is that every producer country will see a drop in income due to the reduced price per barrel. And each producer country will be incented to make-up for this reduced revenue by increasing production volumes. Note that every producer is inclined to act in the same way. This implies that there will be a growing production surplus and economics tells us that this will result in a continual drop in prices until the market clears or the the most expensive producers drop out of the market. The middle east has the lowest production costs. Alberta and deepwater offshore are at the high end of the scale.

Second, with oil at $50 a bbl Saudi Arabia will be running a significant budget deficit. The need a price of $100 a bbl to match their social spending.

What is clear is that there will be a decline in ME petrodollars available for reinvestment in the G8. The ME countries will need to finance their deficit spending and it is likely that they will do so by liquidating their investment portfolios. Again, these financial reserves are held in the G8 countries.

How these effects reverberate through the global economy remains uncharted. London real estate values will take a hit. Global liquidity will be impaired. Central banks will all participate in a race to the bottom through various forms of QE and or negative interest rates. And stock market valuations, already at an unreasonable high, will likely collapse.

In a number of ways the current situation bears similarity to the period of the 1929 crash. The one significant variable is the possibility of a wider conflict in the ME to take production off the market. My hunch is that this is a very likely outcome.

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