Tags: Brian Lee Crowley, Business - Energy, Canada's Business, Macdonald-Laurier Institute, Oil and gas wealth benefits all of Canada, Robert Murphy

Oil and gas wealth benefits all of Canada – Part 1

June 13, 2012

By Robert P. Murphy
New York University
and Brian Lee Crowley
The Macdonald-Laurier Institute

OTTAWA, ON, Jun 13, 2012/ Troy Media/ – Recently a number of high-profile Canadians, including the Premier of Ontario, Dalton McGuinty, and the Leader of the Official Opposition (NDP), Thomas Mulcair, have disparaged the effects of high commodity prices and Canadian exports of such products because of their impact on the value of the Canadian dollar.

Many have linked Canada’s current experience with that of the Netherlands in the 1970s, which was dubbed the ‘Dutch Disease,’ referring to a situation where high commodity prices and exports lead to an appreciation of the currency, which in turn subsequently hurts other exports, particularly manufacturing. The Macdonald-Laurier Institute has commissioned a series of essays to explore the accuracy of this argument, the real effects of a high dollar, and the state of manufacturing and resource extraction in Canada.

This first essay in this series examines the benefits of the Canadian petroleum industry to provinces other than the oil- and gas-rich western provinces of British Columbia (BC), Alberta, and Saskatchewan. It turns out that citizens, businesses, and governments in other parts of the country enjoy substantial benefits from resource extraction in western Canada, which at the very least complicates the simplistic picture painted by those decrying the impacts on the dollar and Canadian manufacturing.

The ‘Dutch Disease’

International trade theorists have developed formal modelsillustrating the possibility of a global resource boom (in the oil sector, for example) indirectly hurting the manufacturing sector in oil-rich countries. Intuitively, the mechanism is that the increased global demand for the commodity causes an appreciation of the resource-rich country’s currency, which (other things equal) makes it harder for other manufacturers in that same country to export their own wares because of the change in the currency. In other words, the appreciation of the currency from the commodity boom makes other goods like manufactured products less price competitive. This situation is referred to as the ‘Dutch Disease’ because of the experience of the Netherlands in the 1970s, and it is what many critics allege has been happening in Canada.

Although such effects can occur in simplified models of the economy, it is not obvious what larger conclusions one should draw from them, especially concerning government policies towards natural resource development. For example, would the critics who decry the ‘Dutch Disease’ go so far as to say Canadians would be better off if their oil and gas deposits were magically transported to other countries, so that their citizens, instead of Canadians, would earn a flow of goods and financial assets from the rest of the world?

International trade with multiple currencies is a difficult topic that confuses even professional economists. The layperson might benefit from first thinking about these issues in the context of an economy with a few individuals who all use the same currency. In this setting, suppose one individual suddenly discovered abundant supplies of oil on his land, and then began selling them to his neighbours. At first, one might think that this behaviour would ‘hurt the export market’ of everybody else in the small community, because now people would spend some of their money on the newly-discovered oil, rather than spending it on goods and services sold by other individuals.

Yet it obviously would be short-sighted to stop the analysis there. After all, the person who discovered the oil deposit would himself be able to spend more on the wares of his neighbours, because of his higher monetary income (from the sale of the oil). Trade patterns would be rearranged, of course, but the mere discovery of oil deposits per se wouldn’t hurt (on average) the standard of living of the others in the community; on the contrary they would be enriched by the greater abundance of resources.

There is a similar effect when it comes to natural resource extraction in Canada. Yes, it may be true that high worldwide commodity prices cause foreigners to concentrate more of their purchases on Canadian petroleum exports, rather than Canadian manufactured goods. But at the same time, these increased earnings in the Canadian petroleum sector allow for greater purchases of manufactured goods within Canada. In principle, these effects could be quite large, showing that Canadians in general and even the manufacturing sector in particular are enriched by the presence of bountiful resource deposits.

Provincial distribution of employment and output impacts generated by Canadian resource development

As explained in the previous section, a major weakness in the ‘Dutch Disease’ perspective is that it overlooks the sense in which western Canadian resource development provides ‘export markets’ for the other provinces. Thus, even if it is true that other things equal high worldwide commodity prices lead to large Canadian resource exports and hence make it harder for Canadian manufacturers to export their own goods, in practice other things aren’t equal, because the profitable Canadian resource sectors are able to demand more goods from manufacturers in neighbouring provinces.

To get a sense of just how large this effect might be, we will summarize three recent papers that model the economic impact of (segments of) the energy sector on the various provinces. The studies focus on different activities, and involve two independent methodologies, yet all reach the same conclusion: Western resource extraction showers large economic benefits on all provinces.