Monday, June 24, 2013

The Resource Trap Explained

Canada is suffering from the Resource Trap, or Resource Curse. We don't have it acutely yet, to the point of sterotypical corrupt petro-states, but we are suffering numerous symptoms from the list:
  • Dutch Disease. Yes, Mulcair was right. Oil sales have driven up our dollar and made our manufacturing and service exports less competitive.  This isn't difficult to understand and while you can try to argue the overall effects of oil are net positive (e.g. Alberta buys equipment from Ontario), there's no denying the basic case that manufacturing (concentrated in Ontario and Quebec) have been hurt.
  • Revenue Volatility. Alberta has gone through serious cases of this several times. Now with Newfoundland and Saskatchewan increasingly reliant on oil sales for their provincial budgets, I think we can call this a national problem.
  • Lack of diversification.  Not only are we failing to diversify, we are concentrating ever more of our labour market on extractive industry.  Every article extolling all the people moving out West for work is really about this.  Some of them come from industries that are already in long term decline or outright dead, like various depleted fisheries, but many also come from the manufacturing sector (see Dutch Disease above).
  • Corruption. This one hasn't shown up yet in terms of oil execs doling out sacks of cash to buy off government officials, but if you look you can see our political system restructuring itself to serve the needs of the country's most powerful economic class.  The Federal Government gutted environmental laws to ensure various oil projects would get rapid approvals, and withdrew from Kyoto.  Climate change is just ignored.  Even the Alberta PCs with decades of uninterrupted majority rule were gunshy about raising royalties more than nominally despite credible analysis from all sectors not owned by big oil that this could and should be done.  They were right to fear it, Big Oil nearly put the Wildrose into power in protest over it.  Approval of the Keystone XL pipeline federally was basically a non-issue.  Not even Mulcair is openly opposing it and Trudeau has spoken out in favour.  Oil pipelines spill all the time and the companies are handled with kid gloves, huge ponds of horrific toxic sludge accrue in the north, and there's no plan to do anything about them.  Eventually, a flood will take them into the MacKenzie river.  Problem solved!
Why does this happen?

The basic problem of an abundance of natural resources is that in order to exploit them as a free-market economy, you're bascially expected to sell/rent permits to private owners to extract the resource and sell it for profit (Norway is a noteworthy exception, but sadly not really a model followed by Canada).  You are, by definition, setting up a class of rentiers who draw wealth from the land by virtue of a legalism issued by the state entitling them to that wealth.  These people are not like sterotypical gold prospectors panning rivers from a 19th century gold rush, they will already be rich and powerful since it takes a lot of money to get a modern resource extraction operation running.

Rentiers are not really entrepeneurs.  They are in the business of extracting rents, foremost.  Competition is not that important (except in obtaining more sources of rent in the form of extraction permits to resource rich land).  You're not really going to be able to drive your competition out of business - after all they have guaranteed revenue streams too, from their resource leases.  You can fight for market share, but that's a lot of work. Better ROI on spending your time finding more of the resource in areas not yet exploited.  I really suspect the big oil companies do not actively collude on gas prices, they simply all choose not to compete very hard because competing is a lot of work and effort and it isn't their focus.  We'll buy the product anyway, so why bother?

This is, you might say, the default direction of a resource system.  Avoiding this takes a lot of work and thought in how you design the incentives and how the money is used.  We really didn't engage in such an exercise.  Pierre Trudeau tried to do a few things on this score, but they were undone and they didn't become self-sustaining. 

It becomes a curse when it becomes your society's dominant industry, a sort of "resource industrial complex" that automatically has power and influence over the political system just by dint of its impact on the economy and government revenues. It begins to take over.

Of course rentiers never just sit back and let their influence over the state accrue naturally, they aggressively seek to expand it through all means legal and not so legal.  After all, at some level you understand that your primary source of wealth is not "innovation" or some such nice market concept, but a piece of paper issued by the state which empowers you, and you alone, to profit from this stuff that nature left in the ground (oil, diamonds, whatever).  If government is the source of your wealth, then the easiest place to make yourself wealthier is by influencing government to let you keep more of it.  Decreasing royalties, tax breaks on capital expenditure (which you would have made anyway), and straight up tax cuts all work.  So does gutting labour and environmental standards, which drive up your costs for extracting the stuff.  Annoying!

Canada has gone several steps down this path. At some point, perhaps we've already done it, you cross a kind of Event Horizon where the logic of the system carries you the rest of the way whether you want to or not.   Any hope we have of stopping this rests on not just electing a new government in 2015, but ensuring that government is empowered and emboldened to take us off this path.  I'm afraid neither major opposition party looks likely to do that as they stand (I'd give the NDP better odds, but far from a lock).  This is where ideology matters much more than partisanship.  Broad awareness of our poor strategy in going all-in on oil is key.  Without a change, we may as well join OPEC.

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