By Janice Plumstead
In the Globe and Mail

July 31, 2015

 

Alberta’s NDP government has made the pursuit of diversification a key objective by promising a new royalty regime to encourage value-added upgraders to process bitumen in the province. The government, however, is putting the cart before the horse.

Before it heads down the road to diversification, it needs to take a step back and work to stabilize the effect that resource revenue has on Alberta’s budget.

Economic diversification requires long-term investment and effort. Lacking private-sector enthusiasm for upgrader projects, the government may need to offer loan guarantees and other incentive programs to kick-start such a project, increasing the risk to taxpayers.

With a budget deficit estimated at $7-billion, this year is a particularly bad time to add risk. The price of oil has plunged from more than $100 (U.S.) a barrel a year ago to less than $50 a barrel today. The price collapse has led to layoffs, cuts in capital investment and a general decline in economic activity throughout the province.

Low oil prices seem inevitable for the indefinite future as geopolitical events unwind. Regardless of whether the U.S. Congress quashes the Iranian nuclear agreement, sanctions against Iran are not expected to be renewed. This will allow a new oil supply to enter the market, further increasing the glut. At the same time, China’s slowing economic growth will put a damper on demand for oil and other commodities, further depressing prices.

The Alberta government has a few unsavoury options to deal with the shortfall in the coming budget: running deficits, borrowing money to bridge operating and capital shortfalls and, eventually, further increasing taxes. The alternative option, implementing broad austerity measures, is not likely in the short term.

For more than 40 years, Alberta governments have tried and failed to establish fiscal discipline around volatile resource revenue. Alberta’s recurring problem is that when resource revenue is plentiful, the pressure to increase public spending is irresistible. When the revenue drops, the province is burdened with unaffordable public spending.

There are international examples the government can look to. Chile, for example, has successfully managed volatile copper revenue for the past 15 years, reducing budget volatility and introducing programs for industry diversification. Chilean exports also include wine, agri-food, wood products and manufactured equipment.

Alberta is no stranger to fiscal rules. In 1976, the Peter Lougheed government passed legislation for the Heritage Savings Trust Fund, which allocated 30 per cent of resource revenue to savings. Since then, there has been a succession of fiscal management laws passed, notably the Deficit Elimination Act, introduced by the Klein government in 1993. Under this legislation, drastic spending cuts were made to eliminate provincial debt and balance the budget.

Because of the Heritage Savings Trust Fund, much of the discussion about managing volatile resource revenue in Alberta has focused on savings, but less on adjusting spending to match revenue volatility.

To ensure government spending is sustainable against revenue, the province ideally would restrict the amount of resource revenue that goes into the budget. Alberta had a rule like this once. Each year at budget time, a limited amount of resource revenue was allowed to be used for the budget. Over time, the limit was incrementally increased until it was removed altogether.

The success of any fiscal rule depends on Albertans’ willingness to accept the restrictions it will place on government spending. In turn, the public must also demand spending that is stable and predictable. Rarely has this happened in Alberta. Only during the Klein years, when drastic cuts were made to spending, was it controlled.

Those cuts, however, were unsustainable and not always strategic. Not many years after the debt repayment goal was reached, the spending spiral picked up again.

The NDP should reintroduce an annual limit on the amount of resource revenue that can be transferred to the general fund. Then, the government can set spending limits and adjust taxes and other fees accordingly. Depending on the oil price cycle, savings will either flow from excess resource revenue or the government will make withdrawals as needed, leaving the budget intact and stable.

Stabilizing the amount of revenue that can be used to support annual budgets will support the government’s plan to pursue long-term and sustainable diversification strategies. Diversification, on the other hand, won’t solve the volatility problem any time soon. That will require discipline.

Janice Plumstead is senior economist at the Canada West Foundation.