Can Alberta learn from Norway and Ireland?

by Paul Delany

Alberta’s economy has been growing about twice as fast as that of the rest of Canada, and if oil prices remain high it will continue to do so. The province is turning into a separate kingdom, with per capita income more than 50 per cent above the Canadian average.

But what is the right strategy for managing a prosperity that stems from a finite endowment of oil and gas? One traditional Canadian answer has been to cut the tall poppy down to size. Pierre Trudeau tried to do this with his National Energy Program in the 1980s, and we do it on an ongoing basis through equalization. While there have been calls for a more generous equalization program, Ottawa will probably do no more than tinker with equalization in coming years, while Alberta continues to pull away from the rest of Canada. When we consider its future, we might do well to look at two other societies transformed by recent wealth: Norway and Ireland.

Saving for the future

Their envious neighbours like to call the Norwegians “blue-eyed Saudis,” but the two countries could hardly be more different when it comes to spending their oil money. Saudi Arabia is a country of spectacular consumption by a feudal elite, while everyday work is left to foreign workers with no rights. Norwegians now have the highest per capita GDP in the world; yet as a society, they have been reluctant to enjoy their wealth. More precisely, they plan to spend it later, after most of their oil has gone. Norway’s great fear has been of the “oil curse”: wealth that has done more harm than good in the countries possessing it.

Oil was discovered in the Norwegian sector of the North Sea in 1969 and production began in the mid-1970s. Possession of oil contributed to Norway’s vote against joining the European Union in 1972, a decision reaffirmed in 1994. By 2000, Norway had become the third or fourth largest exporter of oil in the world, at more than 3 million barrels a day. Norwegian oil production peaked in 2001 and has been slowly declining. But in terms of revenue, this decline has been more than offset by the quadrupling of oil prices since 9/11. Most of the profits from Norwegian oil flow directly to the state, thanks to the dominant position of the national champion, Statoil.

By the beginning of this century Norway had paid off its national debt, and still the money poured in. In 1990 the Norwegian parliament, the Storting, voted to establish a Government Petroleum Fund to receive excess oil revenues. The fund reached US$240 billion by the spring of 2006, and it is now growing at about $3 billion per month. There is $52,000 in the fund for each Norwegian man, woman and child, and this amount is projected to double by the end of 2009. After that the fund’s value is expected to level off as oil reserves are depleted. When the oil is gone, Norway will have the fund as a cushion, a permanent benefit from the fat years of North Sea production.

The first aim of the Petroleum Fund has been to restrain the Norwegian oil boom by shifting consumption from the present to the future. The money going into the fund could have been distributed to the general population, following the example of Alaska’s oil dividend program. Norwegians might now be receiving a dividend of about $8,000 a year each. But their government has feared the twin perils of oil-driven inflation and the social corruption caused by easy money. The oil windfall needed to be sterilized so that it would not have any radical effect on the domestic economy. The fund therefore decided to invest entirely in foreign assets (initially bonds, later adding stocks and derivatives). It has also chosen to be a passive investor, not taking a big enough stake in any one corporation to exercise control. The fund has acted like a conservative individual providing for his or her old age. This mentality is reflected in a change of name in 2006: the “Government Petroleum Fund” has now become the “Government Pension Fund.” Knut Kjaer of the Norges Bank has called it “a tool to help the government face the challenge of an ageing population.”1

The fund’s passivity reflects Norway’s political culture. Since World War II it has been a classic Scandinavian welfare state, with very high taxes, a high cost of living and generous social benefits. The state has enjoyed legitimacy and authority as the guardian of every citizen’s welfare. Americans may mistrust government, the French may be angry at it, but Norwegians largely accept it. The directors of the Petroleum Fund have more money at their disposal than the government has, but they don’t throw it around. If blessings flowed from the fund, this would usurp the budgetary powers of Norway’s elected representatives. Only the state has the right to guide what happens in the economy or culture.

An egalitarian society like Norway’s will not be disposed to concentrate wealth for any narrow purpose. One should not expect to see in Oslo an art gallery to rival the Getty Museum, though the government is spending more than $800 million on a new opera house. The Petroleum Fund could do such things with a few months’ revenue, but its mandate prevents it doing anything that the government has chosen not to do. Private support for culture is limited, because state management of Norwegian oil has made it impossible for any Norwegian J. Paul Getty to emerge. The government could have set aside a small portion of its windfall to seek excellence in specific areas of culture or research, but it seems to consider excellence and equity irreconcilable, even when oil money has put excellence within its grasp. The fund is not just designed as a bulwark against inflation or wasteful consumption. It seeks also to prevent new oil wealth from having a radical impact on Norwegian society. In due course, the benefits of the fund will be returned to all Norwegians as they enter old age. Its resources will melt invisibly into the general comfort and prosperity.

Recently, the Petroleum Fund has moved toward activism in one area: investment policy. In 2005, it charged an “Advisory Council on Ethics” with establishing investment guidelines. The council proposed that the fund should only support “sustainable development”: it should not invest in companies that produce arms, violate civil rights or have questionable business practices. One of the council’s first acts was to send a series of sceptical questions to Wal-Mart. After the company failed to reply, the Council recommended in November 2005 that the fund no longer hold Wal-Mart shares or bonds. These holdings amounted to $400 million, about 0.2 per cent of Wal-Mart’s capitalization. The divestiture has taken place, along with other fund investments in arms manufacturers and the like. As with any sanction or boycott, the fund’s refusal to hold Wal-Mart shares would only have an effect if most other investors threatened Wal-Mart’s managers. That is not going to happen, evidently. Still, when Norway’s pensioners eventually draw an income from the fund, they will be able to feel that their money is relatively clean (though how much they get will depend on the success of global capitalism).

Taking a stand on corporate ethics is easier than taking responsibility for the strategic development of the Norwegian domestic economy. Norway has been afraid of “Dutch disease,” named after the side-effects of the Dutch gas boom in the 1970s. An influx of foreign currency from natural resource exports tends to drive up the recipient country’s exchange rate and price its manufactured goods out of their traditional markets. Norway’s main industry has been shipbuilding. If oil revenues had not been sterilized through the Petroleum Fund, it is argued, the kroner would have shot up and Norwegian ships would have lost their market. Instead, Norwegian shipbuilders specialized in more complex vessels (including oil rigs), prices have not risen excessively and the industry has remained healthy. New high-tech ventures have also flourished in Norway.

The Irish miracle

Does the threat of “Dutch disease” mean that oil revenues, unless sterilized, are bound to be a curse for small economies? This is a topical question for Alberta, and for other small jurisdictions open to global movements of trade and capital.

Many small nations or regions – of about two to five million people – are more successful, economically and culturally, than larger and more unwieldy countries. These small entities are well placed to deploy tax arbitrage against larger bodies that they are attached to. The most prominent example is Ireland, which for many years has set its corporate tax rates far below the European Union average. The current Irish rate is 12.5 per cent; larger EU countries are mostly in the 30 to 35 per cent range.

When Ireland entered the EU in 1973, it was relatively poor and without natural resources. But it qualified for EU subsidies, had a young and well-educated population and, after 1999, was the only English-speaking country in the Eurozone. Since the mid-1990s, a boom in foreign investment has pushed Irish GDP per capita above Britain’s, and 20 per cent above the EU average. With just over 1 per cent of the EU population, Ireland has in recent years attracted about a quarter of all U.S. investment in the EU. Per capita wealth is now higher in Ireland than in the United States. The aggressive use of tax arbitrage transformed the Irish economy in a single generation.

The new EU members from eastern Europe are emulating Ireland’s strategy. They too are experimenting with low corporate rates and flat-rate income taxes. Most of them are growing faster than the older members of the EU, while France and Germany complain about a “race to the bottom” by tax-cutters in the east. New investment in manufacturing is more attractive in Hungary or Slovakia than in France or Germany. Like Ireland, the eastern countries may be able to attract European headquarters of U.S. multinationals. Microsoft, for example, funnels all its European profits through Ireland because of its low tax rate. In 2005, Microsoft Ireland reported profits of $9 billion. Almost all of this money was earned in larger European countries, which were not pleased to see Ireland harvesting tax revenue on their behalf.

Norway could have used its oil revenues to cut its corporate taxes to zero and become the biggest European tax haven of them all. Or it could have cut the consumption taxes that have made it a very expensive country to live in and stifled its tourist potential. But such drastic measures would conflict with Norway’s social democratic sense of fairness and fear of the destabilizing effects of an open door for international corporations. If foreign investment should flood in, Norway would have to move even more of its government revenue offshore as a counterweight; otherwise the kroner would be driven up and the economy would overheat. Nonetheless, sterilization of oil revenue may not be the best strategy in the long run. Norway could have taken advantage of North Sea oil to diversify its economy more aggressively and lay a foundation for long-term growth. The opposition Progress Party wants to break out of the straitjacket of Social Democratic resource policy, but so far the Norwegian electorate has refused to give it a mandate to do so.

Alberta’s options

Not being a sovereign nation, Alberta has fewer tools for handling its oil boom than Norway does. Interest rates and the exchange rate on the Canadian dollar are determined nationally rather than locally. On the other side, labour shortages can be relieved by interprovincial migration. But the main instrument wielded by the government is the provincial budget, supplemented by the Alberta Heritage Fund.

Since 1994, Ralph Klein’s government has used oil revenue to strengthen its balance sheet, paying down the provincial debt from $23 billion to zero. Some oil revenues have also been directed to the Alberta Heritage Fund, a fiscal buffer that currently stands at about $15 billion (about $4,500 per capita). Alberta finance ministers have not managed the Heritage Fund according to any consistent plan. Like most finance ministers, they have found it convenient to have different pockets between which to move money as expediency requires. In the current fiscal year, absurdly enough, Finance Minister Shirley McClellan put $1.75 billion “surplus” revenue into the Heritage Fund, then took $1 billion out for program spending. McClellan has earmarked $750 million added to the fund as an advanced education endowment, intended to reach $3 billion in coming years. She also added $500 million to a separate endowment, the Alberta Heritage Fund for Medical Research.

Paying down the provincial debt was a sensible way of managing the flood of oil revenue. It was also a form of sterilization, since most of the money that paid off bondholders was leaving the province. In the past couple of years, though, Alberta fiscal policy has become a muddle. Klein seems to have run out of ideas as his mandate nears its end; meanwhile, the spike in oil prices provides the Alberta finance minister with income on an unprecedented scale. There are three ways of dealing with the revenue windfall: allowing it to pass through to consumption, investing in public works and shifting it into the future through an endowment fund. The 2006 Alberta budget dabbles in all three choices, including a $400 per capita oil dividend in imitation of Alaska. What is lacking is any coherent strategy for the province’s future. Major decisions await Klein’s departure at the end of 2006.

As already noted, there is one other way to dispose of the embarrassment of oil riches: equalization across provinces. Here one encounters the arbitrariness of national or provincial boundaries. Norway devotes a higher percentage of GDP to foreign aid than any other country, but still less than 1 per cent. It keeps almost all its oil wealth for itself. At the other extreme, Scotland has about the same population as Norway, but no fiscal independence. Once North Sea oil comes ashore in Scotland, the royalties are shared by all of the United Kingdom, with a population ten times that of Scotland.

Federal systems represent an intermediate position, but not all federations are the same. In the United States, there is no equalization between states. People equalize themselves, so far as they can, by moving to a better job in another state, or by moving from an expensive state to a cheaper one. Canada does more to help people stay where they are, in the name of preserving their language or culture.

Alberta, nominally in control of its own natural resources, nevertheless faces pressure to share its wealth with the rest of Canada. Newfoundland Premier Danny Williams and Bloc Québécois leader Gilles Duceppe have been demanding changes to equalization that would bring further golden showers to the Atlantic provinces and Quebec, and the recently released federal review of equalization would also make the program more generous.2 But strict equality will never be achieved as long as the provinces control their natural resources; nor is it obvious that equalization, in its present form, contributes much to Canada’s economic health. In the past, Ontario accepted equalization in exchange for political dominance and support for its manufacturing base. But if Ottawa wanted to make Alberta into a cash cow for less fortunate provinces, it is not clear what, if anything, Alberta would receive in return for slowing down the oil boom in this way.

Alberta could become “Canada’s Ireland” by cutting or even eliminating its corporate income tax. Expected revenues from this tax are estimated at $2.2 billion in 2006–7. The overall surplus is estimated at $4.1 billion, so elimination of corporate income tax would still leave the Alberta government in surplus. Such a drastic cut would fuel resentment in other provinces, as corporate head offices moved west. Some U.S. corporations might move to Alberta too: if Alberta had no corporate tax the Canadian federal tax, currently 21 per cent, would be well below the U.S. rate of 35 per cent. Head-office employment in Calgary is already growing steadily, but the westward tilt could speed up.

Other provinces already offer selective tax concessions: for movie production in British Columbia, automobiles in Ontario, Bombardier jets in Quebec. But Alberta could make itself extremely attractive to any established Canadian business with sweeping across-the-board tax cuts. Even if it was politically impossible for companies to move, they could still feel the heat. Air Canada, for example, is finding it difficult to keep up with WestJet, which benefits from its low-tax and union-free location in Calgary. The main limitation for businesses wanting to move to Alberta is simple lack of capacity. No large blocks of office space will be available in Calgary before 2009. Fort McMurray, the oil sands capital, shows the dire results of trying to put a quart of growth into a pint pot of infrastructure. In July 2006, Shell Canada reported that costs for its oil sands expansion had increased 50 per cent in one year.3

Oil booms inevitably spill over into the housing market. Prices in Calgary and Edmonton have risen by more than 40 per cent in the past year. Residential construction has to compete with the oil sector for scarce materials and labour. At the same time, housing shortages make it difficult to import workers from other regions, driving up labour costs even more. Interest rates, which are set nationally, cannot rise enough to choke off the boom. Finally, as the housing market heats up, speculators move in from outside the region to buy houses for profit, rather than to live in. Wherever money is available in a boom market at moderate interest rates – as in Alberta, Ireland or London – house prices rise far beyond their normal relation to average incomes. The surge of hot money into the housing market is perhaps the most dangerous side-effect of an oil or finance boom, and it may take a nasty recession to cure the problem.

Rising costs for oil sands development suggest another path to stabilization: simply leave the oil in the ground until it can be produced in a more orderly fashion. Whether or not global oil production is about to peak and then decline, countries such as the United States and Britain are certainly on a downward slope. If supplies remain tight and prices rise on the global market, a country can produce less and still increase its revenues. In the long run, the value of oil left in the ground may be greater than the returns from current production. If the Alberta government believed this, it could stretch out the period of oil sands development simply by delaying permits.

Canadian oil production in 2006 will be about 2.5 million barrels a day, equally divided between conventional oil and oil from the tar sands.4 While conventional oil production is gradually declining, oil sands production is projected to increase to 3.5 million barrels a day by 2015, and most of this extra production will be exported. It is very doubtful that the extra tar sands oil can be brought into production without rampant cost inflation, not to mention environmental damage. Restraint in oil sands development would leave more capacity for Alberta to diversify its economy and direct growth toward the populated south, where it can be accommodated more easily. Alberta’s “oil fund” would then contain more oil in the ground and fewer securities purchased after extracting and selling the oil. However, the latest policy statement from Alberta’s oil ministry argues for developing the tar sands as fast as possible, even using imported liquefied natural gas to do so.5

An explicit policy of holding back tar sands development would arouse hostility from the United States, which is counting on more energy imports from its politically stable neighbour. In the past, few countries have had a conscious policy of restraining oil production. They have preferred to keep pumping and accept whatever the market was willing to pay. Nominally, OPEC has existed to balance oil supply and demand; in practice, few countries have respected their quotas and Saudi Arabia has flooded the market when it feared that prices were getting too high. This situation may be changing now, thanks to political uncertainties in major producers (like Iraq, Iran, Nigeria and Venezuela) and rapid growth in demand from China and India. With overall production of about 85 million barrels a day, the loss of a million barrels a day is enough to affect the world price. There have been hints that Norway may be quietly holding back production to extend the life of its resource and help keep oil prices firm.

Slowing down the pace of oil sands development would be more than just speculation about the price of oil 10 or 20 years from now. The main argument for restraint is that the Alberta economy cannot grow faster than 5 or 6 per cent a year without major distortions and inflationary bubbles. A tax reduction strategy combined with an oil sands slowdown would redirect that growth: from resource industries to diversified new ventures, from the hinterland to the cities, and from the north to the south. Growth would become more complex, more granular and more sustainable. The best time to start shifting the economy away from oil is when you still have plenty of it left.

 

Notes

1          www.norges-bank.no/english/petroleum_fund/articles/lugano/index_lugano_2001.html

2          Expert Panel on Equalization and Territorial Formula Financing, Achieving a National Purpose: Putting Equalization Back on Track (Ottawa: Department of Finance, 2006). Available online: http://www.eqtff-pfft.ca/epreports/EQ_Report_e.pdf

3          “Cost of Athabaska Could Hit $20 Billion,” Toronto Globe and Mail, July 6, 2006, p. B1.

4          Canadian Association of Petroleum Producers, Canadian Crude Oil Forecast, 2006.

5          See Andrew Nikiforuk’s critique, “Plan? What Plan? Alberta’s Energy Future,” Canadian Business, June 5–18, 2006.

 

 

Paul Delany is a Vancouver writer, formerly a professor of English at Simon Fraser University.