Doug Saunders has written a dreadful column about the "resource curse", and I'm going to explain why it's dreadful

This column by Doug Saunders on the "resource curse" in last Saturday's Globe and Mail is quite dreadful:

When the price of oil is the foundation of your country’s economy, a sudden plunge to half its value focuses the mind wonderfully, doesn’t it?

One's heart sinks at the very first sentence: the premise is wildy at odds with the facts and can lead to nothing useful.

Here is the share of NAICS sector 21 (Mining, quarrying and oil and gas extraction) and NAICS sector 31-33 (Manufacturing) as a share of GDP:

Do you think that looks like an economy whose foundation is the price of oil? Me neither, but the facts be damned: there's a narrative to construct! (In case you're curious, NAICS sector 21 accounts for less than 25% of Alberta's GDP.)

Phrases such as “resource curse” suddenly sound a lot less like airy academic vagaries. Boasts such as “energy superpower” sound less confident and more tragic. And it becomes harder to dismiss as fictions or insults terms such as “staples trap” or “Dutch disease” or “bitumen cliff.”

Oh dear lord. If God provides you with an abundance of something that the rest of the world values highly and is willing to pay through the nose to obtain, then this is a blessing, not a curse. If the 'resource curse' has any meaning, it has to do with politics, not economics. In countries with weak institutions, resource rents are often captured by elites and can reinforce their power. (Daron Acemoglu and James Robinson's Why Nations Fail is probably the definitive take on this point.) In Canada - and Alberta and Norway, come that - strong political institutions have made sure that the resource wealth is widely-shared, and not squirrelled away in oligarchs' offshore bank accounts.

Those all refer to a well-known phenomenon: When an economy is built on the extraction of raw materials, the incoming flood of easy money makes it very difficult for a country to thrive in non-resource fields. During a resource boom, your pumped-up currency and labour costs hurt other export industries and many service sectors.

I can only infer that it is received wisdom on the Globe and Mail's op-ed pages that high wages are a Bad Thing. It wasn't so long ago that Gary Mason was using the same platform to tell us that low wages were the path to prosperity, because, well, he doesn't seem to understand just what it means to be prosperous. Nor does Doug Saunders, apparently. (Again, please read Joe Heath on this.) According to the Globe op-ed page, workers' leaving the manufacturing sector in search of higher wages is something to be regretted, because <reasons>.

Your competitiveness plunges.

Whose competitiveness plunges? As Paul Krugman once explained at great length, "competitiveness is a meaningless word when applied to national economies. And the obsession with competitiveness is both wrong and dangerous." This sort of statement makes sense in the context of a firm whose business model is based on having access to low-wage workers, but to go from there to claim that the Canadian economy is somehow worse off when wages rise is, well, 'both wrong and dangerous'. 

You lose interest in innovation, research and development, because you make more money taking things out of the ground.

This is what Macleans' Colby Cosh calls the 'Beverly Hillbillies' theory of the oil sands: "One day [Jed Clampett] was shootin’ at some food, and up from the ground came a-bubblin’ crude." The notion that Alberta's oil wealth is just sitting there, waiting to be gathered up by unskilled yobs is both widespread and wrong. As Cosh puts it, "The oilpatch isn’t distinguishable from other kinds of mining or manufacture, or even service businesses, in the degree to which it involves risk, innovation, or scientific sophistication."

Despite the wealth flood, you run up public and private debt, because rates are low and the boom seems perpetual. You become dependent on imports of both goods and debt, which are cheaper when your currency is strong.

I can barely parse this. Is he talking about external debt or total debt? If he's talking about external debt, it should be noted that external assets have grown even faster. Indeed, the recent depreciation of the CAD has increased the net international investment position by pushing up the CAD value of foreign assets. To the extent that public and private debt have increased in Canada, the obvious explanation is the recent recession and record-low interest rates. Other countries that don't export oil have seen the same. Moreover, the whole point of engaging in international trade is to obtain imports: the improvement in Canada's terms of trade has increased our purchasing power.  

Then the boom comes down on you. At the moment, most petroleum-based countries are feeling it. Russia is devastated: After spending its reserve savings trying to save the ruble, it’s now facing ruin. Hyperinflation has kicked in. Food prices rose by as much as 30 per cent. Mortgages, which most Russians put in more stable foreign currencies, have become unsustainable.

Venezuela, which used oil revenues to prop up an artificial economy by subsidizing food and fuel, is faring even worse. (Indeed, reports suggest that Cuba’s rapprochement with the United States this week happened, in part, because Havana feared the total demise of its partner state.)

But what about Canada? We’ve been hurt – the dollar’s plunge and Alberta’s looming fiscal crisis are just a start. But we’re not Russia or Venezuela. They can fairly be called rentier states: That is, everything their governments do depends on payments for petroleum. Canada is more than a pool of oil and a flagpole, isn’t it?

Yes and no. Canada has many other industries, although a good number of them are also resource-based – and during the 2000s, there was a “commodity convergence” so the prices of everything from oil and gas to food grains often rise and fall together.

In 2000, raw resources accounted for 40 per cent of Canada’s economic activity. By 2011, it had risen to almost two-thirds. 

If you saw this column in the print version, this is what you read. And if you are even remotely familiar with the facts of the Canadian economy, you probably said something like this:

 

The online edition was quickly edited and now reads: 

In 2000, raw resources accounted for 40 per cent of Canada’s economic export activity. By 2011, it had risen to almost two-thirds.

The goalposts have shifted from "the price of oil is the foundation of your economy" to "raw resources", but let's let that pass. It's still wrong. Total exports in 2011 were $620.1b, and here are the components that could be ascribed to the "raw resources" category:

• Farm, fishing and intermediate food products: $24.1b
• Energy products: $103.7b
• Metal ores and non-metallic minerals: $20.7b
• Forestry products and building and packaging materials: $30.4b

Adding those up gets you to 29% of total exports - less than half of the claim made in Saunders' column, after the correction. Energy exports account for 17% of total exports and about 6.8% of GDP. Petro-economy, indeed.

Was Canada’s resource boom actually destroying the viability of other industries?

To the extent that it was destroying the viability of industries whose business model was based on paying low wages, perhaps it was. I don't have a problem with that. 

During peak boom years, it was unacceptable even to ask.

This is must be some kind of joke. The question has never stopped being asked ever since oil prices started rising in 2002. The Ontario manufacturing lobby has never been in the habit of staying quiet when things didn't go its way.

When the Opposition leader noted in the House of Commons, in 2012, that a federal study had shown that Canada was falling prey to “Dutch disease” (named after the 1960s oil boom, which devastated other exports in the Netherlands), Conservative MP Kellie Leitch offered the government’s response: “The leader of the Opposition wants to call Canadian employers a disease.”

Even some far better informed Canadians made light of the problem. One popular counterargument was best expressed by Mark Carney, then Bank of Canada governor, in a 2012 speech in which he acknowledged that some “Dutch disease” factors were present, but said we shouldn’t worry because it was good money...

Here I think I'll just direct people to this blog post I wrote for Maclean's: "Why do they call it Dutch 'disease', anyways?"

...and, besides, oil prices were going to remain high for a very, very long time.

“The bank’s view is that a large, sustained increase in demand is the primary driver of elevated [oil] prices,” Mr. Carney said. “The breadth and durability of the commodity rally underscore this conclusion.” He pointed out that “rapid urbanization” of the developing world would keep demand high throughout the foreseeable future.

He, and much of Ottawa and Moscow and Caracas, failed to consider the possibility that it would not be lack of demand but rather abundance of supply (led by huge new U.S. reserves) that would kill the boom.

Once again, the goalposts have been moved. The claim is now that because oil prices stopped rising, it was a bad idea to take advantage of higher oil prices when they were rising. This doesn't make any sense. Or at least, it makes at least as much sense as this tweet from circa 2005:

Sauders - and many, many others - appears to be labouring under the notion that economies must decide upon a given allocation of productive resources across sectors and stick with it for eternity. The idea that labour and capital can be re-allocated as relative prices evolve is an alien notion to these people. But textbook economics would tell you that it's good idea to shift away from resources when their prices fall, and that it's a good idea to shift toward resources when their prices rise. Governments don't have to get involved.

There were two ways to avoid a resource trap:

Given the size of the resource sector, this question isn't of much interest. How about ways of avoiding the manufacturing trap?

By investing heavily in “smart” industries (which Canada did a bit of)

Who, exactly, was supposed to have done this investing, and why?

and by keeping the oil revenues out of your own economy like Norway (which puts more than 90 per cent of its petroleum earnings into non-Norwegian investments, to keep the money beyond its borders).

This wouldn't have affected the shift to the resource sector.

Canada did the opposite: We spent, even more than we earned.

There's no factual basis for this claim. Net wealth has increased, and Canada's net international investment position has improved.

Much like those other energy superpowers, we somehow used a money flood to build up large levels of both public and private debt,

That's not what happened. See above.

much of it denominated in foreign currencies that are becoming more expensive by the day.

This doesn't pass the smell test. If that were the case, then the depreciation of the CAD would have the effect of reducing our net international investment position, as the CAD value of foreign-currency liabilities increased. The opposite is happening: this increase is more than offset by the CAD value increase in foreign assets.

Resource curse indeed. It might be time to start taking those insults seriously.

Maybe it might be time to start taking some basic textbook economics seriously.

This column is yet another example of anti-economics. Nowhere does it make reference to or mention of such basic concepts as comparative advantage, and its grasp of the basic facts is shaky at best. And yet it is confidently presented on the op-ed page of Canada's Newspaper of Record.

Coda: Today's Globe has this remarkable chart:

 

Both series are measured in the same units, but by having two y-axes and telescoping the scale of the axis used for energy exports, it produces a chart in which the scale of variation of the energy series is exaggerated to support the claim just above the chart.

Here is what you get using the same axis for both series:

Such is the quality of the economic analysis we can expect from the Globe.

Comments

[Min]

Thanks. Great post. :)

[am]

Canada is not an oil economy even though it has lots of oil. It has good diversification from commodities. The quote from Professors Acemoglu and Robinson is appropriate. Their general thesis is about extractive political and extractive economic institutions. The former very often leading to the latter with the harm identified in their work. But it is not just about extractive institutions. There are also nutsville economic policies, not extractive in the sense of Why Institutions Fail. But just basing governments revenues and expenditure on a price of a commodity continuing at unrealistically high levels and then when the price crashes there is nothing to do but borrow or lay-off. A recent example was in Scotland where the independence group were basing government revenues and expenditure on $113 a barrel. If the yes vote had prevailed then Scotland would be going to the IMF by now, before the actual date of independence. Now Norway has based everything on the day oil runs out and built up reserves in a sovereign wealth fund for that day. This sensible policy will also include provision for oil price fluctuations when oil is still possessed and the ability to manage the current reduction in revenue easily in such circumstances.

[BigPicSyn]

Question: how come the data in the charts is different? The Globe data shows no spike in energy exports in 2009-2010, whereas your chart does. I assume your y-axis is in 10's of billions? If so, the Globe data shows energy ranging from around 80-85 to 110 during the series, but your data shows it ranging from around 60 to 110. In the same vein, the non-energy exports start at around ~290 billion going to 340 billion in your data but go from 350 to 440 billion in the Globe data. Are they using a different series?

[Sigmund Aas]

Fantastic post, as a Norwegian I'd like to steal all of it for our discussion on the same topic. There seems to be some strange sado - masochistic lamentation of the fact that one is making profitable use of natural resources. If only we had let ourt oil stay underground we would all be better off because then nobody would have worked in the oil induustry. We'd be much poorer but for some strange reason better off. I never got this argument but it never disappears from the Op - Ed pages in Norway either.

"Was Canada’s resource boom actually destroying the viability of other industries?"

This argument is always brought forward in Norway as well. And your answer is perfect, I never understood why we should actively aim for lower wages (unfortunately this argument, at least in Norway is presented on both sides of the politivcal spectrum, even labour organisations have trotted this argument forward, sadly).

An argument you dont mention that is always forcefully presented in Norway is the "what on earth are we gonna live off on when the oil runs out" is another one of those useless emes that for some reason sounds "very serious" in a Krugmanesque way.

Thanks again for a great article!

[Sigmund Aas]

I was a bit quick in posting the comment above and apologize for all the typos. Is there any way to edit ones comment?

[Stephen Gordon]

Sadly, no.

Thanks for that perspective; I suppose I shouldn't be surprised that similar arguments are being made in Norway as well.

[Neil]

We'd be better off because of loss aversion. That's really all these articles come down to: we can expect some economic decline when our terms of trade in large export sectors get worse. We'd be happier if we were poorer, but things always improved, at least a little.

The sad thing is that for many people, this is probably true.

I was actually a bit surprised that Norway sees similar arguments, given that the enormous sovereign wealth fund there is usually held up as a great example of what you can do to ensure long term prosperity in an economy heavily dependent on a volatile sector.

[Majromax]

@Stephen Gordon: It appears that your graph focuses exclusively on exports of goods. Should you not also be including exports of services? That might explain some of the discrepancy. Cansim 380-0070 suggests that services make up ~15% of Canada's export total.

[Bob Smith]

It's not often that the adjective "dreadful" is used in relation to a newspaper article, well do!

[Sigmund Aas]

Norwegians are indeed happy and proud about the oilfund (with quite good reason I think). That does not stop the lamentations over the horrors of actually allocating a bit of the economy to the task of getting the oil out of the ground, though. Just today there was an op - ed in a leading, very left leaning daily (it used to have the name "The Worker´s Paper") where the commentator delivers the following gem: "The oil and gas industry have pushed up wages and costs to the great detriment of other business sectors. The black gold has turned into a black hole sucking in the resources from the economy". (My translation).

His position is that we have known for 20 years that we some day would run out of oil and that we have failed to structure our economy to handle this fact. Again, apprantly we should have left the oil in the ground, so that we would have avoided building up a competitive oil and gas industry. Instead we could have focused on something else. What this else is, is never mentioned, except for the usual wooly stuff about knowledge and technology being the future, and of course the manufacturing thing is always in there. If only we made proper stuff, instead of just digging holes in the ground. Also in Norway very few seem to be cognizant of the fact that you have to do a little bit more than just dig, and that these pretty smart People will probably be able to something else With their time if/when the oil runs out.

The commentator is in no way unique with this perspective. Hardly a day goes by without some leading newspaper stating that our economy is not prepared for the time when we run out of oil. All of them stating that we have grown fat and lazy, cushioned by to generous wellfare budgets that will no longer be affordable when we run out of oil.

I am pulling my hair out on a daily basis.

[W. Peden]

A book that I read recently on these issues is "Oil is Not a Curse: Ownership Structure and Institutions in Soviet Successor States", by Pauline Jones Luong and Erika Weintal. They found that, when one controls for ownership structure, the "resource curse" hypothesis doesn't stand up well.

I enjoyed this post, and it's an area that I'm finding more about. (I probably should have done so before our referendum campaign here in Scotland.) As "am" pointed out, it's a good thing we didn't become independent, given that the fiscal plans proposed were based on optimistic forecasts of oil prices (and not a few other things).

[Stephen Gordon]

Sigmund Aas: Thanks again. We hear ever so much about how if only we did what the Norwegians did, things would be ever so much better.

[Jim Groves]

The "resources curse" is that squabbles over resource rents diverts attention from what is needed to increase productivity. While we might not quite be sub-Saharan Africa, Australia certainly has that. And don't tell me that Canada - a country leading the charge against action on climate change - doesn't!

[John Chant]

Thanks, Steve.

I loved the comparison in the two final charts. Manipulated charts can be much more exciting but...

Huff's How to Lie with Statistics still remains relevant after 60 years. It should be required reading for columnists who deal with economics and their editors.

John Chant

[Victor Short]

What makes it so difficult for economists to understand the difference between the gift of land+resources from and capital+goods produced by humans? The notion that there is such a difference must unnerve some primordial glue binding the profession together...

Land is not capital. And governments have an obligation to manage land+resources in an organic relation to the polity that they represent. Instead of a false dichotomy between "keeping it in the ground" and optimization of market returns, there is an obvious middle ground that is being ignored here. The late Peter Lougheed was calling for a moratorium on oil sands development back in 2008 to try and slow things down. But he was ignored in favour of the dominant libertarian ideology that everything must be available on the market at market-determined prices at all times.

[Patrick]

Victor: You need to consider that possibility that a majority in AB has elected to exploit the resources now rather than later. It may or may not be a good decision, but just because you disagree doesn't necessarily imply that there must be a failure of democracy.

[Mike Freimuth]

This is good stuff. I wrote a paper on the resource curse for a graduate class and, yeah, it's basically a lot of nonsense. Theoretically, they get it by essentially assuming some kind of positive externality associated with manufacturing. So if you ASSUME that an economy based more on resources and less on manufacturing is bad, then you get the conclusion that an economy based more on resources and less on manufacturing is bad.

Empirically, there is a quote I will never forget that went something like this (from a middle eastern country, I think Saudi Arabia).

"In a few years we went from camels to Cadillacs. Now we are going back to camels."

When the price of oil, or whatever, falls, everyone gets all apoplectic about how much it hurts oil-rich economies and conveniently forgets about the part where they went from camels to Cadillacs in the first place. That poor reasoning goes beyond the editorial pages of financial publications. It is largely present in academic research on the subject.

BTW, when I presented how stupid I thought the idea of a "resource curse" was, my teacher told me I had a bad attitude, haha. Maybe I do. It's still wrong though....

[Victor Short]

Patrick: The target of my scorn is not the imagination deficit of Albertan voters. It is the economics profession's insistence that land+resources should be treated no differently than capital+goods, which is to say they should be exploited and priced by market supply and demand. It is the inability to consider how the nature of the gift from god, nature (or whatever non-human agent is to your own preference) differs from stuff produced by human beings. The point is that politics+government has an inherent say in the distribution of this gift of land+resources, and in finding a middle ground that doesn't depend on the false dichotomies presented here.

[Stephen Gordon]

We don't have any trouble making that distinction. At least, I don't. It's either implicit or explicit throughout the post.

[Victor Short]

Professor, the distinction is made in terms of the distribution of rent generated from what is a publicly-owned resource. But not in terms of the ontological difference between land and capital. For the former, markets-prices should not be the determining factor in dictating what goes forward.

"The idea that labour and capital can be re-allocated as relative prices evolve is an alien notion to these people. But textbook economics would tell you that it's good idea to shift away from resources when their prices fall, and that it's a good idea to shift toward resources when their prices rise. Governments don't have to get involved."

I can only assume from this passage that your response to any attempt to slow down oil sands development by politics+government (Lougheed's efforts to promote a moratorium being the most pertinent example) would be to label it as an unnecessary intervention. You have forgotten the first factor of production - land - as almost every professional economist makes a habit of doing. Land does not respond to price signals, so it is up to a polity to decide how this factor should be incorporated into the conditions of production, not labour and capital responding to a market in of itself.

[Mike Freimuth]

Victor,

" Land does not respond to price signals, so it is up to a polity to decide how this factor should be incorporated into the conditions of production, not labour and capital responding to a market in of itself."

I don't know how you got that impression. Land can be used for many different purposes, the owners of the land can reasonably be expected to put it to the most profitable use, the most profitable use depends on market prices, when they change, it changes. There is no reason that this must be treated differently from any other resource.

[Victor Short]

You are confusing land with its owner. When I say land+resources, I mean land and resources. Not proprietary capital.

[W. Peden]

"Land does not respond to price signals, so it is up to a polity to decide how this factor should be incorporated into the conditions of production"

Doesn't follow.

[Jacques René Giguère]

Part of the problem is that the entire value of the production is counted in GDP, instead of the value added by extracting. Resources in situ are an asset. They are often counted as an income to be spent. Norway doesn't do the mistake and set up a SWF to shift the asset to another form. Nigeria does the mistake. AB? Your judgment...

[Victor Short]

W. Peden: Someone has to speak for land other than value-seeking labour and capital owners. And because a polity is defined by its territory, it does follow that it is the responsibility of a political community to do this. How this works in practice depends on political ideas, institutions, and conventions. Economists limit this political responsibility to distribution of rent derived from these resources, but any attempt to dictate the conditions of production and prices is considered an irrational affront on economics itself.

In the case of the energy sector, environmental pollution is obviously a major reason for the need to treat land differently from labour or capital. But the argument I am making should in no way be reduced to an 'environmentalist' position. The practice in some German jurisdictions of government officials administering housing prices so as to prevent land value bubbles is one example of how land-use is treated as a thing apart from markets.

[Mike Freimuth]

Victor,

"Someone has to speak for land other than value-seeking labour and capital owners."

You could say the same thing about capital if you wanted to. The only difference is you don't want to. You have arbitrarily decided that land is special and has some form of rights in and of itself that its owners don't appreciate but this is nothing more than a (peculiar) assumption on your part. If people other than the owner value land in some use which is different than the use to which the owner is dedicating it, then they can buy it and put it to the alternative use. This potential for alternative use will be reflected in market prices. It's not different, except that you personally don't like the highest valued uses that some land is put to.

[Victor Short]

You are not appreciating the difference between land and capital. Capital is a human-made institution dealing with proprietary claims to things (be they physical, intangible, or future income, etc). A land owner is speaking for land as capital, as it relates to his proprietary claim to either physically use it or lease it for someone else to use in a value-seeking process.

This is not the same thing as speaking for land as land. When dealing with land as its own unique factor of production, optimizing monetary values is not the be-all and end-all as it may be for capital. There are other things to consider, environmental and social. To say that these considerations should be met by other people buying up the property completely misses the point that land as land has to be distinguished from land as capital. If Albertans decided they agreed with Lougheed's arguments that oil sands development should be slowed down, then they should have some control over the situation. Same goes with mega-quarries in a rural Ontario county, or fracking that may poison ground water, or condo developments that price out residents from a neighbourhood. Land-use is a social beast whether value-seeking labour and capital owners like it or not.

[Marcus A.]

Mike, you really should respond to Victor with intellectual honesty. It doesn't mean you gave to agree, but do you really consider land to have no social value. Is social replaceable with capital?

[fc]

A quick and hearty thanks from a non-economist. I had read the Saunders article, and was uneasy but did not quite know why. This post - the the ensuing debates - are wonderfully clear.
I hope you will continue with the occasional post that is accessible to those of us not trained in economics! Thanks. fc

[Senator-Elect]

Although I'm not sure I agree with this criticism, I'm curious to know whether the Globe has responded. Unfortunately, they probably don't have the resources to do so, but anything published in their pages should be at least accurate and coherent.

And the Globe should be willing to engage with criticism to promote national debate. What else is a national newspaper good for? It's not as though we're about to have an election that could turn on resource economics....

[Wendy_waters]

A bit late to the party, but thanks for writing this. Great post. In uncertain times like this, much of my job involves dispelling myths perpetuated in the mainstream media so we can generate investment strategy recommendations based on facts and not fantasy. This post saved me a lot of time. Thank you again.