26 August 2019

Balancing the Economy #nlpoli

Both Delia Warren and Dwight Ball believe that we need to diversify the provincial economy and reduce our dependence on oil.

They both believe that our future should lie with more renewable energy.  Delia thinks there is room for things like wind farms.  Dwight, an original and enthusiastic Muskrateer, thinks we need to develop Gull Island as quickly as possible.

Both Delia and Dwight are wrong.

The Newfoundland and Labrador economy is more diverse than at any time in its history. There are more sources of economic activity – particularly activity that brings new money from outside the province – than there were before the 1880s, for example, when the fishery was it.  By the early 20th century, you could add mining and forestry to that mix and by the end of the century there was manufacturing, professional services, electricity, and information technology.  Then came oil.

Oil brings a lot of money into the economy, so it is not surprising that it gets a lot of attention. But oil is not the only economic game in town today as the fishery was before.

Balancing the Economy

If there is a problem in the economy, it is one of balance between oil and the non-oil parts of it.  That’s a different problem than diversification.  TO balance the economy, you would need to strengthen the non-oil bits of it.  Put another way, you’d have to put more value in it.

You can get a good sense of the provincial economy by reading a budget paper called  - not surprisingly - The Economy. You can see the size of different sectors by both the value of goods or services themselves and by the amount of the labour force taken up with each activity.   You can’t get a clear picture because oil has spin-off impacts on things like finance, which is a service sector that is almost as big as oil itself.

Imagine a balance with oil and related economic activity on one side and everything else on the other.  The goal in re-balancing the economy would be to increase the value of the non-oil stuff such that it took fewer segments of the economy to offset oil.  Increasing the non-oil value not only increases the potential government revenue from taxes it also means that a downturn in oil is less likely to send the whole economy into a tailspin.

With that image in your head,  you can see why The Way Forward plan  to double the size of the province’s oil industry doesn’t make things better.  It makes things worse.  Well, it does if your goal, as Dwight Ball supposedly wanted. Was to reduce the impact of oil and gas on the provincial economy.  If the economy is out of balance now, then doubling the oil part of the economy means you have to increase the value of the other parts all the more than you did before.

Government’s Oil Addiction

There is an oil-related problem in the provincial economy but it isn’t what either Dwight or Delia are talking about. You can see the problem with the massive deficits the provincial government has been running for most of the past decade. 

Starting in 2006,  the provincial government boosted its own spending based on volatile, unpredictable oil revenue. The first sign of a problem came within three years when oil prices plummeted.  The government didn’t reduce its own spending.  The second sign of the problem was in 2013, when oil prices tanked again.  And again, the government didn’t reduce spending.

It took a third major drop in oil prices to force the government to reduce spending but the reduction has been modest in comparison to the size of the problem.  Annually, the government spends about $2.0 billion more on a cash basis than it takes in.

The problem in Newfoundland and Labrador is not that the economy is too dependent on oil but that the provincial government is too dependent on oil revenues.

Alberta economist Trevor Tombe has developed a simple way of showing this vulnerability.  His measures shows none-renewable resource revenues (oil and minerals) and deficit as a share of total government spending.

The chart shows that measurement from 2006 to 2018.  In every year,  non-renewables plus deficit ( which is basically the drop in oil prices) has been more than 30% of spending.  The average is about 40% and two of the five times the annual “Dependence Index” was above 40% was the past two years in a row.

RBP has been writing about this problem for most of the time SRBP has been around.  In 2013, SRBP ran a simulation to show another way government could have handled spending and the huge oil revenues that poured in for a few years. 

At the end of the simulation period, the government had about $7.5 billion in the bank and had boosted spending, including capital works every year up to the end of the simulation.  A second simulation three years later showed that by following the same policies, the government would have started to run deficits in 2016 and that one would have been far lower than the one that actually showed up.

If you go back to your picture of the economic balance, you’d have to add a chunk of government spending to the oil side of the economy.  That’s where the economic problem in the province really is.  Not oil itself but the impact of government’s chronic overspending based on oil revenue.

The Williams Tories boosted spending to unsustainable levels and never stopped.  They increased the size of the public service in absolute terms and as a share of the labour force.  It’s around a third of the work force, which makes it one of the highest in the OECD.  That expansion increased the government’s long-term debt due to unfunded pension liabilities, which, together with Muskrat Falls and the chronic overspending has led to a series of credit downgrades in the past three years.

Since 2005, the provincial government has been using its own spending to substitute for sustainable - that is private sector - economic development. Muskrat Falls is nothing more than the biggest example of make-work in the province’s history.

Why Renewable Energy Isn’t the Answer

In Newfoundland and Labrador politics, bullshit is the go-to solution for most problems. We’ll call it nonsense just to be polite.

Here’s why the renewables solution is just nonsense:  they cannot pay for themselves. 

If they cannot pay for themselves, then they cannot replace oil.

And if they cannot pay for themselves AND  replace oil, they certainly cannot pay for themselves,  replace oil, AND pay the costs of Muskrat Falls.

In order for renewable energy to be the answer to the government’s spending addiction and the public debt problem, it has to make a profit.  It can’t. It cannot even pay for itself.

What energy sources we have or are likely to have are too expensive for the current market and the one likely to come. New wind farms far closer to market in North America – and hence less costly – are coming online at the current wholesale market price for electricity in North Eastern North America.  You cannot build Gull Island cheaply enough to make money at those rates and you cannot build wind farms here – very far from likely markets – any cheaper either.

Both Dwight and Delia want to use non-renewable resources to help fix the province’s problem.  Danny used to brag that Muskrat Falls would use oil royalties to build a revenue-generator from renewables.

They all came up with the wrong answer because they all went chasing after the wrong problem.  In Danny’s case, his problem was how to build Muskrat Falls not how to deliver cheap electricity reliably to meet the local need.  Delia and Dwight are chasing after their own fantasies.

Newfoundlanders and Labradorians need to balance the economy  - not diversify it - yet all they get are solutions to some other problems.