Oil prices, Interregional Adjustment and the Canadian Economic Union
In the summer of 1980, federal-Alberta relations were going through a period of conflict and mutual suspicion. Around the same time as the Mellon memo and the Treasury review of Alberta’s contribution to Confederation, three respected economists from the University of Alberta produced a paper for the Treasury on the oil, interregional adjustment, and the Canadian economic union.
The 4-page Executive Summary (presented below) examines the question of how might an adjustment to the terms of trade within a federal state (i.e. higher oil prices) ideally be carried out. Key issues examined include: the structure of ownership of natural resources (public versus private); redistribution or recycling of oil wealth in a federation; and whether there are other reasons to equalize resource rents other than reasons of “efficiency.”
The observations contained in the first section of the report appear obvious, including the observations that urban land dwellers (Calgary and Edmonton) see their prices rise in relation to the rest of the country. A key element in the analysis is the central feature of resource ownership. However, the reality since the exploitation of the Leduc field and the oilsands, is the failure of successive Alberta governments to collect significant rents, leaving the state vulnerable to periods of capital strikes and threats to invest elsewhere.
The study does touch on a key aspect of inter-governmental relations at the time, namely Alberta’s fiscal power which enabled the government to bid up the price of labour for public sector workers. (This was a complaint often voiced in intergovernmental discussions.) In my personal experience, as as graduate student at UofA in the late 1970s and early 1980s, I was amazed at the munificence of university fellowships. However, much of this munificence did go to urban land owners through rent!
Of special interest is the conclusion that redistributive schemes should be aimed at the individuals, not provinces. How this could be done under the equalization scheme then or now, is a moot point.
“Executive Summary
August 28, 1980
L.S. Wilson. M.B. Percy, and K.H. Norrie
This paper addresses three separate but interrelated questions: 1) is there any sense in which the economic response within Canada to developments in the energy sector since 1973 can be said to be detrimental to the efficient functioning of the National Economic Union? 2) If so, does this provide an economic justification for redistribution of provincial resource revenue through some sort of equalization scheme? and 3) are there any other economic arguments other than efficiency ones for an equalization scheme?
The first section of the paper looks at the adjustment issue in the context of a simple, descriptive two region model. The West produces oil (i.e. energy products generally), a small range of manufactured goods and a broad range of non-tradeable products (e.g. housing), using capital and labour (and resources as in the case of oil). The East produces a broad range of processed goods (including tradeable services) and the same kind of non-tradeables as the West. All factors in both regions are. assumed initially to be privately owned. An increase in oil prices relative to manufactured ones, as has transpired since the early 1970s, creates a classical transfer problem, except that in this case it is between regions rather than independent nations. We outline the adjustments that can be expected as a result, both in the short run, when a simple exchange of asset ownership is involved, and in the longer run when changes in the interregional flow of commodities and factors result. The actual pattern of interregional adjustment within Canada appears to be consistent with these expected trends, to the extent that the paucity of regional data allows any inferences to be drawn at all
Our conclusions from this section are as follows:
- The initial disturbance came from an increase in the world price for oil, over which the Western producer provinces have absolutely no impact.
- The terms-of-trade movement in favour of oil necessarily means that consumers of oil must suffer a real income decline, while producers will experience a real income increase. Put differently, oil-consuming regions will have to reduce their consumption of other types of goods and services in order to consume larger quantitates of other goods and services for the same oil output. From an Eastern viewpoint, the real culprit, if one must be identified, is their price inelastic demand for an important commodity import.
- The process of interregional adjustment that is apparently underway in Canada is desirable in the sense that it is consistent with a redirection of commodity flows and a reallocation of factors in a manner that will increase the overall efficiency of the economy. This is premised on the belief that the terms-of-trade change is a permanent one, and importantly on the assumption made to this point not all factor rewards are appropriated by the private sector. We return to this second point below.
- This same type of interregional response to a terms of trade adjustment has occurred several times throughout Canadian economic history. The adjustments in the Maritime since the 1860s, the wheat boom era and the reallocation out of prairie agriculture since WW II are the most obvious examples here. In the first and third cases, it should be noted, central Canada was the recipient of a terms-of-trade Improvement.
- To the extent that the price of Western oil has been held down below its opportunity cost by federal- provincial agreement, the real income loss borne by the East is correspondingly reduced. Put differently, the size of the real resource transfer the East has a consumer of oil has to make is that much less than it would otherwise have been.
- The operation of the current equalization scheme has reduced the economic adjustment face by the Atlantic provinces, Quebec and Manitoba even further, but the nature of the funding of that scheme has meant that this is largely at the expense of Ontario.
- The presence of a common currency, a branch back banking system, and the lack of any formal barriers to interregional factor migration further reduce the extent to which real income declines and unemployment in the East have had to bear the brunt of affecting the real transfer.
- There are potentially quite significant income distributional implications within both the West and the East. Owners of geographically immobile factors (e. g. urban land) benefit disproportionately in the West (at least as a transitional phenomena) and suffer proportionately in the East. This likely goes a long way towards explaining the political support for further economic expansion in the East, and the political outcry emanating from eastern politicians over the existence of even the greatly reduced transfer underway.
The second section of the study introduces into the discussion the important institutional feature that the ownership of natural resources, and thus the economic rents generated in the oil sector, accrue in large measure to the provincial government rather than the private sector. This has potential distortionary implications for the economy as a whole since mobile factors of production may be induced to migrate to resource rich provinces to a greater extent than what purely economy-wide efficiency criteria would dictate. We outline here the nature of this fiscal-induced migration, the circumstances under which it might occur, the nature of the economic costs involved, and how an equalization scheme can be used to avoid these distortions. We report on some rough measures of the apparent fiscal incentives to migration that exist currently, but admit to a lack of any further firm evidence on actual factor responsiveness to these.
The third section of the paper reviews the public finance literature to determine whether there are any economic arguments other than the efficiency one given above, for an equalization scheme of some sort. We review here the notions of fiscal gap, interprovincial economic spillovers, and horizontal equity and find them wanting. This leaves the more traditional equity arguments that apply to the redistribution of any type of income, but these seem to require a redistributive scheme aimed at individuals rather than provinces.
A final section provides a brief summary and some concluding remarks.”
Source: Provincial Archives of Alberta, Hyndman papers- PR1986.0245, Box 53, File 757.