Spending Like There's No Tomorrow
Why don’t Canadians save more of their resource wealth?
When Peter Lougheed died last September, those paying tribute to the revered former Alberta premier summed up his legacy in terms of three main achievements: he modernized a former agricultural economy; he aggressively took on Ottawa when provincial interests were at stake; and he established a political dynasty that still governs the western province more than four decades later. These are impressive accomplishments. But they are not what set Lougheed apart from his peers. What distinguished the former Alberta premier was that even as he dealt with short-term problems, he kept one eye fixed on the horizon and planned for the day when Alberta’s plentiful resources would no longer keep the economy afloat.
A key part of that plan was setting up the Alberta Heritage Savings Trust Fund in 1976 and depositing into it 30 percent of the oil and gas revenues pouring into provincial coffers. The temptation for most politicians is to spend the money available (and sometimes more). Yet Lougheed decided that saving was the best way to address both of the challenges Alberta was then facing: the probability of declining resource income in the future and the need for economic diversification. “We want the best jobs here,” he told the Alberta legislature when defending his plan. “We want the brain power here. We want the upgrading of our resources here. We don’t want to be shipping our jobs down the pipeline or sending our agriculture products down and buying them back. We want diversification.” His party won the 1975 election, when the savings fund was an issue, and every election since.
It took 30 years for another provincial premier to follow his lead, an illustration of the lack of a saving gene among Canadian politicians. In 2006, Jean Charest, the Liberal premier of Quebec, set up the Generations Fund and began depositing water power royalties paid by hydro electricity producers. The fund held $4.3 billion at the end of March 2012, the earnings from which the Charest government had earmarked to help pay down the provincial debt (estimated at $183.8 billion at that time). The minority Parti Québécois government of Pauline Marois threatened to wind up the fund but changed course under pressure from the Liberals. Not only will it be preserved, but it will also be strengthened with the addition of 100 percent of mining royalties (estimated to be about $325 million a year) starting in 2015–16. The PQ did the right thing, albeit for political reasons.
At least Quebec has such a fund. All the provinces and territories receive significant revenues from non-renewable resources, aside from Prince Edward Island, which is rich in agricultural land. Think of potash and uranium in Saskatchewan, diamonds in the Northwest Territories, offshore oil in Newfoundland and Labrador, coal and offshore gas in Nova Scotia, coal and natural gas in British Columbia, or nickel in Manitoba and Ontario. “Just think of the resource wealth out of Ontario and Quebec over the decades from mining,” says one business historian. “It was spent and never put into a sovereign wealth fund.”
The federal government is equally averse to saving non-renewable resource funds. Joe Oliver, the natural resources minister, was quick to dismiss the idea in October 2012, although technically it is not his area of responsibility. “If we aren’t receiving those hundreds of billions of dollars, we would not be able to afford the same level of health care and the same level of education and other programs,” he told James Munson of iPolitcs.ca. As we will see, this is a common excuse. Yet by counting on non-renewable resource revenues as income, governments find themselves in a bind when notoriously volatile resource prices falter. Finance minister Jim Flaherty provided the perfect illustration of this trap this past November when he said it would take longer to balance the budget because resource prices were weaker than expected. Had he been putting those revenues into a fund and counting only on fund interest for income, those low resource prices would not have pushed him so far off track.
However, an increasing number of governments around the world, ranging from wealthy, developed Norway to struggling, underdeveloped Timor-Leste, have seen the wisdom of putting at least some of their non-renewable resource revenue into a sovereign wealth fund. There are at least 45 national and sub-national resource-backed funds in existence. More are being planned. Last October, the same month Oliver adamantly rejected the idea, oil-producing Angola launched a $5 billion savings plan. All these countries, states and provinces believe they have found the balance that has eluded most governments in Canada between funding current needs, such as health and education and planning for the future. “Most economists would argue that at least a portion of non-renewable resource revenues should be saved,” says Jock Finlayson, executive vice-president and chief economist at the Business Council of British Columbia. “Here, Canada’s record can only be described as lamentable.”
Five closely related phenomena—not the mechanics—have made this idea a non-starter for the federal government and most of the provinces: there is widespread misunderstanding, which at times appears wilful, of what a fund does and why it is needed; there is a prevailing attitude that resource revenues are no different than any other income; facing voters every four or five years makes it more attractive for governments to spend now rather than save for later; constant talk of Canada’s resource bounty feeds the perception that those resources are limitless; and, finally, there is the seductive idea that the commodity boom sparked by the industrialization and urbanization of Asia will last for the foreseeable future, albeit with some bumps along the road.
Most of these obstacles are not unique to Canada. But politicians elsewhere have managed to rise above or see through them. Norway is the poster child for resource-backed savings funds. As of mid August it had 3.7 trillion kroner or about $617 billion in its Government Pension Fund Global (formerly known as the petroleum fund), compared to Alberta’s paltry $16.1 billion at the end of March. And Norway was not the first country to adopt the idea. That honour goes to Kuwait, which began setting aside surplus oil money in 1953. It was followed three years later by the Gilbert Islands (now Kiribati), which did not want to spend all its profits from phosphate mining.
Norway set up its fund in 1990, although it did not make the first deposit until 1996. The government’s reasoning was simple: revenues were pouring in from Norway’s share of North Sea oil. But that resource was not expected to last and when it was gone Norway would be left with an aging population and declining revenues with which to pay for pensions and government services. (Oil production peaked in 2001, although gas production has been increasing.) Intergenerational equity—the idea that resources belong not just to the current generation but also to future generations—was a strong driver initially. So, too, was the feeling that natural resources belong to the people and thus profits from production are different than profits from any other business. It was only later, when high oil prices were driving up the value of the Norwegian currency, that a decision was made to counteract the pressure by investing the fund’s assets abroad, a process known as sterilization. (To buy foreign investments, the fund would have to buy foreign currency and sell Norwegian currency, thus putting downward pressure on the value of the krone.) All 100 percent of the government’s petroleum revenues go directly into the fund and the government has set a limit on annual withdrawals from the fund of 4 percent of the fund assets, regardless of whether the fund actually earned more or less than that in a given year. In 2012, for example, the fund had assets of 3.3 trillion kroner at the beginning of the year, leaving the potential withdrawal at 132.3 billion kroner.
To take another example, Chile, the world’s largest copper producer, channels government mining revenues into two funds, a savings fund to cover future pension payments and a stabilization fund that is topped up when copper prices are high and drawn down when copper prices are low. There is also provision for dire emergencies so that in 2010 the fund could be used to cover damages caused by the 8.8 magnitude earthquake that devastated Santiago and the surrounding region. In the case of a less developed country, Ghana joined the club of oil-producing countries in 2010 and set up a savings and a stabilization fund in 2011. The country did not have the capacity to absorb the windfall all at once, so some of the money was “parked” in foreign assets until it could be put to good use.
Yet this seemingly sensible idea has not found fertile ground in Canada, at least at the political level where it counts. Alberta started off well, putting 30 percent of non-renewable resource revenue into its new fund in the first two years. But as there was no legal requirement to maintain that level of funding, contributions tailed off and stopped completely between 1987 and 2005. Post-Lougheed governments dipped into the fund to cover current expenses. Deposits were made in 2006, 2007 and 2008, but nothing since. Unlike Norway or Alaska, where contributions are mandated by law (in Alaska’s case it is 25 percent of non-renewable resource revenues; in Norway’s it is 100 percent), Alberta left the door open to political tinkering, with a not unexpected result. That may change if Alison Redford, who took over as premier in 2011, follows through on pledges to revamp the fund, which by some estimates would be worth at least $100 billion today if government had stayed the course.
Elsewhere in Canada, the idea of creating a fund gets short shrift, if it is raised at all. Newfoundland and Labrador, which has gone from being a have-not province to a have province on the back of revenues from offshore oil and mining, would seem to be a perfect candidate. George Anderson, author of Oil and Gas in Federal Systems, noted that Newfoundland and Labrador has already produced more than half of its offshore oil and “should be thinking urgently about a savings plan.” That has no appeal to Kathy Dunderdale, the premier. “People talk about a legacy fund all the time and we respond to that by saying, ‘That’s our legacy fund, the investment in infrastructure’,” Dunderdale told the St. John’s Telegram. Opponents paint a black-and-white choice between a savings fund and spending on education, health or infrastructure, when the experience of countries and sub-national jurisdictions indicates that the two are not mutually exclusive.
Of course, it is not just Canada. Australia too has decided against a resource-backed fund, despite some strong support from economists and others. Saving resource revenues is hardly a radical idea, Saul Eslake, an Australian economist who supports the idea, said in a speech last year. “Indeed, it goes back thousands of years. The Christian Bible relates how the Prophet Joseph advised the Egyptian Pharoah that ‘20% of the produce of the land during the seven plenteous years [should be] laid up … as a reserve for the land against the seven years of famine’.”
Sadly such arguments have worked no better with the government of resource-rich Australia than they have in Canada. In both countries critics have tended to seize on one narrow reason for a fund, counteracting upward pressure on the currency when resource prices rise, ignoring the other benefits such as intergenerational equity, smoothing out government spending or parking windfalls for later use. One argument that made the rounds in Australia is that if a resource boom is likely to last a long time, it makes no sense to lean against the wind by setting up a sterilization fund that will cushion parts of the economy from a rising currency, thus delaying what they see as an inevitable and necessary restructuring. Australia’s massive iron ore reserves are expected to last 70 years at the current rate of extraction. Natural Resources Canada estimates that at the current rate of production, Canada’s oil reserves would last 175 years, and that was before the Alberta Geological Survey produced a report in November pointing to potential massive reserves of shale oil and gas.
The healthy bits of the economy will bounce back, one Australian economist said. And those that fail are not relevant to the country’s long-term advantage. “Dive shops in Cairns are going out of business but the Great Barrier Reef is not going away,” he says. “You can bring back stuff if you need to.” The problem with this argument is that it comes uncomfortably close to the idea that today’s hot resources will still be in demand tomorrow and that this boom, unlike those in the past, will not end unexpectedly, derailed by political or economic events or technological breakthroughs. Export-related sectors squeezed by a higher currency such as manufacturing, tourism and educational services for foreigners cannot be resuscitated overnight. Sometimes they cannot be resuscitated at all. And as they decline or disappear, the economy becomes more dependent on the resource sector and more vulnerable to the sudden swings in global commodity prices.
In Canada, which has a more diversified and less resource-dependent economy than Australia, the debate at the national level has been framed—one could even say sidetracked—by an argument about whether Canada is suffering from Dutch disease. This is a term coined by The Economist in the 1970s to describe how a surge in gas revenues in the Netherlands pushed the currency up and the manufacturing sector down.
Canada’s manufacturing sector, which had been in long-term decline before the uptick in commodity prices, nosedived further as the Canadian dollar strengthened. This was taken by Thomas Mulcair, NDP leader of the Official Opposition, as evidence that Canada was indeed suffering from this ailment. Such is the level of political discourse in Parliament these days that government ministers reacted by claiming Mulcair had called the energy sector diseased. Mark Carney, governor of the Bank of Canada, tried to raise the discussion to a more sensible level by presenting bank research showing that about half of the dollar’s appreciation against the U.S. dollar could be attributed to high energy prices, 40 percent to the depreciation of the U.S. currency (exchange rates are after all a measure of the relationship between two currencies), with the remaining 10 percent accounted for by foreign investment drawn to Canada by the resource sector, a sound economy and a stable financial system. His verdict was that manufacturing was not suffering from Dutch disease but rather structural changes in the global economy and would just have to adjust.
However, the Organisation for Economic Co-operation and Development, the rich country club to which Canada belongs, has taken a different view. In a 2008 report it recommended that Alberta put more money into its Heritage Trust Savings Fund and be more systematic about how it allocated these funds, and went on to recommend that the federal government consider setting up a federal savings fund to which windfall gains from the resource sectors could be allocated. The OECD was set to make an even stronger recommendation in the 2012 report but dropped it just prior to publication, leaving the suspicion that the federal government, which vets the report, insisted on the deletion. The proposed wording—“Create a sovereign wealth fund for natural resource revenues and invest in foreign assets to limit the effects of Dutch disease, while saving for future generations”—ran contrary to the government assertions that Dutch disease did not exist.
It also did not fit well with the idea that resource income is just like any other income for the government. Supporters of resource funds argue this is not the case. The argument goes as follows: Resources are capital assets that are turned into financial assets when extracted. These financial assets should be invested, not spent. “We are mismanaging our fiscal position because we are using the monetization of an asset, which should be an intergenerational asset, to maintain a high level of ongoing permanent expenditure,” says David Emerson, former federal minister of industry, international trade and foreign affairs. “It’s going to come home to roost.”
Another frequent objection is that the provinces, which under the constitution have jurisdiction over natural resources within their boundaries and collect the bulk of the royalties, are in a better position than the federal government to set up funds. It does not have to be either/or. It can and should be both. Ottawa collects mining royalties in the Northwest Territories (although it is in the process of devolving that responsibility to the territory) and Nunavut, and will collect royalties from offshore oil and gas production in the Arctic, if it proceeds. In the year ending in March 2011, the most recent figures available, the royalties from the five mines in the two territories (three diamond, one gold, one tungsten) amounted to $108 million. A federal resource fund based on royalties alone would start small, especially since Ottawa is sharing some of this revenue with aboriginal groups with settled land claims. But if the predictions of future mining and oil and gas development in the North become a reality, the fund has potential to grow. What better way to show that Ottawa intends to be a responsible steward in the Arctic than by starting on this next phase of resource exploitation by setting up a savings fund for the future?
The debate in Australia about whether that federal state should set up a sovereign wealth fund suggests another possible route. In a paper written for Australian National University arguing in favour of such a fund—“The Dutch Disease in Australia: Policy Options for a Three-Speed Economy”—economist W. Max Corden says the fund could be financed out of general government revenues when the budget is in surplus. The OECD suggested something similar in 2008 when it said that the Canadian government could estimate the impact of oil prices on federal tax revenues and then set aside any windfall gains. This suggestion has the added advantage of smoothing out government revenues and removing the temptation to boost spending when high resource prices bump up revenues. It is always easier for a government to raise spending than rein it in when revenues drop.
Even if the federal government chose not to set up a fund, there is a potential peace dividend to be had if all the provinces with non-renewable resources set up savings vehicles. Since 1957, the year the equalization program was set up, the provinces have been fighting with Ottawa and among themselves over what share of their resource revenues to include when calculating their fiscal capacity to deliver public goods and services. It is currently 50 percent. Resource-poor provinces would like to see 100 percent of these revenues included because it increases the payments they will receive. Resource-rich provinces argue that revenues from non-renewable resources should not be included at all because they are capital assets, which can only be used once, rather than permanent income. If they followed through on this logic and put all non-renewable resource revenues into provincial sovereign wealth funds, spending only the income from those funds, they could rightly claim these revenues should be excluded and only fund income included in the fiscal capacity calculations. This would simplify the fiendishly complicated equalization program and end a battle that has gone on for more than half a century.
The spectre of “Alberta envy” is usually raised at this point because with its immense oil wealth it would have the largest fund. Yet Alberta will have that money regardless. What matters is what it does with that money. In the past, Alberta has used its resource wealth to keep tax rates low (or non-existent in the case of a provincial sales tax). This puts other provinces at a disadvantage in terms of attracting business and investment. Putting more of Alberta’s resource revenues into a fund that invests in other parts of Canada would be potentially less damaging to the interests of other provinces. This is already being done to a certain extent. The top ten real estate holdings in the Heritage Fund include Yorkdale, Square One and Scarborough Town Centre shopping centres in Toronto and Place Ville Marie offices in Montreal. It could do much more.
One common pitfall is not adequately ring-fencing savings funds to prevent raids by future governments. “Most of the funds did not stand the test of time and have been raided at some point, with only a few exceptions, such as Norway’s,” says Daniel Dumas, a specialist in resource-backed sovereign wealth funds with the Commonwealth Secretariat. Canada already has a model it could follow in the Canada Pension Plan Investment Board, which stood at $161 billion at the end of March. (It is not a resource-backed fund.) It receives Canada Pension Plan payments not required to meet current obligations and invests them so that pensions can be paid in the future. There has been no attempt to raid it since it was set up in 1997, perhaps because any changes require the approval of two thirds of the provinces with two thirds of the population, a higher bar than is set for changes to the Constitution.
“Every government should have three funds,” says Rick van der Ploeg, research director at the Oxford Centre for the Analysis of Resource Rich Economies, “a generational fund that is untouchable, a stabilization fund that can be used to smooth income from the fund to cope with the notorious volatility of commodity prices, and a parking or absorption fund, when you need time to build up your capacity.” Setting up a separate rainy day or stabilization fund that can be raided takes pressure off the savings fund. It is also important that the revenue stream from the resource fund goes directly to government with no strings attached. This delivers a stream of income to the government and prevents the resource fund from becoming a rival state within the state or an excuse for the government to spend less in areas ostensibly covered by the fund. (There is the separate question of whether Canadian governments are raising enough money from natural resources, which warrants further study.) Finally, amassing great pools of wealth requires transparency. Here Norway again is the gold standard. There is a digital display on the home page of Norges Bank Investment Management’s website that shows down to the last krone how much Norwegians have saved of their oil and gas windfall from the North Sea. Information on how and where that money is invested is easily accessible and openly discussed.
Saving resource wealth should not be a matter of partisan politics in Canada. Advocates of the practice come from all points along the political spectrum, both in Canada and around the world. We pride ourselves on being a cautious, small-c conservative country. How often did you hear that given as a rationale when Canadian banks did not follow their American peers into the mortgage abyss during the global financial crisis? But when it comes to resource revenues, we are spendthrifts. That could change if we have an informed, national discussion. But like all ideas, this one needs a champion with vision. Peter Lougheed was one such man. Surely Canada can produce others.