Alberta’s Changing Industrial Structure: Implications for Output and Income Volatility

• Main Authors: Bev Dahlby, Mukesh Khanal
• Format: Article
• Language: English
• Published: University of Calgary 2018-02-01
• Series: The School of Public Policy Publications
• Online Access: https://www.policyschool.ca/wp-content/uploads/2018/01/AB-Industrial-Structure-Dahlby-Khanal.pdf

The counterpart to the economic cycle is the policy cycle. Whenever there is a downturn in the Alberta economy because of slumping oil and gas prices, politicians of all persuasions, from Peter Lougheed to Rachel Notley, have called for policies to diversify the economy, on the assumption that expanding other sectors of the economy will insulate Alberta’s economy against volatile oil and gas prices. However, just because a sector is not directly part of the oil and gas extraction sector, does not necessarily make it counter-cyclical. In fact, the sectors that have been promoted in the name of diversification are often linked to the oil and gas extraction sector and follow the same boom-bust cycle.In other words, the government’s attempts to subsidize certain sectors in the name of “diversification” do not insulate the provincial economy from fluctuations in oil and gas prices and may even exacerbate the economic cycle. Missing in the discussion is an appreciation of how changes in the structure of the Alberta economy have affected output and income volatility. In the last 20 years, sectoral output shares have become more diversified in Alberta, and this has contributed to a 21 per cent reduction in aggregate output volatility over that period. Successive governments have tried promoting manufacturing as a way to diversify the economy, but manufacturing is the third most volatile sector, and its volatility is linked closely with the boom-bust cycles of the oil and gas extraction sector. So, increasing manufacturing, including petrochemical manufacturing, will actually make output volatility worse, not better. In fact, a one standard deviation increase in average per capita output in the oil and gas extraction sector is associated with in a 9.45-per cent increase in average per capita output in the chemical manufacturing subsector, suggesting the same boom-and-bust relationship between the two sectors. It is not the only sector like that: 16 other sectors in Alberta are linked to the same boom-bust cycle as the oil and gas sector. The more important diversification issue in the province is not output volatility, but the volatility of labour income. In the last 20 years, labour income has become increasingly concentrated in Alberta’s two most volatile sectors, oil and gas extraction and construction. As a result, volatility of aggregate labour income in Alberta increased by 40 per cent during that period. Rather than trying to change Alberta’s industrial mix by subsidizing industries that may only contribute to more volatility of economic output, a more sensible government approach would be to adopt policies that address the problem of labourincome volatility. That would include finding ways to expand unemployment insurance for Alberta workers, as the current federal government policy actually provides fewer supports to unemployed Albertans than it does to residents of other regions. Average weekly earnings of Albertans were 20 per cent higher than national average weekly earnings over the 2012 to 2016 period. However, maximum annual insurable earnings under EI are determined based on national average weekly earnings. Higherwage earners should have the opportunity to enrol in a voluntary supplemental EI program, and if the federal government does not want to provide it, the provincial government could. Additionally, the government can promote self-insurance among workers by expanding tax-sheltered savings products, like tax-free savings accounts, so workers can accumulate back-up funds when labour incomes are high, to help sustain them during downturns. Finally, the provincial government needs to abandon its procyclical spending patterns. That means spending less money when oil revenues are high, to avoid exacerbating labour and material shortages, and maintaining spending, rather than forced cutbacks, during downturns in the economy. That, of course, would require a great deal more political discipline than the easier and more fashionable attempts to subsidize output diversification.