In spite of the enormous contribution of energy natural resources to our fiscal and economic well-being,  our national psyche continues to be torn by ambivalence toward this unique endowment of nature.

This should not be surprising. The thought of being “hewers of wood and drawers of water” has tormented Canadian thinkers and writers for much of our history. More recently, campaigns to brand Canada as an environmental pariah and producer of “dirty oil” play to old insecurities and sensitivities. For many, it adds to a deeply ingrained international view that staple economies tend to underperform compared with more balanced industrial economies over time. In the case of natural resources, there has evolved a significant literature on the so-called curse of natural resources.

But not so fast. Tectonic shifts in the global economy have transferred potential economic advantage to many of the world’s resource-endowed economies. Subject to cyclical interruptions, this advantage is likely to continue for years or perhaps decades. While history is awash with cases where resource wealth turned out to be more a curse than a blessing, there is an opportunity for Canada to chart a new and course. By leveraging and carefully managing energy and resource assets, an advanced, knowledge-based, technologically rich economy is attainable.

My intent is to place the need to think about energy in the context of the “curse of natural resources.” I will offer what I believe are some foundational principles and some public policy imperatives for expunging the curse and gaining lasting benefit.

First, Canada is a small trading economy. Prosperity depends on competing in an international marketplace, where globalization has wrought massive economic and geopolitical change. It is therefore imperative that Canadians recognize, accept and adapt to the new realities of global commerce. Strong linkages will have to be forged with emerging economies where economic growth and innovation will be increasingly abundant.

Second, a longer-term, more disciplined approach to managing energy and resources is required. Natural resources are long-term assets that belong to generations of Canadians now and into the future. Government leaders and decision-makers have an implied custodial and stewardship responsibility to manage across the generations.

In fiscal and economic terms, nonrenewable energy and natural resources are long-life, fixed assets that, when sold and monetized, should be reinvested in ways that will benefit Canadians over the long term. Pretending that resource revenue is just another form of operating revenue, to be spent on current consumption of public services, is an abrogation of this responsibility.

Even a stronger platform for North American management of energy, the economy and the environment are not enough. Improved linkage to the developing world will remain essential.

If this sounds like a motherhood and apple pie principle, it is not. Adherence to these principles of public finance will require profound and difficult change. Without a compelling narrative that resonates with Canadians, badly needed fiscal decisions will face extreme resistance. Around the world, such governance challenges have given rise to what Jeffrey Sachs and others refer to as the curse of natural resources. In many countries, particularly in the developing world, corruption and cronyism exacerbate the curse.

Driven by technology, the process of wealth creation worldwide has been transformed to the point of shaking the world’s economic and geopolitical foundations. Trade has evolved from old models of production and exchange, to supply chains, to what the Dominic Barton in McKinsey Quarterly now refers to as “global grids” of value creation and Jean-François Lamoureux of Export Development Canada (EDC) calls “integrative trade.” As an example of the extent to which wealth creation has changed, EDC estimates that sales of the foreign operations of Canadian companies now exceed total export sales from Canada. Much trade today is actually a by product of these internationally integrated networks of value creation.

The world’s knowledge reservoirs can now be accessed from virtually anywhere using devices you can hold in the palm of your hand. Countries that for centuries have been trapped in poverty and misery are being developmentally liberated. The China miracle, rather than an isolated one-of-a-kind phenomenon, is really the most visible leading edge of a broader shift that is rapidly taking root in hundreds of countries.

The new global reality is redefining the rules of competitive engagement for business, government and individuals.

In just a few decades the “huddled masses” have emerged as new consumers, labour market participants, producers, innovators, competitors and even global investors. Poor countries that are home to billions of people are industrializing, building infrastructure and investing en route to becoming advanced modern economies. Unfortunately, in many jurisdictions, the economic revolution has run far ahead of democracy, human rights and rule of law.

Among the many corollaries of this tectonic shift is a tidal wave of demand for energy and resources to support this wave of development, which has entered what many believe is a “super cycle,” providing wellendowed countries massive cash flows and favourable terms of trade.

Meanwhile, the old industrial world is foundering. Vulnerable and slower-growing, the pressure is on it to establish new relationships and linkages with the new order. Combine all this with the evolution of “grids” or “networks” of global value creation and you have competitive pressures on a massive scale. For old order, trade dependent countries the challenge is to adapt or face marginalization. The juggernaut of dynamic new economies is now all but unstoppable. And that describes where Canada today finds itself.

Very slowly, North America is migrating toward a continental platform for production, wealth creation, management of security and the environment. And without better, more secure arrangements in North America Canada risks exposure to US nationalism and protectionism. An integrated platform also provides a powerful foundation for all three partners of the North American Free Trade Agreement (NAFTA) to compete and maintain their influence in the new world, although acceptance has been slow and uneven.

The question remains: Can North America adapt sufficiently to sustain its position as a geopolitically and economically dominant continent? More pointedly, can the US reach beyond parochial and partisan domestic pressures, reinvent itself and embrace the North American partnership as vital for its own economic future?

But even a stronger platform for North American management of energy, the economy and the environment are not enough. Improved linkage to the developing world will remain essential.

Canada’s case, realizing the full benefits of our energy and resource potential requires a more robust North American partnership to be augmented by quantum enhancements in framework arrangements with the growing markets of Asia and Latin America. Participation in the emerging Trans-Pacific Partnership is critical, as are focused strategies to improve the port, rail, pipeline and road capacity associated with gateways and global access corridors to the west coast, and eventually to the Atlantic and Arctic. Failure to execute in these areas will cost dearly in wealth creation and opportunities for generations of Canadians.

An imminent test of Canada’s adaptive capacity will be our ability to open up the west coast to enable access to Asia Pacific markets for natural gas and oil. Both Enbridge and Kinder Morgan have oil pipeline proposals that will ultimately require government approval in the face of opposition from Aboriginal and environmental groups. The capacity to transport and liquefy natural gas faces fewer hurdles, but still remains a distant reality.

Few would disagree that the longterm future of the country and its people is a core responsibility of government, and probably not to be entrusted solely to the animal spirits of individuals and free markets. Yet it is the long term, the intergenerational long term, that governments seem to struggle with the most: witness the debt and fiscal mess the Western world is poised to dump on future generations. In country after country, collective resistance to curtailing public spending is met by piling on more debt. Debt markets willing, the costs are being passed on to the next generation.

The management of nonrenewable energy resources presents something of a mirror image. The rights to develop and extract the resource asset are sold, converted to cash and spent on current consumption of public service, leaving little of benefit to successor generations. In some cases, we double up. We spend on current public services beyond what we pay in taxes, we monetize long-term resource assets to pay some of the bills and take on debt to pay the rest. This is hardly a model of fiscal probity and intergenerational stewardship.

In the province of Alberta, for example, nonrenewable resource revenues typically make up over 20 percent of the revenues required to support the operating expenses of the government. But the problem is even more complex than that.

Energy and natural resource markets are notoriously volatile. The more government spending relies on such revenues, the more fiscal volatility and instability become embedded in fiscal frameworks. Making matters worse, swings in revenues are chased upward by increased spending in the up cycle, only to remain stuck at high levels by political resistance in the inevitable revenue down cycle. Thus the combination of volatile revenues and expenditure ratchets create a vicious cycle of fiscal erosion.

Resource booms also boost incomes, spending and investment, which translates into cyclical swings in sales and excise taxes, income taxes, property taxes and more. A prolonged collapse of the boom also cools these boiling pots of revenue growth, again aggravating expenditure ratchet and fiscal balance effects.

So a common manifestation of the curse of natural resources is fiscal volatility and instability.

A second manifestation of the “curse” is a nest of structural issues often bundled together under the label “Dutch disease.” In reality, resourcebased or staple economies have been afflicted long before the term was popularized in relation to economic stresses brought on the Netherlands as a by-product of the North Sea oil boom in the 1980s.

SIGN UP

The inner workings of government

Keep track of who’s doing what to get federal policy made. In The Functionary.

Read it now.

SUBSCRIBE

The Functionary

Our newsletter about the public service. Nominated for a Digital Publishing Award.

Here is the typical pattern. A resource price boom sharply improves the terms of trade for a resource-endowed country. Export revenues expand and the currency appreciates. High prices and profit margins in the resource sectors stimulate production and new investment. Demand for construction services and materials inflate costs for required labour and materials. Project capital costs escalate. Marginal resource projects eventually become uneconomical, and those that are completed often carry an inflated cost base for many years, through amortization and depreciation.

Resource booms also boost incomes, spending and investment, which translates into cyclical swings in sales and excise taxes, income taxes, property taxes and more. A prolonged collapse of the boom also cools these boiling pots of revenue growth, again aggravating expenditure ratchet and fiscal balance effects.

But the effects of inflated costs, bottlenecks and negative exchange appreciation are not limited to booming resource sectors. They spread throughout the economy, driving up costs and generally hurting the competitive position of manufacturing, technology and other trade-oriented businesses. The Holy Grail of “diversification” from a primary staple economy is then set back for extended periods of time and the curse becomes more deeply embedded.

Compounding the problem in some countries are endemic problems of corruption and poor governance. Payoffs for resource licences and permits are a frequent source of graft, and even the large-scale availability of resource revenue can impede accountable governance, since the line of sight between government spending and the tax-paying citizenry becomes blurred by plentiful resource money.

Canada is largely corruption free, but fiscal instability, intergenerational governance issues and the various symptoms of the Dutch disease are all too prevalent.

Having served as chair of both the Energy Policy Institute of Canada, a private sector initiative to develop an energy strategy for Canada, and the Alberta Premier’s Council for Economic Strategy, which is mandated to look forward 30 years at that province’s future with the benefit of some of the best thinkers from both the public and private sectors, I was struck by the compatibility of the two perspectives.

Fundamentally, the public policy and private sector perspectives seek to maximize the value of the energy resource. And there were few notable differences in the need to establish aspirational environmental objectives and to apply technology over a capital replacement cycle to facilitate their achievement. Similarly, the risks and perils of Dutch disease were a common concern from both the public and private sector points of view.

There were also convergent views on the need to secure a stronger, more reliable and more predictable energy and environmental relationship with the US. This included infrastructure for shared energy security as well as compatible and comparable regimes for carbon pricing and environmental management.

There were strong views on the need to open up international markets, particularly in the Asia Pacific, as a way to complement a strong North American platform, manage market risk, achieve full value for the resource and enable Canadians to become global leaders in the energy sphere.

There is also broad recognition of the need for improved efficiency, clarity, certainty and timeliness of project approvals, a reflection of the byzantine complexities of multi-departmental and intergovernmental processes for reviewing and approving major projects. No one was seeking to compromise standards or dilute community and/or First Nations interests, just to improve processes and to acknowledge the need for meaningful steps to improve a tarnished international image.

As usual, however, devils lurk in the details. Those supporting pipeline capacity improvements to west coast tidewater might have different perspectives on routes, on gas versus oil, on how to incorporate the rights and interests of First Nations, and on which are the appropriate ways to deal with safety and environmental risks, for example.

Similarly, approaches to dealing with market bottlenecks, exchange effects and the anti-diversification bias of “gold rush” approaches to resource development were very different. Some felt the private sector has learned from past mistakes and would correct the problems of too much too fast during the boom. Others argued for the need for greater government intervention through improved planning and execution of projects, infrastructure and training and recruitment of skilled labour.

Most would agree, however, on a need for regular and structured processes to bring together key decision-makers, to identify emerging problem areas and to agree on corrective steps. Few would have disagreed with the need for process leadership by government.

Perhaps the most toxic issues relate to long-term management of the resource itself, coupled with a more robust approach to fiscal instability and intergenerational fiscal transfers.

First, governments and others involved in the development and stewardship of resources need constantly to think of future generations of Canadians and their claim on publicly owned resource assets and the environment. This naturally presents the question of the speed and nature of development and exploitation of resources — to extract now or sometime in the future, for example — and includes the nature and extent of environmental protection and restoration.

Second, where resources are monetized, the proceeds should be reinvested into long-term assets that transfer appropriate benefits to future generations. This, however, leaves a fiscal gap and opens up the more contentious issue of filling the gap left when resource revenues are no longer available to pay government operating expenses. Tax increases, user fees and expenditure and program cuts to restore structural fiscal balance are not politically popular. Making them acceptable would require persuading and convincing the public to accept a measure of short-term pain in the interests of a long-term legacy.

Even the question of how resource revenues should be managed and invested for the future invites controversy. Norway, for example, has established a sovereign wealth fund that is professionally managed to achieve sustainable returns with acceptable risks. From the real returns to this fund a portion is made available to enhance the permanent revenue base of the government. But the fund lives on, delivering benefits across generations. By investing large portions abroad, some of the pressure of exchange appreciation is ameliorated, along with the currency-induced cost pressures on other parts of the Norwegian economy.

Other approaches involve investing resource revenues more directly into projects and initiatives specifically directed to long-term diversification of the resource economy. Investments in infrastructure, technology and innovation capacity, or even nonrecurring investments to improve community or educational capacity, are often considered legitimate uses of resource revenues.

And there are different approaches to the governance of such funds. Sometimes they have been established as an arm of the government of the day, with the consequent risks of politicization and the inevitable financial underperformance. Other approaches involve arm’s-length professional fund managers with a strict financial mandate, while others are a hybrid of various nonpolitical professional oversight, but subject to a government mandate that gives sharper definition to the types of investment deemed to be in the public interest.

Canada does need an energy strategy — to capture maximum value from the resource and to leverage resources to create longer-term opportunity for Canadians. But it should also wrap into a larger approach to shaping the future. Twenty-first century Canada is already being shaped inexorably and fundamentally by global seismic shifts, and we need to adapt strategically. Adaptation can be unplanned, involuntary and reactive, or it can have a long-term and disciplined perspective.

Energy is a large part of Canada’s endowment of natural resources, but only a part of the assets that should be managed across the generations. A fundamental challenge is to eliminate what has come to be known as the curse of natural resources, in which resource wealth actually reduces longterm prosperity, stability and sustainability of the economy.

Building on the two guiding principles earlier outlined are six public policy imperatives I believe are important:

1. Always place today, and the decisions of today, in the context of the fundamental forces of change that will shape the world over the next 30 years. Thirty years is not that long, and many developmental and infrastructure undertakings are already planned in that kind of time frame. In this way big, difficult changes can be done in smaller, easier, incremental steps.
2. Reassert the intergenerational stewardship role of government. This means managing the country’s assets and liabilities while explicitly considering intergenerational transfers. This applies in particular to public financial assets and liabilities, and long-term resource and environmental assets.
3. For Canada, as a small trading economy, external linkages will fundamentally affect how, and how well, we are able to seize opportunities and build prosperity over the long haul. Seismic global shifts will change the competitive landscape in the decades to come, and Canada must change and adapt. Continuing to focus on strengthening the North American platform is essential, but it must be complemented by building and improving linkages to the high-growth developing world, particularly in the Asia Pacific and Latin America.
4. Energy and natural resources have become technologically rich, sophisticated sectors in the new global economy. We should focus on using our resource assets as a catalyst to become a world-leading high-tech economy, managing global value grids and selling expertise to the world.
5. The curse of natural resources presents a real threat. One thing is clear: Canada needs to stop funding the current operating expenses of governments from the monetization of resource assets. Long-term investment funds, managed professionally, would provide a way of generating long-term benefits from cashing out such assets and ultimately contributing to the long-term stable tax base.
6. Canada needs a long-term navigational beacon, not a detailed road map with all the complexities and encumbrances. For the country as a whole, some high-level fiscal, environmental, social and economic goals are needed. And because energy/natural resources and linkages to the global economy are so central to our wellbeing, they deserve a special place as part of the “north star.”

Most Canadians have an intuitive feel for where they see the country in 30 years. Individuals and markets do a pretty good job of sorting through the opportunities and chaos of the near term. But governments need to give shape and form to where we want to go as a nation, and the nation needs to provide room for different provinces to customize in their own ways. A coherent and substantive set of principles, benchmarks and approaches that fully respects Canada’s federal system can do that. And while the journey will often be circuitous and iterative, many small, practical steps guided by a widely accepted narrative will leave a better Canada for generations to come.

Photo: Shutterstock