And why the NEP was a failure
The excellent Worthwhile Canadian Initiative blog
Should Canada be restricting oil exports?
Canada is now the largest foreign supplier of oil to the US, to the tune of some two million barrels of oil a day. Should we be? Shouldn't the Canadian government be trying to keep that oil here in order to satisfy our own energy needs? A non-economist might be inclined to respond in the affirmative: the prospect of running out of fuel seems the sort of thing that a government should be trying to prevent - especially in a country as cold as ours!
But that's not how an economist would look at the problem.
The fundamental resource allocation problem is to decide how much oil should be extracted now, and how much should be left in the ground for the future. Economists know that it's usually pretty hard to improve on the outcomes generated by properly-functioning markets, so the first question to be asked when contemplating government intervention would be: is the market functioning properly? Or, in the jargon of economics, what market failure needs to be corrected? In the case of oil, there's the obvious negative externality of the pollution generated during its production and consumption. The solution to this is of course to determine the appropriate mix of taxes and regulations so that the private costs correspond to the social costs.
But once that's done, there doesn't appear to be any other market failure that would justify much in the way of further government intervention:
* The markets are pretty competitive: no-one - not even OPEC - has enough market power to systematically move prices one way or the other.
* There's little reason to think that there are any important informational asymmetries that would distort agents' decisions.
* The oil market's infrastructure is - for the industrialised countries, anyway - remarkably well-developed.
So there's little reason to believe that government intervention would improve on what the market decides. The price should (more or less) reflect the benefits of current production and the costs of depleting oil reserves. But there's lots of reason to believe that it can make things worse. For those of you who aren't familiar with the techniques used in welfare analysis that follows, here's a good power-point introduction.
Here's a graph summarising the situation under free trade:
Since Canada isn't large enough to affect either the world supply or world demand for oil, it takes the world price as given. Consumption will be characterised by the point x0, and production by x1. The difference between the quantity produced (Q1) and consumed (Q0) is exported. (An oil-importing country would be one in which the intersection of the domestic supply and demand curves occurs above the world price.)
Consumer surplus is the region A, the area between the demand curve and the price, while the producer surplus is the sum of the regions B + C. It should be noted that although producer surplus is larger than consumer surplus in this graph, there's little reason to believe that this is in fact so; it's not hard to re-draw the graph with (possibly more plausible) supply and demand curves so that consumer surplus is larger.
What would happen if exports were forbidden? Prices and quantities would be determined by the intersection of the domestic supply and demand curves at x2 in the following graph:
The domestic price would fall to P2, and output would fall to Q2. The region B1 would be transferred from producers to consumers, and the producer surplus would be reduced to the region B2. Note that the region C is now neither producer or consumer surplus - the 'deadweight loss'.
Another option is the 'National Energy Program' (NEP) model, introduced by the federal Liberal government in 1980, which essentially set domestic prices according to the autarky case, but also allowed suppliers to export 'excess' production at the world price:
Production goes back to free-trade levels (i.e, x1), and domestic prices and consumption are the same as in the autarky cases. Compared to the free trade case, the welfare effects of the NEP were to transfer B1 from producers to consumers, leaving a producer surplus of B2 + C2, with a deadweight loss of C1.
Len Waverman and Robert McRae presented some estimates for the effects of the NEP in this study. Their estimates probably shouldn't be taken as definitive, but they provide a good idea of the order of magnitude of the distributional effects of the NEP (amounts are in 2006 CAD):
* Residents of Alberta lost roughly $46 000 per capita.
* Canadians outside Alberta gained $7 500 per capita.
* The deadweight loss amounted to around $40 000 per Albertan.
So it's not really a surprise that Albertans have a very bad memory of the NEP.
It should be noted that this analysis is based on the short-run supply curves, conditional on the productive capacity that was in place during free trade. But in cases 2 and 3, the price that oil producers receive will be less than the initial world price. The resulting loss in profits will lead to reductions in investment, shifting to supply curve to the left. This shrinkage will stop when the price they receive yields the same rate of profit that they had before - that is, the world price:
In the long run, consumer surplus returns back to its original level A, and producer surplus is reduced further to B1a; the regions B1b, B2 and C are all deadweight loss. The only long-run effect of the NEP or similar attempts to discourage exports would be to fritter away much of the gains from producing oil, with no corresponding gain for consumers.
So should Canada be restricting oil exports? No.
May 21, 2006 in Energy
The excellent Worthwhile Canadian Initiative blog
