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Oil prices have fallen, and our economy will have to adjust. This prospect may alarm many, but Canada has had to adjust to similar shocks throughout its history. The Canadian economy altered its structure in order to take advantage of higher resource prices, and part of that shift will now have to be undone.
There’s no point in pretending that this is anything but a negative shock, but it is possible to overstate the bad news. Firstly, the change in the Canadian economy over the past decade has often been overstated, and sometimes wildly exaggerated. Secondly, the ability of the Canadian economy to adjust is not well-enough appreciated.
No one will be surprised to learn that higher oil prices spurred more oil production, but the increase was surprisingly modest: The average growth rate of after the 2002 was 3.6%, compared to 2.6% during the preceding 12 years. But since other sectors have been growing even faster, the oil and gas sector’s share of GDP declined from 6.4% in 2002 to 6% in 2014.
Its share of employment has increased, but is still only 1.7% of the total. Claims to the effect that Canada has become a “petro state” or that its economy is largely dependent on oil simply do not mesh with the facts. As far as output and employment are concerned, the Canadian economy of 2015 is surprisingly similar to what it looked like in 2002.
One area where oil has played a significant role is exports. Oil exports have increased in value by over 150% — although they still account for less than one-fifth of the total. But here the story is primarily one of prices: The effect of higher prices received outweighs that of the increase in the quantity exported.
Now that oil prices are falling, this effect will be reversed. The adjustment in prices — mainly through a depreciating exchange rate — will be painful: It will reduce consumers’ purchasing power. But the adjustment would be even more painful if we had a fixed exchange or rate — or worse, if we didn’t have an exchange rate to depreciate.
For the rest of this article, click here: http://news.nationalpost.com/2015/01/27/stephen-gordon-the-petro-plunge-will-be-painful-but-we-will-adapt/