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

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