Government-Expenditure Crowding-In Effect and Lack of Economic Diversification in Oil-Producing Countries: Lessons from Alberta

Abstract

In this paper, I examine the impact of oil price shocks, government expenditure, and Chinese investments in the energy sector on Alberta’s economy. The aim is to understand how government expenditures transmit oil-price changes to the economy, thereby exacerbating economic cycles in Alberta, an oil-exporting region, and to provide policy recommendations that could help Alberta benefit from future oil price drops. To my knowledge, I am the first to examine the effects of oil price changes, government expenditures, and investments from China on Alberta’s economy, accounting for inter-industry and household demand effects. I find evidence that Alberta’s manufacturing sector depends heavily on the oil and gas sector; government expenditure has a crowding-in effect that exacerbates economic cycles; Chinese investments in Alberta’s energy sector contribute positively to Alberta’s economy; and West Texas Intermediate (WTI) oil price is an important factor. I use actual WTI values and oil future values to simulate and forecast key explanatory variables. The results are robust to different variations of the model, and when creating in-sample and out-of-sample forecasts. The results of my analyses yield three policy recommendations for Alberta: (a) implement a long-term counter-cyclical fiscal policy, preferably during a boom period; (b) diversify both the oil and gas sector (to increase petroleum product exports) and the manufacturing sector (to increase non-oil related production); and (c) open the economy to additional foreign investment.