What is economic diversification?
Economic diversification in Alberta is not a new conversation. People have been talking about it for decades. And while many agree that a diversified economy is best for Alberta’s long-term prosperity, there is not much talk of our current context, what diversification should look like and how we can attain it. Let’s start with a basic summary of diversification.
We’ve all heard that you shouldn’t put all your eggs in one basket – concentrating your efforts and resources in one area is risky as you could lose everything. Having a single, dominant industry means that when a negative shock affects that industry, the whole economy is adversely affected. (However the opposite is also true: when the dominant industry is doing well, the rest of the economy also benefits, so diversification does not always necessarily lead to a better outcome). The oil and gas resources in Alberta has led the province to specialize in that sector.
In a diversified economy, a number of unrelated industries create economic growth and job creation. When one sector has a negative shock, the other sectors remain largely unaffected. Diversified economies are less volatile, but may not be as prosperous because they are not focused on the area where they have the best comparative advantage. To generalize, concentrated (non-diversified) economies may have a greater reward, but it comes at a greater risk. Diversified economies may have less risk but there can be less reward.
What does it mean for Alberta?
There are three angles we can use to look at how diversified Alberta’s economy is: employment diversification, production diversification and income diversification.
In 2019, Alberta’s biggest employment sector was the retail and wholesale trade industry, employing about 14% of workers. Following that, health care and social services employed 14% of workers and construction employed 10% of worker in Alberta. The resource sector (mining, oil and gas) employs about 6% of workers in Alberta.
Perhaps surprisingly, Alberta’s labour market was the most diversified amongst Canadian provinces in 2019. And it’s been the most employment-diversified province every year since 1976. If we compare the provinces to the United States, even the states with the most diverse labour market (California, Colorado and Utah) are less diversified than most provinces. So Alberta is the most diversified labour market in North America.
The main production sectors in Alberta are resources (26%), real estate (10%), construction (8%) and manufacturing (8%). The only province with a higher reliance on the resources sector is Newfoundland, with resources representing 36% of the economy thanks to development of the oil industry there. Newfoundland, Alberta and Saskatchewan are the least diversified provinces in terms of production.
In comparison to US states, Alberta is more diverse in production than only five states: Alaska, D.C., Delaware, Indiana and Wyoming. Compared to other oil-producing regions in the states, Alberta is significantly less production-diverse than Texas and North Dakota, and slightly less diverse than Oklahoma.
The main source of income in the provinces is similar to the main sector of production. As such, the resource sector is the main income generator in Alberta, Newfoundland and Saskatchewan. Those provinces are the least diversified in terms of income source.
Alberta’s income diversification score fluctuates because income in the resource sector depends on the price for selling its production. At the height of the latest oil boom in 2014, only four US states had less income diversity than Alberta: Alaska, Delaware, D.C. and Indiana. Even the oil-producing US states were more diversified than Alberta.
We can see that Alberta has a diversified economy in terms of employment, but a concentrated (or non-diversified) economy in terms of production and employment. However, a lack of diversification is not necessarily a problem on its own. The issue comes mainly from when the dominant sector is volatile and prone to boom-bust cycles. Let’s look at volatility in Alberta.
Labour market volatility
Although Alberta has the most employment diversification in Canada, its labour market volatility is one of the highest. The most significant contributors to labour market volatility are the construction, resources as well as professional, scientific and technical services sectors. Together these three sectors account for about half the labour market volatility but represent less than a quarter of the province’s jobs. The oil sector accounts for about 16% of the volatility but represents only 6% of employment.
When it comes to production, greater diversification leads to lower volatility, so they least diverse provinces (including Alberta) are the most volatile. In Alberta, the agricultural, construction and management services sectors are the most volatile in terms of real growth. The resource sector only ranks as the 8th most volatile sector out of 20. However, it is responsible for about 30% of the total production volatility because of its high share in real GDP and a high cross-correlation with other sectors such as construction, manufacturing and wholesale trade.
The main source of income volatility in Alberta comes from changes in commodity prices, especially oil. The movements in commodity prices also influence the level of diversification, increasing the resource sector share when prices rise and reducing it when prices decrease. As such, Alberta has a high level of income volatility: the resource sector has a standard deviation three times bigger than that of the whole economy.
Should Alberta diversify?
Alberta tends to be less diversified than the oil producing states in the US. Despite oil being a major industry in states like Texas and North Dakota, it has a smaller share of the economy in terms of production and income. This suggests that simply having oil and gas resources doesn’t necessarily lead to a concentrated (non-diversified) economy. So why does Alberta have one?
The answer may be output. Each worker in the resource sector produced an equivalent of $390,000 in national income in 2017, the latest year of available data. That is three times as much as the average worker in the rest of the economy. On average, the resource sector has generated four times more income per worker than the rest of the economy over the past 20 years.
This high productivity in the resource sector means that to replace one worker in that sector would require creating at least three jobs in other sectors to keep that national income unchanged (all else being equal). It therefore means that as Alberta’s economy diversifies from the oil and gas industry, the GDP per capita is like to lower towards the national average. However, with this cost comes an important benefit – a much less volatile economy – which is the object of diversification.
How to diversify
There are two ways to diversify an economy: promote the development of other industries to reduce reliance on a single one, or reduce the dominant sector’s volatility by diversifying its activities, products, customer base and markets.
To diversify through developing new industries, it makes sense for Alberta to push agri-business, chemical, petrochemicals and plastics as well as tourism. These are all sectors where Alberta has a comparative advantage. Alberta also provides a high quality of life, business-friendly environment, world-class infrastructures and a young and educated population to attract other sectors.
To diversify through reducing volatility, Alberta could promote the use of oil for industrial usage, for example the use of bitumen to produce asphalt. If we look at the energy industry as a while, Alberta could develop renewable energy, alternatives to fossil fuels and technology that can be exported.
While diversification is almost sure to come at a cost, the benefit of lower economic volatility and more sustainable long-term prosperity in the province will likely outweigh the cost.
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