Putting oil revenues into a savings fund isn’t always a great idea – by Stephen Gordon (National Post – March 31, 2015)

The National Post is Canada’s second largest national paper.

Pundits outside Alberta are almost unanimous in their support for a Norway-style sovereign wealth fund. If only the Alberta government had saved more of its resource revenues, the argument goes, then the Alberta government would have saved more of its resource revenues. Or something like that; details are never the strong suit of big-picture pundits. It’s usually enough to make the clearly unarguable point that it would nice to have an extra $1 trillion on hand, just like the Norwegians.

The Alberta government could have set aside some of its revenues into a wealth fund. But then again, so could have the federal government and any of the other provincial governments; Quebec already has put away $7 billion into its Generations Fund. The mechanics are pretty simple: set expenditures less than revenues and put the savings into a wealth fund. Any government can do it, so why don’t they? The answer is of course that saving is costly, and the benefits of being able to finance future spending don’t always exceed the costs of sacrificing current expenditure.

There are two things you can do when your income goes up: You can spend the increase, or you can save it (or some combination of the two). The theory of optimal savings says that the decision depends on whether or not the increase is temporary or permanent. A purely temporary jump in earnings — a good example is winning the lottery — should be saved, so that the benefits can be spread out across a long period of time.

Similarly, people whose careers pay very high salaries at first and then fall off to a much lower level — for example, elite athletes — are well-advised to save the bulk of their earnings during the peak years.

This is the idea behind a resource wealth fund. If the burst of resource revenues is short-lived, then it’s best to think of them as a lottery-style windfall that should be saved and then spent across a longer period of time. “What will we do when the oil runs out?” is a question with real resonance in Norway. Norway’s oil reserves were never very large, and production peaked in 2001. At current rates of extraction, existing reserves will be exhausted within a few decades.

This was also the context behind the establishment of Alberta’s Heritage Fund in 1976. The oil sands were not yet viable, and the estimated lifespan of conventional oil reserves was measured in decades. Preparing for a post-petroleum Alberta made sense in the 1970s, and so did a resource wealth fund.

For the rest of this article, click here: http://news.nationalpost.com/full-comment/stephen-gordon-putting-oil-revenues-into-a-savings-fund-isnt-always-a-great-idea/