The bottom has fallen out of the oil market. In recent months oil prices have dropped in half. When and whether prices recover is unknowable. Insofar as this is associated with a worldwide economic slowdown, increased supplies, and Saudi Arabia's intent to regain market share, prices could be depressed for a long time.
Oil, of course, accounts for a large portion of the Alaska economy. Including indirect effects some estimates are as high as 50 percent. This ensues from the oil industry's own spending and from state spending. The vast majority of unrestricted state revenues come from oil, and state spending recirculates petrodollars into the economy.
If the price collapse endures for more than a few months, it is possible the Alaska economy could slip into recession. The oil industry will spend less because projects feasible at high prices are no longer economic, and because they have less cash. And the state will have fewer revenues, with a massive budget deficit. These factors will remove several billion dollars from the economy, causing it to shrink.
A similar occurrence happened here in 1986. Oil prices dropped from $27 to $9 per barrel. In addition to oil industry cutbacks, the state budget was cut by 40 percent. It was not pretty.
The total number of jobs in the economy dropped 10 percent, a good barometer of how much the economy contracted. It took four years to come back to pre-price-crash levels. Housing prices dropped by 30 percent. Foreclosures were up 10-fold. The number of new home mortgage loans dropped in half. Fifty percent of the banks in the state failed. Bankruptcies abounded.
In 1986, the state did not have significant savings. And the large drop in state spending contributed to the severity of the recession. One big difference between then and now is the state currently has a large reserve of savings. And in crafting the upcoming state budget it may be useful to factor in the role of state spending in the economy.
A function of state spending in Alaska, besides providing essential services, has become to recycle petrodollars into the economy. Cutting the budget too much could make a bad situation worse. The money in state savings now sits outside the economy. Spending it would bring outside money back in. That is what causes economic growth.
Of course the savings also have to be preserved both to create earnings income and to be available for future use. So any plan to use savings must also plan to preserve it.
In 2004 such a plan was devised. It was called Percent of Market Value, or POMV. The plan worked as follows: The Permanent Fund's financial advisors believed the fund could be expected to earn an average long-term return of 8 percent annually. Of that 8 percent, 5 percent would be real growth, and 3 percent inflation. Under POMV, 5 percent of the value of the Permanent Fund would be used, split evenly between dividends and state spending. This would provide additional state revenues, while growing the Permanent Fund, in perpetuity. That is how most large endowments operate.
Going forward, depending on how POMV was structured, dividends exceeding last year's amount of nearly $1,900, and ever increasing, would be sustainable. In the long run, given the difference between how dividends are calculated, dividends would probably be higher under the status quo method, except for one important factor.
The current budget plan appears to simply deplete money from the $12 billion budget reserve accounts. That practice is not sustainable, and those accounts could soon be drained dry at the rate they have been used lately. The recent state forecast shows these funds reduced by half next year. If these accounts are depleted, the only source of money left would be the Permanent Fund earnings reserve account. As it gets similarly exhausted, the dividend will plummet. Declining oil production exacerbates this problem.
POMV was endorsed then by the Permanent Fund trustees to make the earnings less vulnerable to overspending, and to preserve the fund and the dividend. It was also endorsed by the administration, some legislators, and many economists.
Because the constitution currently separates Permanent Fund principal and earnings, and POMV combines them, POMV would require a constitutional amendment. While there is no time to enact that this budget cycle, it is possible for the Legislature to pass what would amount to a financially similar result, at least for this year. At current oil prices POMV does not fill the entire budget gap itself. (And the fund's long-run forecast of market returns may be different from 2004.)
The budgeting process will determine the level of state services Alaskans want, how much they want to pay for, and how to pay for it. The state is blessed with resources that could ameliorate some of the misery associated with what could be a nasty slump.
Roger Marks is an economist in private practice in Anchorage. Between 1983-2008 he was a senior economist with the Tax Division of the Alaska Department of Revenue.
The views expressed here are the writer's own and are not necessarily endorsed by Alaska Dispatch News, which welcomes a broad range of viewpoints. To submit a piece for consideration, email commentary(at)alaskadispatch.com.