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OTTAWA — Ontario will soon be a have-not province, and is poised to start collecting equalization payments in two years, economists at Toronto-Dominion Bank say.
Ontario's economy is struggling to deal with the compounding effects of high energy costs, a strong loonie, and now a U.S. downturn, the economists note in a paper published Tuesday morning. But it's the rising prosperity of the energy-rich provinces, and not Ontario's actions, that have turned Ontario into a have-not, their paper argues.
“The change in Ontario's equalization status is essentially a story of soaring commodity prices,” say Derek Burleton, director of economic studies, and Don Drummond, chief economist. “There is much more at play here than just Ontario's economy.”
They calculate that Ontario would be eligible to receive $400-million in federal equalization transfers in the 2010-2011 fiscal year, and $1.3-billion in fiscal 2011-2012.
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And the central Canadian province could even start getting payments next year, they warn. Data to calculate who should get what is notoriously delayed, and since Ontario is on the edge next year in TD's calculations, its fortunes could go either way.
Ontario makes up about 40 per cent of Canada's economic output and about 38 per cent of the country's population. Its prosperity over the decades has meant that, historically, it has been among the richest Canadian provinces.
The province has complained loudly in recent years, however, that it has been treated unfairly by the federal equalization formula. Premier Dalton McGuinty argues that the formula favours transfers to the Eastern provinces, despite rising resource revenues, while failing to fully account for rising fiscal costs in Ontario.
At the same time, Ontario's prosperity has been declining, when compared with the rest of the country.
Economists have been warning lately that Ontario is destined for have-not status, but the TD report crunches numbers to show exactly how much the province's relative position has deteriorated.
Data released on Monday by Statistics Canada showed that Ontario's nominal gross domestic product per capita — a common measure of standard of living — rose 3.4 per cent in 2007, compared with a national average of 4.8 per cent.
Ontario's standard of living has been below the national average for two years in a row now, and the gap is growing, the Statscan data show.
Under the old equalization formula, Ontario would not receive equalization payments in coming years, because the richest province's fiscal capacity was not included, nor were resource revenues. But under changes brought in last year, half of a province's resource revenues are now included. Alberta's wealth is also included in the formula. The changes make Ontario look much poorer, relative to the more prosperous, energy-rich provinces.
TD's calculations predict that British Columbia, Alberta and Saskatchewan will all be contributors to the equalization formula, or “have” provinces, over the next few years.
But Mr. Drummond is skeptical about whether Ontario would actually ever see any equalization money, even if it does qualify.
He notes that in the 1970s, Ontario was eligible for payments, and actually received some money, as energy prices soared. But support for Ontario was not politically acceptable, and so Ottawa changed the equalization formula, and retroactively clawed back Ontario's payments.
Finn Poschmann, director of research at the C.D. Howe Institute, expects to see similar political manoeuvring this time around, and doubts Ontario would actually ever be on the receiving end of equalization.
“The formula is a product of a political process,” he said. “It's designed to produce a politically acceptable result. So when tensions result, the formula changes.”
And tensions in the West would definitely be exacerbated by the prospect of Ontario receiving equalization, he added. It would mean a small proportion of the country's population, about 30 per cent, subsidizing the other 70 per cent -- a situation that Alberta would probably find unacceptable.
Ontario would probably also balk at being labelled a have-not, Mr. Poschmann added.
“Ontario does not want to be on the receiving end of equalization,” he said. “It's a place that you don't want to be.”
Still, Mr. Drummond adds that Ontario taxpayers fund a huge portion of the federal government's revenues, providing $21-billion more to Ottawa than they received in transfers, in 2005. That surplus won't disappear immediately, he said.
“In actuality then, Ontario residents will, in effect, be paying the equalization tab with their own money,” the paper says.
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Canadian economy rattled
Weakness in manufacturing and wholesale trade undermined Canada's economy in February, leading to a 0.2 per cent contraction compared to a month earlier – a much poorer performance than economists' expectations of a 0.2 per cent expansion.
“Very little to cheer about in February,” said Stewart Hall, market strategist with HSBC Securities Canada Inc.
The February contraction means that over the past three months, Canadian economic activity declined 0.7 per cent at an annualized rate – the deepest three-month contraction since 1997 and the first such contraction since November 2001, when the U.S. was dealing with a recession, notes Michael Gregory, economist at BMO Nesbitt Burns.
“Canada's sturdy domestic demand is being nearly offset by the headwinds coming from U.S. recession, a strong loonie and credit conditions,” Mr. Gregory said.
On Wednesday, Statistics Canada said weakness in manufacturing and wholesale trade were mainly responsible for the Canadian economy shrinking 0.2 per cent in February. (The Globe and Mail)
Statistics Canada said wholesale trade and manufacturing were mainly responsible for the decline, but declines were also noted in retail trade, oil and gas extraction, transportation and the financial sector.
The weak February real gross domestic product comes after a 0.6 surge in January, and a 0.7 decline in December.
Tourism, government and construction activity all rose in February, but not enough to offset the declines in the other six sectors of the economy, Statscan said.
Economists immediately began scaling back their expectations for annualized growth in the first quarter of 2008. The Bank of Canada said last week it expects a 1 per cent expansion, at annualized rates, in the first quarter, but after seeing the February GDP details, economists said first quarter growth would barely be on the positive side of zero.
“Right now, assuming GDP comes in flat in March, first quarter GDP is on track for a mere 0.2 per cent annualized gain, which is well below the Bank of Canada's forecast,” Jacqui Douglas, economics strategist at TD Securities, wrote in a note to clients.
Wholesale activity, especially in motor vehicles and building supplies, dropped 1.4 per cent in February, reversing a big climb in January, Statscan said.
Manufacturing activity fell 0.7 per cent on the month. Even though production of motor vehicles registered a healthy advance, February saw big drops in output of wood products, and petroleum and coal products.
The energy sector dropped 0.9 per cent, dragged down by a 0.7 per cent contraction in oil and gas extraction.
And retail trade activity dropped 0.6 per cent because of sparse activity at pharmacies, clothing stores and car dealerships, Statscan said.
In a sign that the global credit crunch is taking a toll in Canada, activity in the finance and insurance sector slid 0.2 per cent as the volume of trades on stock exchanges fell.
Overall, goods production dropped 0.4 per cent in February, the fourth month in the last six to register a contraction. Output of services dropped 0.1 per cent in February, the second time in six months for a small decline.
Compared to a year ago, economic activity in February advanced 1.5 per cent, with a 2.0 per cent contraction in goods output offset by a 3.2 per cent advance in services.
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Most economists say the Canadian economy will manage to avoid a recession this year, but a growing number say Ontario may not be so lucky.
The University of Toronto's Institute for Policy Analysis is the latest to join the recession camp. Its new forecast for the Ontario economy is calling for negative growth in the first six months of the year — what it calls a "very mild" recession.
Its forecast says the Ontario economy shrank by 0.4 per cent in the first quarter and will shrink by another 0.1 per cent in the second quarter. The third quarter will show no growth, while Q4 is expected to record tepid growth of 0.3 per cent.
The Institute cites the fallout from a worsening U.S. economy, a big drop in Ontarians' savings rate and dismal trade figures in the first quarter. It forecasts that motor vehicle exports from Ontario in the first three months of the year will fall by 10 per cent from the previous quarter.
The forecast's authors — Peter Dungan and Steve Murphy — say overall growth in Ontario will be just 0.1 per cent in 2008, before rebounding somewhat to 2.2 per cent growth in 2009 and 3.2 per cent in 2010.
'Very mild' recession
"As recessions, go this one should be very mild," the authors say. "The central banks in both the U.S. and Canada have clearly indicated a willingness to provide accommodative monetary conditions."
But they say they're worried that the U.S. slowdown will be even worse than expected.
Export Development Canada came out with an export forecast Wednesday that said Ontario exports would drop by seven per cent in 2008. "Ontario's exports will be battered this year by the high Canadian dollar and eroding U.S. sales," said EDC deputy chief economist Peter Hall.
Several big bank forecasts have warned that the Ontario economy will be on the brink of recession in 2008. TD Bank Financial Group chief economist Don Drummond said there will be at least one negative quarter of growth in Ontario and "quite possibly" two consecutive negative quarters — the technical definition of recession.
Desjardins Group said last month that Ontario's economy was heading for two straight quarters of negative growth.
"Its economy is at the mercy of the manufacturing industry, especially the automotive sector, which is going through a period of major restructuring," said Desjardins Group deputy chief economist Yves St-Maurice.
Last week, Ontario finance minister Dwight Duncan acknowledged that the provincial economy was "going sideways" — a stagnation that would continue "until well into 2009." The provincial economy grew by just 0.1 per cent in the last quarter of 2007.
