Saturday, February 18, 2012

Drummond Report: An excerpt on how Ontario got into this mess

The roots of Ontario’s current fix lie in both the economy and in the province’s record of failing to keep growth in government spending in line with revenue growth. Ontarians have long been accustomed to their economy growing faster than the rest of the country. This was once true: in 15 of the 21 years from 1982 to 2002, Ontario grew faster than the national economy. But changing economic conditions have hit Ontario harder than other provinces over the past decade; in all nine years from 2003 to 2011, Ontario’s real economic growth was below that of the rest of the country.
The reasons are simple. Beginning in 2003, the Canadian dollar began a strong ascent that lifted it from the persistent lows of the previous decade (around 70 US cents) to the recent highs (around parity with the U.S. dollar) during the past four years, with only a brief dip in late 2008 and early 2009. This surge in the currency made Ontario’s exports more expensive for foreigners to buy and rendered the province’s exporters less competitive, while also making imports cheaper.
The impact on Ontario’s nominal GDP was huge. The contribution of trade to the economy is measured by net exports, the difference between what the province sells outside its boundaries and what it buys from other countries and provinces. Ontario’s net exports to other provinces, where there was no currency effect, remained relatively stable. But the contribution to GDP of net exports to other countries first vanished entirely and then began to detract from Ontario’s growth. The financial crisis and resulting U.S. recession, during which auto sales fell by about one-third, aggravated this trend. The province’s international trade surplus, which accounted for 4.3 per cent of GDP in the 1998–2002 period, disappeared by the middle of 2006 and was replaced by a trade deficit, which in the first three quarters of 2011 diminished nominal GDP by 7.5 per cent.
Ontario’s overall GDP per head relative to the rest of the country reflects the turnaround in trade. In 1998–2002, Ontario’s GDP per person was 14.1 per cent higher than the average for the other nine provinces and three territories; in the first three quarters of 2011, it was 6.5 per cent lower. Since 2006, Ontario’s GDP per person has been below the average for the rest of Canada.
Another way to look at the data is to track the growth of total GDP in current dollars, because that is the province’s tax base. Since 2002, the year before the dollar began its ascent, nominal GDP has grown by less than 33 per cent in Ontario, compared with almost 59 per cent in the rest of the country.
The recent recession was tougher on Ontario than on the rest of Canada. The province’s growth faltered in 2007, slowing while the rest of the country continued a brisk expansion. In 2008, Ontario’s real GDP fell during the winter (the first quarter) and, aside from a small uptick that spring, continued to shrink until growth resumed in the summer of 2009 (the third quarter) — five quarters of contraction over a period of six quarters. Elsewhere in Canada, the recession did not begin until the final quarter of 2008 and then lasted only three quarters in total. From peak to trough, Ontario lost 5.0 per cent of its GDP; the rest of the country lost only 3.7 per cent. Since the low point in the second quarter of 2009, the Canadian economy as a whole has recorded respectable real growth. But in the two years through the third quarter of 2011, Ontario lagged the rest of the country, with 5.8 per cent growth compared with 7.4 per cent elsewhere.
The human cost of this lacklustre performance shows up in the employment picture, where the old verities of a labour market in which Ontario always outshone the rest of Canada have been replaced by new patterns:
Ontario’s unemployment rate, once reliably lower than the national average, has been above the national rate for over five years now and was generally higher than the jobless rate in Quebec from the beginning of 2009 through the third quarter of 2011. In 2009 and 2010, the Ontario unemployment rate was 0.7 percentage point higher than the national rate; the gap narrowed in 2011, when the Ontario rate was 7.8 per cent, while the Canadian rate was 7.5 per cent.
The employment rate, perhaps the best measure of the health of the labour market, could once be counted on to be at least three percentage points higher than the national average. But since 2008, it has been lower than the national rate. In 2011, 61.6 per cent of working-age Ontarians had a job, compared with 61.8 per cent nationally. The Ontario rate is down 2.1 percentage points from the most recent peak in 2003 and 2004. Such a difference translates into about 229,000 jobs.
The decline of factory employment — traditionally a source of well-paid jobs — as a share of total employment accelerated in the past decade. Such jobs have been growing steadily less important in all developed countries, a consequence of strong productivity gains relative to other sectors of the economy and of outsourcing manufacturing activity to lower-wage Asian countries. In 1976, manufacturing accounted for 23.2 per cent of all Ontario jobs; this fell to 18.2 per cent in 2002 after recovering from an even lower reading during the recession of the early 1990s. Through the rest of the latest decade, as the dollar climbed and the auto industry faded, manufacturing’s share of employment has slid rapidly — to 11.8 per cent in 2010 and 2011.
Not surprisingly, incomes have also been affected. In the 1980s, real personal income per capita — that is, average personal income per person adjusted for increases in the implicit price index for all consumer spending — grew by an average of 1.9 per cent annually in Ontario, compared with 1.4 per cent in the rest of the country and 1.6 per cent nationally. Those were the days when Ontario was substantially richer than other parts of Canada. In the second half of the 1980s, when the Ontario economy was booming and other provinces were struggling with low prices for oil and other resources, Ontario’s average personal income was more than 20 per cent higher than the average in the rest of Canada. This changed dramatically after 1990. In both the 1990s and in the period from 2000 to 2010, Ontario’s real personal income per capita grew at only about half the rate that it did in the rest of Canada. In the period from 1990 to 2000, the average annual growth rates were 0.4 per cent and 0.8 per cent respectively; between 2000 and 2011,4 they were 1.0 per cent and 2.0 per cent. By the third quarter of 2011, this extended period of slow growth relative to other regions had left the average Ontario income, in current dollars, 0.5 per cent lower than incomes in the rest of Canada.
Can we expect better in the future? Barring another major global financial or economic crisis, a caveat that on some days feels shaky, Ontario and Canada will continue to recover from the recession and embark on a new expansion. But for Ontario, future growth will almost certainly be slower than it has been in the past. This has not been a normal business cycle for the world economy, one in which recession is usually followed by a rapid return to full capacity and further growth beyond that. It has been one set in motion by a financial crisis. As Bank of Canada Governor Mark Carney noted recently, “… history teaches that recessions involving financial crises tend to be more severe and have recoveries that take twice as long.”
Ontario also faces further structural changes. Manufacturing, once the vibrant heart of the Ontario economy, has for years been dwindling as a share of the province’s output and employment base. This is true in most of the developed world as factory work continues to migrate to low-cost Asia. In addition, the higher dollar continues to make it harder for Ontario to compete in world markets, especially in the United States, the province’s main external market. The U.S. is choking on public and private debt and faces years of slow growth as governments and individuals work off their excess borrowing. At the same time, U.S. auto sales, though up from their low point, will take many years to fully recover from a precipitous decline between 2007 and 2009. Ontario’s auto industry has also bounced back from its even steeper drop in production during those years, but it remains much diminished, perhaps permanently. Ontario industry, which has benefited for decades from plentiful electricity at subsidized rates, faces much higher power prices, made necessary by the imperative to replace essential infrastructure after years of neglect.
There is another barrier to income growth: almost all the growth in Ontario’s working-age population and labour force will come from immigration, but the incomes of recent immigrants have been well below those of workers who were born in Canada or arrived earlier. The average wage of recent immigrants (those who have been here for five years or less) was only about 76 per cent that of Canadian-born workers in 2010, while immigrants who have been here for 5 to 10 years had an average wage that was 85 per cent that of Canadian-born workers. Those with over 10 years in Canada had wages comparable to Canadian-born workers. Since more than two-thirds of future jobs will require some form of post-secondary education, it is particularly distressing that immigrants with university degrees are having such a difficult time integrating into the workforce. In 2005, recent immigrants with a university degree had median earnings of only $24,636, less than half the $51,656 earned by those with degrees who were born in Canada. The $27,020 gap was wider than it had been in 1995.5
In short, we cannot count on robust economic growth alone to resolve our difficult fiscal challenges