Unnatural resources
Oil and gas weath threatens to unbalance an already precarious economic situation
Robin Boadway
With all the attention the financial crisis has been getting, it is easy to overlook the real economic crisis that is evolving in Canada.
The immediate one is the imminent recession, which the Conservative government must have seen coming, even before the October election.
The more serious one concerns the natural resource boom in Western Canada. This portends some fundamental changes in the structure of economic activity among the regions of Canada — changes that particularly threaten our industrial heartland.
Begin with the recession, which will be part of the fallout of the seizure of financial markets. Our banks may be relatively insulated from the instability faced by U.S. and European banks, but we cannot escape the consequences of reduced demand for our exports by the U.S.
The usual response to reduced private sector activity is to boost government spending. Unfortunately, the room for manoeuver by the federal government has been seriously impaired by its squandering of the federal surplus, especially with the ill-conceived reduction in the GST rate. Although it may not be able to avoid going into deficit, it will hardly be able to apply fiscal stimulation as rigorously as it ought. On the contrary, the government proposes to respond by finding ways to cut public expenditures to keep any deficit in check. The only reasonable way it can do that is to reduce transfers to the provinces and pass the budgetary problem on to them. This would suit the Conservative priority of decentralizing fiscal responsibility, but it would also make it much more difficult for the federal government to respond to the longer-term challenges facing the Canadian economy.
Those challenges have to do with the mixed blessing of the sizeable resource wealth some Canadian regions find themselves with. Even with environmental issues aside, natural resource wealth can be more like a curse: adjusting to the rapid increase in resource prices causes enormous economic dislocation, and it demands at least some federal management.
Resource industries attract skilled labour and capital away from manufacturing and service sectors — the sectors that create the most jobs and innovation (and therefore productivity). This reallocation is exacerbated when provincial resource revenues are not saved, but instead spent, largely on imports, thereby driving the exchange rate up and further damaging export-dependent industries.
This problem is compounded in Canada where, unlike other federations, resources are owned by the provinces. This not only creates enormous imbalances in the federation, but also provides resource-rich provinces with the funds to invest in, and attract, businesses and workers from other provinces. The result is perverse: regional economic development ends up being dictated by the luck of the natural-resource draw. No resource-poor province is spared. The Maritimes are drained of their young workers and potential entrepreneurs. The manufacturing sectors of Ontario and Quebec are hollowed out, and Ontario is now a “have-not” province that may qualify for equalization payments as soon as 2010.
To be sure, the recession will temporarily mitigate the resource boom, but only temporarily. Alberta, British Columbia and Saskatchewan can weather the recession — especially the latter two, which are cushioned by the equalization system. Ontario and Quebec, which rely heavily on the U.S. market, will continue to shed jobs.
All this was predictable and indeed was well underway before the federal election. The federal government has a constitutional commitment to offset horizontal fiscal imbalances and to promote regional economic development. The only way it can fulfill these commitments is by pursuing nation-building policies to mitigate the consequences of province-building in resource-rich regions: investing in public infrastructure; committing to human capital by funding post-secondary education; bolstering the federal share of natural-resource revenues by eliminating tax breaks for those industries; reforming employment insurance to allow central Canadian industries time to adapt; and mitigating the effects of the natural-resource curse by encouraging provinces, perhaps through the equalization system, to save their resource earnings in heritage funds.
While the federal government cannot defy the logic of the market, there are nonetheless policies that can at least mitigate the combined consequences of increased resource-dependency and recession. All of them involve hanging on to significant fiscal clout at the federal level.
