Manufacturing drop a drag on Ontario, as rising commodity prices lift Alberta

Share

Canada's two most important provincial economies are travelling down different paths. Yet both have government finance structures with badly cracked foundations.

The budget plans of Ontario and Alberta got a public airing on Monday as Kathleen Wynne's Ontario government issued a mid-year update of its fiscal and economic outlook and Alberta Premier Jim Prentice unveiled the first Speech from the Throne under his leadership.

In Ontario, the key takeaway was that the province's struggle to rein in its chronic budget deficits is getting harder. Finance Minister Charles Sousa reported that revenue for the 2014-2015 fiscal year (ending March 31) now looks to be more than $500-million short of what the province had budgeted last spring. The tepid provincial economy is growing even more slowly than the government had hoped, and that is slowing tax revenue.

Ontario remains committed to getting its projected $12.5-billion budget deficit to zero by 2017-18, but the strains on the revenue side are exposing the inherent problem with closing that gulf.

The least painful way to wipe out a deficit is to tone down spending for a while and let economic growth naturally produce increased revenue. But with Ontario's expected growth pace slowing, it is hard to see how this province is going to grow its way out of this deficit – let alone keep deficits under control the next time the economic cycle turns downward.

The past decade has transformed Ontario's economy, and not in a good way. The province's traditional manufacturing base was decimated by the long-term rise in the Canadian dollar and the deep global recession. In 2003, manufacturing accounted for 21 per cent of Ontario's gross domestic product; by 2013, it was just 12 per cent. The decline in the key sector has been a substantial drag on the province's economy; GDP growth has averaged just 1.4 per cent a year over the past decade.

The recovering U.S. economy has brought hope for a manufacturing recovery, yet growth and revenue continue to disappoint. As the Bank of Canada recently noted, the manufacturing downturn resulted in business closings and restructurings that spell permanent losses of jobs and economic capacity. In many cases, market share has been lost to more competitive countries, maybe for good.

Ontario is pinning its hopes on spending more – specifically, on infrastructure investment. The hope (and it is one economists generally share) is that better infrastructure lifts productivity and thus expands economic growth – breaking the province from the slow-growth vicious circle it looks stuck in otherwise. Still, it is an expensive long-term strategy for a government that has pressing financial problems right now, and total government debt already nearing $300-billion.

But as Ontario has faded as Canada's economic engine, Alberta has risen, thanks to a decade-long upward cycle in commodities that spurred huge oil profits. The province's annual GDP growth over the past decade has averaged 3.5 per cent. The provincial budget looks headed for a surplus this year; the throne speech talked up the government's plans to build more schools, improve health care access and upgrade roads.

But Alberta's energy bonanza is also its Achilles heel, and Mr. Prentice knows it. Oil and gas royalties account for fully 20 per cent of the provincial government's budgeted revenue; every $5 change in the North American oil price benchmark, West Texas Intermediate, is worth more than $1-billion a year in government revenue. The sector is also pivotal to the province's employment growth and business investment.

The government's 2014-15 budget is based on an assumption that West Texas Intermediate would average nearly $97 (U.S.) a barrel for the year, and that the benchmark for Alberta's oil sands crude, Western Canada Select, would average nearly $81 (Canadian). Both are now far below those assumptions – $75 (U.S.) a barrel for WTI, $67 (Canadian) for WCS. The provincial government will almost certainly have to trim its price and revenue assumptions in the quarterly fiscal update scheduled for Nov. 26.

Alberta's throne speech acknowledged that "a budget tied to volatile energy prices imperils our fiscal resilience over the long term." And in Ontario, Mr. Sousa said the government will consider "other tools" if necessary to wrestle the budget into balance. But both provinces are very short on detail about how they will address their long-term revenue conundrums. These are unlikely to be easy or quick fixes; the entire base of the government revenue structure may need re-examining. Forget new tools; new toolboxes may be in order.