Canadian Business Outlook Varies By Region

Earlier this week the Bank of Canada released their summer 2008 Business Outlook Survey. Not surprisingly, optimism about the future is higher in resource producing provinces than in provinces that export finished goods and services to the United States:

“On balance, firms located in Western Canada are expecting an increase in sales growth over the next year, while those based in Central and Eastern Canada are expecting sales growth to slow. Overall, strong commodity prices and expectations of still-healthy domestic demand are helping to offset the negative effects of a weak U.S. economy and a strong Canadian dollar on the sales outlook.”

Dutch Disease is hitting Ontario, in particular, hard. The province saw a 0.3 percentage point decrease in real GDP during the first quarter due to the related effects of higher commodity prices and a continued high Canadian dollar. And the problem may be getting worse – of particular concern is that the loonie is likely undervalued given the current level of oil prices.

The conventional wisdom is that, on net, high oil prices benefit the Canadian economy, and any harm done to Quebec and Ontario is offset by gains from Western Canada. But in a report issued yesterday (PDF) Douglas Porter, Deputy Chief Economist of BMO Capital Markets, suggests that any further rise in oil prices is likely to be detrimental to Canada:

“There is a strong case to be made that the surge in oil and gas prices crossed the tipping point this spring from providing some economic ballast for the domestic economy to acting as a heavy anchor… While it would no doubt be painful for the previously resilient TSX and Canada’s merchandise trade surplus, lower energy costs would remove a tremendous burden from the U.S. and global economy and would take some of the pressure off simmering inflation pressures.”

Canada, with its North-South tradeflows and reliance on unequally geographically distributed commodities is far from a optimum currency area . This presents particular difficulties for the Bank of Canada. Interest rate cuts would weaken the dollar and promote growth in Ontario, but would also accelerate the commodity price inflation coming from the West; the Bank of Canada (BoC) has a strict mandate to keep inflation between 1 to 3 percent.

There is, however, almost no demand for drastic changes in Canadian fiscal policy coming from Canada’s manufacturing heartland. It would appear that any potential policy, from removing the BoC’s inflation containment mandate to a return to fixed exchange rates are seen as being inferior to the status quo.

Mike Moffatt is the Economics Guide for

3 Responses to "Canadian Business Outlook Varies By Region"

  1. Rachel Ziemba
    Rachel   July 10, 2008 at 8:04 am

    Given the contraction we are seeing in Ontario (which seems poised to continue, do you think that there will be calls for more fiscal support? Or will this result in any change in the system of transfer payments between provinces?

  2. Mike Moffatt
    Anonymous   July 10, 2008 at 9:33 am

    "Or will this result in any change in the system of transfer payments between provinces?"It may have to because the system is starting to fall apart. But any attempts to change it are going to further fuel regional tensions and squabbling between political parties, as the Conservatives hold the vast majority of their seats in the West and rural ridings and the Liberals hold most of their seats in cities such as Vancouver, Toronto, Montreal and London. Plus Liberal MP Garth Turner’s easily misinterpreted remarks on his blog aren’t helping matters.A good primer on the equalization situation was recently published in the Globe and Mail. The hilights:"The damage to Ottawa’s bottom line could be so severe that the Queen’s University economist Tom Courchene calls the impending crisis a "fiscalamity." In an extraordinary analysis for Policy Options magazine, Mr. Courchene outlines how the inclusion of resource royalties in the calculation of how much each province raises from its taxes is driving the so-called average provincial fiscal capacity up into the sky. As this average rises, poorer provinces will be eligible for more equalization to bring their per capita payments close to that amount… with oil closing at $144.18 (U.S.) a barrel on Friday and natural gas prices that have more than doubled over the last year – Mr. Courchene figures this could add hundreds of millions of dollars to next year’s equalization tab."That is bad news for Ontario taxpayers, who provide roughly 40 per cent of federal revenues, and for Ottawa’s own finances. As Mr. Courchene told The Globe and Mail, "Ottawa simply cannot afford to equalize mushrooming provincial energy royalties from which it receives no revenues." He added that this dilemma could destroy the current formula, plunging the country into another bitter federal-provincial squabble…"Mr. Courchene’s calculations of the inequity are startling, crammed into one small chart that parses the past to predict an unsettling future. First, he examines total provincial revenues from all sources last year, including federal transfers, concluding that the Ontario government had less money per person than any other provincial government. A lot less. Alberta had $11,942 per capita; Newfoundland and Labrador had $11,520; Ontario had only $8,155 per person. Yet Ontario taxpayers are financing generous services for the people of other provinces…"

  3. Mike Moffatt
    Mike Moffatt   July 10, 2008 at 9:37 am

    I need to stop hitting the anonymous button…