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special issue: federations and the economic crisis
Ottawa, provinces ally to quell meltdown
REUTERS/Fred Thornhill
Canadian Prime Minister Stephen Harper (right) and Ontario Premier Dalton McGuinty answer questions at a news conference in Toronto in June 2009. The two outlined details of the US$ 9.5 billion in Canadian loans to General Motors as part of their efforts to save the former giant automaker from extinction.
BY ALAIN DUBUC
Among the economies of the world’s bigger nations, Canada’s will experience the least painful recession in 2009, and is likely to have the most muscular recovery in 2010. This helps explain why the political debates sparked by the international economic crisis have been less divisive in Canada than elsewhere.
Canada’s slowdown has not yet been serious enough to cause painful debate about the merits of federalism – usually a favourite activity for Canadians. As well, much of the economy’s strength is linked to the success of Canadian ways of doing things. Canada has managed to sidestep much of the crisis thanks to its stable financial system, healthy public finances and economic policies that balance the market and the state. This crisis highlighted the existence of a Canadian model – and showed it works quite well. The only question is whether it will continue to work if the crisis deepens due to the heavy interdependence of the Canadian and U.S. economies.
Despite a strong economy before the crisis, Canada’s provinces have their own economic problems. In the east, the Atlantic Provinces still struggle over the demise of the cod fishery and a decline in tourism, with few new industries. In Quebec, government social programs like $7-per-day daycare and generous maternity and parental leave have strained its tax base. As the crisis hit, Ontario’s auto industry suffered enormous losses, and with declining corporate income tax revenues, the province ran into deficit. In the Prairie Provinces, Saskatchewan’s budget has a surplus in part because of revenues from potash. Manitoba’s budget is shored up by $2 billion in equalization payments. In Alberta, the oil sands provide wealth and a solid tax base, but at a cost to the environment that caused a senior U.S. advisor to President Barack Obama to question whether they meet American standards. In British Columbia, the spread of the pine beetle threatened the forest industry, a major source of employment and tax revenue.
The international financial crisis sparked intense political debate in Canada. It was a key issue in the 2008 federal election campaign, when major stock indexes were tumbling and the crisis was starting. After the Conservative Party, led by Prime Minister Stephen Harper, emerged to lead another minority government, the state of the economy sparked the worst parliamentary crisis in recent Canadian history.
Stimulus leads to deficit
The new government tabled an economic and fiscal plan aimed at turning around the deteriorating economy, including budget cuts to avoid a deficit. As some of the cutbacks had a very partisan dimension, the opposition parties – the Liberal Party of Canada, the New Democratic Party and the Bloc Québécois – formed an alliance that threatened to defeat the Conservatives and form a coalition government.
To stay in power, the Conservatives presented a January 2009 budget that gained Liberal support. It included stimulus measures of $29 billion in 2009-2010 and $22 billion in 2010-2011, steps that were in line with expectations of international bodies. The budget emphasized temporary stimulus measures – targeted tax relief for low-income taxpayers, help for the unemployed, job training and home renovation – and major infrastructure programs. The Conservatives announced a deficit of $34 billion for 2009-2010 and $30 billion for the following year. This marks a major change in direction for Canada, one of the few industrialized countries to have eliminated its deficit, and where deficit-free budgets had become almost compulsory in the provinces and Ottawa.
Ideologically, this budget represented a key shift for the Conservatives, who eschew state economic intervention and staunchly oppose deficits. In fact, this budget was more aligned with the centrist approach of the Liberal Party. But the strategy shift of the Conservatives means there is widespread consensus on the need for intervention and on the need for temporary deficit financing. This ideological convergence is the key factor that has allowed the Canadian federation to co-ordinate its actions to fight the recession. The other major player to emerge in this scenario is Michael Ignatieff, the new leader of the Liberal Party, who is said to be waiting for the right moment to pull the plug on Harper’s minority government.
Economically and politically, the federation is very decentralized. About 45 per cent of public expenditures are made by the central government and 55 per cent by provincial and local governments. The central government’s ability to act in special situations is limited and can be hampered if the provinces move in the opposite direction. But co-operation on the policy front did occur in this case, as almost all provinces adopted budgets aimed at stimulating recovery, participated in infrastructure programs announced in the federal budget and accepted the resultant deficits.
Provinces have muscle
Canadian provinces, unlike constituent units of many other federations, have considerable powers of taxation and so they have resources to strike out on their own in different directions. But they chose not to do so. This policy alignment was not imposed by Ottawa and was not the result of intense negotiations or institutional mechanisms. A January 2009 meeting of federal and provincial leaders succeeded – mainly because the provinces reacted favourably to Ottawa’s plan to launch major stimulus initiatives.
Governments worked together and agreed to a common course of action.
Monetary policies to stimulate the economy and ease credit did not generate much opposition or debate. The Bank of Canada, an independent federal body, is responsible for monetary policy. Its actions were well received, namely to announce a major reduction in interest rates coupled with the unusual announcement that it would keep them low for a long period.
It must be emphasized that the Canadian financial system’s stability meant Ottawa did not have to intervene in a massive way to support Canada’s banks, as took place in the U.S.
However, the way the recession hit the country has started to create tensions that will lead to major challenges in coming years for Canadian federalism. The country’s recession was not caused by a financial crisis, but rather by a significant decline in exports to the United States, which buys 80 per cent of Canada’s exports, and the collapse of prices for oil and other commodities. Provinces that rely on exports or natural resources were hit the hardest.
Regional disparities exist in Canada, as in all federations. What is new and unique in this crisis is that the most affluent provinces have been hurt the most by job losses and lower production. This new reality could have major consequences for Canadian federalism and on the formal and informal premises it is based on. Similarly, challenges associated with the international crisis must be dealt with differently by each region.
There are six key points at stake that will determine the future of the Canadian federation.
First, there will be a major impact on the federal government’s finances, not only because of the structure of its revenue streams, but because it can no longer count on the wealth of its two richest provinces, Ontario and Alberta. The federal government said in June that its deficit could exceed $50 billion this year, up from its previous estimate of $34 billion. As it is not expected to return to a balanced budget soon, the central government is effectively deprived of its main tool for reducing regional tensions: its budget surplus.
Ontario gets aid
Second, the economic problems of Ontario, the most powerful province, challenge the logic of the equalization program, used by the federal government to provide funds to provinces whose fiscal capabilities are weaker than the national average. This program enables all provinces to provide a comparable level of services to their residents. The increase in oil prices that enriched Alberta, coupled with Ontario’s hard-hit manufacturing sector, mean Ontario has become a recipient of redistribution payments, which will undoubtedly lead to a painful review of the program.
Third, the recession’s unequal impact affects another tool of inter-regional equity, the federal employment insurance (EI) program. The EI program was revised in the 1990s to make admissibility and payment duration vary by region, depending on its unemployment rate. But this system is not adapted to the current crisis, in which there is very high unemployment in normally prosperous areas. Canada’s unemployment rate hit 8.6 per cent in June, up 0.2 per cent from May and 2.4 per cent higher than in June 2008, according to Statistics Canada.
Fourth, the federal government’s participation in the North American initiative to help the automotive industry has opened a Pandora’s Box. The CDN$ 9 billion provided for General Motors provoked strong reactions from other regions. They asked why the federal government was providing massive aid to this industry, based in Ontario, but not assisting other suffering industries which provide more jobs, such as in forestry. These are classic tensions in a federation, but they open the door to difficult discussions about fairness and development priorities.
The fifth challenge is related to energy and the environment. The U.S. administration of President Barack Obama has made global warming a priority and is linking recovery efforts with sustainable development. U.S. policies, such as automobile emission limits, support for green energy or the creation of a cap and trade system, will be of major significance for Canada. The U.S. move toward environmental protection also threatens Alberta’s oil sands, which throw off high levels of greenhouse gases.
Squabbling over energy
Faced with these issues, Canada is poorly equipped on a constitutional level to develop a comprehensive energy policy because natural resources fall under provincial control. How can the oil sands be curbed or their carbon footprint reduced without infringing on the rights of the provinces? People in Alberta and British Columbia still remember the National Energy Program adopted by the Liberal government of Pierre Elliott Trudeau in 1980, which many there saw as a federal grab, one of taking oil from the West and providing it to Eastern Canadians at inexpensive rates.
Another potentially sensitive issue is the proposed substitution of coal-generated electricity with hydroelectric power, a move that could alienate Quebec, a hydro-electric producer, if it means federal involvement in trans-border energy transportation. Quebec is traditionally very protective of its jurisdictions.
Sixth, Canada runs the risk, as it emerges from the crisis, of facing a challenge to its monetary policies, also fuelled by regional imbalances. Crude oil’s price rebound, which favours producing provinces like Alberta, has triggered a very rapid increase in the value of the Canadian dollar against U.S. funds. This adversely affects provinces that export manufactured goods, including Quebec and Ontario. This will lead to enormous pressures on the federal government to intervene in the name of fairness and for the Bank of Canada to incorporate exchange rate stability into its monetary policy objectives.
Canadian federalism has functioned well during this recession. But there is a risk that some of the federation’s foundations might be shaken during the lengthy process of exiting the crisis. These challenges are new, they are not of a constitutional nature, strictly speaking, and they do not involve the traditional opposition of Quebec to the rest of Canada. They will involve a new sharing of wealth among the regions and adjusting to a major reshaping of the world’s economies provoked by the crisis. The real challenge for Canadian federalism will be to adapt itself to a country in the midst of fundamental change. 
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