It is not often that Ontario and Prince Edward Island are considered to be in a dead heat economically. But this year, Canada’s biggest and smallest provincial markets are in a fiscal “battle of the basement” as the two provinces are reporting the slowest growth in real gross domestic product.

TD Bank Financial Group pegs P.E.I. with 1.7% growth in real GDP and Ontario with 1.8%. Royal Bank of Canada and Bank of Montreal rank P.E.I. the lowest, while Bank of Nova Scotia calls it a tie.

This is the first time since the 1991 recession that Ontario has ranked last or almost last among the provinces in growth rate. Ontario’s real GDP growth has been slowing since 2005, when it was 2.9%. But this measurement doesn’t take sufficient account of the scope of Ontario’s economy. P.E.I.’s real GDP, $4.1 billion, is less than 1% of Ontario’s $530.5 billion, according to RBC, so it is as disproportional a comparison as, say, potatoes and minivans.

Although growth in Ontario’s economy may lag the supercharged resources-based economies in the West and the East, it is still a rich province. GDP per capita in Ontario, which RBC estimates at $41,283 in 2007, is surpassed only by Alberta’s $54,852. Ontario’s total GDP of $578.4 billion is almost double that of second-place Quebec’s $292.7 billion; it is also more than double Alberta’s $269.8 billion.

There are better indicators of the health of the Ontario economy — of any economy — than GDP. Taking into account the poten-
tially catastrophic combination of the principle factors at play in the Ontario economy — declining demand in the U.S. for Canadian manufactured goods, the soaring loonie and escalating commodity prices — the Ontario economy is proving to be adept at accommodating its own weakness.

Despite substantial losses in manufacturing-sector jobs — which decreased by 5% in 2007 from 2006 — Ontario’s unemployment rate remains historically low, if not record-breaking.

“There are very few years since we have been tracking that have lower unemployment,” says Dale Orr, chief economist at Global Insight Inc. in Toronto. “We’re just nervous because, for once, we are above the national average.”

Ontario’s average unemployment rate for 2007 was 6.4%, while the national average was 6%. Ontario’s unemployment has remained low on the strength of the its service industry. When the manufacturing sector let 50,000 workers go in the first half of 2007, the service sector took on 80,000. In combination with real wage increases, that bodes well for Ontario workers.

“[Real wage increases are] in the neighbourhood of 1%,” says Jim Stanford, an economist with the Canadian Auto Workers Union. “But after a few years in which wages barely kept pace with inflation, it is a good sign.”

And this comes at time when Ontario’s economic health has been in doubt. The spike in commodities prices, culminating in US$100-a-barrel oil that took the Canadian dollar along for the ride, drove growth in the resources-rich economies of both Canada’s East and West. But it did quite the opposite for the industry-heavy centre of the country.

In 2006, the manufacturing sector generated 18.8% of Ontario’s real GDP, according to an RBC report — second only to Quebec manufacturers’ 20.1% share — and international exports generated 48.8%. The C$ has been on an upward trend since 2003, chiselling away at exporters’ profits.

Coupled with a rapid decline in demand for Canadian manufactured goods south of the border because of the U.S. credit crunch, the high C$ has left Ontario exporters struggling. Talk of recession in the U.S., where real GDP growth came in at an annualized 0.6% in the final quarter of 2007, has not helped, either. But, for the most part, that risk has been discounted after timely responses from the U.S. administration in Washington, D.C., and the Federal Reserve Board.

RBC’s January Provincial Outlook downplays the risk of even a technical recession: if there is any lag, it will be short-lived — two quarters, followed by growth.

Orr, on the other hand, puts the odds of a U.S. recession at about 50/50. And because Ontario’s economy is closely tied to that of the U.S., “any threat of a U.S. recession is a risk for Ontario,” he says, but not for Canada as a whole.

@page_break@Technical recession or not, the slackened pace of growth in the U.S. has added to the woes of Ontario exporters. The automotive industry in Canada has already been hit particularly hard by the ascending loonie on top of the climbing cost of materials and energy. Between 2004 and 2006, above-average car sales in the U.S. mitigated the hit. Even so, according to Stanford, the car manufacturing sector has lost 200,000 jobs since the C$ started climbing vs the U.S. dollar.

“Until the past few months, there wasn’t a cyclical problem,” Stanford says. But now, he says, the cycle’s peak is behind us. There are more cars in the U.S. than drivers, and those cars are newer than they have ever been. As credit becomes more expensive, it will be a long while before consumers think about replacing them.

The weakness in Ontario’s automotive sector is not purely cyclical. The Big Three U.S.-based automakers, which have dominated auto manufacturing in Ontario, are losing market share to their foreign competitors, Orr says. Toyota Motor Corp. and Honda Motor Co. Ltd. are expanding their Ontario operations and can be expected to pick up part of the slack.

Housing starts have also plunged in the U.S., to around half the levels for 2006, extending the exporters’ woes beyond cars into building materials and household purchases such as appliances.

“American consumers have been knocked around a lot,” says Peter Hall, vice president and deputy chief economist for Export Development Corp. in Ottawa. “With the credit crunch, they don’t have the spare cash around or the capacity to dip into home equity [as they might have a few years ago.]” They are putting off big purchases.

The same trend has not materialized in Ontario. Although Ontario housing starts were down by an estimated 7.3% to 68,092, according to an RBC report, there is no shortage of construction, as several new office towers and hotels are reaching skyward in downtown Toronto. And real estate remains strong. The average resale home price continues to climb — up by 6% in 2007 over 2006.

So, the GDP growth and the export sector provide an unbalanced picture of Ontario’s economic health. And, considering what has been thrown at the manufacturing sector, its reaction has been “nothing short of marvellous,” says Hall. “Manufacturers are going to tough it out.”

There are things to be done to position manufacturers for success in a US90¢ per C$1 universe. Now is the time to invest in machinery and equipment, for example, because the high C$ provides a break on the import costs for capital investment, says Hall. Canadian manufacturers need to identify and exploit cost advantages and efficiencies, and examine options such as offshoring components, he adds.

Still, there will be more drops in exports to come. Provisional numbers by EDC forecast a 2% drop in Canadian exports in 2008, with a 4%-5% downside risk for Ontario.

Although the C$ at par with the US$ provides a de facto discount on inputs such as machinery and equipment imported from the U.S., this comes at a time when manufacturers may not have the cash flow to take advantage of such an opportunity, according to Stanford.

“They are worried about more imminent concerns, such as payroll,” he says. “The savings are cold comfort when, with the high dollar and high cost of labour, there is less reason for multinationals to invest in Canada. The government has to play an active role in keeping the industry here to offset some of the damage done by the high dollar.”

But, so far, the Bank of Canada has allowed the commodities market in general and the oil boom in particular to drive the C$ higher at the expense of the manufacturing sector. And the federal and Ontario governments hesitate at the prospect of offering subsidies to encourage investment in the province’s auto sector.

Orr is less sympathetic than Stanford, naturally. Anything other than a timely, effective and temporary fiscal stimulus package to address the cyclical downturn amounts to throwing away money, he says: “People need to learn to live with the high dollar because it is not going to go below US90¢. Lots of companies still won’t be able to compete.”

As Ontario is the Canadian province most closely tied to the U.S. economy, the high C$ is a provincial — not a national — threat.

There is a big bonus for firms that do not export, have not been affected by the sluggish U.S. markets and are in a position to take advantage of the high C$ to invest in production efficiency, Orr says. The same goes for firms that export to Europe and Asia.

DOMESTIC CONSUMPTION

This year, Ontario producers have turned to Canada’s biggest market — Ontario — and they have not been disappointed. Ontario’s domestic consumption has been incredibly resilient. In other parts of Canada, demand for Ontario’s manufactured products remains high, especially in the booming West. But even Alberta’s current frenzied economic activity accounts for a slim 2% of the U.S.’s GDP. Ontario’s long-term economic health depends on U.S. economic growth accelerating.

The retail sector in Ontario has seen an interesting year. Ontario is home to the busiest border crossing in the country, but, says, Derk Nighbor, senior vice president of national affairs at the Retail Council of Canada, the impact of cross-border shopping on Canadian retailers is negligible. The Ontario retail sector registered 3.5% growth in 2007 over 2006, according to TD economists. Meanwhile, Toronto is an “incredibly competitive market,” in which there was deflation on apparel and electronics due to the C$, Nighbor explains. But for the rest of Ontario, the C$ has not affected retail prices.

The service industry has been Ontario’s saviour. Ontario tourism has had its share of catastrophes this decade, among them SARS, border security and power outages, but the sector has been largely unaffected by the rising C$.

“Ontarians are Ontario’s best tourists,” says Gary Wheeler, spokesman for the Ontario Ministry of Tourism. Three-quarters of all trips are inside the province. And among Canadians, Ontario is the leading tourist destination, attracting 42% of domestic travellers. Ontario has positioned itself as a place to experience.

The province is a prime destination for British, German, Mexican, Indian and Chinese tourists, says Wheeler. And it has seen returns on aggressive advertising campaigns in the major U.S. markets of Boston, Chicago and New York. In 2004, the latest year for which statistics are available, Ontario saw 118 million visitors who spent $11.6 billion. IE