The big question for 2008 is what becomes of the economies of Ontario and Quebec if the U.S. slides into recession. Will they avoid the U.S.’s fate, given the volumes their manufacturing sectors sell south of the border?

It doesn’t seem possible, yet Central Canada thinks it can weather a U.S. downturn. Quebec is relying on substantial capital spending and personal tax breaks to provide offsetting stimuli, while Ontario simply believes it can tough it out.

The resiliency of manufacturers beset by a Canadian dollar trading around parity with the U.S. dollar has surprised economists. After all, it was only five years ago when the loonie was languishing around US63¢. A 40% increase in costs, in theory, should have devastated exporters that sell to American customers in US$ prices.

But Canada’s manufacturers have been able to survive because domestic demand — particularly in Western Canada — has been strong. This has made it possible for the manufacturers to live with lower C$ revenue from U.S. sales, as they awaited a fall in the loonie back to the US80¢ range, as economists had previously expected. But now the loonie seems to be stabilizing at US90¢ or higher, and domestic demand is weakening. As resources prices come off recent highs in the face of slower growth globally, the economies of the western provinces are cooling, which will affect their purchases from Ontario and Quebec.

A U.S. recession could be the straw that breaks Central Canada’s back.

The cooling off in Western Canada is much different from what’s happening in Central Canada. Western economic growth will continue to be strong, just less buoyant. In fact, a cooling off is welcome. Inflation is the danger in that part of the country, with Alberta’s consumer price index up by 5% in 2007 from 2006, and Saskatchewan’s up by 2.8% year-over-year. Even with slower growth forecast for 2008, inflation is expected to be almost 3% in Alberta and well above 2% in Saskatchewan.

Very tight labour markets are contributing to inflationary pressure; Alberta’s unemployment rate was 3.5% in 2007, while Saskatchewan’s was 4.2%.

Another factor adding to inflationary woes is very strong retail sales. TD Bank Financial Group economists estimate retail sales were 9.2% higher in Alberta in 2007 than in 2006, and 11.3% higher in Saskatchewan.

British Columbia and Manitoba have also benefited from the resources boom: witness unemployment rates of 4.2% and 4.4%, respectively, and retail sales gains of 6.6% and 8.5%, respectively. Inflation, however, is less of an issue, up 1.8% in B.C. in 2007 and up 2% in Manitoba.

Contrast these figures with Central Canada’s. Ontario’s jobless rate was 6.4% in 2007 and retail sales were up just 3.5%. In Quebec, the jobless rates was 7.2% this past year, while retail sales were up 4.3%. In both provinces, inflation was around 2% in 2007.

Conditions are better in Atlantic Canada than in the central provinces — particularly in Newfoundland and Labrador, where offshore oil and Voisey Bay nickel production fuelled 8% gross domestic product growth in 2007 and an 8.5% increase in retail sales. But unemployment in Newfoundland and Labrador remains high at 13.6%, albeit down from 14.8% in 2006 and 16.5% in 2003.

Jobless rates have also dropped significantly in the three Maritime provinces. Indeed, from a historical point of view, Nova Scotia’s 2007 unemployment rate of 8% and New Brunswick’s 7.5% are remarkably low. Like Newfoundland and Labrador, Nova Scotia has offshore gas that is being developed and New Brunswick has proven to be as, if not more resilient than Ontario.

On the surface, New Brunswick’s challenges seem daunting. Export volumes account for more than 40% of real GDP and 90% is sold in the U.S. The province’s main resources industry is forestry, which is only resources sector not participating in the resources boom. Yet New Brunswick is staying afloat by finding new ways to grow. It was early into the call-centre game and is proactively figuring out ways to produce value-added forest products such as rayon made from wood pulp.

Prince Edward Island doesn’t have much muscle, given its tiny size, but it has the advantage of heavy dependence on food processing, a sector that isn’t particularly vulnerable to economic cycles. In addition, its important tourism industry has been less affected by the high C$ than might have been expected, as most of its visitors come from other parts of Canada. The province has also attracted some financial services firms.

@page_break@The territories are also beneficiaries of the resources boom — although Nunavut hasn’t yet capitalized on expectations. Most of the activity there is still in the exploration stage. As well, its average weekly earnings for the mainly Aboriginal population are still the lowest in the country. Yukon and Northwest Territories, in contrast, boast the highest wages as they take advantage of diamond, gold and oil and gas deposits.

Here’s a look at some of the key factors determining provincial growth.

> Manufacturing Dependency. The high C$ has hit manufacturing hard. A good deal of the sector’s products are exported to the U.S., while another considerable portion competes with imports from the U.S. whose prices have fallen while the loonie has climbed.

Although Quebec has the highest dependency on manufacturing — it accounted for 20.1% of the province’s GDP in 2006, the latest year for which these figures are available — it’s Ontario, with manufacturing at 18.8% of GDP in 2006, that is most vulnerable. Automobile manufacturing makes up a large part of its exports and, because of the slowing economy, U.S. demand for autos is weakening. And when it comes to attracting new investment in the auto sector, Ontario is at a disadvantage to southern U.S. states and Mexico.

Nova Scotia, too, has considerable export dependence, 15.5% of its GDP. The remaining provinces are not as dependent on exports for their GDP growth; Manitoba’s and P.E.I.’s dependency is around 11.5%; B.C.’s is 11%; Alberta’s, 9.8%; New Brunswick’s, 8.9%; Saskatchewan’s, 7.5%; and Newfoundland and Labrador’s, 6.5%.

> Exports Dependency. Selling outside Canada is usually a good thing. But it does make you more vulnerable, when, as now, your major trading partner is slowing down. That vulnerability becomes even greater if currency moves are negative — again. as now. Every 1% rise in the loonie takes 1% off US$ revenue when it is translated back into C$.

Export vulnerability varies depending on what is being sold. If it’s everyday products — such as processed potatoes, in the case of P.E.I. — demand may be only slightly affected. If it’s autos, as is the case with Ontario, then exports are very vulnerable; auto sales are cyclical, with demand usually falling in economic slowdowns.

Then there are resources. Even with a setback brought on in early 2008 by slowing global growth, demand and prices will remain high enough for resources companies to still make substantial profits.

Ontario is generally the province most dependent on exports, at 46.5% of GDP in 2006. With 86.4% of those exports sold south of the border, that translates into 40.2% of provincial GDP that’s vulnerable to U.S. economic troubles.

New Brunswick’s and Alberta’s exports are even more concentrated on the U.S., with 88.5% and 90%, respectively, of exports going south. But because exports account for a lower portion of their GDPs — 43.4% for New Brunswich and 36.6% for Alberta — their overall dependency on U.S. exports is lower. In addition, most of Alberta’s exports are high-priced oil, which makes its vulnerability very low — at least, in terms of volume. Oil prices may come down to around US$60 a barrel if a U.S. recession triggers a marked global slowdown, but most economists don’t expect that.

B.C. has the lowest dependence on exports to the U.S., with exports comprising just 18.2% of GDP and only 61% of that going to the U.S.

The dependency rate of other provinces range from Nova Scotia’s 19% to Quebec’s 28.6%.

> Consumer Spending. Consumer spending is the bedrock of economic growth in industrialized countries, but there can be significant differences in the degree to which the ringing of retail cash registers drive local economies.

Personal expenditures accounted for as little as 52.9% of real GDP in Alberta in 2006, and as much as 72.2% in P.E.I. That means the expected 7.2% increase in Alberta’s retail sales in 2008 won’t have the impact in that province that it would have in P.E.I. It also means that any faltering of consumer confidence will hurt P.E.I. more than it will Alberta.

These extremes in reliance on consumer spending are not surprising. P.E.I.’s tourism industry means high retail sales, while the massive investment dollars going into Alberta’s oilsands reduces its reliance on consumer spending.

What’s surprising is that Ontario’s consumer dependency is only 55.9%, lower than Saskatchewan’s 57.3% and Newfoundland’s 59.1%, even though those two provinces are experiencing heavy investment in resources. This helps Ontario a little, as TD economists expect the province’s retail sales to increase by just 2.2% in 2008, the lowest increase in the country.

Consumer spending as a percentage of GDP is in the low 60% range in Quebec, Manitoba and New Brunswick. Nova Scotia’s 70.3% is second-highest. IE