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GLOBAL ECONOMICS LTD.

CHAPTER 15

HOW WILL WE FARE?

"How will we fare?" is the most important question on the minds of most Canadians when faced with the prospects of Quebec separation. We have heard much about the calamitous economic consequences independence will have for Quebec and we fear that the rest of Canada will be similarly affected. Quebec's separation will undoubtedly send a shock wave reverberating through financial markets. A run on the Canadian dollar and an upsurge of interest rates could lead to cutbacks in investment and consumer spending. Skillful damage control and good economic management will be required to get through the difficult transition period without a recession.

We have many strengths that will enable us to weather the storm and to build a strong future, but how we fare depends on how we react and what we do. If we let ourselves be guided by spite, we can turn a perilous situation into an economic disaster. If we follow our self-interest dispassionately, we have a reasonable chance of surviving the difficult transition period without major disruptions. In the long run, we can actually benefit.

LOST INTERNATIONAL STATURE

With a quarter less people and a GDP that would be more than 23-per-cent lower, we have to face the unpleasant reality that a Canada without Quebec would not carry the same economic and political weight internationally. A new Canada would no longer have the seventh largest economy among the industrialized nations belonging to the Organization for Economic Co-operation and Development, but would fall to the eighth position, after Spain.

The significance of this downgrading is difficult to assess. Canada has taken considerable pride in its membership in the G7, the group of seven leading industrialized countries. Brian Mulroney, in particular, always took great pleasure in hobnobbing with the likes of George Bush and François Mitterrand. Yet Canada became a member of this elite club almost as an afterthought. When the G7 was formed in 1975, it wasn't even asked to join . Canada was eventually brought in a year later at the insistence of the United States, as a counterweight to the heavy European representation.

Still anxious to keep the G7 from turning into a European-dominated club, the United States would probably not welcome Spain as a G7 member simply because its economy had become larger than Canada's. However, there could be pressure to drop Canada without adding Spain. In any event, Canada's participation in the G7 which is now marginal at best would become further marginalized.

Canada would also become a slightly less important player in other important international organizations such as the GATT, the IMF, the World Bank and the OECD. But this is unlikely to make a great difference in our ability to defend our interests in the international arena.

Potentially as important as our lost stature in the international community would be the weakening of our bargaining position with the United States. Canada currently has more than 170 treaties governing its relations with the U.S.A. As Quebec would have to negotiate a similar complex web of treaties or to seek to adopt existing treaties, American negotiators would have their hands full just dealing with Quebeckers. This could make it more difficult to get them to focus on our evolving priorities.

ECONOMIC IMPACTS

Most of the studies on the consequences of separation have traditionally emphasized the effects of a split on Quebec, especially those undertaken in the province itself. What would happen in the rest of Canada has always been of secondary interest. Even English-Canadian studies that have been conducted from a federalist viewpoint have tended to emphasize the impact on Quebec, in part to show Quebeckers how damaging the split would be.

Yet there have been a few efforts to quantify the impact on the rest of Canada of such a split. The Economic Council of Canada's annual review, before the Council was chopped by the Tories in an austerity move in 1992, looked at what would happen if Quebec seceded and was given control over all the programs provided to Quebeckers by the federal government and over all federal tax revenues paid by Quebeckers. The Economic Council estimated that this would have a negligible positive impact on the rest of Canada.

In contrast, the Royal Bank of Canada predicted a disaster. Immediately before the 1992 referendum on the Charlottetown Accord, the Economics Department of the Royal Bank stepped boldly into the fray with a prediction that if Quebec were to separate, investment would fall sharply in the two years after the split and then only recover slowly. Eight years after breakup, economic activity would be an astonishing 18 per cent lower than otherwise and per-capita income 15 per cent lower. The annual income loss would be $3,900 for each Canadian or $10,140 per household. Unemployment would be 3 to 4 percentage points higher and 630,000 Canadians would have emigrated. This would be an economic catastrophe of the first order for Canada.

Fortunately, the Royal Bank's doomsday predictions are totally unbelievable. No other reputable economists have forecast an impact even close to this. No one has even predicted such a large impact on Quebec, where most economists agree that the impact would be concentrated. The estimates for the decrease in GDP in Quebec range from negligible to as much as 10 per cent.

At the low end of the estimates for the impact on Quebec is the ever optimistic Bélanger-Campeau commission, which argued that the costs of sovereignty for Quebec would be minimal if reason prevailed in economic relations with the rest of Canada.

Economist Pierre Fortin of the University of Quebec at Montreal estimates that the Quebec economy would only decline 2 per cent and unemployment would rise 1 percentage point. The Economic Council has estimated that Quebec would see a drop of 1.4 to 3.5 per cent in its GDP, equivalent to another small recession. At the high end, are two independent estimates prepared by Patrick Grady and by Marcel Côté and John McCallum, both of which call for substantial declines in Quebec output of 5 to 10 per cent of GDP.

If the impact in Quebec, where effects of separation would be concentrated, were at the very most 5 to 10 per cent of GDP, how could the impact in Canada as a whole possibly be as large as 18 per cent of GDP as the Royal Bank has suggested? And where would the 630,000 people leaving Canada go? After all, it's not that easy to get a green card to work in the United States.

If we were to appoint an English Canadian commission to estimate the cost of Quebec separation to the rest of Canada, it would probably conclude that in the short run (say one to three years) the transitional costs will be small if reasonable economic relations are established between the two sides, and that in the longer run there could even be economic benefits.

FISCAL BENEFITS

As a less well-off province, Quebec has long benefitted from inflows of money from the federal government and taxpayers in the rest of Canada. Most beneficial is the equalization program, which provides billions of dollars every year so that "provincial governments have sufficient revenues to provide reasonably comparable levels of public services at reasonably comparable levels of taxation." In the 1994-95 fiscal year, Quebec receives $3.9 billion in equalization payments from the federal treasury. That's over 45 per cent of the total of $8.5 billion of such payments going to the seven poorest provinces. Ontario, British Columbia and Alberta, the provinces in which almost 80 per cent of the Canadian population outside of Quebec lives, don't get a cent in equalization.

The Canada Assistance Plan is another program where Quebec gets more than its per-capita share of federal funds. The plan was originally designed to pay half of the cost of welfare programs in all provinces but, as an austerity measure, growth of the payments to the three richest provinces has been capped at 5 per cent per year since 1992. As a result, Ontario, and British Columbia get less than half of their social assistance spending covered by the federal government. Ontario feels especially hard done-by because the federal government now pays only 29 per cent of its welfare costs, while it still pays 50 per cent in the equalization-receiving provinces. This costs Ontario $1.7 billion in 1994-95. Alberta still gets back 50 per cent of its spending on social welfare from the federal government but only because it has made draconian cuts in its expenditures. Because Quebec is the biggest of the poorer provinces, it now accounts for 34.6-per-cent of all the money Ottawa spends under the Canada Assistance Plan.

Though other payments by Ottawa for areas like health and education go equally to all the provinces, both have and have-not, because of its large share of equalization and Canada Assistance Plan payments, Quebec manages to account for 31.4 per cent of all major federal transfer payments to the provinces, even though it makes up less than 25 per cent of the population.

Unemployment insurance is another federal program where Quebec gets more from Ottawa than it pays in. That's because Quebec has had a chronically higher unemployment rate than the national average. In 1993 alone, Quebeckers and their employers paid $4.4 billion in UI premiums while receiving $5.5 billion in benefit payments, for a net benefit of $1.1 billion. We are, of course, neglecting many smaller programs where Quebec gets less than its share as the Bloc Québécois will be quick to remind us. Grain subsidies and R&D support are two areas often cited. But it is the big programs that count most in the overall balance of benefits.

One smaller program benefiting Quebec that is a particular irritant to other provinces is the Canada-Quebec Accord on immigration, which guarantees Quebec in perpetuity at least $90 million per year to settle and train immigrants. This amount currently accounts for a third of the total federal government money allocated for immigrant settlement and integration services even though Quebec took in only 18 per cent of immigrants in 1993. Ontario, on the other hand, takes in 55 per cent of immigrants and gets the same amount - $90 million. The provinces like Ontario and British Columbia that are receiving the lion's share of immigration do not have the funds needed to facilitate integration into Canadian society.

The income tax system also works to Quebec's advantage. Because personal income tax takes a larger percentage of earnings as incomes rise and because Quebeckers have lower average incomes than other Canadians, they pay less in federal taxes as a group than their population share. In 1992, Quebeckers contributed less than 23 per cent of federal revenues, while accounting for more than 25 per cent of the population.

Estimating Quebec's net balance out of Confederation--whether it takes out more out of the federal government than it puts in--is a very difficult exercise. It involves complex and sometimes arbitrary assumptions about how you treat the federal deficit and where taxes are actually paid. For example, the deficit is usually treated as a deferred tax and sales taxes like the GST are allocated to the province that consumes the taxed goods rather than the province that produces the goods. Still, there is a consensus among economists that Quebec takes more money out of Confederation than it puts in. Even the Bélanger-Campeau commission itself estimated that Quebec received a net fiscal benefit of $2.7 billion or $409 for every man, woman and child in 1988. The Fraser Institute, in its Government Spending Facts Two estimated that Quebec's net current fiscal benefit was $696 per capita in 1990. This works out to a hefty $4.9 billion per year.

Successive federal governments under both Liberal Pierre Trudeau and Conservative Brian Mulroney have spent heavily in the regions. This has been influenced by the large contingents of Quebec MPs, who always managed to sit on the government side of the House, and who have a big stake in federal largesse. The Quebec caucus has been particularly adept at using its political weight, which has in turn led Ottawa to do likewise in other regions. The result has been the spending of billions on projects from the Hibernia oil development, to Mirabel airport in Quebec and oil upgraders in Saskatchewan, which has only exacerbated Canada's deficit and debt problems.

While Quebec is only one of seven recipients of equalization payments, it is by far the most politically influential. Concerns have been voiced in the Atlantic provinces as well as in Manitoba and Saskatchewan about their continued access to federal transfer payments if Quebec secedes. The worry is that with Quebec gone, the political will in the three richer provinces to support these payments may also disappear. These fears are probably exaggerated. For one thing, the constitution commits the federal government to the principle of equalization. And there has been no indication that residents in the Ontario, Alberta and British Columbia are any less committed to helping their less affluent cousins than they ever have been. (Mobility in Canada is such that a large percentage of Westerners probably came from back east in any case.) In fact, with Quebec gone, the federal government would be better able to afford continuing to pay equalization and other transfer payments to the other poorer provinces.

There's a final fiscal advantage for the rest of Canada in the event of Quebec separation. If Quebec were to separate taking along its quarter share of the debt, the rest of Canada would have to shoulder a debt that would be a bit lighter to carry. (Net debt would fall from $547.9 billion or 73.6 per cent of GDP to $411.5 billion or 71.4 per cent of GDP.) This would make Canada more creditworthy and slightly lower the interest rates that have to be paid to bondholders. Over time, the burden of this debt for Canada would fall because growth of both population and the economy would likely continue to be faster than in Quebec as it has been for the past 20 years.

As for Quebec, its newly-acquired $136.4-billion share of the national debt would come on top of its existing provincial debt of $66-billion. Quebec is already the fourth highest indebted province (as a percentage of GDP) after Newfoundland, Saskatchewan and Nova Scotia. Its credit rating is already lower than that of the federal government and of Ontario, British Columbia and New Brunswick. Taking on this new debt would make the split decidedly more difficult and costly for Quebec than for the rest of Canada. But this would be Quebec's problem, not ours.

Canada's federal deficit would be lower if Quebec were to separate (even assuming unchanged interest rates) because Quebec would no longer gain a net fiscal benefit from the federal government and would assume a heavier debt burden. By subtracting Quebec's share of the various federal government revenues and expenditures, we can roughly estimate that the federal deficit in the current fiscal year 1994-95 would fall from $39.7 billion or 5.3 per cent of GDP to $27 billion or 4.7 per cent of GDP. The Government of Quebec, on the other hand, would find that the extra revenues it would take over from the federal government would be $12.7 billion less than the additional expenditures it would inherit. This initial deficit would, of course, be unsustainable and have to be offset through huge spending cuts and tax hikes. Quebeckers expecting separation to solve their financial problems would be severly disappointed.

The elimination of the duplication and overlap of federal and provincial programs would make a much smaller contribution to deficit reduction than professed by separatists. While Jacques Parizeau claimed savings of as high as $3 billion during the Quebec election, Daniel Johnson only conceded savings of $500 million based on government studies.

But let's not become too complacent in comparing our fiscal position with Quebec's. Even with Quebec gone, Canada would still be one of the most highly indebted states in the industrialized world. Only Italy, Belgium, Greece, and Sweden would have higher higher debt in relation to GDP.

TRADE

In contrast to fiscal relations, which is our strong suit, trade is a vulnerable area for both partners. If the separation of Quebec is allowed to disrupt trade flows, it would hurt the Canadian economy, perhaps seriously. Investors would likely look south for better and more secure opportunities. Ontario and the Atlantic provinces would be the most affected by any disruption in trade because of their greater dependence on trade with Quebec (7 1/2 to 8 1/2 per cent of all manufacturers' shipments from the Atlantic provinces and Ontario went to Quebec in 1989). The Atlantic provinces would also be vulnerable to any obstacles that Quebec might set up on trade flows between the Atlantic provinces and the rest of Canada if relations ever became acrimonious. But not so vulnerable as Quebec which ships over 29 per cent of its manufactured shipments to the rest of Canada. On the other hand, the Prairies and British Columbia would hardly notice an ripple even if there were huge dislocations in Quebec trade flows because only 3.8 per cent of manufacturers' shipments from the Prairies and a meagre 1.6 per cent from British Columbia go to Quebec.

The secession of Quebec need not automatically bring interruptions in trade in its wake. The speedy conclusion of a mutually beneficial trading agreement could preserve good trade relations and prevent any disruptions. An agreement on the right of passage through Quebec of shipments from Western Canada and Ontario to the Atlantic provinces would also go some way to reassuring those in the east who fear that they will be cut off from the rest of Canada.

In the longer run, a Canada without Quebec would be able to pursue a more aggressive trade liberalization policy. The highly protected and vocal Quebec textile, clothing, footwear, and dairy industries would no longer be a force holding back future trade negotiations. There would also be an opportunity to get a better deal for Newfoundland on the sale of Churchill Falls power by threatening to turn off the switch.

ANGLOPHONE MIGRANTS

Quebec anglophones are the most highly mobile group in Quebec society, being able to fit right in immediately wherever they move in English-speaking North America. Since the Second World War, Quebec anglopohones have been 10 to 15 times more likely to leave Quebec than francophones. As Quebec anglophones are also adamantly opposed to Quebec separation, they are likely to vote with their feet if Quebec secedes. In the five years after the first PQ election victory in 1976, there was a net loss of 106,300 anglophones. While Quebec's anglophone population has continued to dwindle, with a net loss of 41,600 from 1981 to 1986 and 22,200 from 1986 to 1991, there were still 626,000 anglophones in Quebec in 1991. But an April 1991 survey revealed that almost half of these intended to leave if Quebec were to become independent.

Anglophone newcomers from Quebec are uniquely poised to make an immediate and important contribution to the economy of the rest of Canada. They are highly educated and skilled. More than half the anglophones aged 25 to 44 years who left Quebec between 1981 and 1986 had university degrees. They are already fluent in English. And many bring their high-paying jobs with them, especially if they are part of a corporate move.

There has been an exodus of head offices of English-Canadian companies (or most of their functions) out of Quebec for many years. Companies like Northern Telecom, Sun Life Assurance, the Molson Companies, Royal Bank of Canada and the Bank of Montreal have all moved most or all of their headquarters to Toronto, even if some still have their legal head offices in Montreal. Some of these companies went with fanfare; some stealthily in the dead of night. If Quebec separates, most of the remaining English-Canadian companies will probably also leave, either because of legislative requirements or a simple business choice.

Canadian Crown corporations headquartered in Montreal could be directed to pull up stakes. Canadian National Railways has 2,900 head-office staff at its headquarters, while VIA Rail has roughly 700 employees. Private corporations in the transportation field like Air Canada and CP Rail would be required to move their head offices to Canada by federal legislation.

Canadian financial institutions or their holding companies located in Montreal, such as Power Corporation and Imasco, could be forced to leave to comply with federal legislation governing financial institutions. The Royal Bank still has a 1,200 head-office staff housed in Montreal's Place Ville Marie. Purdy Crawford, the chairman of Imasco Ltd., the tobacco conglomerate and parent of Canada Trust, has gone on record as saying that if Quebec were to separate, his company would have to consider moving its head office out of Montreal.

Canadian federally regulated telecommunication firms and their holding companies are also subject to restrictions on ownership. The most important telecommunication firms in Montreal are BCE Inc, its subsidiary Bell Canada, and Teleglobe Canada. Red Wilson, BCE's Chairman and CEO was quoted in the October 1994 Globe and Mail Report on Business Magazine as saying, "BCE is a Canadian company under the Canadian Business Corporations Act and would therefore be located in Canada." Bell Canada itself would have to be split so that its Ontario and Quebec telecommunications businesses could be regulated separately.

There are also a few other Pan-Canadian or international companies still domiciled in Montreal that might find a separate Quebec to be too small of a base for their Canadian or world-wide operations. The largest of these is Alcan Aluminium Ltd., which has always hesitated to leave Quebec because it benefits from low power costs at its Quebec smelters, where it owns its own hydro dams. If these companies decide to move, let us make sure it is not to the United States. We have already mentioned that pharmaceutical and defence-related businesses might see the advantage of moving as well. In addition, there are dozens of other smaller, but not unimportant pan-Canadian companies such as Zellers, Reitmans and Chateau Stores that may find it difficult to remain based in a separate Quebec.

OPPORTUNITIES FOR TORONTO

Toronto and Montreal have long vied for the position of Canada's major metropolis. Montreal was originally much more important. Once the centre of the fur trade and the head office for the building of the trans-continental railway, Montreal occupied the position as the country's leading transportation and financial hub until supplanted by Toronto following the Second World War.

The growth in north-south trade and post-war immigration favoured the expansion of Ontario and Toronto. The climate of political uncertainty following the election of the PQ in 1976 and the 1980 referendum contributed dramatically to the shift of the head offices of major corporations from Montreal to Toronto.

The separation of Quebec from Canada would reinforce Toronto's position as Canada's dominant metropolitan centre. Indeed, with Montreal removed from Canada and its remaining links with the Canadian hinterland weakened, there would be no challengers. Toronto would be the logical destination for any migrating head offices to go. These head offices would bring with them the need for an expansion of key support areas such as financial, accounting, legal and other business services, resulting in many spin-offs to the local economy.

If Montreal were no longer part of Canada, the federal government would no longer need to even the playing field by favouring Montreal over Toronto. Admittedly unsuccessful initiatives such as the establishment of World Financial Centres in Montreal and Vancouver would be abolished. Toronto and Western Canadian consulting engineers would no longer have to compete with Montreal's politically well-connected SNC-Lavalin for their share of the federal government largesse provided through the Export Development Corporation and the Canadian International Development Agency.

The Toronto Stock Exchange and the Toronto securities industry would benefit from reduced competition from the Montreal Stock Exchange and Montreal investment dealers if Quebec were to separate. Montreal's strong position in Canadian financial futures and options would be vulnerable.

GREATER COHESIVENESS

A Canada without Quebec would be a much more cohesive and governable political entity. The incessant wrangling over Quebec's place in Confederation would be over, once and for all. The provinces could be expected to participate whenever a federal provincial meeting was called, without constantly worrying about whether Quebec would boycott the meeting for one reason or another. Federal proposals could be judged on their merits rather on the basis of whether they increased or decreased provincial, particularly Quebec, government powers. It is sad to say, but we would be in a much better position to make the difficult decisions required to deal with the economic and social problems facing Canada today.