HALIFAX – Today AIMS released major new research showing that federal subsidies to Atlantic Canada have damaged the regional economy, not helped it, and that Atlantic Canada’s economic growth has been boosted by cutbacks in recent years.

A $400,000 Nestegg for Every Atlantic Canadian

Regional subsidies – not what Ottawa spends in Atlantic Canada, but the difference between expenditures and revenues – have been huge. Ottawa could have saved up a gift of $400,000 for each man, woman and child in the region – more than $1 million per average family had this difference simply been put into short-term securities starting in 1971. That’s about $1 trillion, nearly twice the size of the national debt.

Such a counterfactual comparison is only illustrative, but it does provide a sense of the opportunity cost of these subsidies. Subsidies once equalled about 40 per cent of regional GDP and have declined to under 20 per cent.

This research will “change the way we all think about the economy of Atlantic Canada,” says AIMS president Brian Lee Crowley, of AIMS’ first book, Looking the Gift Horse in the Mouth: The Impact of Federal Transfers on Atlantic Canada, by Fred McMahon, AIMS senior policy analyst.

Atlantic Canada’s economic growth has rapidly increased relative to the rest of Canada as the federal fiscal crunch forced cutbacks to regional subsidies through the 1980s and 1990s. Through this period, Atlantic Canada’s economy has consistently outpaced growth in the rest of the nation, and Atlantic Canada has cut the GDP gap with the rest of the country by a third. Subsidy cutbacks in recent years reduced distortions which have inhibited economic growth in Atlantic Canada. Gift Horse explains how the massive infusion of subsidies, particularly in 1970s, created these distortions and raised costs for Atlantic Canadian producers, slowing private investment and widening the unemployment gap with the rest of the nation. Atlantic Canada’s previously strong economic growth turned sluggish, and the region’s trade picture darkened as cost pressures shifted regional demand from local production to imports.

The idea that regional subsidies inhibit economic growth, and that subsidy reductions would spur it, may be unconventional political reasoning, but it is remarkably consistent with standard economic theory, the evolution of Atlantic Canada’s economy over the last 35 years, and international experience with foreign aid.

“This research shows Atlantic Canadians can make it on their own; that we need not remain dependent on the rest of Canada for our economic future and well-being,” says McMahon. “Canada’s experiment with massive regional subsidies has done us more harm than good.”

Exploding the myths

Regional subsidies have become a cornerstone of today’s Canada, constitutionally, politically and financially. Most analysts believe (1) regional subsidies at least boost personal income and (2) while they fail to spur regional growth, they do little economic harm. Both ideas are wrong.

Atlantic Canada’s economic growth outpaced the rest of the nation, closing the GDP gap, when subsidies were low in the 1960s and when they were cutback in recent years. Regional growth faltered only when Ottawa dramatically boosted subsidies in the 1970s.

Personal income growth in the region also consistently outpaces the Canadian average, closing the income gap, but this growth is unrelated to subsidies. Whether Ottawa ratcheted subsidies up dramatically – they once reached $5,000 (1996 dollars) per capita—or dragged them down sharply, as in recent years, Atlantic Canada’s income growth continues to outpace the national average at an unchanged rate.

The relationship between GDP and personal income growth suggests each subsidy dollar suppresses about a dollar’s worth of regional economic activity. Although further research would be required to pinpoint the exact magnitude of the effect, the important question is whether subsidies have significantly suppressed regional economic growth, and left Atlantic Canada more dependent while less economically vibrant.

Here, the evidence is compelling, supported by statistical analysis, empirical evidence from a number of different data streams, and a review of regional economic history.

“These results call into question some of the basic assumptions of fiscal federalism. An understanding of the mechanisms at work here may help us design a more sensible fiscal framework, one that helps regions with their real needs, but doesn’t lead to damaging economic distortions,” McMahon says.

Adjustment difficulties

The decline of regional subsidies will help free Atlantic Canada from economic distortions, and put the economic fate of the region in the hands of Atlantic Canadians themsleves. Yet, withdrawing from the dependency of 35 years will not be a painless process.

Some sectors and geographic areas will be harder hit and slower to adjust than others, though it’s worth repeating that despite massive reductions in subsidies over the last decade, regional personal income growth has continued to outpace the Canadian average at an unchanged rate.

Long term prospects are bright. Regional growth has already sped up, and a review of the region’s history shows that Atlantic Canada has done best when it’s able to trade freely with other markets, something increasingly possible as North American and world trade barriers fall. Regional exports are already booming.

“This book is a sober look at the harvest we have reaped from our own myth-making about dependence and regional weakness. Not only does it show we can do better, it shows we already are doing better,” Crowley says.