Elsewhere in this issue, and in the Winter/Spring 2009 issue of Inroads, Pierre Fortin has set out his view that Quebec is doing well economically.¹ We challenge this view. We agree that Quebec has a more equal distribution of income than other Canadian provinces; we disagree that the standard of living in Quebec is adequate. It has not achieved the level it could if better economic policies were pursued.

Quebec’s dependence on federal transfers

Two different measures of income can be used to assess a jurisdiction’s absolute and relative economic success: disposable income per capita and real GDP per capita. Disposable income per capita – that is, income after deduction of personal and payroll taxes – measures the standard of living accessible to the residents of a territory through private consumption, and includes both market income (wages and salaries, investment income and private remittances) and public transfers to individuals.

Hence, disposable income per capita in Quebec includes transfers received from federal Employment Insurance and Old Age Security. Quebec’s disposable income per capita is higher than it would be if Quebec were to finance its present social spending without equalization payments and other transfers received from the federal government. Without equalization, Quebec would need to impose higher personal income and payroll taxes, among other measures needed to raise revenues. While a good indicator of the average standard of living, Quebec’s disposable income is a poor indicator of its economic performance because, in part, it is at the mercy of the generosity of the federal government; its capacity to pay will depend in part on economic activity in other provinces.

This is illustrated in Figure 1, showing federal transfers as a share of personal income. In 2006, these transfers amounted to $2,240 per capita in Quebec and $1,870 in Ontario. Summing over all Quebecers, this difference amounted to $2.8 billion. Furthermore, in 2006 Ottawa derived only 19 per cent of its revenues from individuals and firms in Quebec, as opposed to 41.5 per cent in Ontario.² So Quebec gains more in transfers and pays less in taxes.

Real GDP per capita measures value added during the production process in an economy. Hence, it reflects the average economic market output for every resident of a jurisdiction. This is not a perfect indicator of economic activity, since it omits nonmarket activities and is not directly linked to income availability or distribution^. Despite these drawbacks, however, it remains the conventional way to evaluate the economic productivity of different jurisdictions, either national or subnational. Figure 2 presents per capita Quebec GDP and disposable income between 1981 and 2008, expressed as percentages of per capita GDP and disposable income in the rest of Canada.

For nearly the entire period, Quebec per capita GDP was roughly 85 per cent of that elsewhere in Canada; in the last four years it has declined to about 82 per cent. On the other hand, Quebec per capita disposable income has been consistently closer to the level elsewhere in Canada than the relative productivity of Quebec’s economy would warrant. That is what equalization and personal transfers make possible. What is disconcerting is that, in this decade, per capita disposable income has increased faster in Quebec than in the other provinces (as evidenced by the rising disposable income ratio), while at the same time Quebec’s relative productivity (as measured by the GDP ratio) has declined.

Since 2000 Quebec has become increasingly dependent on federal transfers, such as equalization, to fund its social programs. As shown by Figure 3, total transfers from Ottawa accounted for 18.4 per cent of Quebec government revenues in 2009. A decade earlier, in 1998, the ratio was 14.8 per cent. In less than a decade, annual federal transfers to Quebec grew by $7.4 billion. Equalization payments may be a good way to ensure similar standards of public programs from coast to coast, but they were never meant to continuously subsidize higher social program expenditures in one province relative to others. In the 2009–10 fiscal year, Quebec will receive $8.3 billion in equalization payments, representing nearly 60 per cent of the total.³ Equalization payments will amount to $1,075 for every Quebec citizen and more than 10 per cent of Quebec government revenues.

In sum, Quebec is more dependent on Ottawa’s willingness to fund its social programs than any other province outside the Maritimes, and its population is less productive than the population in most other provinces. In 2008, Quebec’s per capita GDP was 18 per cent below the average outside Quebec (see Figure 4).

Proper pricing to sustain the “Quebec way of life”?

Why is Quebec not doing as well as the other large provinces? Structural factors are part of the answer. The fact that most Quebecers are unilingual francophones reduces population inflows and outflows as a mechanism to adjust to economic changes within the North American economy. Relative labour immobility allows the Quebec government to use high labour taxation to subsidize capital investment. High labour taxes enable Quebec to invest in selected industries more than do most provinces, and many of these state-directed investment funds have generated disappointing results in recent years. Hence, the high payroll taxes may well be lowering private investment and what would otherwise have been provincial productivity. And the existence of a sovereignty movement is unlikely to increase the attractiveness of Quebec to investors.⁴

So, is 21st-century Quebec doomed to be a poor, sovereigntist-ridden province, much as it was poor and priest-ridden in the first part of the 20th century? In our opinion, no. Proper pricing in various sectors can free up resources and ensure economic growth.

At present, too many publicly supplied private goods in Quebec are sold at inefficiently low prices. One important example is hydroelectricity. Fortin wrote, “If you happen to sit on large reserves of oil and gas, you’re okay; if you don’t, you’ll be found in the bottom ranks of North America for real income per capita.”⁵ Quebec’s abundant hydroelectric capacity should be the equivalent of oil. However, the policy of no electricity price increases adopted for most of the 1990s encouraged overconsumption within Quebec and restricted the potential for export income. In 2005, Quebec was the second highest per capita electricity consumer in the world, just behind Iceland and ahead of Norway and the rest of Canada.⁶

The result is that Hydro-Quebec is forgoing export sales. With a differential of 13.3 cents per kilowatt-hour in average cost of production between Hydro-Quebec and New England utilities, such exports would realize substantial revenues for the Quebec treasury.⁷ Many American states have faced power shortages in recent years. Exports from Quebec could provide the American market with greener, more affordable power. Both jurisdictions would be better off.

The example of Newfoundland shows that a relatively poor province can improve its position by efficiently managing its resources.⁸ Newfoundland’s per capita GDP grew at a sustained annual average rate of 5.1 per cent from 1981 to 2008. In comparison, Quebec’s per capita GDP grew at an annual average rate of 1.7 per cent during the same period. Last year, Newfoundland stopped receiving equalization and attained its fourth budget surplus in a row because it managed its natural resources efficiently. Instead of freezing prices, it allowed private producers to transform the raw resource, and then charged high royalties. In 2008–09, offshore oil royalties were $2.5 billion, nearly a third of provincial government revenue.⁹

A large majority of Quebec homes are heated electrically – at unduly low prices. The appropriate policy would be for the Quebec government to phase in higher prices, giving time to allow households to adapt to the new price structure.

Another example of a publicly supplied service for which Quebecers pay an unduly low price is postsecondary schooling in community colleges (Cégeps) and universities. Everybody in the Quebec education milieu – from university chancellors to leaders of teacher and student unions – considers Quebec universities underfunded compared to other Canadian institutions of higher education. A larger part of universities’ budgets comes from the provincial government in Quebec than, for example, in Ontario,¹⁰ while Quebec fees are the lowest in Canada. Since university education yields high private returns, at least for undergraduate degrees,¹¹ it would be sensible to increase fees, thereby improving the funding and quality of university education in Quebec. In the long run this would increase the productivity of Quebec’s labour force. Here is another simple application of the user-pay principle.

In general, it is possible to attain Quebec’s social goals in a more efficient fashion by using correct pricing, whether of electricity, universities, pharmaceutical insurance or other goods and services. Revenues thus obtained could be used, where appropriate, to subsidize consumption by low-income households either through refundable tax credits or through education-related grants and low-interest loans. Correct pricing would do away with ill-conceived universality realized through subsidized prices, which is poor public policy, albeit good politics.

If Quebec were to reform its pricing policies over, say, the next 20 years, it could slowly unravel inefficient implicit promises to keep prices of publicly supplied services artificially low. In the case of hydroelectricity, raising prices would simultaneously raise government revenue and induce less wasteful electricity use within the province. By raising electricity rates and requiring a higher portion of postsecondary education costs to be borne by tuition, Quebec would have more fiscal room to aid those who need it and to further reduce corporate and individual taxes. Instead of always looking for new investors and immigrants, Quebec could then hope to attract wealthy people and workers. This would invert the current vicious circle of poverty into a virtuous circle of wealth creation.

The real challenges are just ahead

Poorer, more dependent on federal transfers than most provinces and economically mismanaged by its politicians, Quebec was already in trouble before the present economic downturn. In Quebec as elsewhere, economic debates on pricing publicly supplied services such as electricity and postsecondary education, on fiscal implications of an aging population and on public finances in general have been put on the back burner because of the recession. There is no escaping these dilemmas, however. Sooner rather than later, Quebec will have to face its economic situation. Either it accepts declining economic and political influence as its fiscal dependence on other Canadians increases, or it engages in difficult structural reforms to provide public services more efficiently. Let us highlight a few facts as we enter – hopefully – the postrecession period.

The population is now aging at a faster pace in Quebec than in other provinces. As shown in Figure 5, the dependency ratio (ratio of those under age 15 plus those over age 64 to those between 15 and 64) was historically lower in Quebec than in Ontario and in Canada overall. That was the consequence of the historically high Quebec birth rate. Reflecting the current low birth rate, the ratio will grow faster in Quebec in the next decades than elsewhere in Canada. In 2031, it is expected that each Quebec dependent will be supported by only 1.6 people in the active age interval (a dependency ratio of 0.63); in 1985, each dependent was supported by 2.3 in the active population (a dependency ratio of 0.43).

In facing the fiscal implications of its aging population, Quebec will be more severely constrained than all other provinces because of its large public debt. In its 2009–10 budget plan, the Quebec government produced a table showing debt as percentage of provincial GDP among the provinces. The conclusion is simple but devastating: Quebec is the most indebted province by far, whatever the debt definition used.¹² Figure 6 shows the ratio of public debt to GDP for Ottawa and the four major provinces, by three measures:

• gross debt: accumulated deficits plus liabilities of civil service pension funds;
• net debt: gross debt less net financial assets of the government;
• accumulated deficits.

Based on the broadest debt definition, Quebec’s debt equals nearly half of its annual GDP. Its closest contestant for the sad title of most indebted province is Nova Scotia with a gross debt-to-GDP ratio of about a third. Quebec’s natural comparator, Ontario, is in far better fiscal shape.

Heavily indebted jurisdictions have less freedom to pursue public policy initiatives. They constantly risk having their credit rating revised downward by major rating agencies such as Standard and Poor’s or Moody’s. Lower ratings mean higher interest rates on public debt and potential difficulty in refinancing.

Finally, Quebec has been losing population to other provinces almost from the day data on interprovincial migration were first produced in 1961. For example, in 2006–07, Quebec increased its population by 0.5 per cent through international immigration; however, it lost 0.17 per cent to other provinces the same year.

Difficult choices

With its aging population and considerable productivity gap relative to other provinces, Quebec will not be able to continue as the generous welfare state it is – unless it undergoes major changes. The status quo in its public finances is unsustainable in the long term. Quebec’s government faces difficult choices. It must choose some combination of reduced generosity of social programs and a sharp rise in taxes and/or prices of publicly provided services.

If it is prudent, Quebec can meet social objectives without ending up bankrupt. The key is wise management of its natural resources.