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In England and France: We have calculated that interregional
income differentials in England are also tightly distributed, once
adjusted for cost of living differences. In general, rural areas show
lower average income than London as published in official statistics;
yet equalization is nonetheless realized across both types of territory
when similar occupations are considered (Baran and O’Donoghue, 2002).
INSEE analysts in France have shown that “overall differences in price
levels between Paris (prices higher by 13%) and the rest of the country
is of the same order of magnitude as differentials in earnings levels”
(Fesseau,
Passeron and Vérone, 2008:1).
In Canada:
Figure 1 shows changes in Quebec’s share of the total Canadian
population since 1921. This share remained constant at 29% from 1941 to
1966, but showed a declining tendency thereafter and stood at 23.1% in
2011. In 1981, the population of Quebec was 74% that of Ontario vs. 61%
in 2011. Similarly the population of metropolitan Montreal represented
94% of Toronto’s in 1981 vs. 68% in 2011.
Let us now consider regional income per capita. Using coefficients of
variation of GDP and of disposable income per capita, Figure 2 below
shows that economic disparities between the provinces have declined over
the last 30 years. This reduced dispersion occurred as important
movements of population took place: declining shares in the Atlantic
Provinces and Quebec together with rising shares in Ontario, Alberta and
British Columbia. This movement of the population and its corresponding
change in GDP indicate that in a provincial economy, integrated into a
national economy, adjustments are realised by quantities, not prices or
income per capita, except for the price of land. In the long term,
growth differentials are entirely capitalized in the price of land.
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Figure 2 |
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Economic Disparities Between Provinces, 1981-2005 |
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Source: Department of Finance (2006: 115). |
The Quebec-Ontario economic disparity is the most vivid case in point.
The overall Quebec economy has witnessed a widening gap with Ontario and
the rest of Canada over the last half century, when measured in terms of
overall economic growth, population, investment and employment increase.
In 2010, nominal GDP per capita in Quebec amounted to 87.2% that in
Ontario, personal disposable income to 89.1% and average weekly earnings
to 88.8%. Overall, income per capita in Quebec lagged behind Ontario by
11 to 13 per cent.
Yet labour market adjustments and how immigrants choose their location
have resulted in real per capita income being equalized between Ontario
and Quebec. The cost of living in Montreal was 11.2% below Toronto.(4) Because land is a resource in fixed supply, its price increases faster
in Toronto than in Montreal. Montrealers in general earn lower monetary
incomes, but these are wholly offset by lower land prices. When extended
to the whole of Ontario and Quebec territories, this suggests that
the lower cost of land in Quebec almost
perfectly compensates for the lower GDP per capita. The divergence in
total growth has been capitalized in land prices. This adjustment
process continues until real incomes have equalized across the
provinces.
The Government of Quebec in particular has
traditionally defended the level of equalization payments it receives on
the basis of its supposedly lower GDP per capita relative to that of
Ontario and to the average of all provinces combined. This is precisely
the question that we address in this paper: Does the level of per capita
income effectively vary across provinces? In national, integrated
economies, overall GDP and per capita income move in the same direction.
Because of this association, observers often assume that the same
relation holds at the regional levels. Actually, adjustments to
interregional growth differentials are realized by product and
factor mobility, not by prices, with the exception of the price of land
and of non-tradable local services like hairdressing salons.
Quantities, not prices or incomes, adjust.
Slow-growing regions should therefore have as high per capita real
income as fast growing ones, even though they grow at a lower rate.
Growth differentials are capitalized in the price of land and of local
services, the only prices that vary across the economy. >
Land price differentials across the country thus provide an immediate
and easy-to-observe measure of interregional growth.
The significance of the analysis for equalization is obvious. Since
there is no significant gap in real per capita income between
slow-growth regions and the rest of Canada, the level of equalization
payments received by each province should be similar, most likely zero
for each.
One widely accepted critique of the equalization program holds
that it has magnified regional income disparities by preventing workers
from moving to their most productive location outside slow growth
regions. It is true that productivity is negatively impacted by
equalization. Equalization does reduce the mobility of resources, of
human capital in particular. Fewer people have moved from Quebec and
from the Atlantic Provinces to more prosperous regions of Canada. But
observed real income convergence invalidates the conclusion that
interregional income disparities are increased. What equalization does
is make explicit the transfer of the burden of lagging provinces to
other regions of Canada. Absent equalization, higher growth, higher land
rents and higher wages would have ensued in Alberta, Ontario and B.C.,
thanks to lower taxation and higher immigration. Their growth is
negatively impacted. High-growth provinces are
the first victims of fiscal equalization. Yet lagging provinces have
gained nothing. They have lost in less depressed land prices and lower
nominal wages what they have gained in subsidies. They also share in the
reduced per capita income across the country. Equalization is
self-defeating, a pure waste. Furthermore,
provincial politicians are induced by equalization to be less
responsible and to enact measures that limit economic freedom.
Equalization is but one policy enacted by the federal government
exerting concentrated regional incidence in one or multiple provinces.
Other programs like zoning and subsidies to corporations also
differentially impact specific provinces. The Canada Health Transfer and
the Canada Social Transfer have negated this ideal of fiscal
responsibility for several decades. Our assessment of equalization
applies similarly to all such federal programs.
Natalist policies are another case in point.
Even when enacted by lagging regions, natalist policies, if successful
in raising birth rates, only lead to subsequently more pronounced
movements of people out of those regions.(5)
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Adjustment in Non-Integrated Economies |
This income equalization process differentiates integrated economies
from economically isolated countries across the world. In the latter
case, labor, like land, becomes a resource in fixed supply because of
low population mobility between countries. Differential growth rates
across countries are capitalized both in land prices and in wages.
Because mobility across countries is low, people in more prosperous
economies gain in terms of relative per capita income, while immobile
people in lagging countries experience relative income declines.
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The Economic Theory of Federalism Revisited |
A number of policy and institutional implications can be derived
from our analysis, particularly in relation to zoning, regional
development programs and federalism.
The logic analyzed in this writing does not invalidate the
traditional theory of federalism, but it does set time and other limits
to its action. The economic theory of federalism teaches that in an
integrated economy, decentralised governments’ mistakes are rapidly
revealed. People (and capital and goods and services) victimized by a
lagging economy can respond to the inefficiencies of their local
government and choose to move out. Local and provincial governments’
ability to abuse their tax and regulatory powers is curtailed by
intergovernmental competition. Regions (provinces and local governments)
cannot shift the burden of their own costly policies to the rest of the
national economy.
It remains true that a local economy cannot directly shift the
burden (or the benefits) of its government’s policies to the rest of the
economy. But as local victims of inefficient policies are driven away,
and as fewer immigrants from outside the province, including from
abroad, flow in to the now less buoyant local economy, the burden of
provincial policies is capitalized in lower land prices in that
province. As interregional adjustments are ultimately realized by
people’s mobility, real per capita income in that province converges
toward the national level. A less optimal distribution of the population
ensues, but living standards are nonetheless equalized across Canada.
The mobility underlying this process impacts on the growth of the
unfortunate province, not on the standards of living of its inhabitants.
Lagging regions gain, not so much from federalism or decentralisation,
but from being part of a common national market.
To the extent that the local population values growth in the local
economy, federated or decentralised governments are induced to minimize
their inefficiencies. But to the extent that their real income per
capita relative to other regions is not affected by the failures of
their provincial government as a result of people’s mobility, local
people do not bear the full cost of such policies. This cost is spread
to all regions of the federation by the action of the underlying
mobility. Ultimately, it takes the form of a less optimal population
distribution. To the same extent, the local median voter is not induced
to resist as vigorously policies that hurt him or her. Again, in an
integrated economy, regional parochialism can be a profitable ideology.
This may also explain why the empirical record is mixed on the
contribution of federalism to containing government growth (Borcherding
and Lee, 2006; Grossman and West, 1994).
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Milke and McMahon (2012) have underlined the unjust nature of the
policy. For instance, the $7.6 billion in equalization transfers to
Quebec ends up subsidizing (through cheap university tuition and child
care, among other services) even the rich in a “have not” province as
poor taxpayers in “have” provinces pay for the well-off in recipient
provinces. Furthermore, because production costs are lower in “have not”
provinces, services can be provided at a lower cost in receiving
provinces. (More on this dimension below.) Equalizing funds in recipient
provinces result in those provinces being able to afford a higher level
of services than the provinces that fund them. Milke and McMahon also
argue that equalization is inefficient, boosting government spending and
pulling resources away from the private sector in receiving provinces.
By bidding resources away from the private sector, governments in
recipient provinces artificially increase costs for the private sector
and reduce competitiveness and growth.
