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reality check

Ontario Finance Minister Dwight Duncan delivers his response to the Drummond report at a news conference in Toronto, Feb. 15, 2012.

Ontario's economy is in the midst of a gut-wrenching transformation marked by years of slow growth, weaker manufacturing and reduced spending by government, consumers and business.

In his gloomy outlook, economist Don Drummond estimates long-term growth of just 2 per cent annually and warns that it could be less than that. Such a level would be too low to support significant expansion of employment or business investment. And unlike the 1990s, Queen's Park will not be able to rely on expanded revenue from a strengthening economy to grow its way out of its deficit troubles.

Ontario's core manufacturing has been bloodied by low-cost competition in emerging markets, an enfeebled U.S. economy, which still accounts for the bulk of the province's exports, and a strong Canadian dollar that further hurts competitiveness and erodes profit. At the same time, Ontario is attracting fewer immigrants coming to Canada in search of economic opportunities, shrinking both the labour pool and the market for goods and services.

A booming housing market, heavy household borrowing, and government fiscal and monetary stimulus helped paper over these weaknesses. But these sources of growth are drying up, too.

As a result, the engine that once powered the Canadian economy is now struggling just to stay on the rails.

"We have to realize that we are moving from a leveraged-based economy to an investment-based economy," said Benjamin Tal, deputy chief economist with CIBC World Markets. "I suggest that it will be healthier, but it will be slower."

But in Ontario, a reboot of the economy would require a revival of manufacturing, of which the signs are few and far between.

Manufacturing employment in the province has fallen precipitously to its lowest level since 1976, accounting for only 11.6 per cent of total jobs, compared with more than 18 per cent a decade ago.

"This narrower base has to help support the steady growth in public sector employment," the Bank of Montreal said in an analysis. Almost as many Ontarians now work in health care and social assistance as in the province's factories, the bank notes in a telling chart. Just 30 years ago, three people held down manufacturing jobs for every one employed in health and social services.

No wonder, the Drummond report concludes that "[w] cannot count on robust economic growth to resolve our fiscal challenge."

The report's projections hew closely to the consensus of economy watchers in the private sector.

"Ontario has taken the turn and we have to figure out what's on the horizon," said Jacques Marcil, senior economist with Toronto-Dominion Bank. "The most prudent and most likely scenario is quite in line with what he described."

The question is whether this is a temporary situation that can be reversed or if the province is facing a new, more painful normal. And if that's the case, will a strong dose of austerity be enough to repair its tattered finances?

"Never say never," said Doug Porter, deputy chief economist at BMO Nesbitt Burns. "If the U.S. economy ever got back on its feet we could have a year or two of very strong growth."

But after that, the economy would once again shift into a lower gear, because its key problems – fierce global competition, worsening demographics and a strong loonie fuelled by the commodities boom in China and other emerging markets – are only going to worsen.

"Maybe the most important thing that the Drummond report pointed out was that the economic landscape has fundamentally changed," Mr. Porter said. "The underlying growth rate is not as strong as it used to be and the outlook is not as robust as it would have been in the eighties and nineties."

Still, it's too early to dismiss Ontario's manufacturing as a long-term drag on the economy. Rising costs, labour woes and technological gains are driving some production back to North America. The trouble is that it won't do much on the job front.

"Although you can have many winners [in the new manufacturing era] the winners, unfortunately, will be in capital-intensive industries," Mr. Tal said. "So you won't see the manufacturing sector creating jobs. In fact, the opposite might be the case. That's another factor in the softening of the potential growth for the economy."