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Bonds good, coherent plan better.

April 11 is the last day you can buy a Northern Ontario Grow Bond. You have to be 16 and a Northerner. And you can't spend more than half a million dollars. Are Grow Bonds the answer to your prayers?

For an individual investor, the bonds are a safe place to park some money. With an inflation rate under two per cent, the four per cent guaranteed by the corporation produces a nearly risk-free real return of over one per cent.

For the North it is good deal, although not for the obvious reason. And for the people of Ontario? Maybe not.

The Grow Bond legislation is a major victory for the Northwestern Ontario Associated Chambers of Commerce (NOACC). Several years ago, NOACC, the Northwest Development Association and the Northwestern Ontario Municipal Association began to pressure the Ontario government for funds for business expansion.

Believe it or not, the business community in the North was arguing that the free market wasn't working. NOACC claimed that the administrative cost of investing in remote Northern communities was too high. As a result, banks and the private investors were ignoring productive investment opportunities in the North. The market system was sucking money out of Northern Ontario and NOACC wanted the government to fix the problem.

The existing government programs weren't working, according to NOACC. Although Ontario spent 65 million dollars on tax-credit subsidies in 2001, and the labour-sponsored-funds invested five billion dollars across the country, NOACC reported that "there has never been a single investment in northwestern Ontario and only two in the entire North since the labour-based funds were created."

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The solution was for the government of Ontario to become a venture capitalist. NOACC wants the new Grow Bond Corporation to take risks. If it sticks to safe investments, it won't contribute much to the Northern economy. Northerners are not being asked to become venture capitalists, of course. The Grow Bond Corporation guarantees investors a four per cent return.

Taking risks means there are bound to be defaults. If just 10 per cent of borrowers default on just half of their loans, the Corporation will need a 5 per cent risk premium to break even. If the expense-ratio turns out to be 5 per cent, the Corporation would have to charge around 14 per cent to cover all its costs.

But the idea is to offer cheap loans. For many years in the United States, industrial development bonds similar to the Grow Bonds have been offered at less than the prime rate. The U.S. Prime Rate is "the base rate on corporate loans posted by at least 75 per cent of the nation's 30 largest banks." The City of San Antonio Industrial Development Authority provides funding at 60-80 per cent of the prime rate. The Howard Hughes Medical institute recently used Economic Development Bonds to collect over $75 million at 2.5 per cent. For Canada, the prime rate is currently about 4.25 per cent, which means that the Grow Bond Corporation may have to lose 10 per cent every year to do its job.

Fortunately, the government in Queen's Park has agreed to make up the difference, so losing money is a good deal. It will keep Northern savings in the North. It guarantees a reasonable and secure return for Northern investors. And it guarantees that southern taxes will be used to subsidize some Northern businesses.

Critics say that programs that provide cheap capital are just bribes to get companies to move from one municipality to another. They may help one community, but they usually hurt another, so the net gain is nearly zero. When everyone offers bribes, all they do is make the shareholders better off. But why should we care? Torontonians will be bribing companies to move North!

It is not clear that Grow Bonds can create many jobs. Kentucky has one of the oldest bond schemes.

Researchers at the University of Kentucky concluded that the programs had probably worked. Industrial employment in Kentucky stayed roughly constant when it fell in the rest of the U.S. Another study from Illinois showed that companies that received funds from a bond program grew by 48 per cent and profits increased by 54 per cent. It sounds good, but companies that borrow money to expand usually do expand. The study couldn't show that the expansion wouldn't have happened without the bond program.

Overall, the Grow Bonds can't hurt and they may do some good.

But capital subsidies are not a substitute for a coherent economic development strategy. Let's hope that NOACC uses some of its new-found muscle to win some more fundamental changes.

Dr. David Robinson is an associate professor of economics at Laurentian University. He can be reached at drobinson@laurentian.ca.
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Title Annotation:ECONOMICALLY SPEAKING
Author:Robinson, Dave
Publication:Northern Ontario Business
Geographic Code:1CANA
Date:Apr 1, 2005
Words:796
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