Michael Binnion, CEO of Questerre Energy and head of the Quebec Oil and Gas Association, has a great blog post up in which he discusses the impact that equalization payments have on Quebec's energy and natural resource policy.

Looking at Quebec's budget, Binnion observes:

It seems to me the Quebec budget actually exposes a huge problem and many Quebec commentators have pointed it out. Quebec is being paid by the Federal Government for reduced resource royalties and related taxes. Worse if Quebec increased the price of Hydro, increased its mining royalties or developed its oil and gas discoveries, the Federal Government would penalize them.

What Mr. Binnion is pointing out is the moral hazard inherent in the equalization system, or, for that matter, in most any insurance or social welfare system. According to the OECD, Moral hazard describes behaviour when agents do not bear the full cost of their actions and are thus more likely to take such actions.

There are many examples of moral hazard one could cite, but consider what happens when governments become the disaster insurer of last resort, or otherwise transfer the costs of risk-taking from those who take the risk to those who bear the cost.

As researchers at the Wharton Risk Center observe,

Highly subsidized premiums or premiums artificially compressed by regulations, without clear communication on the actual risk facing individuals and businesses, encourage development of hazard-prone areas in ways that are costly to both the individuals who locate there (when the disaster strikes) as well as others who are likely to incur some of the costs of bailing out victims following the next disaster, either at a state level through ex post residual market assessments or through federal taxes in the case of federal relief or tax breaks.

In the case of Quebec, the people of the province do not have to bear the full cost of their decisions to suppress the economic activities of mining or fossil fuel production, because the rest of Canada will make up foregone revenues through equalization payments. Some people might think that sounds like a good deal: after all, Quebec gets to have a high quality of life without having to dirty its hands with things like energy and natural resource production.

Alas, as the economists say, there's no such thing as a free lunch: with the free ride comes dependency, and eventually decay. As Binnion observes:

The Government of Quebec is like a person on Government assistance. If they get a job their assistance goes down. If they lose a job their assistance goes up. In Provinces like Alberta we need to realize that equalization is not something we do for Quebec - it's something we do to them! A model of producing more than you consume is sustainable for a society, but a model of consuming more than you produce is not.

As Fred McMahon of the Fraser Institute proved in an award-winning essay, the situation is not unique to Quebec -- transfers to Atlantic Canada for economic development can also create economic distortions perversely retarding development in Atlantic Canada:

Government influence in the marketplace also operates through a number of other channels: economic development programs, tax policy and rulings, direct and indirect subsidies, etc. When government does step into the marketplace to influence the distribution of resources, the link between price and the most productive use of a resource is broken, and resources can be misallocated to less efficient uses to the detriment of the economy.

Binnion closes out his blog post on an optimistic note, pointing out that it need not be this way for Quebec, any more than it had to persist in Atlantic Canada:

Newfoundland fought the Federal Government and insisted on a deal that did not penalize them for developing Hibernia or Voisey's Bay. Today Newfoundland is a have province. If it worked for Newfoundland it will work for other Provinces too.

Let us hope that Quebec's public -- and her decision makers -- come to understand the moral hazard of equalization payments and reconsider their antipathy to the valuable economic activities that are energy and natural resource development.