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Foreign Takeovers & The Canadian Economy


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Foreign Takeovers & The Canadian Economy

  1. 1. Foreign Takeovers & The Success of the Canadian Economy Colin R. Best FOREIGN OWNERSHIP IN CANADIAN INDUSTRY The issue of foreign ownership of domestic firms has been ongoing since the early 1900’s. Over the past forty years, much has changed with regards to trade and globalization in developed and developing nations. The removal of tariffs and barriers to free trade (GATT, FTA, and NAFTA) has laid the foundation for foreign ownership across Canada and North America. In 1975, due to the concerns over foreign ownership, the Foreign Investment Review Agency (FIRA) was created to monitor and control foreign takeovers in Canada. However, the elections of Margaret Thatcher, Ronald Reagan and Brian Mulroney meant the end of interventionism in Canada and elsewhere, in the name of laissez-faire and globalizationi. As a result, in 1985, Investment Canada replaced FIRA, which facilitated and solicited foreign direct investment (FDI) rather than control it. Over the past decade, FDI has grown dramatically as a major form of international capital transfer. In 2007, total foreign direct investment increased 17.8 percent from 2006 to $1.5 trillionii. The share of foreign control in the Canadian economy has remained relatively stable for many years. Of the roughly 1.2 million corporations that did business in Canada in 2005, less than one percent were foreign-controllediii. However, despite their small numbers, foreign- controlled corporations continued to play an integral role in the Canadian economy. In 2007, they accounted for 21.2 percent of assets held in Canada, and 30.5 percent of operating revenuesiv. Despite the odd fluctuation, these shares have remained fairly stable ever since the post-recessionary period of the mid-1990s. Among foreign-controlled corporations operating in Canada, the United States continued to be the dominant force by a wide margin. American- controlled firms held 61.0 percent of foreign-based assets and generated 62.6 percent of foreign- based revenuesv. Up until recently, there had been no government intervention blocking the sale of planned takeovers of domestic firms by foreign parties. But in April 2008, the Conservative government rejected the $1.3 billion sale of Vancouver-based MacDonald, Dettwiler and Associates’ (MDA) space-technology division to Alliant Techsystems Inc., a Minnesota-based space and weapons company. Until that time, the federal government had never in the 23-year history of the Investment Canada Act blocked a foreign takeover because of a failure of the “net benefit” test. Ottawa had reviewed and approved 1,587 foreign takeovers, according to figures from Industry Canada. Another 11,214 foreign acquisitions required notification under the Act, but not a formal review. With the increase of foreign capital into Canada over the past century, we have seen many sectors of the economy prosper tremendously. However, it is highly simplistic to view high levels of foreign ownership as generally a positive for Canada in a changing global economy. This paper will examine the effects of foreign ownership and discuss how foreign direct investment in Canada has played an integral role in the success of the Canadian economy. Colin R. Best Telfer School of Management November 17 2008 1
  2. 2. TRADE POLICY AND GOVERNMENT As the regulatory climate in Canada became more restrictive under FIRA, there was a reduction in multinational activity and FDIvi. As restrictive regulations gave way to more liberal policies towards FDI in the post-FIRA era, the importance of foreign controlled firms increased. Up until recently, with oil and gas, uranium and other precious and non-precious metals increasing in value, Canada has seen alarming rates of M&A activity in its resource sector. This has many questioning the validity and effectiveness of Canada’s foreign ownership policy. The liquidity that was created by escalating commodity prices has led to many of Canada’s industry- leading companies being bought up by foreign firms. It is argued that, “companies themselves have become mere commodities to be bought and sold on a day-to-day basis”vii. The Investment Canada Act allows reviews of large foreign takeovers to “examine whether the Act’s net benefit test is designed appropriately to capture the range of benefits that are crucial to Canada’s economic success”viii. Proposed takeovers that fail this test can and should be rejected. In the midst of an economic crisis, the Conservative government is trying to find ways to boost the country’s productivity. Prime Minister, Stephen Harper, vowed to open up some sectors of the economy to more foreign ownership and change the rules governing foreign takeovers of Canadian companies, mainly in the airline and uranium mining sectors. Harper commented that Canada is country of “free enterprise, free markets and free trade”, and that “these principles form the cornerstone of our prosperity. But we also believe a government needs to know when to be able to draw the line when any foreign takeover would jeopardize our national security”. Harper’s platform includes raising the threshold for a foreign investment review to $1 billion in business value from the current level of $295 million in gross asset value. He also pledges to create a new national security review process in the Investment Canada Act and make ministers responsible for foreign investment reviews and to provide reasons if a transaction is disallowed, and, conversely, if an investment is permitted to proceed. The overall result would mean that larger, more sensitive takeovers would wind up going under the microscope. While the companies involved in the sectors in question have said they will benefit from the move, opponents of the move say it does not protect important Canadian sectors and may be unfavourable toward the Canadian economy. EXCHANGE RATES AND TRADE BARRIERS In an article written by Rachel McCulloch, she explains that there are two economy-wide influences on FDI: exchange rates and trade barriersix. Exchange rate movements have an apparent effect on relative production costs; dollar depreciation, all else equal, makes producing traded goods in Canada more profitablex. Essentially, a weaker currency makes a country’s products and services cheaper to purchase. By raising production costs relative to those elsewhere, “an appreciation of the source country’s currency might shift investors’ preferences toward other regions of the world”xi. This is not necessarily the case under every circumstance. During the Canadian recession of the 1990’s, a weak dollar was not enough to entice foreign investors. The appreciation of a country’s currency can result in a net outflow of foreign ownership within that country. Another factor that has a profound effect on the relationship between FDI and exchange rates is intervention. Intervention controls erratic fluctuations in a Colin R. Best Telfer School of Management November 17 2008 2
  3. 3. country’s currency and can have varying effects. “Heavier intervention moves the country closer to a fixed exchange rate policy, and less intervention enables a country to approach the free float ideal”xii. A less volatile currency attracts foreign investment because it reduces the risk of doing business within that country. Loosening the barriers to trade can also help attract foreign investment. One study suggests that there are reasonable grounds to conclude that, “the major regulatory changes of recent decades—the implementation of FIRA and the subsequent replacement of FIRA by Investment Canada—had an appreciable impact on the aggregate share of economic activity under foreign control”xiii. The reduction of trade barriers over the past thirty to forty years has given way to many foreign-owned firms engaging in business activity in Canada. The free market economy of Canada can continue to generate benefits for the economy, so long as the government is able to protect the national interest and identity of Canada in the process. NATIONAL IDENTITY & REGIONAL DIFFERENCES With foreign ownership of Canadian firms increasing at an accelerated rate year after year, it begs the question whether the Canadian industry is being hallowed out. Polls suggest that the majority of all Canadians wish to preserve the “national identity” of Canada. The dominant desire is for control over national affairs. This seems natural because, “the maintenance of control over the destiny of one’s own society is fundamental to the psychology of nationalism”xiv. In the 1980’s Pierre Trudeau commented on foreign direct investment in Canada: I don’t worry over something which is somewhat inevitable, and I think the problem of economic domination is somewhat inevitable, not only of the United States over Canada but perhaps over countries of Europe as well….These are facts of life, and they don’t worry me. I would want to make sure that this economic presence does not result as I say in a real weakening of our national identity. I use that general expression too. The way in which I do that is to try and balance the benefits against the disadvantages. It is obvious if we keep out capital and keep out technology, we won’t be able to develop our resources and we would have to cut our standard of consumption in order to generate the savings to invest ourselves and so on….Each country wants to keep its identity or its sovereignty, to speak in legal terms. It has to instantly make assessments, and when we make assessments it is to try and select those areas which are important for our independence, for our identity. It seemed as if Trudeau had little personal attachment to nationalism and looked at foreign investment as a benefit to human welfare and not as much as a benefit to Canada as a nation per se. The benefit to human welfare via foreign investment varied throughout Canada. In the past, the Maritime Provinces and Quebec have had severe unemployment problems and have been extremely anxious for more investment, be it domestic or foreign. Furthermore, they have traditionally been dominated as much by Canadian firms based in Ontario as they have by foreign firms. Recently, the Prairie Provinces have benefited greatly from the economic boom based on foreign investment, particularly the development of the oil sands in Alberta. Also, Colin R. Best Telfer School of Management November 17 2008 3
  4. 4. British Columbia, “shut off behind the Rocky Mountains, has traditionally been oriented toward close integration with the U.S. Pacific states”xv. How does one protect “national identity” when economic success through foreign investment varies from province to province? It is apparent that there is an emotional attachment to nationalism and it makes it difficult to strike a balance between welcoming foreign ownership into our borders and protecting our home-grown Canadian companies. EFFECTS ON THE CANADIAN ECONOMY There are a number of negative effects that have been mistakenly associated with an increase in foreign ownership in Canada; lost head-office jobs, lower investment rates, hollowed- out economies, declining levels of research and development, losses in productivity, erosion of high-paying jobs, and elimination of competition have been attributed to the rise of FDI in Canadaxvi. However, a report from Statistics Canada (StatCan), based on two-decades of studies and research, suggests that foreign investment and ownership has been a benefit to Canada. StatCan reported that foreign-controlled firms actually increase head-office employment. The research explains that “the effect of foreign takeovers has not been to reduce the number of head offices in Canada nor head-office employment. As a result of foreign takeovers, more new head offices were created than lost and aggregate employment in head offices was just as high after the takeovers had occurred as before”xvii. Productivity also increases with foreign ownership. One such study showed 40 percent of all manufacturing plants in existence in 1997 were new plants that came into existence in the preceding decade. And 47 percent of the manufacturing plants operating in 1988 were no longer in operation in 1997xviii. Mergers and acquisitions play a large role in stimulating this activity, with foreign firms accounting for 60 percent of the productivity gains from these plant renewalsxix. The StatCan study concluded that a “disproportionately large share of the contribution to labour productivity growth is due to foreign controlled firms closing less productive plans and opening more productive plants”xx. This study clearly gives some truth to Schumpeter’s idea of ‘creative destruction’. In addition, foreign-controlled firms better utilize technology, and highly innovative, have higher labour productivity, and pay higher wages to more skilled white-collar workersxxi. Although these advantages can be seen in Canadian multinationals operating in foreign markets, they still benefit the Canadian economy nonetheless. CONCLUSION Over the last four decades, foreign multinationals operating in Canada have increased dramatically. The removal of tariffs and barriers to free trade has made foreign ownership in Canada more accessible to those interested in doing business in Canada. It is recognized that regulation is an important factor that serves to influence the volume of multinational investment in Canadaxxii. The introduction of the Investment Canada Act and more liberal policies toward FDI has undoubtedly affected the size of FDI inflows in the Canadian economy as well. The recent economic crisis has led the Conservative government to change the rules governing foreign takeovers of Canadian companies to try to stimulate the economy and only time will tell its success. Colin R. Best Telfer School of Management November 17 2008 4
  5. 5. We have seen that exchange rates and trade barriers are perhaps the two biggest factors that have an effect on foreign direct investment and that anticipated movements of currency values play a significant role in shaping international capital transactions. Furthermore, loosening the barriers to trade can attract foreign investment under many circumstances but at what cost? The issue of protectionism and maintaining our national identity at a time where foreign investment is at its highest is a difficult one. It can be argued that greater independence through reduction of foreign investment would carry an economic cost but what degree of sacrifice are Canadians willing to accept as a cost of independence? The answer to this question would certainly vary across the different regions of Canada. Evidently, the economic vs. control effects of foreign investment is most definitely a trade-off. The effects of foreign investment in Canada and their importance to the success of the economy has always been a debated issue. There are many misconceptions as to the effects foreign ownership has on the Canadian economy. Increases in head-office jobs, higher investment rates, increase in healthy competition, increased investment in R&D, productivity gains, and an increase in the number of highly skilled workers with high-paying jobs has all contributed to the success of the Canadian economy. There has always been a build-up of nationalistic reaction to foreign controlled businesses operating within Canadian borders, which has created pressure for action by the government, albeit very limited in nature. The progression toward absolute integration with the United States has led to arguments that suggest that there is virtually nothing unique about Canada in its culture or other characteristics. This raises questions about national identity and whether or not Canada’s preservation as a nation is practical or even worthwhile. Regardless of the attitudes and views toward foreign ownership, the benefits to the Canadian economy as a whole cannot be forgotten. Foreign takeovers are a sign of economic success. It is a global world and the more Canada regulates and legislates to close its borders, the more it becomes isolated toward the global market. Colin R. Best Telfer School of Management November 17 2008 5
  6. 6. Endnotes i McCulloch, R. (1993). New Perspectives on Foreign Direct Investment. In Foreign Direct Investment (pp. 41). University of Chicago. ii Statistics Canada. (2008). Foreign control in the Canadian economy: FDI stats. Ottawa. iii IBID iv IBID v IBID vi Fayerweather, J. (1973). Foreign Investment in Canada: Prospects for National Policy. New York: international Arts and Sciences Press. vii Jackson, A., (2007). Mel Watkins on Foreign Take-overs. The Progressive Economics Forum. Retrieved November 7, 2008, from viii Investment Canada Act. (1985). Investment Canada Act. Ottawa. ix McCulloch, R. (1993). New Perspectives on Foreign Direct Investment. In Foreign Direct Investment (pp. 41). University of Chicago. x Fayerweather, J. (1973). Foreign Investment in Canada: Prospects for National Policy. New York: international Arts and Sciences Press. xi McCulloch, R. (1993). New Perspectives on Foreign Direct Investment. In Foreign Direct Investment (pp. 41). University of Chicago. xii Peng, M. (2009). Global Business. South Western Cengage Learning. xiii Fayerweather, J. (1973). Foreign Investment in Canada: Prospects for National Policy. New York: international Arts and Sciences Press. xiv IBID xv IBID xvi IBID xvii Statistics Canada. (2008). Foreign control in the Canadian economy: FDI stats. Ottawa. xviii IBID xiv IBID xx IBID xxi Fayerweather, J. (1973). Foreign Investment in Canada: Prospects for National Policy. New York: international Arts and Sciences Press. xxii McCulloch, R. (1993). New Perspectives on Foreign Direct Investment. In Foreign Direct Investment (pp. 41). University of Chicago. Colin R. Best Telfer School of Management November 17 2008 6