The Ins and Outs of Foreign Investment

To provide a little context for our current national debate on foreign investment, I did a little digging recently in the FDI data. Some of my findings surprised me.  Yes, Canada exports slightly more FDI capital than we import (that is, the net investment position in FDI is slightly positive).  But most of what we export is in banking; most of what we import is in commodities (no surprise there).  In terms of total gross incoming FDI, Canada’s position is the worst since WWII — even though our net position is slightly positive.  And in non-financial industries only (excluding banking), our net position is the worst since the 1970s. On the other hand, Canada’s gross inflow is not large compared to many other small and medium developed countries (this surprised me).

Moreover, Canada’s banks (the source of most Canadian outgoing FDI) are powerfully protected against the competitive effects of incoming FDI.  That initially seems ironic … until you think that the actual goal of policy should not be to either promote or stop FDI in general, but to promote those kinds that benefit your national strategic development goals (including measures to develop key industries, and to promote key companies).  Other countries with pro-active industrial policies (Brazil, China, many European countries) regulate both inflows and outflows of FDI, with the aim of promoting national-champion firms and the key value-added sectors which those firms populate.

Here’s a recent piece I wrote for the Globe and Mail’s web section considering these ins and outs in more detail:

The Investment Canada Act was implemented in 1985 by the government of Brian Mulroney.  It replaced the former Foreign Investment Review Agency (FIRA), which had become a potent symbol of Pierre Trudeau’s interventionism.  While the new Act was explicitly intended to welcome foreign investment (including takeovers) with open arms, it did include a “net benefit” test to supposedly protect Canadian interests.  That test was hardly stringent: after all, in its first quarter-century of existence, federal regulators approved 1637 large takeovers, and turned down just two (the blocked sale of MDA’s space division in 2008, and this year’s hostile bid for Potash Corp.).  On rare occasions when Investment Canada officials used the test to extract incremental commitments from a foreign firm, those commitments proved secretive and unenforceable.

The real value of the net benefit test, it turns out, was as a political carte blanche: it gave federal politicians enough leeway to turn down any proposed takeover they deemed too hot to handle.  Indeed, for both of the takeovers turned down under the Investment Canada regime, it was minority government (not net benefit) that led to their demise.  Those two particular cases sparked concern and anger across a surprisingly wide swath of Canadian political opinion – and that sparked their rejection by a fragile Conservative government.  The irony is inescapable: in practice, Stephen Harper’s laissez faire conservatives have been more willing to interfere with capital flows than any other federal government since Mr. Trudeau’s.  Clearly, their commitment to someday winning a majority, is firmer than their commitment to any particular economic philosophy.

To provide intellectual cover for this surprising turn, the Prime Minister has now signalled another review of the Investment Canada Act.  This is déjà vu all over again: after all, it’s only two years ago that the Act was last “updated” (in the wake of his government’s MDA decision).  At that time, “national security” was added as a post-hoc justification to the list of the Act’s considerations.  Now the government may add another buzz word – “strategic asset” – to the legislation.  The only effect of this change would be to reinforce the government’s existing ability to turn down any takeover it wants to (but only when the political winds are blowing the right way).

Instead of continuing to wordsmith an Act that has almost always been a rubber stamp, we should undertake a more honest and wide-ranging examination of the pros and cons of foreign investment.  And the starting point of that examination should be a review of where we stand right now.  Here are a few of the relevant statistics concerning the comings (and goings) of foreign investment:

• Foreign investment in Canada grew a lot through the recent wave of takeovers: by $170 billion over the last five years. The current stock of foreign direct investment in Canada equals 36 percent of Canada’s GDP. That’s the highest in our postwar history.
• Canada’s reliance on incoming foreign investment is not unusual by current global standards. Many countries are much less reliant on foreign investment (like the U.S., Germany, Japan, even Mexico). But many (especially in Europe, where the web of cross-border investment is tight) have much more. For example, Belgium, Ireland, and Sweden all report more than twice as much incoming foreign investment (relative to GDP) as Canada.
• This suggests that the issue at stake may not be so much the sheer amount of foreign investment, as what it is used for, and the conditions under which it enters.
• Over half of Canada’s incoming foreign investment is located in our mining, oil and gas, and primary metals industries (like nickel, aluminum, and steel). And foreign hunger in those sectors explains most of the recent surge in foreign control in Canada. In this regard, incoming foreign investment is only reinforcing Canada’s status as a resource supplier. That’s much different from European countries, where incoming foreign investment is concentrated in high-tech, value-added industries.
• Of course, Canadian companies also invest abroad in their own foreign subsidiaries. In fact, since 1997 the book value of Canadian corporate investments abroad has exceeded the book value of foreign direct investment here. That net balance has eroded somewhat in recent years (due to mega-takeovers of Alcan, Stelco, Inco, and others), but Canada is still slightly in the black. Some commentators (like the University of Calgary’s Jack Mintz) thus conclude that Canada has nothing to fear from foreign investment, since we’re getting as much action abroad as we are giving up here at home.
• However, the foreign investment that leaves Canada looks very different from the foreign investment that enters. Most Canadian-owned FDI abroad is in the financial sector. And eighty percent of the new foreign investment that’s headed out in the last five years is in banking and finance.
• In other words, the overall apparent balance in Canadian foreign investment relationships hides some important structural imbalances. Canada has been ceding ownership over resource industries, offset in the statistics by the increasing global reach of our big banks.
• Without those banks, Canada’s foreign investment position would be much bleaker. If we consider only the non-financial portion of the economy (that is, the economy that produces real goods and services, rather than trading in paper assets), Canada’s net foreign investment position is worse (minus 10 percent of GDP) than at any time since the 1970s – which is when the Trudeau government first created the FIRA.
• Ironically, Canadian banks are effectively protected against foreign takeovers themselves, by virtue of federal restrictions on share ownership and mergers. Without those rules, at least some Canadian banks would have been taken over during the irrational exuberance that preceded the 2008-09 financial crisis (when U.S. banks, flush with huge but temporary profits, were prowling for acquisitions). So the source of most of Canada’s outbound foreign investment, is itself testament to the value of our remaining limits on inward foreign investment.
• This lesson can be interpreted more broadly, across other sectors. To have successful foreign investment abroad, strong Canadian-based companies must exist to undertake it. We have those “national champions” in banking, but not many others. In that regard, an untrammelled inflow of foreign capital hurts us on both sides of the ledger: by giving up ownership rights over an increasing share of our home economy, while simultaneously undermining our capacity to invest abroad.

Our foreign investment policy should be integrated with an overall strategy for developing key industries – and the key companies which lead those industries.  If foreign investment enhances the real capacity of our national economy (by adding real capital investment, technology, and export opportunities that we wouldn’t have had otherwise), then it’s a no-brainer: we clearly benefit.  But for the most part, that’s not the kind of foreign investment we’ve been getting lately.  Meanwhile, as more Canadian “champions” are bought out by foreign suitors, the more one-sided will be our engagement in global investment flows – since those are the same companies that have the capacity to invest in the other direction.

That’s why our legislation must be rethought and restructured.  It will take much more than adding a buzz word or two.  Rather, we need to rethink our whole approach to building globally successful Canadian industries, and globally successful Canadian-based corporations.  That won’t happen by either throwing the door to foreign investment wide open, nor by slamming it shut.  We need a deliberate, strategic approach to using foreign investment, in both directions, to nurture our companies, and develop our economy.