Liberalising Foreign Direct Investment: What will this Mean for Innovation, Corporate Governance and Risk Management in Canada

Following a significant number of high profile takeovers of longstanding Canadian corporate personalities and growing concerns about ongoing ‘hollowing out’ of the Canadian economy, the government commissioned a panel to review its competition and foreign direct investment policies. The Competition Policy Review Panel has recently released its results. The Report and its recommendations focus on three areas: liberalizing foreign investment rules, streamlining the competition regulation regime, and promoting a globally competitive business environment.With this focus, the five person panel recommends that Canada relax foreign investment restrictions on telecommunications, air transport and uranium mining companies to enhance competition. The Panel Chair, Lynton Wilson, captures the message of the report arguing that Canada must be more innovative and competitive in order to succeed and prosper in a highly competitive 21^st century global economy.

The panel makes 61 recommendations in its 134 page report. Some specific recommendations include: lifting the de facto ban on Canadian bank mergers, raising the threshold for ownership in Canadian airlines from 25% to 49%, liberalizing foreign ownership of uranium mines, allowing foreign takeovers of telecommunications companies with less than 10% of national market share, amending the Investment Canada Act threshold for review from $295 million to $1billion, reversing the onus in order to require the government to demonstrate that an investment would be contrary to the national interest, creating a Canadian Competitiveness Council to advocate for competition in both public and private sectors, and increasing the overall transparency of the foreign investment review process. Industry Minister Jim Prentice has indicated that the government would be responding to these recommendations in the coming days.

Promoting competition and innovation in order to survive in the global economy is a very popular theme and mantra of governments and pundits. Innovation and competition are desirable outcomes of good economic policy. Though competitiveness and innovation are certainly worthwhile goals, less certain is how best to promote these ends. Though there have been numerous and sustained indicators that freer and fairer international trade benefits all economies, opening up the border to unrestricted (or unreciprocated) free trade is not necessarily the best road to innovation and competition. Facilitating foreign direct investment must be part of a much larger economic strategy that includes investment in education and training, capital investment in local innovation, physical and technological infrastructure and the myriad other building blocks of building sustainable and innovative economies.

It is true that, by most measures, Canada has been a beneficiary of freer and fairer trade. NAFTA and other regional or bilateral trade agreements have benefited Canada and other countries which rely on exporting goods to other markets. It is also true that most countries have benefited from freer and fairer trade.But the benefits of unrestricted trade are becoming more nuanced, particularly for countries such as Canada which has companies and resources that other larger countries lack and want. The energy and mining sectors have been, and will continue to be, appealing sectors for foreign investment and takeovers. Though it easy to open up a country’s resources to whatever the market will pay for them, it is not merely left-wing ranting to say that these decisions will have longer-term consequences. Do we really know what those consequences are? Is it truly in the best interests of Canadians and our presumed collective objective of creating a sustainable and competitive economy to further liberalise foreign direct investment? Will such liberalization lead to more investment, more innovation, more job creation and to Canada playing a more meaningful role in the emergent global economy? Maybe liberalizing FDI will have this longer-term beneficial impact. Maybe we have little choice in the matter since global markets will leave Canada behind if it constructs too many barriers to the free movement of international capital and investment. And myaybe the answer lies, as usual, somewhere in between.

Advocates and detractors line up on both sides of this debate. What makes meaningful discussion about sustainable economic policy and the role of FDI difficult is that there is a faith in and acquiescence to the power of the markets. For many reasons which are much more complex than our ability to discuss them here, the idea of liberalizing markets plays favourably in both political corridors and Main Street sidewalks. Sometimes it plays well because it is presumed that markets are beyond control or regulation even if we wanted to control or regulate them. But the truth about markets and our ability to control them is more subtle. We do regulate markets, and with some success. Markets are not perfect. Markets benefit some and not others. Markets do fail. They have failed and will continue to do so. And markets and those who manage them do not always make the best decisions about the risks they take. The recent failure of markets to control and manage credit risks provides yet another dramatic example of the fallibility of markets. So we do recognize some of these potential market failures and we do take regulatory steps to dampen the impact of unbridled markets.

It is with these insights and acknowledgements that the Canadian government should approach foreign direct investment. FDI should be encouraged but it must be combined with other economic strategies that ensure that there are tools to promote the creation of Canadian talent, companies and innovation. Though some argue that the market itself will make these choices, it is not so simple. The Canadian economy has not shown a remarkable capacity to innovate and keep at the leading edge of competition in a fluid and global economy. Many of the reports that study Canada’s competition and innovation relative to other industrialized nations are not particularly flattering. The most recent report from the Conference Board of Canada on How Canada Performs: A Report Card on Canada (June 30, 2008) re-iterates that Canada has been slipping in the competitiveness and innovation rankings.

This report alone is neither definitive nor even particularly instructive of the causes of our decline in the innovation rankings, but these types of reports and the repetition of their message should give all Canadians cause for concern. What we should also know is that among the countries that consistently rank higher than Canada in innovation are those countries which have less liberal foreign direct investment rules than we do. Though there may be many explanations for these ‘exceptions’, they should give us pause as we decide how best to remain relevant in the global economy. There may be good reason to believe that the path to innovation and competitiveness may not only be achieved through liberalizing foreign direct investment and may, in some cases, be counterproductive. The fact is that many other industrialized countries have less liberal FDI laws and regulations than Canada. Though advocates of FDI liberalization may argue that these other countries and economies are larger or are linked to regional economies and can afford some trade restrictions, maybe the truth is that there is more nuance to the relationship between FDI liberalization and innovation than its advocates realize.

There are also broader issues at play beyond the impact that FDI may or may not have on Canadian innovation. Another important and often neglected part of FDI is the likely impact on the ability of Canadians and their government to regulate the way in which corporations are governed. If many foreign corporations are (in fact even if not in law) controlled through offshore headquarters, will this offshore influence have a potentially negative impact on the outcomes for corporate governance and risk management in Canada? What happens when corporate headquarters are in countries where the government maintains an active interest in, or control of, those companies? Though corporations listed and operating in Canada will remain subject to Canadian corporate and securities laws and regulations, what new problems may arise if a growing number of corporations are controlled by corporate interests whose decision-making is motivated by offshore pressures, events and politics? Will Canadians be able to dictate the norms and expectations for corporate governance if the corporate headquarters which determine overall decision-making and company policies are not located in Canada? Will foreign companies have the same incentives to invest in research, development and training, particularly in extractive industries such as oil, gas and mining? Will Canadians be able to influence the ways in which companies disperse risks when those companies are more in tune with and influenced by risks at home- wherever home may be? Will the enforcement of Canadian regulations be set aside to the dictates of foreign policy, trade disputes and politics external to the best interests of Canadians?

All governments, including our own, need to examine more of these nuances and the possible longer-term implications of FDI on the principles and aspirations of good corporate governance and risk management. While pursuing and streamlining FDI, the Canadian government should, therefore, consider other regulatory and market-based incentives for all companies (local and foreign) to improve and disclose their corporate governance and risk management practices. Fostering local innovation, good corporate governance and effective risk management should also be promoted and assured when advocating for increased foreign direct investment in Canada. We should promote freer and fairer international trade and encourage foreign direct investment but we should also be live to some of the current and future hazards of embracing FDI and explore some of the regulatory and market-based ways of controlling these hazards. Other highly competitive and innovative economies have considered these hazards and so should we.

Foreign direct investment and increased competition are inherently good policy goals and there are a number of ways by which their benefits can be optimized and their negative impacts reduced. But the way forward on these complex issues is not necessarily and conclusively a wholesale embrace of FDI. And in fairness to the Competition Policy Review Panel, a wholesale embrace is not being recommended. The government will still maintain its ability to consider the national interest through its review process. It is just the burden of proving the national interest that will shift to the government from the FDI investor. The Panel also acknowledges the other elements of economic policy that need to change in order to fully promote innovation and competition. FDI is not the only way to increase competition.

The problem is not so much with the Panel’s recommendations but rather with the government’s lack of commitment to the other elements of economic policy that are critical when opening up the economy to more FDI. Where are the commitments to fostering Canadian technologies, ingenuity and capital investments in existing and prospective innovations and companies? These are not novel or protectionist measures of left-wing or socialist capitalism-deniers. These are the strategies of the most successful economies in the world. These are the strategies of those countries which are preparing to play on the competitive field of global markets. Canada’s small population, vast geography and proximity to the United States, makes these economic strategies even more critical. Streamlining FDI may be relatively easy but it is the other commitments to and investments in innovation that are more immediately necessary to Canadian aspirations in the global marketplace.

Despite an apparent coalescence around the merits of free trade and FDI, it is still uncertain whether liberalizing Canada’s foreign direct investment and competition laws will lead to a healthier and more innovative economy for Canadians. Canadian economic strategy needs more than a commitment to making FDI more streamlined. It requires investment in local innovation, ingenuity and capital investment. It also requires regulatory innovation to ensure that all companies operating in Canada have an unfailing commitment to the principles of good corporate governance and risk management no matter where headquarters are based and no matter what external political imperatives are at play. This will be a much more difficult task.

By Robert Adamson, Executive Director, CIBC Centre for Corporate Governance and Risk Management
June 30, 2008