That's the title of a nice survey for the Institute for Research on Public Policy by Walid Hejazi, available here. After being a hot-button topic for the past half-century or so (note to non-Canadians: yes, really), FDI has accumulated a thick crust of myths that could do with some dispelling:
The debate around foreign direct investment is too often framed around two caricatures: that outward FDI is synonymous with exporting Canadian jobs and inward FDI is synonymous with excessive foreign control of Canada’s economy.
From the abstract:
A dispassionate analysis of the evidence shows that the benefits of foreign investment far outweigh any real or imagined drawbacks. Foreign firms operating in Canada are more innovative and productive than their Canadian counterparts, and they pay higher wages. More importantly, they import significant amounts of technology from their parent companies, and the benefits of these technologies spill over to domestic firms. In addition, though the stock of inward FDI did increase somewhat as a share of GDP in the late 1990s, it has held steady since then at just over 30 percent — the same share as in 1970.
Worries about corporate takeovers and the “hollowing out” of high-value head office functions in Canada are also misplaced. Foreign takeovers have actually increased head office activities in Canada in recent years, because foreign firms typically find it to their advantage to keep such activities geographically close to their Canadian operations...
The debate about foreign investment in Canada ignores the fact that Canadian multinationals have quietly become major players in the global marketplace. Canadian direct investment abroad has exploded in the past 30 years, and Canadian firms now own more foreign operations (in terms of dollar value) than foreign companies own in Canada. Far from exporting jobs, this investment abroad serves primarily as a beachhead for market expansion, stimulating domestically produced exports and high value added head office activities such as engineering and design. Policies toward FDI should avoid counterproductive restrictions and focus on fostering a domestic economic environment that enhances the competitive posture of Canadian firms.
These are points that should be hauled out regularly when FDI is being discussed. But there is one part where things get murky:
As expected, domestic innovation and low corporate tax rates are shown to be important levers, but not in the ways that are commonly assumed. Domestic innovation and technology-oriented foreign investment are complements rather than substitutes (i.e., the former helps attract the latter). And low corporate tax rates in fact have little effect on the decision to invest in Canada, but they do help Canadian companies compete more effectively in foreign markets.
In the latter part of the paper, Walid* runs a regression with inward FDI on the left-hand side, and gets a negative (albeit insignificant) estimate for the corporate tax rate coefficient. This may seem to be a surprising result, since it is sometimes claimed that lower corporate tax rates will attract foreign FDI to Canada.
But that story isn't the one that I would tell. To the extent that foreign FDI is conducted by foreign multinationals, there's little reason to expect that domestic tax rates will affect inward FDI: the relevant tax rate for a foreign firm is that of its home country. Where lower tax rates would affect foreigners' decisions are at the level of the individual 'passive' investors who are looking for a place to send their savings without seeking a controlling interest. These flows are about an order of magnitude larger than those of FDI.
But aside from that, I see little to quibble about, and I encourage people who are interested in the role of FDI to read this study.
*We overlapped at U of T during our grad school years.
I can see why the general public may be taken with these myths (i.e. the big bad Americans) will control our economy, etc. But our policy makers really ought to know better, and yet the Canada Investment Act, that outdated piece of Trudeau era economic nationalism, continues to exert its malign influence.
Conference Board came out with a paper just this month on productivity and there is so little investment in physical capital in Canada. Lack of FDI - particularly as it relates to infomration and communications technologies, is one of the reasons given.
Posted by: Matthew | January 26, 2010 at 07:27 PM
It's easy to see how open and direct competition and foreign investment benefit smaller (population wise) countries. Hong Kong, Luxembourg, Singapore, etc have some of the highest standards of living and are all open for foreign business. Just comparing the wireless and telecom industries of Canada versus Europe and the USA show how lazy and uncompetitive companies will otherwise become. Even worse, these more expensive companies (especially in telecom) leave Canada at a direct competitive disadvantage. Our companies have to pay more for their telecom versus others.
But the real benefit of foreign investment is our businesses getting access to capital to expand and deploy. The recent kerfuffle with WIND mobile's launch showed how badly they needed the cheaper and more importantly available foreign funds to build out their network. They're not the only company in this position and it's costing Canada jobs and bigger companies.
Posted by: Christopher Hylarides | January 26, 2010 at 08:32 PM
Q: When studies of this nature are undertaken, does one account for share ownership? For example, companies that are traded on the NYSE but based in Canada. Say 51% American ownership, but head office in Calgary.
Canadian or American company?
Posted by: Just visiting from macleans | January 26, 2010 at 08:33 PM
Canadian, because of the country where the head office is located. But it's an important point, because it puts into question the whole notion of a company having a nationality.
Posted by: Stephen Gordon | January 26, 2010 at 08:48 PM
Shares floating on the NYSE aren't necessarily owned by Americans for that matter. Beyond that, I doubt most institutional shareholders care which operations are located in which country beyond how it affects performance. I can't see a company that operates and is headquartered in Canada facing significant pressure to move its head office, even if it were largely owned by American investors.
Posted by: Andrew F | January 26, 2010 at 11:39 PM
Yes, in my starry-eyed youth I used to think foreign ownership was evil. Then I did some reading, experienced multinationals first hand and changed my mind. A few disparate observations follow:
A head office could be tiny relative to operations. Some Canadian-listed companies might have one executive officer in the country. What does this suggest? Canada has some kind of advantage in capital services, e.g., the resource sector. Shouldn't Canada be exporting capital services?
Foreign takeovers often occur at the top of volatile resource markets allowing foreign owners to eat the losses, or more importantly shoulder the risk.
The arm-bending power of foreign-owned multinationals is much exaggerated. Local politicians can inflict expensive measures on foreign companies, perhaps holding up licenses or permits for long periods of time.
I'm convinced the technology transfers are significant. It pleases me to see Canadian multi-national companies exploiting natural resources in poor, developing countries. The learning-by-doing potential is enormous. The Canadian public effectively deters companies from cheating on social obligations to the host country.
Posted by: westslope | January 27, 2010 at 03:27 PM
I don't understand how this study could control for industry-to-industry differences in innovation and salaries -you need more innovation and higher salaries in pharmaceutical research than in running a coffee shop, but there aren't any major domestic pharmaceutical companies, are there? So the findings may be just reflecting industry-to-industry differentials.
Any thoughts on the deal the Ontario government has just signed with Samsung? It was generally panned in the locker room after hockey last Sunday as giving Samsung preferential access to transmission lines - and probably giving them excessive say on where the lines will be built - and creating a climate of uncertainty for locally based start ups/entrepreneurs.
My big worry is the FDI in the tar sands - the scale of the environmental clean up that we're going to need there is mind-boggling, and who will pay?
Just because FDI has had benign effects in certain times and certain places doesn't mean it will continue to be innocuous.
Posted by: Frances Woolley | January 29, 2010 at 07:50 AM
"My big worry is the FDI in the tar sands - the scale of the environmental clean up ..."
Isn't that a problem no matter who provides the money? In any case, I suspect the answer is: the taxpayers of AB.
Posted by: Patrick | January 29, 2010 at 09:24 AM
And unlike the argument by Jim Prentice/Harper that Canada needs to wait for the US to decide which way they are going on GHG reduction, there is nothing preventing the Syncrudes/Suncors/Shells from cleaning up their tailings ponds (filtration, flocculation, centrifuging etc), only enforcing existing regulations or tightening them (an economic argument to turn a blind eye could have been made in the early days of the industry, but that no longer is the case).
Mind you, the buffalo on that 1 sq km of restored land are almost becoming exploited celebrities. I wonder if each one has a pet name.
Posted by: Just visiting from macleans | January 29, 2010 at 09:50 AM
I am surprised the "study" does not look at the arguments developed around the effects of foreign ownership on domestic economic performance and the democratic political process by Walter Gordon and the Watkins report in the 1960s and others since that time. He is studying Hamlet (the myths) without including the Prince of Denmark.
If you postulate the benefits of foreign investment, compare them to no investment, then you get the results reported in the IRPP study.
Posted by: duncan cameron | January 30, 2010 at 05:59 AM
Duncan: "If you postulate the benefits of foreign investment, compare them to no investment, then you get the results reported in the IRPP study."
The useful policy question is, presumably: "What would happen if we ban foreigners from investing directly (FDI) in Canada", right? (Or "restrict" maybe, instead of "ban", but "ban" is simpler).
It doesn't seem especially useful to ask (except perhaps as some academic thought-experiment): "What would happen if we could wave a magic wand and take the resources that foreigners invest directly into Canada and give those same resources to Canadian investors?"
Now, if we banned FDI, presumably there would be some response by Canadian investors, who would: use leverage to borrow from abroad (portfolio investment vs FDI); consume less, save more, to replace part of that FDI; do something else. But that's not the same as waving a magic wand to convert FDI into exactly the same amount of Domestic Direct Investment. If Canadians do more direct investment, to replace FDI, those resources have to come from somewhere.
Or have I misunderstood your point? What is the question you think we should be asking?
Posted by: Nick Rowe | January 30, 2010 at 08:16 AM
On second thoughts, maybe we can and do wave a magic wand to convert FDI into Domestic Direct Investment. A useful policy question (not just an academic thought-experiment) is "What happens if we automatically give Canadian Citizenship to those doing FDI?"
(I'm not quite sure how this would work in the case of corporations, but I'm sure someone could figure it out).
Posted by: Nick Rowe | January 30, 2010 at 08:25 AM
If you postulate the benefits of foreign investment, compare them to no investment, then you get the results reported in the IRPP study.
Um, no. Nobody does that. You might take a look at this StatsCan piece, one of the many recent empirical studies that are referred to.
It would appear that the facts have changed in the past half-century.
Posted by: Stephen Gordon | January 30, 2010 at 09:10 AM
The point Nick is that ownership and investment are not the same thing. Trying to account for the impact of foreign owned corporations on the economy and politics of a country is different from "measuring" the effect of investment on GDP. The structure of ownership affects the balance of payments of countries that are net importers of investment capital or net exporters in ways that go beyond simple flows of direct investment, inward and outward. Importantly the ownership structure affects the make-up of lobby groups, funding for think tanks, and even political contributions. Culture matters in an economy, ownership influences political culture.
If you look at Kari Levitt's book Silent Surrender you will see how American foreign ownership abroad after the war affected current account flows of recipient countries. Briefly, the "investments" generated surplus outflow in every year in every region in every sector world wide.
Posted by: duncan cameron | January 30, 2010 at 09:26 AM
Stephen thanks for the reference. Comparing the impact of domestic versus foreign investment with respect to productivity performance is not the only way to describe what is going on. Productivity analysis has it strengths, and also its weaknesses. When you assume a given structure of ownership and a given distribution of income, as comparisons of productivity do, you limit consideration of what I think of as what needs to be changed. The U shape of income distribution, the growing gap if you will, reveals serious problems. The concentration of ownership, and the exercise of private monopoly power should worry us as well. Productivity studies give us what is going on, but it does not follow they can tell us what needs to be done differently.
I am not sure how the U.S. has been performing in productivity terms in the last ten years, but it created no net domestic employment since 1999.
Posted by: duncan cameron | January 30, 2010 at 09:41 AM
There's rather a lot of evidence connecting productivity to prosperity, so I don't think we can dismiss concerns about productivity so easily.
And why can't we claim that by excluding foreign investors from Canadian capital markets, concentration of ownership will increase? Or that by protecting domestic managers from the threat of foreign takeover, we're likely to see more incompetent management, crony capitalism and the rise of oligarchs?
If you think that foreign ownership is worsening inequality, then it seems to me as though the burden of proof is on you to make that case. I'd be interested in seeing the notion formalised and taken to the data.
Posted by: Stephen Gordon | January 30, 2010 at 10:58 AM
Stephen far be it from me to dismiss productivity concerns. I mostly have problems with measurements of productivity. It is GDP or NI based? Do we use the market exchange rate or some measure of PPP? And how about getting solid numbers on the services sector? With manufacturing falling as a percentage of employment and GDP, given our inability to measure service productivity as accurately as manufacturing productivity, you could argue that our ability to estimate productivity gains or losses had diminished. If we can't rely on estimates of what is going on in the economy, why should be use them to guide us in policy-making? I prefer measures of employment and unemployment, and levels of income as indicators of where we have been, and how we are doing.
Posted by: duncan cameron | January 31, 2010 at 11:04 AM
Okay, but that still means that you have to come up with a story about how FDI is bad for employment and income. And then you have to see if the data fit your story.
I don't like your chances. It's pretty easy to tell a story in which FDI is good for employment and income, and available evidence seems to be consistent with this story. I'm afraid 50-year-old anecdotes leavened by xenophobia are not going to be enough.
Posted by: Stephen Gordon | January 31, 2010 at 06:45 PM
The story has to do with foreign ownership, not FDI Stephen. It has to do with power, and influence, empires, colonies and satellites, what Harold Innis called centre and margin. Xenophobia ( you know like current China bashing, or two decades ago Japan bashing) have nothing to do with the economic argument for regulating foreign ownership, but emotions do run high. After all it is a story that has historical roots, including the debate over absentee landlords in Ireland at the time of the famine.
The foreign ownership debate is about should certain property rights get to trump democratic rights? It is about where politics and economics meet. Concern about foreign ownership does not go away because "models" show gains from FDI and therefore "prove" the superiority of "free" international capital mobility over industrial policy or strategy.
I will be watching how the U.S. deals with its jobs deficit. Does the IRPP survey suggest that FDI is the answer for them as well?
Posted by: duncan cameron | February 01, 2010 at 09:03 AM