Economic nationalism is the last refuge of incompetent managers

At one point during the coverage of last Thursday's budget, Allan Gregg suggested that some of the measures - liberalizing the telecoms market, tariff cuts - would bring economic nationalism back to the public agenda (my immediate reaction). And today, Jeffrey Simpson is talking about the perils of the 'branch plant economy'.

Just what is the problem with foreign ownership, anyway? The usual stories about low productivity and R&D being done elsewhere are hopelessly out of date. A 2005 StatsCan study (pdf) found that "foreign-controlled plants are more productive than domestic-controlled plants" and "are also more innovative, more R&D intensive and use more advanced technologies." Their presence also has spillover effects, forcing domestic rivals to increase their productivity as well. What's not to like?

And it's important to remember that Canadians own foreign assets as well. In fact, Canadian direct holdings abroad are greater than foreign direct holdings in Canada. We can stop worrying about 'Canadian champions': by this zero-sum metric, we're already winning. What's our prize?

What happens when foreigners buy an existing Canadian asset? The way this transaction is usually described, it occurs by accident when the government isn't paying proper attention. But before foreigners can buy a Canadian-owned asset, the Canadian owners have to agree to sell it. And it is presumably the case that the price is higher than what they think the asset is worth, or they wouldn't agree to the transaction. Any discussion of foreign takeovers that misses the part about willing Canadian sellers is going to be flawed.

Probably the biggest losers are the former Canadian managers, who will be either pushed aside or down the ladder as the new owners install their people. Indeed, it is presumably the case that their justification for paying top dollar for those assets is that they can manage them better than the previous Canadian managers could. And they're probably right.

In his 2008 Innis Lecture, Dan Trefler made this comment:

Figure 11 shows the average educational attainment of managers in Canada and the United States. Fewer than one in three Canadian managers has a university degree. In contrast, almost half of U.S. managers have a university degree, many of them advanced degrees. Not only are Canadian managers less well educated but they do not seem to appreciate the value of an education. In extensive surveying done by the Institute for Competitiveness and Prosperity (ICP), the most pronounced difference we found between Ontario and U.S. peer-state managers was in attitudes towards education.

One question posed was: ‘If you had to give advice to a young person about the level of education they should have, which one of the following would you advise them to achieve?’ While it was almost unheard of for an American manager to recommend less than a university degree, fully one-quarter of Ontario managers responded that a high-school diploma was good enough. See figure 12 and ICP (2003b, 36). Canadian managers live in a marketplace where education is not important because innovation is not important.

I really don't see the point in insisting on Canadian ownership of assets located in Canada if that means tolerating mediocre management, low rates of innovation and poor productivity.

Here are those figures:

Comments

[Patrick]

Hmmm... Let's see if I've got this right: foreigners presumably buy a Canadian firm because they think it's NPV under their control is greater than the NPV under current ownership (otherwise buyer and seller wouldn't be able to agree on a price).

So are those who get hot and bothered about foreign ownership really saying that they want to minimize the NPV of firms operating in Canada?

[westslope]

On the bright side, I believe that Canadians are much more open to foreign investment and control than they were, let's say, almost 40 years ago when the nationalist Waffle wing threatened to take over the federal NDP and were finally purged from the party.

Big box retailer Home Depot is popular and seems to have had a noticeably beneficial impact on domestic competition--Rona and Canadian Tire. Do these kinds of examples get through to voters? I'm not sure to what extent. Sometimes. More so than discussions of 'technical spillovers'.

[westslope]

I suspect that many foreign buyers of mature, champion-like Canadian resource companies time their purchases with commodity-market peaks. Some appear to underestimate the political hold-up potentials (Newfoundland) or the militancy of some unions (northern Ontario).

From a risk management perspective, it all looks good. Why not let foreigners hold the bag, take the losses, as well as put up with the shirking, work stoppages, intimidation and violence?

I wouldn't worry about the managers too much. In many cases, they are at least as valuable as the assets in the ground and will stay or be redeployed. If not, the absence of relational contracts with the new foreign owner should facilitate firing redundant or incompetent managers.

[Matthew]

When I opened up the Globe today and read that simpson column I said to myself, "Stephen is going to be all over this one."

[Stephen Gordon]

Yeah, that was pretty much my reaction as well...

[CBBB]

Good post, it's absolutely true that education is not, by-and-large, appreciated by Canadian employers. If you have a degree better to try your luck south of the border - in Canada working and a Tim Horton's or stocking grocery shelves is considered to be acceptable work for graduates, even those from hard-sciences backgrounds.

[Mick Marrs]

I work for one of the 2 large canadian telcos, and I have worked for several others I have a university degree in Comp Sci. and a masters degree in economics. So here is my perspective, not only is education downplayed but advanced degrees hold no weight with Canadian telco managers.

The greatest concern I see with Canadian productivity is that periodic training is not encouraged and the first line item that gets cut.

The usual explanation is that we don't need to be experts at anything in particular as long as we can manage our vendors and let them do the heavy lifting i.e. R&D.

This wasn't an issue when the vendors were Canadian companies but since the implosion of Nortel and the rise of the Chinese vendors it looks like all our R&D is going off-shore.

Not great for Canada or Canadian productivity but makes the shareholders and managers look like stars.

[Declan]

I'm not too fussed one way or the other about who owns which companies. I do wonder about the implicit assumption in this post that more education = better managers. I've never really noticed that correlation in real life, I don't see a theoretical reason why this should be the case, and I'm not aware of any empirical research on the subject.

Maybe this has been 'proven' and I just haven't heard about it, but I wonder if it isn't just an unthinking assumption. My own opinion is that relevant experience / the right personality type is more important than education and the tendency to try and substitute education for experience among managers usually leads to bad results.

[Christopher Hylarides]

With the possible exception of banking (and even then, regulation is more important), foreign ownership isn't a bad thing at all. In fact, when foreign companies buy up Canadian ones, they tend to invest via knowledge transfers as well as money. This is good for the country when those employees move on to other Canadian companies and increases competitiveness in general. So we learn new mining techniques, new technologies, and new ways to do things and enjoy the spillover effects.

[Just visiting from macleans]

Since we are all now Albertans, do you have similar data for that province?

If you do, I bet it would show a remarkedly different bar graph. Not so long ago, Charlie Fisher, then President and CEO of Nexen was calling for huge investment in the trades in the province for the 100,000 workers needed for the building boom. At the same time, Mike Lazaridis, co-CEO of RIM was making speeches about the need to invest further in post secondary education, centres of excellence etc. Who has the better long term plan?

If higher levels of education lead to higher productivity, as your analysis suggests.... is there not some economic disconnect by advocating unfettered development of our natural resources? We could all just do what Ontario is contemplating - more and more foreign students to fill the voids in our universities, or perhaps as a short term solution to pay the bills.

[Andrew F]

There's a working paper from the Centre for Competitiveness and Prosperity (which Roger Martin heads) in Ontario on management in the manufacturing industry. The paper seems to conclude that advanced management training is one of the missing links for the manufacturing industry here. We apparently have pretty well-developed operations management (high uptake of Lean manufacturing principles) but the business decisions behind them are being made by people less qualified than average in the USA.

link here http://www.competeprosper.ca/index.php/work/working_papers/working_paper_management_matters/

[Chris S]

Since we're talking about "plants" though, doesn't that mean this is mainly about manufacturing?

Which - according to Stephen ...

http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/12/damage-report.html

http://worthwhile.typepad.com/worthwhile_canadian_initi/2007/09/manufacturing-i.html

... just isn't big enough to get super-worried about. If it isn't big enough to be worried about how bad it gets, why worry about how good it gets?

Finally, it's almost invariably the case that innovation and R&D are risky. And if there is one strong sub-text to the last two years or so, it's that the Canadian economy seems to operate in a far more risk-averse way than that big one next door. This is bad when the returns are high, of course, but the same risk limit on the upside reward tends to put a limit on the downside loss as well.

[Andrew F]

Interestingly, that working paper I mentioned also discusses cultural differences between Canadian and US managers, and finds not evidence of that difference in risk aversion you refer to. I'd say a lot of US firms are pretty prudent, too. You're just focused on the few firms that blow up because they had an incentive and a regulatory loophole to take a very risky position.

[Patrick]

Chris S: Business R&D isn't usually pie in the sky scientific research. Often, it's more of an engineering exercise. Everyone knows the problem can be solved, they know (more or less) how to solve it, and they know there is a market once the problem is solved. The difficulty is usually, at least in my experience, finding the horses to pull it over the finish line - hence the call for better management and more focus on a trained and productive labour force.

I don't know if this is true in a macro sense, but I've seen it often enough to suspect it might be.

[Scott Proudfoot]

I am not an economic nationalist but I think it apparent that foreign owned companies will tend to keep more of the good stuff at home ( senior level jobs, R & D, etc.) The result is that Canadian foreign owned companies have good jobs but not the best jobs. That may not be such an issue for individual companies but scale may matter when a significant proportion of the Canadian Business 500 are foreign owned, almost half. Culture may also matter in that the goal of many innovative Canadian company founders is to grow big enough to be sold (often to a foreign buyer). Perhaps the Canadian Character prefers comfort and quality of life to power and riches. Not necessarily a bad choice but there are consequences. You might also want to look at how Canada has benefited from the philantrophic activites of sucessful owners such as the Research in Motion duo and compare that to the charitable activities of the senior executives who pass through our branch plant economy. There are some multiplier benefits from having world class companies and owners in Canada that may not show up in the stats. Having said all that, more protectionism is not a solution. But, we are some distance away from determining what is.

[Mike Moffatt]

"I am not an economic nationalist but I think it apparent that foreign owned companies will tend to keep more of the good stuff at home ( senior level jobs, R & D, etc.) The result is that Canadian foreign owned companies have good jobs but not the best jobs."

But if we're worried about labour income inequality in Canada, do we really want these jobs in our country?

[Mike Moffatt]

Yes, I'm kidding and yes it was a tounge-in-cheek reference to:

http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/08/economic-policy-advice-for-the-ndp-part-i-inequality.html

:)

[Patrick]

Seems to me that the counter-factual case is not an equally successful operation with all the executives in Canada, rather it's a much less profitable operation with the executives in Canada, or possibly no operation (if the Canadian management/owners can't make it profitable).

And R&D seeks out facilities, funding and smart people.

[Just visiting from macleans]

And R&D seeks out facilities, funding and smart people.

It also avoids industry where today's short term problems can be addressed not by innovation and good management, but by short term solutions brought about by political pressure and lobbying.

How do you spell relief? R-O-Y-A-L-T-I-E-S

[Just visiting from macleans]

Speaking of...

Innovation is our hidden deficit

...
Private-sector innovation is a different story. In 2007, the Canadian business sector ranked 14th among OECD countries in their R&D expenditures as a percentage of the economy. Canadian business R&D spending was only 1 per cent of GDP, well below the OECD average of 1.6 per cent, roughly half of what the U.S. spends and barely a third of Sweden, Finland and South Korea.

This R&D spending is also highly concentrated. The service sector, now 70 per cent of Canadian GDP, spends only 0.6 per cent of its output on R&D, while the natural resource, utilities and construction sectors, which account for 16 per cent of GDP, spend barely 0.3 per cent on R&D.

What this means is that a “business as usual” approach to innovation will just not cut it...

The oil sands, where yet-to-be-developed technologies have the potential to fundamentally redesign carbon dioxide emissions, energy intensity, water usage and soil remediation, is a case in point.

http://www.theglobeandmail.com/news/opinions/innovation-is-our-hidden-deficit/article1497976/

[westslope]

From reading some of the comments, I wonder if a university degree works differently as a signaling device in Canada as compared to the USA.

Just visiting from Macleans: This business of keeping up to the Jones in R&D expenditures over GDP leads to all kinds of bad policy and waste in my opinion. Canada's economic structure is different from the USA, more resource dependent. That may be changing, but in the past, that meant the knowledge component was less intense in many Canadian sectors than, let's say, the US aerospace sector.

But I would be all in favour of bringing back something like the old Economic Council of Canada. Might cost about C$25 to C$40 million to run right now. The ECC put out all kinds of policy relevant, empirical research in the day. Filled out the policy niche between academia and private sector economists quite nicely. Provided research funds for economists, mostly academic. What is there not to like?

[James Cavendish]

Completely agree with Trefler, Mick & CBBB. I was recruited into BC hi-tech a decade ago as a highly educated and experienced UK engineer. These companies are run by popularity rather than performance and serve mainly to transfer wealth from shareholders to executives and ibanks. Trial and error trumps analysis. Most of them fail, creating no value and dragging down per capita GDP. Rinse, repeat.

[Just visiting from macleans]

westslope.

The quoted passage in comparing R&D as a pct of a country's GDP is as valid as the comparisons provided in the original blog posting - but I take your point.

Mine had more to do with the absolute dismal levels of R&D expenditures in most companies (my achilles heel are the oil sands producers). As far as I am concerned, economists can't on one hand laud the fact that Canada's terms of trade have increased (principally as a result of rising oil prices), so make hay when the sun shines - let's go all in - then sit back and smugly claim "Economic nationalism is the last refuge of incompetent managers" when this reality is a direct result of these same economic policies. There is a reason why Canadian managers are risk averse and not innovative. They don't need to be. Just dig a bigger hole.

[Just visiting from macleans]

westslope,

Lang and O'Leary Exchange (with A Coyne guest hosting with Lang Mar 11) interviews Gwyn Morgan (former head of EnCana) on royalties, but scroll to 5:00 when they ask him about the oil sands "pr" problem. Note his advice - NOT to invest/fix the problem, but rather get out and spin/do a better job pushing the oil sands story.

http://www.cbc.ca/video/#/News/Money/Lang_&_O%27Leary_Exchange/ID=1438396978

This is a typical Canadian management solution.

Morgan, you may recall, was head of AECL when Wiebo Ludwig began his vigilante efforts in the 90's against AECL for supposed fugitive sour gas emissions from AECL's wells/facilities. He was named Canada's outstanding CEO of the year in 2005.