Geoffrey HalePolitical Science 3170

November 2, 2010

OutlineForeign Investment – Basic conceptsImplications of trade liberalization, changes

to national tax policies for foreign investmentInvestment: neutrality vs. “national

champions”

Foreign investment – basic conceptsPortfolio investment

Investment in shares or bonds of corporation involving less than 10 percent share of equity ownership.

“Passive investment” – not engaged in market for control

Foreign direct investmentBusiness investment across national borders that

involves controlling ownership share of corporation Depending on ownership structure, may involve majority

ownership or ownership of as little as 10 percent of voting shares in widely-held company

Inward FDI – investment by foreign-controlled corporations in Canadian-based firms (“greenfield” vs. Mergers & Acquisitions)

Outward FDI – investment by Canadian-controlled firms

Foreign investment in Canada-- Historical PerspectiveRatio of Inward to Outward FDI1926 4.261960 4.631980 2.132001 0.7020090.93

Sources: Cross (2001); Statistics Canada (2010).

Implications of Shifting Trends in Canadian, Global FDICanada receiving declining share of global, N.

American FDITrend for global firms to service N. American

markets through U.S. based firms in many sectors.U.S. share of new FDI in Canada now below 50%

Overall share of FDI as share of GDP has plateaued about 30% -- same level as early 1970sRelative concentration in manufacturing, resource

industriesDecline in FDI resulting from tariff reductions

offset by FDI increases from growth in N. American, global supply chains

Implications of Shifting Trends in Canadian, Global FDIHistorical trade-offs between increased trade,

greater FDI reflecting effects of high national tariff barriers

Trade liberalization complementarity (mutual reinforcement) of trade and investment flowsReflects growth of intra-corporate, intra-industry

trade through international supply chainsMay also reflect effects of R&D, services flows in

some sectors

Implications of Shifting Trends in Canadian, Global FDIInward FDI

Independent research suggests positive contribution to: Productivity – driven by capital investment, inward R&D

transfers, necessity for international competitiveness Increased wages – linked to productivity, need for skilled

labour Modest positive increase on head office employment

(quantitative) Other “spillover benefits”

– R&D networks: direct & secondary. – Benefits of increased domestic competition higher productivity, lower prices for consumers.

Controversy over: strategic direction, control of major corporations (qualitative) potential risks associated with foreign state-controlled firms,

strategic wealth funds whose takeover activities may be driven by political rather than economic factors.

Implications of Shifting Trends in Canadian, Global FDIMarket disciplines for management of Canadian

firmsgovernment protection seen to contribute to

complacency, declining competitiveness of private sector management, lower share prices.

returns for shareholders growing element in government revenues, pension funds returns.

Relative availability of capital increases costs of capital to Canadian firms

Implications of Shifting Trends in Canadian, Global FDIOutward FDI

Canadian firms, investors heavily engaged in outward FDITotal value of outward FDI has exceeded inward FDI since

1997Canadian acquisitions of foreign firms typically smaller, but

more numerousDomestic debates over foreign investment raise issues of

reciprocity, equality of market accessGrowing share of outward FDI to “offshore financial centres”Policy implicationsRestrict market access for firms from countries that do not

provide reciprocal access to Canadian firmsPotential to impose conditions on foreign takeovers re: “net

benefit” and “national security” rulesPotential to impose market-based decision-making,

transparency tests on foreign state controlled firms, strategic wealth funds

Creative Destruction in the Canadian Corporate Sector

Changes in structure and control of Canada’s 200 largest corporations: 1990-2007Same name, shareholder structure 71 35.5%Canadian controlled, changed shareholder 48

24.0%Same name, shareholder structure

no longer in top 200 29 14.5%Foreign controlled 29 14.5%Company ‘transformed, renamed’ 20 10.0%Out of business 3 1.5%

Source: Michael Grant and Michael Bloom (2008), “Myth and Reality: Corporate Takeovers in an Age of Transformation” (Ottawa: Conference Board of Canada, January), 9.

Key drivers influencing FDI levelsMarket cycles key factors in driving “M&A”

activity:Takeover booms 1997-99, 2005-07.Reinforced by N. American or international patterns

of industry consolidation (e.g. steel: 2002-07; base metals mining: 2005-07)

“Conventional” FDI significantly influenced by:Trade liberalization Exchange rate shifts

Tax rate effects limitedSome correlation of lower CIT rates, greater outward

FDI.

Policy Implications:Pro-Market vs. Pro-Business Policies“Pro-Market” “Pro-Business”Emphasis on creating

domestic conditions for effective business competition, rather than favouring specific firms

Greater emphasis on lower CIT rates, support for general R&D, skilled labour, infrastructure development

Generalized investment rules (e.g. net benefit, nat’l security)

Emphasis on promoting “national champions”, favouring firm and sector-specific policies within disciplines of int’l trade rules

Greater emphasis on sector-specific subsidies (open and disguised), research support.

More ad hoc, restrictive and/or transaction-specific investment rules

Policy Implications:Pro-Market vs. Pro-Business PoliciesPro-Market Pro-BusinessStronger orientation of tax

and securities laws to shareholder interests rather than those of corporate boards, executives

Competition, anti-trust laws and regulations used to promote competition, regardless of individual firms’ national origin

Rules for foreign-state owned firms, SWFs more oriented towards market-based decision-making

Securities laws typically give corporate boards, executives greater autonomy, flexibility to resist hostile takeovers

Competition, anti-trust laws, regs relaxed to protect “national champions”

Strong restrictions on foreign-state owned firms, SWFs – or ad hoc decision-making open to political influence.