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"Keep Canada's flag – Hysterical claims that the Canadian economy is being sold out ring hollow, says economist"

This article was published in The Globe and Mail on April 19, 2007.
Written by Don Drummond.

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As any proud Canadian, I would prefer to see the Canadian flag flying from companies operating in our country. And who doesn't cheer a Canadian company expanding across the globe? It is understandable, then, that many Canadians are disheartened to see some venerable Canadian businesses fall into foreign hands. But the facts don't warrant the hysteria that the Canadian economy is being sold out. Nor do recent foreign acquisitions spell lower employment or wages for Canadians.

Since NAFTA took effect in 1994, the stock of Canadian foreign direct investment abroad has grown more than the stock of foreign direct investment into Canada. Last year was only the third since 1994 that the balance of foreign direct investment flows went against Canada. Each year, more foreign companies were purchased by Canadian firms than Canadian firms purchased by foreigners.

Ontario's Institute for Competitiveness and Prosperity defines a global leader as a firm ranked in the top five of their particular product or service category by sales revenue or assets. The institute counted 33 Canadian global leaders in 1985. By 2006, the number had more than doubled to 72. The institute states: "We are growing globally competitive Canadian firms at a rate that wildly exceeds the rate of foreign acquisition. Net, we simply are not being hollowed out. We are thickening up."

Moreover, concerns related to foreign acquisitions are greatly exaggerated, most notably loss of head offices and jobs. Statistics Canada found that from 1999 to 2005, the number of head offices in Canada, and the employment found therein, rose. Head offices of foreign-controlled firms contributed to all the gains in the number of head offices and accounted for six out of 10 new jobs created. The agency concluded that "as a result of foreign takeovers, more new head offices were created than lost and employment in head offices was as high after the takeovers had occurred than before."

Another concern is that foreign companies will divert research and development to the home country and impair Canadian productivity, and ultimately employment and wages. Again, the evidence paints a different picture. A 2005 Statscan report found foreign-controlled manufacturing plants are more productive than domestic-controlled and are more R&D intensive, innovative and technologically advanced. Further, they pay higher wages and use more skilled workers.

This does not mean Canada's doors should be flung open to any foreign takeover. Companies operating in countries that would not welcome Canadian acquisitions should not be given carte blanche to come into our market. We should also be leery of foreign state-controlled enterprises that might not operate in a profit-maximizing fashion.

While the data indicate that the hollowing-out argument is itself rather hollow, one can't help thinking there's something wrong here. Two years ago, in documenting the unprecedented rise in corporate retained earnings around the globe, TD Economics predicted a wave of mergers and acquisitions as companies ran out of options for spending the money internally and wealthy investors and pension funds turned to private equity in response to low returns in fixed income markets. But why are Canadian companies being put on the market? And why aren't other Canadian companies buying them?

Many are blaming recent Canadian tax changes, particularly the proposed tax on income trusts to start in 2011. By lowering the value of many of the trusts, critics argue, the move made them vulnerable to takeover. March's budget proposal to deny the deductibility of interest on borrowings for foreign affiliates is alleged to compound the problem by restricting to some degree Canadian companies to the domestic market and limiting their options for becoming global players. The budget proposal to eliminate withholding taxes on interest payments coming into and out of the country has even been thrown into the mix, noting that this would facilitate foreign companies operating in Canada (as well as helping Canadian companies operating abroad).

Yet the recent wave of foreign acquisitions started before the trust tax announcement of Oct. 31, 2006, and the phenomenon has not been restricted to the trust market. Still, there needs to be a comprehensive review of the full effects of all the recent tax changes, including a careful benchmarking against the international taxation regimes of other countries. Each measure has been put forward in isolation. It is quite possible that the combination may have unintended effects on the vitality of Canadian businesses. In the case of the proposed denial of interest deductibility for foreign affiliates, the intention of the measure still isn't clear, a month after the budget, and the transition rules are clearly problematic.

The broader issue is the rather long Canadian economic history of poor productivity growth and limited competition. Public policy is certainly partly to blame. We have one of the highest rates of taxation on capital in the world, although the problem now resides more in the provincial jurisdiction than the federal. Many sectors have excessive and inefficient regulation, and competition is restricted through legislation.

Canadian business leaders must also bear some responsibility. In many cases, they have not boldly taken on global competitors. Nor have they fully responded to the investment opportunities offered by strong profit growth and declining prices of imports of machinery and equipment due to the stronger Canadian dollar.

Canadians' economic well-being will suffer if we attempt to restrict incoming foreign direct investment. But it would be good to see more Canadian flags flying over the companies operating in our country. Achieving this will require a public policy agenda geared toward driving up productivity growth and corporate leadership prepared to aggressively take on any and all competitors.

Don Drummond, senior vice-president and chief economist at TD Bank Financial Group, is a former federal associate deputy minister of finance.


Executive Headshot :  Don Drummond
Don Drummond
Former Senior Vice President and Chief Economist
TD Bank Financial Group

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