The ‘net benefit’ criterion for foreign investment is meaningless

Making it mean something will make things worse

by Stephen Gordon

(Jeff McIntosh/AP Photo/CP)

Tom Flanagan has some advice for the federal government on the CNOOC takeover bid for Nexen:

Rewrite the “net benefit” standard, and put it in the fall budget implementation act… In the meantime, approve the Nexen acquisition and keep Canada open for business.

As it stands now, the “net benefit” test is vacuous: a takeover bid passes the test if the federal government says it does. There are no objective criteria that firms and investors can consult when preparing a bid; they can only hope that their proposal doesn’t create the sort of controversy that might lose votes for the governing party.

Improvisation may provide great entertainment, but it’s a terrible way to govern: markets function best when everyone knows the rules. So it’s a good idea to want to set up a sensible, predictable set of guidelines for approving or rejecting takeovers of Canadian firms by foreign investors.

Foreign investment review criteria should start with a justification for why we’d be comfortable with rejecting a foreign takeover in the first place. The logic behind adopting this stance involves a tricky bit of blurring possessives. First, an asset owned by a Canadian investor is transformed into a “Canadian-owned” asset. It’s only a short leap of logic from there to conclude that the asset belongs to all Canadians, and that the decision of to whom it should be sold is a collective one that should be made by the government. (Please do not attempt this manoeuvre at home. In particular, please do not try this with my Canadian-owned home.)

It is possible that foreign ownership incurs collective costs that outweigh the individual benefits of freely selling an asset at a mutually-agreed-upon price. It’s possible, but available evidence suggests that it’s extremely unlikely.

Foreign ownership became an issue some fifty years ago, and there were credible reasons for concern. Foreign-owned branch plants tended to be less productive and less interested in innovation. But the problem wasn’t foreign ownership per se, it was the fact that the raison d’être for these branch plants was the high tariff wall protecting Canadian industry. Firms with nothing to fear from foreign competition have little reason to be concerned with low productivity.

Things are very different in the post-NAFTA world. This Statistics Canada study (opens pdf) finds that:

foreign-controlled plants are more productive, more innovative, more technology intensive, pay higher wages and use more skilled workers… [Multinational enterprises (MNEs)] have accounted for a disproportionately large share of productivity growth in the last two decades. Finally, we find robust evidence for productivity spillovers from foreign-controlled plants to domestic-controlled plants arising from increased competition and greater use of new technologies among domestic plants.

But it’s not the fact that foreign-owned companies are, well, foreign that endows them with these qualities. The key is that these companies are competing on world markets. Canadian-owned companies with an international orientation do just as well:

What matters for economic performance is whether plants belong to [MNEs] rather than ownership per se. Canadian multinationals are as productive as foreign multinationals.

Another recent study published by the Institute for Research on Public Policy (opens pdf) reaches similar conclusions:

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.

There are other arguments for using the government to block asset sales to foreigners, but I don’t find them convincing. These include:

  1. Claims to the effect that Canadian-owned companies are more likely to sacrifice profit in order to advance the Canadian public good. I don’t think even the people who use this line believe it.
  2. Arguments that hinge on the use of the word “strategic.” Military analysts use this term for things that are necessary to maintain operations. If we’re obliged to apply this idea to economics, a strategic asset would be something that is vital to the functioning of an economy. There are a few privately-owned assets that fit this definition (large financial institutions, communications companies) and many that don’t (most notably resource extraction companies). The operations of these “strategic” firms are regulated, because private companies can’t be expected to sacrifice profit for the public good—see point 1 above. The nationality of the owners of these assets matters much less than the regulatory environment in which they operate.
  3. Blocking the takeover as a way of punishing the behaviour of the other government. There is a certain nobility in sacrificing financial gain in order to demonstrate your support for a point of principle. There is markedly less nobility in sacrificing someone else’s financial gain in order to make your point.
  4. Linking the takeover to an unrelated issue. For example, the benefits of foreign investment don’t depend on whether or not the other country allows its investors to sell their assets to Canadian buyers.

It’s a good idea to replace the existing “net benefit” test with explicit criteria for rejecting the sale of an asset to non-Canadians. The problem is that when you start to look for good economic reasons for refusing a foreign takeover, you quickly realise that there aren’t any.




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The ‘net benefit’ criterion for foreign investment is meaningless

  1. The most recent post by Mr Wells is the only real reason to consider refusing the foreign take over. And even then, it isn’t so much about foreign as it is China and the new agreement that seems to be heavily in China;s favour.

  2. First, an asset owned by a Canadian investor is transformed into a
    “Canadian-owned” asset. It’s only a short leap of logic from there to
    conclude that the asset belongs to all Canadians, and that the decision
    of to whom is should be sold is a collective one that should be made by
    the government.

    ****

    Author might want to rethink this notion that it’s a “short leap”.

    • Well, it’s one that a lot of people seem able to make without noticing it.

      • It’s the belonging to all Canadians bit that doesn’t apply. A thing does not need to belong to all Canadians for regulations to exist regarding how it may be sold, conducted or dealt with.

  3. We are either open for business or we aren’t. Stop messing about with meaningless phrases.

    One thing the govt could do is tell Canadians how many businesses we own abroad. Govt always give the impression that ‘foreigners’ are coming in here by the truckload and snapping up everything we have….leaving us with nothing. Then they wonder why the population opposes the whole idea.

    • A takeover by a foreign government-owned entity is an entirely different situation than a private company taking something over. We no longer tolerate our own governments wading into the takeover arena (I believe the absurd Mulroney decision to allow Canada Post to buy Purolator from ONEX Corp. in 1993 was the last major federal action of this type), why would we accept others doing it?

      • State corporations are a commonplace in the world….we call them crown corporations in Canada.

        And like I said, either we’re open for business or we’re not.

  4. One size does not fit all, which is why a fairly vague “net benefit” test is useful, because there can be no set objective criteria.

    Every company is somewhat unique, even within the same industry. Nexen and Suncor are extremely different companies.

    And one has to consider the intentions of the buyer. The intentions of the buyer are an essential part of the net benefit test. BHP was going to mine full out (severely impacting provincial finances and its entire royalty framework, forcing the province to totally rework how it taxes resources, which would have impacted other companies who had expected a stable royalty and taxation regime). BHP blow up Canpotex, and ship out of Washington State, rather than BC.

    i.e. BHP’s intentions were basically malevolent, it one examined what they intended to do.

    No “objective criteria” would have been able to capture that.

    • Wow, another post of yours I agree with. In addition to intentions (on which we are often sold codswallop) there is “foreign based where” not just because we believe their government to be nasty or even just unstable, but also for the putting all eggs in one country’s basket thing, which we’ve mostly done with the U.S. and definitely see the downsides. It is true that sometimes only one country is buying of a certain industry or whatever, but flexibility and each unique situation judged on its own merits is important.

    • Well, unless the objective criteria included the intent of the buyer. But your point overall is good and flexibility is often a virtue. What I’d like is for written decisions on the matter to be made public so that interested parties can examine the reasons and attempt to get a sense of comity. (I feel the governor general should do much the same in important matters like pro-roguing parliament when the other party is gunning for a confidence vote).

  5. When we are done with Nations altogether and join as one big world, then this attitude works. But you don’t get to have it both ways. One big world will find it hard to go to war due to lack of accessible enemy–and I’m more than fine with that. Somehow, I doubt free-market multinational capitalists want to ignore borders in that instance however, so they don’t get to ignore very real considerations between one country and the next here.

  6. “The problem is that when you start to look for good economic reasons for refusing a foreign takeover, you quickly realise that there aren’t any.”

    Actually, that’s only a problem if you confuse “net” with “economic”.

    Most of us aren’t so single-minded.

    • Indeed. The really long term consequences are unknown. Foreign investment is extremely beneficial, no doubt. Even foreign takeovers are generally beneficial, at least into the foreseeable future. The alternative is not allowing Canadian shareholders to benefit from the investments they’ve made by cashing in on a foreign takeover, which then frees up money to be invested in something else. However, over the really, really long term, I worry what an economy almost entirely owned by foreigners will look like, and how well it will serve us. Anyone who pretends to know the answer to this is full of it.

  7. Only test I think is acceptable is if Canadian company has developed new proprietary technology that significantly helps Canadian industry and the company does not wish to be taken over. If a Canadian mining company created new process to turn lead into gold, for instance, I would be ok with Canadian government keeping tech to ourselves.

    And from my narrow focus of auto industry, foreign companies do much better job with productivity and innovation. Just one example, foreign car companies management and workers don’t see each other as enemies, they work together to make company better. Toyota has philosophy – The Toyota Way – and it encourages workers to improve manufacturing process.

    • You know, when you speak for yourself, you come off as quite bright.

      You should do it more often.

    • if a company doesn’t want to be taken over its next to impossible to do so. You can have a different class of shares for people who just get dividends and have only statutory minimum rights to run the company, so that even a publicly traded company can essentially run itself and make its own decisions.

  8. What transparent process does the People’s Republic of China use to determine whether companies can have access to use natural resources, do business and export from there? After all don’t we want to make sure our processes are … what’s the word? Harmonized?

    • Sure. But that’s no reason to block the Nexen takeover: see point 4 on ‘linkages to unrelated issues’.

      • A Canadian economist enters the Grand Bazaar in Turkey, spots a carpet and asks the merchant: “How much is that rug? Three thousand dollars?”

        “Oh yes sir, you are very knowledgeable of prices. Would you like one or two?”

        “I’ll just take one. Dang. Almost as easy as buying my SUV back home – just found the sticker price, and wrote a cheque right there on the spot. And the dealer took my old car off my hands for nothing – no charge!”

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