Don't be so protective

JACK MINTZ

Globe and Mail – Wednesday July 5, 2006

Recent musings by mining legend Peter Munk on the proposed takeover of Falconbridge and Inco by a U.S. copper miner exemplify the time-honoured fear of the "hollowing-out" of Canadian business. This latest furor highlights the usual debate as to whether such hollowing-out has, in fact, taken place and, if so, whether the federal government should limit foreign takeovers. Neither of these propositions should be supported.

While foreign direct investment did pick up from 1998 to 2004 -- typical of most industrialized countries -- our share of worldwide foreign direct investment has actually declined. And foreign ownership is becoming less important in the largest companies operating in Canada. For example, 56 per cent of the top 50 companies in Canada were owned by foreigners in 1997 (using the typical threshold of a minimum 10 per cent ownership), falling remarkably to 32 per cent by 2003. Of the top 500 companies, 50 per cent were owned by foreigners in 1997 and 37 per cent in 2003.

No matter how you slice the data, little evidence supports a significant hollowing-out of Canadian business.

Even though several high-profile foreign takeovers of Canadian companies have occurred recently (think Hudson's Bay and Fairmont Hotels), other Canadian companies have been growing, recall Manulife's purchase of the John Hancock insurance business and Toronto-Dominion Bank's recent acquisition of Banknorth Inc.

The real story of the past 10 years is that Canada is hollowing out businesses in other countries.

Yvan Guillemette at the C.D. Howe Institute has calculated that Canadian businesses have acquired 43 investments, of at least $1-billion in transaction value, in foreign jurisdictions from 1995 to 2004 totalling $129.4-billion. On the other hand, only 38 large foreign purchases (with at least $1-billion involved) totalling $146.5 billion occurred here in the same period. Yes, the average size of foreign takeovers of Canadian companies is somewhat larger than the average size of Canadian company acquisitions of foreign businesses, but so what?

Since the mid-1990s, Canada has become a net-exporter of capital, with the stock of foreign acquisitions of Canadian companies now over 6 per cent of GDP, which is more than the stock of foreign-owned capital in Canada of about 5.5 per cent of GDP. So what interest is there to stop foreign investment and to protect Canadian management from takeovers here?

Some argue that the loss of head offices creates a significant loss in headquarter functions when Canadian companies are bought out by foreigners. A recent Statistics Canada study, however, has shown that foreign-controlled companies of similar size spend more on research and development in Canada than Canadian-controlled businesses. And foreign companies also pay as much in taxes. There is less evidence as to whether charitable contributions and sponsorships may be diminished, or related legal, accounting and banking services in Canada reduced when companies are purchased by foreigners.

Instead of the usual griping, a strong case should be made for capital markets to be opened up to international investment flows in order to enhance productivity. Businesses are more efficient if poorly performing management is replaced by stronger teams. Furthermore, global consolidation of businesses allows companies to access better pools of talent and technology. It is no surprise that the fastest-growing countries have significant foreign direct investment -- Ireland, Hong Kong and the Netherlands are cases in point.

If anything, Canadians should be asking themselves why more foreign companies are not investing in Canada. And why so many Canadian businesses find it better to invest abroad than at home. Clearly, companies will invest in locations where the after-tax rate of return on capital is highest -- and that isn't here. Outside of oil and gas -- Alberta, especially -- business investment per worker has been lower in Canada than the U.S. and other OECD countries, on average.

Rather than looking at ways to protect Canadian management from competition, we should be considering interventions that make Canada a draw for business. With one of the highest effective tax rates on capital in the world, Canada should pursue major tax reforms that shift reliance on taxes from investments to consumption. We should reduce regulations to open our markets to investments in industries such as energy, where we could easily trump international markets. Financial markets should also be reshaped to create greater competition among service-providers while relaxing rules that limit Canadian financial companies to consolidate and expand in international markets.

The real lesson from the recent takeover debate is to open Canada's doors to global competition for managerial talent -- not to bring in protectionism.

We are not getting enough foreign direct investment compared to other countries, and our businesses are succeeding abroad without narrow-minded governments stopping them from making acquisitions.

Surely, if Canada wants to exploit opportunities elsewhere, it would make little sense to become protective at home.

Jack M. Mintz is professor of business economics at the J. L. Rotman School of Management at the University of Toronto and chair in tax competitiveness at the C. D. Howe Institute.