Wednesday, August 30, 2006

Tampering with FDI

When it comes to the effects of foreign direct investment (FDI), Canada's policy makers have been an indecisive bunch. Our fickle policy stance has been a reflection of that. Surely this comes at a cost.
From The Globe and Mail (28 August), “Bernier backs bureaucrats on foreign investment”:

...Some Canadians view almost any foreign takeover as bad for Canada. Mel Hurtig, a publisher and noted economic nationalist, said foreign investment is almost always a purchase of an existing business, not an investment that creates a new operation. In the past two decades, he said, Investment Canada has reviewed $620.7-billion in foreign investment and that 97.1 per cent of that involved acquisitions. "Foreign investment is not good for us,” Mr. Hurtig maintains.

I'm of course making an example of an extreme view. Hurtig sees FDI as zero-sum and fails to recognize the ambiguous effects of FDI. Hurtig, who argues that FDI is invariably bad, is not alone with his view; however, surely he is the minority among economists. Still, this doesn't stop the media from pandering to them.

The point remains: over the years, policy makers have been indecisive about the effects of FDI. Canada's irresolute policy stance is a reflection of that. Never mind the inherent costs associated with FDI, surely a nation's indecisiveness comes at a cost, too.
Lucie Laliberte, “Globalization and Canada's International Investment Position,” Canadian Economic Observer (1993):

The Foreign Investment Review Agency (FIRA) was created in 1974 to screen new
foreign investment and to review foreign acquisitions of existing assets. This was followed in 1980 by the National Energy Program, which, among other things, also monitored the extent of foreign control in the energy industry. The foreign control ratio dropped dramatically from a peak of 36% at the end of 1971 to 23% at the end of 1986, largely through Canadian takeovers of foreign controlled companies. In 1985, Investment Canada was set up with the mandate of promoting, among other things, [FDI] in Canada. Subsequently, the foreign control ratio rose to 28% at the end of 1991. The recent gain in foreign control was widespread in non-financial industries except for two sectors (food, beverage and tobacco; electrical and electronic products) where foreign control declined.


Another paper points out, “Canada agreed to stop imposing performance requirements, such as requiring an investor to export a certain amount of goods, and) beginning in 1992, to stop screening U.S. direct acquisitions of Canadian assets of less than C$150 million (in constant 1992 Canadian dollars).”

The actions that Canada undertook (to allow FDI, and later to prevent FDI, and even later to promote FDI ...) occurred all the while that economic conditions varied (eg – changes in the exchange rate regime, increases in efficiency, changes to tariff structures). This makes the impact of FDI in Canada all the more difficult to account for. This only adds to the uncertainty about the merits of FDI.

One thing we can assume is that tampering with FDI policy (for example, performance requirements), is not a good thing. Never mind the costs associated with FDI in itself, it's surely not unreasonable to hypothesize that all of the potential volatility caused by Canada's indecisiveness could possibly be more costly. If the benefits of FDI are relatively greater in the long run, stylized fact would lead us to believe that turning the FDI tap on and off will damper the benefits the nation could reap. Studies have shown that with the proper performance requirements in place (when necessary, such as in certain cases in the mining industry) the benefits of FDI in Canada generally outweigh the costs (such as the loss of control of domestic policy) in the long run.

We can't agree on the merits of FDI, but surely Hurtig would agree that inconsistency hurts.

3 comments:

Steve said...

Studies have shown that with the proper performance requirements in place (when necessary, such as in certain cases in the mining industry) the benefits of FDI in Canada generally outweigh the costs (such as the loss of control of domestic policy) in the long run.

Imposing performance requirements is the same as turning the tap partly off. If the investment makes economic sense, then why should some bureaucrat tell you what to do with it?

Still, your point is well taken. Autarkists such as Mel Hurtig and their like have no idea how much damage their views would cause if implemented.

happyjuggler0 said...

FDI is the close cousin of international trade. The goal ought to be to create efficiencies due to scale and proprietary information and comparitive advantage and thus increasing productivity.

Noting of course that in the long run productivity and only productivity can increase wages. Of course education ought to increase productivity too, but they need not be exclusive.

One example of proprietary information would be an oil company that has great imaging technology that allows it to "see" more oil and natural gas deposits than a company that is a potential friendly takeover, and thus increase yield of exisiting fields and also increase yields of exploration companies.

Another problem with the notion that it is desirable to take over foreign companies but undesirable for foreign companies to take over domestic companies is that this beggar thy neighbor attitude may cause other countries to block investments from Canada.

Finally, as a general rule with precious few exceptions, top down government can't make superior decisions regarding supply and demand than free markets can. This ought to give pause to anyone that thinks that an ability to charm one's way into elected office also correlates with an ability to correctly weigh the plusses and minusses of individual market actions commited by individuals who pretty much by by definition have superior information about what is best for them.

Just because politicians feel the need to "do something" doesn't mean we ought to be foolish enough to let them.

true dough said...

Steve --
Thanks for the comment.

I think happyjuggler0 makes an excellent point here: "The goal ought to be to create efficiencies due to scale and proprietary information and comparitive advantage and thus increasing productivity."

Personally I lean towards leaving the market alone with minimal interference to maximize outcomes. The example of proprietary information makes sense. I don't see how pursuing such objectives is quite the same as slamming down a policy to drastically impact FDI across the board. Canada has been known to do this, and many individuals propose that we keep it up. I think all of us here agree on the absurdity of such a thing.
But I agree - interference shouldn't come at the hands of some bureaucrat incognizant of the situation.