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From: Daniel Schwanen

To:   The Hon. Navdeep Bains, Minister of Innovation, Science and Economic Development

Date: August 1, 2018

Re: How to Find More Foreign Direct Investment

Canada, like other economies, seeks to attract foreign direct investment to help grow its standard of living. In recent years, however, Canada has struggled to attract such investments.

Foreign investments that are “direct,” in contrast to portfolio investments in which investors acquire smaller portions of equity or debt in a company, entail the investor acquiring some control over how their new Canadian business is run. In turn, this typically means that a foreign direct investor is making a long-term commitment to Canada.

FDI by and large supports Canadian productivity and relatively high-wage jobs in Canada, because it helps integrate Canada’s economy into the global economy – into value chains where each part contributes what it is relatively best at. As with international trade, FDI is therefore one of the key transmission belts by which Canadians can turn their talents and resources into a high standard of living.

Last year, Canada attracted smaller FDI flows than each of Australia and Mexico, an unusual occurrence. FDI statistics are notoriously volatile – but these unusual phenomena are concerning.

Many factors come into play when a business decides to make an investment from its home economy into a host economy abroad. These range from the size of the market, availability of talent and infrastructure, taxes and regulations. But external trade and investment policies also play a vital role.

In this respect, Canada still maintains FDI barriers for which the policy rationale is simply not demonstrated. This was already pointed out 10 years ago by the Competition Policy Review Panel chaired by Lynton Wilson.

Following these findings, the Wilson report recommended opening up more Canadian sectors, such as telecommunications, to foreign investment. As well, it recommended replacing Canada’s notorious “net benefit” test with a framework under which the onus would be on the government to explain why a specific investment would be contrary to the national interest and should be rejected. To the credit of successive federal governments, Canada has since opened some sectors and activities to FDI that were previously closed – such as when it raised the limit on airline foreign ownership to 49 percent. As well, the threshold over which investors must pass the net benefit test has been raised (meaning fewer investors must pass this test), and the terms of the test have been clarified – including for foreign state-owned enterprises.

Be that as it may, remaining sectoral limits and the net benefit test still constitute the reasons why Canada ranked No. 32 in 2017 among the then-35 OECD countries in terms of its formal FDI barriers.

In this context, Canada needs to take a fresh look at how it can make itself more welcoming. In my recent C.D. Howe Institute paper, I argue that we should adopt the Wilson report recommendations and replace the net benefit test with a requirement that when the government wants to block a prospective investment, it must explain why it is contrary to the national interest.

As well, Canada should remove remaining restrictions on equity ownership of private enterprises, whether or not these restrictions are directed only at foreigners, unless officials can make the case that lifting the restriction would be contrary to the national interest, as has been articulated with respect to the “widely held” rule for large banks.

The “contrary to national interest” demonstration would be based on factors such as threats to national security, fair competition, fiscal or financial stability or the ability of the government to regulate in matters ranging from safety and the environment to support for Canadian cultural content.

Absent that, direct acquisitions of Canadian firms should be allowed, when they make sense for both the foreign acquirer and the Canadian seller. This will maximize the potential benefits of FDI for Canada, at no loss to its sovereignty.

Daniel Schwanen is Vice President, Research at the C.D. Howe Institute

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The views expressed here are those of the author. The C.D. Howe Institute does not take corporate positions on policy matters.