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There’s no good economic reason for the net-benefit test: Globe and Mail Op-Ed

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May 17, 2015

Published in the Globe and Mail on May 17, 2015

By A.E. Safarian and Daniel Schwanen

A.E. Safarian is professor emeritus at the Rotman School of Management. He is the author of Simplifying the Rule Book: A Proposal to Reform and Clarify Canada’s Policy on Inward Foreign Direct Investment, recently published by the C.D. Howe Institute. Daniel Schwanen is vice-president, research, at the C.D. Howe Institute.

Canada has an image problem with foreign investors. We are notorious for our low ranking – 36th of 43 – among countries consistently surveyed by the Organization for Economic Co-operation and Development for the hurdles raised for foreign investors wishing to acquire or take an important stake in domestic businesses.

Yet Canada thrives on the investments Canadians make abroad – and the investments foreigners make here. We think of ourselves as open to the world, but we should raise our game.

The problem is not with cross-border ownership of listed shares or claims such as bonds. Foreign direct investment (FDI) – usually defined as an ownership stake of 10 per cent or more – is where things get sticky for Canada.

FDI is good in principle. When a Canadian business expands its markets or finds complementary strengths through a foreign acquisition, good things happen. When Canadians parlay their strengths at home by linking up with opportunities abroad, Canadian workers, investors and governments all gain.

Inward investment also benefits Canadians. Foreign-owned companies in Canada are typically more productive than the average domestic company and are likely to provide direct and indirect jobs that pay better than the average, as they take advantage of Canadian strengths within global production networks.

These two-way benefits are reflected in the fact that Canada is both a major exporter and importer of FDI. As of the end of 2014, Canadian FDI abroad totalled $829-billion, while the value of foreign FDI in Canada was $732-billion. Hundreds of thousands of well-paying jobs would not be here without such investments.

Canada certainly has attracted large amounts of FDI recently thanks to its relatively stable economic climate, abundant resources, proximity to the United States and skilled work force. FDI in Canada has risen sharply over the past decade in oil and gas and related sectors, as well as finance and management companies.

Canada has, in fact, lowered some barriers to FDI in recent years. But it has not reformed the most important reason for its low ranking: the so-called “net benefit” test it applies to large takeovers of Canadian corporations.

Further, since 2011, it has introduced additional hurdles applying to sizable investments in Canada by foreign state-owned enterprises. In this new policy, SOEs include enterprises “directly or indirectly influenced” by foreign governments. These will now be particularly scrutinized to ensure their practices are on par with those of private players in the Canadian economy – indeed, the requirements on foreign SOEs will be more stringent than those that typically apply to Canadian companies.

By their nature, business investments involve the risk of failure – foreign or domestic. But the net-benefit test gives Canadians a false impression that the government is able to distinguish, on economic grounds, investments that will turn out well from those that won’t – a concept Canadians would recognize as bizarre if applied to domestic firms. Instead, having to show detailed evidence of net benefit imposes an unnecessary and often onerous administrative burden and an added layer of uncertainty for potential investors.

Making investors from abroad jump through hoops to ensure good behaviour doesn’t make sense in our well-regulated corporate landscape. Many legal and regulatory requirements here appropriately apply to investors both Canadian and foreign – for example, that a proposed merger or acquisition pass muster with competition authorities or, in banking, that an investor be of “good character.” Both Canadian and foreign-owned companies must also comply with our myriad environmental and other regulations. Foreign investors in resource sectors must pay royalties to the provinces that own the resources, just as Canadian investors do.

Canada can also impose a national security test for any proposed foreign investment. This test can ensure, for example, that a technology developed in Canada with government support and with important security applications does not fall under the indirect control of a foreign government, or that foreign investors do not compromise the security of Canadians, say, by gaining access to critical infrastructure. Decision-making regarding these complex security issues could be improved by referring any problematic proposal to a high-level interdepartmental committee.

Furthermore, Canada still exercises the option to transparently exclude foreign investors from acquiring controlling stakes in sectors of the economy it deems reserved for Canadians.

It has been argued that Canada’s securities rules make it too difficult for boards to resist offers by foreign (and domestic) investors that may not be in a company’s best long-term interest. But Canadian securities administrators are now addressing this by proposing to allow more time for boards to consider alternatives.

Why, in circumstances where Canada’s security, policies and companies are already as fully protected as they can be, do we maintain a net-benefit test that does not show a bottom-line impact on Canada, imposes an unnecessary burden on investors and gives Canada a dubious (if generally undeserved) international reputation?

The answer is that there is no good economic reason for maintaining the net-benefit test. Canada would improve its reputation and more easily attract investments if it repealed it.

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