Changes in Foreign Control under Different Regulatory Climates: Multinationals in Canada

by G. Gellaty, D. Sabourin and J. Baldwin*

Introduction

Over the last four decades, foreign multinationals operating in Canada have experienced first a retrenchment and then a resurgence in their activities. This pattern of decline and recovery has mirrored underlying changes in the regulatory regime that first tightened and then relaxed the restrictions on inward foreign direct investment. This paper examines the presence of foreign multinationals in Canadian industry, concentrating on the broad relationship between changes in foreign control and the regulatory regime.¹

In the energy sector, the pattern of regulatory change differed from the restrictive-to-liberal transition that in general characterized the end of the Foreign Investment Review Agency (FIRA) period. Here too there are grounds to conclude that regulation had an impact, as foreign control in mining and energy industries has now begun to trend upward, following the pattern seen in other sectors.

The tighter investment restrictions of the 1960s and 1970s were predicated on a widely held view that multinationals truncate their activities in host markets, concentrating low-value activities abroad while locating high-value activities in home economies. From this viewpoint, multinationals were often portrayed as bringing little benefit to host markets, in that many of the economic rents associated with these foreign operations were transferred from affiliates to parent companies.

Many recent studies paint a decidedly different view of multinational operations, arguing that foreign-controlled businesses located in Canada tend to be well-developed firms—productive and high-paying relative to their domestic competitors, with relatively sophisticated innovation and technology activities. There is evidence that these foreign-controlled businesses transmit positive externalities, in the form of productivity gains, to domestic businesses.

Changes in the investment regulatory regime – a brief synopsis

Tariff reductions and regulatory factors have both been posited to affect the level of foreign direct investment (FDI) in Canada. In the late 1960s and early 1970s, much attention was focused on what was widely regarded as the negative consequences of increased foreign control. This culminated, by the mid 1970s, in the establishment of FIRA. Inward FDI that involved the acquisition of Canadian businesses by foreign investors or the establishment of new foreign-owned startups were subject to FIRA finding “significant benefit to Canadians” (see Globerman and Shapiro, 1999).

From 1975 to 1985, FIRA established the broad regulatory framework governing the investment activities of foreign multinationals. While FIRA’s mandate was wide-reaching, Canada’s investment regulatory regime also included a sizable array of sector-specific policies that were tailored to the idiosyncrasies of different industries. Many of these centered on industries that are widely regarded as strategically important to the Canadian economy, such as financial services, telecommunications and oil and gas. The National Energy Program, the most visible of these policies, was implemented in 1980 with multiple objectives, one of which was to encourage the Canadianization of the petroleum industry.

In the 1980s, the broad regulatory climate towards foreign capital shifted from being more restrictive to more liberal. In 1985, FIRA was replaced with a new agency, Investment Canada, whose mandate was facilitating and soliciting foreign direct investment rather than controlling it. At the same time, the foreign investment provisions of both FTA and NAFTA relaxed the thresholds required for review before the agency. The National Energy Program, with the exception of the continued state ownership of Petrocan, was allowed to lapse.

But the tighter regulatory constraints of the 1970s were not relaxed equally across all industries, at least in the near term. In the energy sector, restrictions on foreign ownership continued—albeit attenuated from the earlier period. Restrictions that precluded foreign investors from acquiring “financially healthy” Canadian oil and gas companies remained in effect until the early 1990s (see Globerman, 1999, for more on sectoral policies).

Decline and recovery: Aggregate trends in foreign control

The overall presence of foreign multinationals can be evaluated by examining the percentage of all corporate assets, or revenues, that is accounted for by foreign-controlled firms. Asset ratios are one measure of the extent to which foreign multinationals influence the productive capacity of the domestic economy. Revenue ratios, in contrast, are output-based. Long-term trends in the shares of assets and output under foreign control may differ if foreign-controlled firms become more (or less) capital intensive than their domestic counterparts. The asset and revenue shares of foreign-controlled firms operating in non-financial industries are reported in figure 1.

Figure 1

Over the last four decades, foreign multinationals operating in Canada have experienced a retrenchment and then a resurgence in their share of both assets and revenues. In the 1960s foreign multinationals, via FDI, were increasing their presence in Canada’s non-financial industries. In 1971, some 35% of non-financial assets and 37% of non-financial revenues were under foreign control.

Beginning in the early 1970s, the overall presence of foreign multinationals in the Canadian economy began to decline, commensurate with the onset of a more restrictive regulatory climate. This retrenchment in foreign control continued in earnest after FIRA came into full effect in 1975. In that year, some 30% of assets in non-financial industries were controlled by foreign-owned firms; a decade later, at the conclusion of the FIRA era, only 22% of assets were under foreign control. The revenues of foreign-controlled firms stood at 29% in 1985, down from 35%.

The post-FIRA era saw a gradual resurgence in the share of economic activity accounted for by foreign-controlled firms. Both the share of foreign-controlled assets and revenues began to increase—asset shares gradually from the mid 1980s and revenue shares beginning in the 1990s, though they remained below those experienced during the peak years of the late 1960s and early 1970s.

Conflicting incentives for multinational investment may help explain the initial modesty of the post-FIRA recovery. The fact that the increase in foreign control does not quite offset the previous decline is consistent with an interpretation that attributes changes in foreign control both to reductions in tariffs and to shifts in the regulatory regime. Tariffs declined more or less continuously during the 1965-2000 period. All things equal, both tariffs and the regulatory regime were working to reduce the incidence of foreign control during the 1970s and early 1980s. In subsequent years, these forces would be offsetting—with tariff reductions possibly operating to reduce foreign investment and post-FIRA regulatory changes serving to encourage foreign investment.

Sectoral patterns: energy vs. non-energy industries

This section focuses on long-run changes in foreign control in Canada’s energy sector, which comprises two sub-sectors: petroleum and coal manufacturing, and oil and gas extraction. Concerns over the activities of foreign multinationals in these sub-sectors have persisted well into the post-FIRA era. Figure 2 presents the revenue shares of foreign-controlled firms operating in the energy sector.

Figure 2

Foreign multinationals have long been a dominant force in Canada’s energy sector. During the early 1970s, foreign-controlled firms generated virtually all of the revenues in these industries. With the advent of FIRA, the revenue shares of foreign-controlled companies began to decline precipitously. By the early-to-mid 1980s, the share of energy revenues generated by foreign-controlled firms had declined to about 70%. The reductions in foreign control that occurred under FIRA were similar in both sub-sectors.

The long-run decline in foreign control within the energy sector continued well into the 1990s in both petroleum and coal manufacturing and oil and gas extraction.

Despite much higher foreign control shares in energy industries, the volume of revenues controlled by non-Canadian firms in energy industries is not large when viewed in relation to all foreign-controlled revenues across the economy. The exclusion of energy industries from our non-financial aggregate has only a small impact on the aggregate revenue shares presented in figure 3.

Figure 3

During the FIRA period, the declines in foreign control in energy industries had little qualitative impact on the pattern of aggregate decline apparent within the non-financial sector. In the post-FIRA period, however, there is a slightly larger recovery of foreign activity during the mid 1990s once energy industries are removed from the mix. And the progressive declines in foreign control during the 1970s and 1980s are almost completely reversed—foreign-controlled firms generated 32.4% of revenues in 1968 and 29.7% of revenues in 2000.

Recent changes in foreign control

There has been a sizable increase in the share of non-financial corporate assets controlled by foreign firms, up from 25.4% in 2000 to 29.3% in 2003.² This represents a continuation of the upward trend in foreign control apparent since the mid-1980s, returning to levels witnessed in the mid-1960s.

Table 1 reports on the level of foreign control in specific industries in both 2000 and 2003, along with the corresponding percentage point change and the rate of change (calculated as the percentage point change in foreign control over the period divided by the level of foreign control in 2000). Both the share of assets and operating revenues under foreign control are examined.

Table 1 Assets and revenues under foreign control, by industry

Of the 16 industries for which data are available in both 2000 and 2003, nine experienced an increase in the share of assets under foreign control during this period. The two industries with high levels of foreign control in 2000 also had relatively large increases in multinational activity. Foreign control of manufacturing assets grew by 14% from 2000 to 2003 (from 45.0% of assets to 51.3%). Oil and gas saw the asset holdings of foreign firms increase by 18.0%.

Several other industries experienced very large rates of growth of assets controlled by foreign multinationals. Foreign control over mining assets grew by over 50% during this three-year period from 22.5% to 34.5%. In transportation and warehousing, foreign control grew by 83%.

The two industries with the third and fourth highest foreign control shares in 2000 saw posted declines in foreign control. Wholesale trade saw its foreign-asset share decline by 6%, from 37.8% in 2000 to 35.5% in 2003. Administrative services experienced a 10% decline.

While the overall share of assets under foreign control has increased in recent years, there has been no concomitant increase in the share of revenues generated by foreign firms. In fact, foreign companies accounted for a slightly lower portion of non-financial revenues in 2003 (30.2%) than they did in 2000 (31.1%). Of industries with large increases in the share of assets under foreign control, only mining experienced large gains in the share of industry revenue under foreign control. Within manufacturing, the growth of foreign-controlled assets was accompanied by more modest gains in the foreign share of revenues. The share of manufacturing assets and revenues controlled by foreign companies was virtually identical in 2003, both at slightly over 50%. In oil and gas, the foreign asset share also increased more than the revenue share, but foreign-controlled revenues still remained slightly higher than foreign-controlled assets in 2003.

The observed increase in the share of assets controlled by non-residents was led by a more visible multinational presence in industries with high levels of foreign control. The two industries with the highest foreign control shares in 2000—manufacturing and oil and gas — both experienced sizable increases in multinational activity, with foreign companies acquiring larger shares of manufacturing and oil and gas assets. These industries together accounted for about 65% of the stock of foreign non-financial assets in both 2000 and 2003.

Conclusions

Regulation is one of several factors that serve to influence the volume of multinational investment in Canada. Long-run reductions in tariffs may have been working to discourage multinational investment in Canadian markets during the period studied. Changes in the incentives for multinational investors may also have been occurring via underlying changes in the relative costs of Canadian labour and capital. These too would be expected to affect the size of FDI inflows. Accordingly, it becomes difficult to isolate the impact of regulatory changes from other causal factors.

This multidimensionality notwithstanding, the visual evidence on the relationship between the regulatory regime and foreign control is compelling. Our analysis suggests there are reasonable grounds to conclude that the major regulatory changes of recent decades—the implementation of FIRA and the subsequent replacement of FIRA by Investment Canada—had an appreciable impact on the aggregate share of economic activity under foreign control. As the regulatory climate became more restrictive under FIRA, there was a visible retrenchment in multinational activity. As restrictive regulations gave way to more liberal policies towards FDI in the post-FIRA era, the importance of foreign-controlled firms has increased.

References

Baldwin, J.R. and G. Gellatly. 2005. Global Links: Long-Term Trends in Foreign Investment and Foreign Control in Canada: 1960-2000. The Canadian Economy in Transition Research Paper Series 11-622MIE2005008. Ottawa: Statistics Canada.

Baldwin, J.R. and W. Gu. 2005. Global Links: Multinationals, Foreign Ownership and Productivity Growth in Canadian Manufacturing. The Canadian Economy in Transition Research Paper Series 11-622MIE2005009. Ottawa: Statistics Canada.

Globerman, S. 1999. Implications of Foreign Ownership Restrictions for the Canadian Economy – A Sectoral Analysis. Industry Canada Discussion Paper Number 7. Ottawa: Industry Canada.

Globerman, S. and D.M. Shapiro. 1999. The Impact of Government Policies on Foreign Direct Investment: The Canadian Experience. Journal of International Business Studies, 30, 3: 513-532.

Government of Canada. 1972. Foreign Investment in Canada. (The Gray Report). Ottawa: Information Canada.

Government of Canada. 1968. Foreign Ownership and The Structure of Canadian Industry: Report of the Task Force on the Structure of Canadian Industry. (The Watkins Report). Ottawa: Queen’s Printer.

Industrial Organisation and Finance Division. 2005. Corporations Returns Act 2003, catalogue number 61-220-XIE. Ottawa: Statistics Canada.

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Notes