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Comprehensive Review of the Investment Canada Act Desperately Needed

By Niels Veldhuis Created: January 31, 2013 Last Updated: January 31, 2013
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Two Chinese paramilitary guards watch as China National Offshore Oil Corp. (CNOOC)’s first independent deep-water oil drilling rig, leaves the port of Qingdao, east China’s Shandong Province. CNOOC’s takeover of Calgary-based Nexen Inc. should give legislators reason to revise the Investment Canada Act, argues Niels Veldhuis. (AFP/AFP/GettyImages)

Two Chinese paramilitary guards watch as China National Offshore Oil Corp. (CNOOC)’s first independent deep-water oil drilling rig, leaves the port of Qingdao, east China’s Shandong Province. CNOOC’s takeover of Calgary-based Nexen Inc. should give legislators reason to revise the Investment Canada Act, argues Niels Veldhuis. (AFP/AFP/GettyImages)

If you’re confused about Canada’s rules with respect to foreign takeovers of Canadian companies, you’re not alone. The recent decisions by the federal government to approve the takeovers of Nexen by China’s state-owned-enterprise (SOE) CNOOC and of Progress Energy by Malaysia’s SOE Petronas while disallowing the takeover of Potash Corp. by the privately-owned Australian mining company BHP Billiton, is, at a minimum, confusing.

It’s no wonder Canadians were left scratching their collective heads about why some deals and not others were approved.

Under the Investment Canada Act, which is actually intended to encourage investment in Canada and to review investments by foreigners, an automatic review of significant foreign takeovers is undertaken by the federal government to determine if the takeover provides a “net benefit” to Canada.

While the criteria for determining whether an investment provides a “net benefit” is explicitly set out in the Act (i.e. the effect of the investment on economic activity, the degree of participation by Canadians in the business in question, the effect of the investment on productivity, efficiency, technological development, product innovation, and product variety in Canada, etc.), whether a foreign takeover provides a “net benefit” is not objectively measured.

As Western Washington University Professor and Fraser Institute Senior Fellow Steve Globerman noted in his paper “An Evaluation of the Investment Canada Act and its Operations” commissioned by the federal government, many criticisms have been levied on the “net benefit” test.

These include the fact that “there are no weights attached to the individual criteria,” there is “no option to claim trade-offs among the criteria,” there is “a lack of transparency” and there are “concerns about consistency in the application of the criteria.”

Professor Globerman notes that the main economic benefit of foreign investment comes through increased competition in Canada and the spillover of new technologies which ultimately improves existing Canadian firms.

Unfortunately, the government can use the “net benefits” test to pressure the foreign investors to agree to undertake specific actions (i.e. increase head office employment and production in Canada), which ultimately reduces the efficiency of the foreign company and therefore the benefits associated with increased competition.

While takeovers by SOEs will receive greater scrutiny, the increased influence of sovereign wealth funds or state-owned investment funds has not been fully considered.

Professor Globerman ultimately concludes that there is no strong economic justification for the “net benefits” test and that the government’s screening of foreign takeovers should be limited to national security issues.

The reality is that overwhelming evidence from the academic research shows that foreign business activity is of tremendous benefit to countries that welcome it.

When efficient foreign companies with superior management, processes, and technologies outbid others for relatively inefficient Canadians companies, the result is better managed companies and a more dynamic economy.

That is why foreign business activity has been overwhelmingly found to increase investment, innovation, and introduce new technologies; all of which ultimately translate into lower prices, higher wages, and better quality goods and services.

While this certainly applies to most takeovers by privately run companies, those by SOEs are entirely different. SOEs are backed by government support and may not have superior management, processes, or technologies.

In addition, SOEs are typically guided by political goals rather than pursuing economic or business objectives. Instead of allocating capital where it garners the highest economic return, SOEs can allocate capital for a host of other reasons.

This is why Prime Minister Stephen Harper recently announced tougher guidelines for SOE takeovers of Canadian companies going-forward, especially those in the oil sands. As Prime Minister Harper noted, “Canadians have not spent years reducing the ownership of sectors of the economy by our own governments, only to see them bought and controlled by foreign governments instead.”

While discouraging takeovers of Canadian businesses by foreign SOEs is a positive development, the federal government will continue to use the subjective “net benefits” test to review takeovers by foreign SOEs and all other significant takeovers by private foreign businesses.

This will result in the continued politicization of foreign takeover decisions, which reduces Canada’s ability to attract investment. In addition, while takeovers by SOEs will receive greater scrutiny, the increased influence of sovereign wealth funds or state-owned investment funds has not been fully considered.

What Canada needs is a comprehensive review and debate about the merits of the Investment Canada Act and a transparent, objective way to deal with takeovers by state-owned enterprises and investment funds.

Niels Veldhuis is Fraser Institute President and one of Canada’s most-read private-sector economists.

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