Why Canada Struggles to Attract Foreign Investment

April 4, 2018 Updated: April 13, 2018

Foreign capital has been paramount to building Canada, but in the competition to attract ongoing international investment, Canada is at a crossroads. Direct investment in 2017 dropped to the lowest level since 2010, and mergers and acquisition activity resulted in an outflow of capital from Canada for the first time since 2007, when Statistics Canada started collecting the data.

The issue isn’t so much the tax regime, but rather the regulatory side, said Jack Mintz, a leading public policy expert. And curiously, the “canary in the coalmine” is the service industry, not the energy sector.

As a place to do business, Canada has a lot going for it—from a highly educated workforce to good infrastructure and a stable political situation. But Mintz, President’s Fellow at the University of Calgary’s School of Public Policy, points out that a few knocks against Canada are its small market, dispersed population, and cold climate.

But while those strikes aren’t new, the mystery is why Canada’s performance in attracting foreign capital has faltered in the last few years. And it’s not solely due to the swoon in the energy sector either, according to Mintz.

“It’s interesting that the regulatory issues, particularly since 2011, have started to harm us,” Mintz said in a phone interview.

Regulatory issues is like a catch-all term including carbon taxes, pipeline uncertainty, difficulty getting goods to market, and other frictions like delays getting building permits. These problems impact Canada’s competitiveness.

But there’s also no denying that U.S. tax reform and the ability to write off capital expenditures have made companies take notice and shift investment there.

“So now we’re put in a position where Canada, being a small market and all these regulatory issues, we don’t look so hot as a place to invest,” Mintz said.

He also expects more tax reductions at the state level after Kentucky became the first state to lower corporate and personal tax rates.

Service Sector

The taxation of capital in Canada hasn’t changed much in recent years, but private investment has been falling as a share of the economy.

Canada’s marginal effective tax rate ranks in the middle of the pack. But where Canada lags badly is in private investment as a share of GDP—especially in its service sector. It ranked last among 19 selected OECD countries, based on analysis co-authored by Mintz about Australia’s investment challenge in response to U.S. tax reform.

Epoch Times Photo
Canada ranks last in private investment in the service sector in this group of countries. (Courtesy Philip Bazel and Jack Mintz)

What this means, in combination with the United States sanctioning the expensing of capital expenditures, is that U.S. companies are being incentivized to adopt new technologies like artificial intelligence and robotics, “while in our [Canada’s] system, we’ve done very little to actually encourage the adoption of technology.

“Where we’re more focused on is the creation of technology than the adoption of technology,” Mintz said.

In an interview with the Canadian Press, RBC president and CEO Dave McKay said a loss of capital is likely followed by a loss of talent (human capital). Canada’s loss is the United States’ gain.

One-Stop Shop

A new federal agency, Invest in Canada, hopes to change the narrative. International trade minister François-Philippe Champagne is on a cross-country tour promoting it.

The agency will work with all levels of government to help global investors navigate Canada’s investment landscape. It will take several months for it to staff up and establish programs, but Mintz doesn’t see its measures as being able to overcome the economic and policy challenges Canada faces.

“I think if Canada really wants to attract investment, it’s going to need to do much more than set up a shop and say ‘we’re a great country,’” he said.

Being a one-stop shop can alleviate some regulatory costs, but it won’t do anything for the energy sector, which needs pipelines built, Mintz said.

Enerplus is a perfect case in point of what is underway. The Canada-based oil company now has 80 percent of its production coming from the United States, whereas 10 years ago it would have spent the vast majority on Canadian projects.

“The United States has been a very attractive environment to operate in,” said Ian Dundas, CEO of Enerplus, in an interview with BNN.

He said that for years the United States has been more favourable for his business, with falling tax rates and a simplified regulatory environment.

“There’s going to have to be some tangible changes or it’s going to be very difficult for companies to continue to invest in the Canadian projects,” he said.

“Very sad from a Canadian perspective.”

It’s dollars and cents stuff.

“In the end people make investment decisions based on what they think they can get for their after-tax returns on investments,” Mintz said.

Public Perception

Mike Colledge, president of Ipsos Public Affairs in Canada, said the majority of Canadians like their sovereignty and don’t want to lose control of their assets, but they also don’t fully understand the need for foreign investment. “’Why couldn’t we keep it in Canada?’ That’s the mindset,” he said in a phone interview.

According to an Ipsos poll conducted in late March, 75 percent of Canadians agree that the government should stop sales of Canadian companies to foreign investors. The proportion rises to 79 percent if the acquirer is a state-owned enterprise.

He also added that the 75 percent is a “stable number” dating back to 2012, so there hasn’t been some kind of recent spike against foreign ownership in the public perception.

Currently one in eight Canadians (1.9 million) work for foreign-owned companies in Canada.

Most foreign investment flies under the radar. But in the extreme, the federal government can undertake a comprehensive national security review in addition to determining if the investment is in Canada’s best interest, as it is doing for the deal to acquire infrastructure giant Aecon by state-owned China Communications Construction Company Ltd., which has a record of fraudulent practices and has been disbarred from participating in World Bank projects for eight years. The Ipsos poll showed 73 percent of Canadians oppose this particular sale. The review deadline for the potential $1.5 billion deal has been pushed back to July 13.

On the surface, Canada can appear to be a great place to do business, and Invest in Canada aims to promote that message. But under the hood lies a morass of regulatory issues and even misperceptions about takeovers by non-state-owned enterprises, which are beneficial for job creation, economic growth, and the introduction of new expertise and technology into the country.

However, Canada is seeing a troubling reduction of foreign capital and it’s not just in the energy sector, but in the much larger service sector.

Follow Rahul on Twitter @RV_ETBiz

Follow Rahul on Twitter: @RV_ETBiz