FDI – Gangnam Style

Does the “net benefit” test in the Investment Canada Act require clearer definition and a more transparent process? This is a view repeated by the chattering classes. My view is that the net “benefit test” results from a process that works as well as it can, given the prevailing conditions. Greater clarity sounds good but may make it easier for firms to structure their operations for their own but not necessarily Canada’s benefit. If there is a better way, lets hear the alternatives. Political risk is a separate issue but here Canada can learn from the experience of other countries. The following is my understanding of how economic screening works.
This blog is deliberately titled to entice readers, not that it has much to do with the new South Korean dance craze, but the discussion tries to explain the screening process in today’s world. Consider what happens in screening for a hiring interview. The interviewer makes an assessment of the person based on academic and other credentials, and an evaluation of various personality traits for which there may be soft evidence like letters of recommendation, and today Facebook and other postings. There is no neat formula to determine the future net benefit to the organization of hiring a person. The employer makes a judgment call and usually has the option to terminate an employee’s contract. The actual, as opposed to expected benefit, occurs after the hiring has taken place when the conditions for the employer and individual may have changed.
This is similar to what Investment Canada (IC) does with acquisitions which require its assessment. The acquiring firm provides information on the various economic features required by the act. This is then either approved or rejected. Approval may come after IC officials ask for and get conditions included based on past decisions and the special features of the applicant. The applicant is aware of this, with the advice of a Canadian lawyer, and may be prepared to offer more in a revised application. The officials then feel that they have done a good job, and the applicant that the firm’s owners are cooperative and reasonable. Both sides congratulate themselves, and the process leads to 90% plus approvals. So is the public interest served by this process? Is there a more transparent way?
First, foreign investment screening is similar but not identical to the process used in most other countries with market economies, which have not found an alternative. Second, similar to hiring an employee, ex-post working conditions may change for the firm and its actual performance may not live up to expectations. So, why can’t the conditions set by IC become clarified and enforced to ensure the public interest is served? Enforcement requires knowing the future, having the ability to measure commitments, and to discipline the firm if these are not met, even though market conditions have changed. At times the investor may exceed its commitments. In order to be credible, the host government has to be prepared to ask a foreign investor to leave and dispose of its assets, perhaps to a domestic firm for which there are no similar requirements. Third, we know that a high percentage of IC applications are approved, largely due to informal pre-screening processes which show the applicant and official as working cooperatively, with both earning brownie points in their respective organizations for a successful outcome.
The foreign investor would often like to have specific measurable commitments, but there are none that make sense because of uncertainty about the future. If they were specific, the foreigner would structure the firm in Canada to meet these commitments which seemed right at the time for Canada, but with changing economic and/or political conditions may no longer be applicable. Moreover, the more specific the conditions the easier it is to structure a business relationship in Canada which achieves the firm’s objectives but perhaps not Canada’s. For example, if a foreign firm wants access to Canada’s crude oil supplies or other minerals, it can sign a long term exclusive contract with a Canadian owned supplier. IC is not involved and the foreign buyer does not have to invest abroad. There are a number of commercial ways to achieve access to supplies without investing in Canada. Canadian firms do the same thing abroad when they set up plants to take advantage of cheap labour and then import the product. Alternatively, they can buy the output from a foreign firm without acquiring ownership of it. Often the latter is preferable as investment is not put at risk, and if there is a market downturn, withdrawal will be less costly.
The foregoing deals mainly with economic factors. I will address the political considerations in a separate posting by which time I may have mastered the Korean dance. UN Secretary General Ban Ki-moon has already done so on YouTube.
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