Are fears of Chinese investment in Canada overblown?

Restricting Chinese investment may be good politics, but it is bad economics

“When times are tough, constant conflict may be good politics. But in the real world, cooperation works better.”

Excerpt from Bill Clinton’s speech at the 2012 Democratic National Convention

Economic nationalism is creeping back into national policies with a vengeance. As worries linger about the fragility of the global economy, many governments around the world are ramping up mercantilist measures to protect their economies. These include policies that discriminate against foreign firms, workers and investors, as well as actions that give unfair advantages to homegrown companies.

Québec, sadly, is no exception. In the wake of Lowe’s recent take-over bid of the Québec-based hardware retailer Rona, there was rare unanimity among the leaders of the three main political parties over the need to empower Québec-based companies to resist hostile takeovers from foreign firms. Should the Premier-Elect Pauline Marois follow through on her campaign promise, which she seems poised to do, foreign companies would not only need to pass the opaque “net benefit” test in the Investment Canada Act to take over a Québec company, but they would also need to convince the board of directors of the targeted company that the takeover does not infringe the interests of local workers, suppliers and the community. Such new measures are likely to give Québec policymakers and companies wide discretion to use foreign investment policy for short-term political gains.

The proposed measures are particularly bad news for Chinese investment in the province. Among Québeckers, there is a widespread perception that Chinese companies – and especially state-owned enterprises – operate on different principles than Québec firms. Their investment intentions are considered politically motivated, and there is a growing concern that China might try to lock up key resource markets around the world. While these sentiments are largely unsubstantiated, they could, under the new rules, easily be exploited to block Chinese mergers and acquisitions in Québec.

Economic nationalism may be good politics, but it is bad economics. The health of the Québec economy vitally depends on Chinese investments, and increasingly so. For example, Chinese companies’ willingness to invest in Northern Québec’s rich mining and renewable energy resources is projected to be a key ingredient in the success of the Québec government’s ambitious Plan Nord. And beyond the natural resource sector, the capital outlays of Chinese companies are poised to take off in years to come. It would be a pity if political considerations put these opportunities at risk.

Are fears of Chinese investment in Canada overblown? The short answer is yes.

The debate surrounding the proposed acquisition of Nexen Inc. by the Chinese publicly-traded oil company, CNOOC, and the failed takeover of Potash Corp by BHP Billiton, illustrates our immature attitude to foreign investment and takeovers, especially when it involves one of our domestic champions. We claim to welcome foreign investors, but when they do come, we are not sure we really want them. We demand that other countries treat our investors fairly and follow transparent rules, but are unwilling to do the same for foreign investors here. We want to control strategic sectors, but do not like governments picking champions and interfering in business decisions.

The proposed takeovers of Nexen and Potash Corp raise several issues. First is the concern of a ‘loss of control’ over a strategic sector. However, there is a big difference between controlling the firm and controlling the resource. Canadians have largely rejected direct government control of firms, as evidenced by the significant privatization of crown corporations (such as Potash Corp) that have taken place provincially and federally under every political party. Our goal now is to influence economic activity, not control it. This indirect approach arose for two good reasons. One is the belief, based on good evidence, that direct government control of businesses can become too politicized. This is bad for overall economic growth and bad for investment. The other reason is that there is also recognition that the discipline of competitive markets improves productivity and innovation.

We can control strategic resources through our royalty structures, environmental and labour regulations, competition rules, and licensing requirements. The idea that we need to control the firms to control the resource is nonsense. Allowing Nexen to be bought out does not diminish our power to control how firms extract oil resources, what regulations they have to follow, and what taxes they have to pay. This means we need well thought-out environmental and labour laws, coherent royalty structures and competition rules that apply to all firms equally, including foreign enterprises operating in Canada. The role of governments is to provide an economic environment that allows firms to function within an open regulatory framework based on the rule of law, not ministerial discretion. Let the government set the rules, but let the market decide where and how to invest.

The second issue is maintaining our ‘national champions’. Both Potash Corp and Nexen are large firms with clout in the local and global market. We are justifiably proud of their success, but there is little reason to believe that local ownership confers additional economic benefits. As long as local production is competitive, there is no reason for firms to move out. If local production is not competitive, then even home firms will move. Further, there is growing evidence that foreign firms bring higher wages, larger investments in productivity and added access to world markets.

The third common issue is preserving head office jobs, but this is less of an issue with resource firms. One could move finance and marketing to other places but production is tied to where the resource is. You can’t move either the mine or most of the activities that support it.

Much of our discomfort with the Nexen deal arises from the role of state owned enterprises (SOEs). But well-designed policies will force all enterprises, foreign and domestic, to follow our rule book. We just need to make those rules clear, robust, and consistent.

Fears or concerns surrounding Chinese investment in Canada should be viewed through the lens of Canadian national interest and the benefits and costs of foreign investment to our economy generally. The starting point of analysis is the reality that Canadians benefit from having others investing their capital in our country. This global capital can help us fund projects, expand our businesses more quickly and cost efficiently than we could on our own.

The reasons for this are simple: 34 million people have access to a lot less capital than almost 7 billion people globally. If we could only rely on seeking investment capital from one another, the laws of supply and demand would dictate that our cost of capital would be much higher than for our global competitors with access to greater capital. This would further handicap the Canadian economy and its competitiveness and only make things worse for all of us. This math is hard to overcome. As a result, Canadians need to maintain an open foreign investment system strictly for our own national interest. Accordingly, there is no logic in turning down or fearing investment capital from any particular country as a matter of principle. This is especially so in a world where wealth and capital have accumulated in new places - such as China- and will continue to do so for the coming century.

The question then becomes how we get the most from our investment partners.

This means it also is perfectly acceptable for a strong and prosperous country, with attractive assets like Canada, to insist on ensuring that significant foreign investments offer specific and tangible benefits to the Canadian economy. The art of remaining open to vital foreign investment and maximizing the benefits is in having clear foreign investment rules that provide the process certainty and encourage the right kinds of investment. In the true Canadian tradition, the operating principle should be that, we generally don’t care where you come from or your background, if you come to invest here, act like a partner in the Canadian economy, and follow the rules your investment is welcome. If not, then this may not be the right place for you to invest.

In addition, while we do not want to tie overarching policy initiatives to any particular investment, as investment relationships with any country grow, it is both reasonable and necessary to negotiate overall trade and investment benefits including with countries such as China. One such item is investment reciprocity so that in time Canadians can invest in these countries just as they can invest here. Business partners should expect no less of one another as their business relationships grow. In the meantime, with SOEs, we need to continue to insist on transparency and to ensure that everyone understands, if you don’t play by our clear rules, then we also have clear rules to “stop” the game.

The 2012 offer to purchase Nexen by the China National Overseas Oil Corporation (CNOOC) has, given the size of the purchase (over $15.2 billion), drawn widespread public and media attention in Canada and abroad. While there has been a quickening pace of Chinese investment in recent years, particularly since 2009, the Nexen purchase is an order of magnitude larger than previous Chinese purchases.

The China Institute of the University of Alberta has polled Albertans on questions related to Chinese ownership in Alberta, particularly of the oil sands. When comparing the China Institute poll results to the broader polling conducted by the Asia Pacific Foundation of Canada, Albertans tend to be more comfortable than other Canadians with foreign ownership in general, and with Chinese investment in particular. While the government, media and people in Saskatchewan in 2011 were critical of a bid by the Anglo-Australian firm BHP to acquire the flagship Saskatchewan firm Potash, there are no signs of a similar wave of Albertan concerns over the proposed Nexen deal.

There are reasons for these divergent reactions. First, Nexen, while a large firm in the Canadian energy sector, does not enjoy the same profile in the Albertan corporate scene as does Potash in the smaller Saskatchewan economy. Secondly, the CNOOC bid was a “friendly” bid supported by the target company, while BHP’s bid for Potash was “hostile”, and opposed by the leadership of Potash. Furthermore, the Government of Alberta, including its Premier, has encouraged more extensive involvement by Chinese firms in the Province. There has been no criticism by the Alberta Government subsequent to the announced purchase, and Chinese energy delegations continue to visit Alberta, while the Premier visited China in June and will visit again this month.

Provincial views do matter, particularly when the resource is owned by the Province, which is the case with the energy properties owned by Nexen (although only a minority of Nexen’s assets are located in Alberta). However, the authority for approving the purchase of Canadian firms lies exclusively, at least in theory, with the federal authorities, and the Canadian Investment Act does not provide for any role by provincial governments. In reality, it is hard to imagine, at least with major purchases and where there is clear public or provincial government resistance to a purchase, that the federal government would not take into account the views of the provincial government and the populace of that province.

The broader question of how much foreign investment in a given sector is desirable is a separate issue. While the Canadian public’s reaction to the proposed Nexen deal has been muted, the same might not be the case if the Chinese acquisition target was one of the largest Canadian energy firms, or, a combination of such firms.

A productive discussion about this timely topic must go beyond the usual dichotomy. On the one hand, we should not necessarily be “afraid” of Chinese investments, although we do have to actively manage this growing trend (ideally, in a way that would address related environmental challenges as well).

On the other hand, the argument that Chinese companies are motivated by profit like other companies (and that we should therefore accept all Chinese investments) misses the point in other ways. The conversation about Chinese investment in Canada needs to be situated in the broader context within which deep transformations are occurring.

As the global balance of power transitions to one with a Pacific-based economic centre, and as China extends its economic reach, its influence on the functioning of global markets, including regulatory and governance issues, will grow. We are currently at the very early stages of this trend.

In many ways, this transition period is an opportunity for Canada; it has much to offer China in terms of a stable regulatory and banking environment, advanced models of corporate governance, advanced technology and environmental management skills, human linkages that span the Asia Pacific, as well as natural resources.

However, this period of transition is also characterized by much uncertainty. The capacity of a country like Canada to benefit from Chinese interest depends on a few conditions. At the national level, a long-term concerted energy strategy would help.

It would also help to improve our shared understanding of each other’s business culture and practices. In addition, Canada should engage China at a multilateral level, such as at the G20, and should focus on issues such as reciprocity and corporate governance standards, including those of state-owned enterprises. Canada can best achieve this multifaceted engagement in conjunction with the establishment of a coherent Asia strategy.

Calls for more transparency of the “net benefit to Canada” test, and of the investment review process more generally (by improving post-investment monitoring, for example), both of which are legitimate, are not specific to Chinese investments. As far as State-Owned Enterprises are concerned, specific guidelines were introduced in the review process in 2007, something that should be seen as a constructive step. Fears of Chinese investments in a narrow, short-term sense are thus in some ways short-sighted.

This much is clear: with economic rise comes more political power. US companies may be “motivated by profit,” but the US’s rise in the second half of the twentieth century was not just economic. Nor will be China’s; it will impact the global political economy of markets - and beyond. As China’s influence grows, we should make it a priority to understand how it might want to exert that influence, what it wants to achieve, what it is unsatisfied with at the global level, and why. Only then can Canada act as an informed participant in - and exert some influence on - this global transformation process.