A defence and a criticism of FDI in Canada

Is it a good use of public funds to attract foreign investment?

Photo by Mathieu Stern on Unsplash

Today I want to explore the role of foreign direct investment (FDI) in Canada. This is often a highly contentious topic. John Ruffolo, a leading venture capitalist in Canada’s tech sector and the Vice Chair of the Council of Canadian Innovators, recently had a viral LinkedIn post on this topic. He asked “When does this insanity stop?” following the federal government awarding a large contract to the multinational Ericsson with funding from the Strategic Innovation Fund added on top. Ruffolo argued that:

It is one thing that our governments do not routinely award procurement contracts to Canadian based companies, but it is a real kick in the teeth when they take our scarce tax revenues and hand it to foreign enterprises to compete against our Canadian enterprises. And for what? A few jobs. How about the jobs created by the Canadian enterprises - how much were they awarded with?

Ruffolo calls for greater procurement from Canadian enterprises. All levels of government frankly need to improve on this (and I recommend reading CCI’s excellent recent report on Strategic Procurement in the Age of Innovation for more detail). But instead of going down the procurement route, Ruffolo’s post got me thinking more about some of the arguments in favour of encouraging FDI, as well as some of the other arguments against it, and I thought I would write them up today.

The value of FDI to Canada

Recent research from the OECD highlights a few key facts about FDI in Canada that help establish a baseline of its value:

• Greenfield FDI is export-oriented. Foreign multinational enterprises (MNEs) are responsible for 57% of Canada’s export value and are more involved in Global Value Chains (GVCs) than domestic firms.

• Affiliates of foreign MNEs appear to be more productive than domestic firms in most sectors of the economy with the foreign productivity premium in finance and insurance, construction, and utilities 50% higher. This gap though is smaller with Canadian MNEs who also have greater access to trade networks, advanced technologies and innovation than other domestic firms.

• Affiliates of foreign MNEs are on average more R&D intensive than domestic firms and are considerably more engaged in innovative business activities, including product and process innovations as well as joint product development with other firms.

• Over the past five years, R&D investments have made up a large part of greenfield FDI in creative industries (91%), financial services (42%), and ICT and electronics (34%).

• There are spillovers and benefits to domestic firms, with foreign affiliates sourcing around 40% of total inputs from the domestic market, particularly from domestic non-MNEs - a similar share as in other large open economies such as the US, France, and Italy.

These are all notable contributions to the Canadian economy, and ones that go beyond just job creation (though foreign firms are responsible for around 13% of employment despite making up less than 1% of active firms).

To add to this, I had the great pleasure a few years ago of working with a great team of then-MGA students¹ at the Munk School on an innovation capstone project looking at knowledge and productivity spillovers from FDI and they highlighted a few other benefits that can come from FDI when done well. These can include the role of foreign firms as anchor tenants facilitating the growth of high-tech clusters as well as their role in enabling spillovers.

This can happen through domestic firms imitating innovation, through skills acquisition from MNEs that are transferred to domestic firms when people move roles, through heightened competition that increases the incentives for domestic firms to innovate, and through enabling domestic firms to export goods and services through learning from MNEs’ international networks.

One final note that is also worth mentioning, is that Canada is too small to have leading firms in every sector and every part of technology GVCs. With around 0.5% of the world population and around 1.5% of global GDP, there is no scenario where we can be self-sufficient for innovative ideas and products, even if we can get our act together to get better at commercializing Canadian research. Though strategically procuring goods and services from domestic firms should be a bigger part of the policy tool kit, there will always be an element of relying on foreign firms and technologies if we don’t want to impose huge costs on Canada through the misallocation of resources to inferior products.

The costs of FDI to Canada

Now, this isn’t to say that the impacts of FDI are only positive. There are significant costs that come with it that I think are under-appreciated by Canadian governments.

Dan Breznitz in his book Innovation in Real Places highlights this when calling out countries competing for new MNE research centres. Breznitz argues that:

While this might have led to innovation-based growth in the past, in the current world of fragmented global production, those R&D centers have a mostly negative impact on the local innovation ecosystem. Wages (and other perks) go up beyond the ability of local companies to compete; inequality jumps, since almost only R&D engineers are hired; social fragmentation increases, since most workers develop intese collaboration with other people within their firms around the world, and have very little time to get involved with the local high-tech community; and the innovative fruits of the R&D centers are transformed to the MNCs’ HQs and then outsourced around the world without ever creating jobs for the non-engineers (who end up paying most of the tax benefits awarded to those MNCs).

Other research published this Fall reinforces this by highlighting that when ownership of international knowledge connections of a city is concentrated in a small number of MNEs then the potential for knowledge spillovers is reduced and it reduces the attractiveness of any new R&D investments.

That is all pretty grim.

So what does this mean?

A few quick thoughts then on where this leaves us.

First, FDI still has a valuable role in our economy. Given Canada’s size, there will always be a need to bring in financial resources, technological innovations, and technical expertise from other countries. We’re too small to do it all. When done strategically, in areas complementary to Canadian industries, FDI can have a tangible, positive impact, helping boost overall productivity and increasing our exports.

But the crucial kicker is that it needs to be done strategically and in complementary ways. A blind faith in the benefits of FDI attraction, without reckoning with the costs that can follow, will not leave us in a good place. Yet this is too often the approach, both federally and provincially. FDI attraction agencies promote sectors where Canada has strength, then seek to bring in foreign investment that can harm those sectors and the innovation happening within them. The goal is too often getting a photo-op with a big cheque - not the long-term health of the economy or the local innovation ecosystem.

What would doing it strategically look like? Well, I think it would start off with more granular data on Canada’s place in different GVCs and the type of innovation happening across the country. Where are there gaps where plugging in MNES could help accelerate domestic innovators rather than hold them back? While there is a bigger role for government procurement for sure, another path is procurement by MNEs that helps local firms enter GVCs.

I think it would also mean an evolution in the kind of KPIs FDI attraction agencies are evaluated on. Raw volume and size of investments are crude measures. Instead, what do KPIs based on the overall health of the local innovation ecosystem look like? What about the number of local firms that the MNE is sourcing inputs from?

Finally, how do you also put policies and requirements in place that enable and enforce connectivity within the ecosystem to create spillovers? What strings need to be attached and what infrastructure do you need in place to begin with? Requiring the sharing of assets, such as collaborative research spaces or digital infrastructure, could ensure that MNEs don’t remain siloed and local innovators can reap benefits. Accompanying this with reformed policies and approaches around university tech transfer, as Kyle Briggs has argued for, would also help increase the domestic commercialization of research - reducing the transfer of Canadian-funded research into the hands of MNEs that can come with their presence here.

There is so much more that could be written on this topic. However, it is clear to me that this is an area where we need policymakers to think more strategically.

1. The Munk School team was made up of Alana Fawcett, Zissis Hadjis, Zach Johnston, Fatima Niri, and Erica Wilson.