Key themes for Final

Michael Porter

• Michael Porter is one of the world’s most preeminent authorities on corporate strategy and the competitiveness of nations.

• He has developed numerous economic theories and models to help ascertain competitiveness and strategy.

• We will look at two: Porter’s Diamond Model and his Five Forces Model

Porter’s Diamond• Porter’s Diamond is helpful

in assessing the position of a nation in global competition.

• 4 main factors, with two outside factors:– Factor conditions– Demand conditions– Related and Supporting

industries– Firm strategy, structure and

rivalry

Porter’s Diamond

• Factor Conditions: determinants such as infrastructure, skilled labour, resources, etc. which can give a firm or nation an advantage over another.

• Demand Conditions: What do consumers want?• Related and Supporting Industries: Do we have the

subsidiaries to make our industry successful? i.e. a car manufacturer needs access to quality auto parts manufacturers.

• Firm Strategy, Structure and Rivalry: Does domestic rivalry spur on innovation? Make firms competitive?

Porter’s Diamond

• Chance Events: developments outside of a company or governments control, such as extreme weather or national disasters, wars, technological break throughs, etc. can influence the diamond’s results indirectly.

• Government: can enact policies that influence each of the four determinants.

Porter’s Diamond

• All of these factors (the 4 direct and 2 indirect) can have a major impact on the success or failure of a company and/or nation in any industry or venture

Porter’s Five Forces

• While the Diamond Model deals mainly with a nation’s ability to compete, the Five Forces Model deals mainly with industry and corporations.

• The 5 Forces are:– The threat of entry of new competitors– The threat of substitute products or services– The bargaining power of customers– The bargaining power of suppliers– The intensity of competition

Porter’s Five Forces

The Stern Diamond

• Also called the Diamond of Sustainable Growth, this was developed by economists at NYU’s Stern Business School.

• It is modelled after a baseball diamond, with each base representing a different stage in development. The idea is to get to home plate.

The Stern Diamond

• Home Plate: Non-predatory government• First Base: an efficient financial system• Second Base: entrepreneurs• Third Base: modern management• For a country to get rich, they start at home plate

and progress through each base, arriving again safely at home.

• A country can be evaluated based on what base they are currently on.

The National Policy

• Sir John A. Macdonald sought to strengthen the new Dominion both at home and abroad

• It was based on high tariffs to protect the manufacturing industry. US firms were dumping surplus goods into Canada at below costs.

• Macdonald hoped that by creating a strong manufacturing base in Canada, the nation would become far more secure and less reliant on the United States.

The National Policy

– Construction of railways to link the two coasts of Canada and aid in the movement of goods.

– Encouragement of immigration to Western Canada.

– Exercise of residual legislative powers to establish a strong central government to unite, expand, develop and settle a newly established nation.

Tariffs

• If a country's major industries lose to foreign competition, the loss of jobs and tax revenue can severely impair parts of that country's economy.

• Protective tariffs have been used as a measure against this possibility.

• The disadvantages of protective tariffs are that they increase the price of the goods subject to the tariff, disadvantaging consumers of that good or manufacturers who use that good to produce something else

Negative Side Effects of Tariffs

• It leads to the substitution of higher cost domestic products and lower cost imports.

• Protectionist quotas can cause foreign producers to become more profitable, mitigating their desired effect.

• This happens because quotas artificially restrict supply, so it is unable to meet demand.

• As a result the foreign producer can command a premium price for its products.

Influence of Tariffs

• Reduces both imports and exports• Collapse of trade when tariff barriers

increase• The decline of tariffs are often accompanied

by growth of non-tariff barriers

The Role of Governments

• Power Broker• Benefactor• Regulator• Protector

Definition of Federalism

• Distribution of power in a federation between the central authority and the constituent units (as states or provinces) involving the allocation of significant lawmaking powers to those constituent units

• A system of government in which power is divided between a national (federal) government and various regional governments.

The Unitary State: An Alternative to Federalism

• Power is located in one central authority.• Local authorities are subordinate to the central

power.• The legislature may remove the power granted to it

by the central government.• Example: Municipalities are subordinate to the

provinces in Canada. Their decisions can be overruled by the provincial legislature that they are under.

• Great Britain is an example of a Unitary state

Dual Challenge of Federalism• A federal state must

attempt to build a national strategy.

• Develop a transfer payment policy that redistributes Canada’s wealth fairly.

• A federal state must attempt to appease regional interests.

• Example: Canada must help poorer areas of the country with tax dollars generated in Alberta, British Columbia, Saskatchewan and Newfoundland.

• Result: Alberta, British Columbia, Saskatchewan and Newfoundland send more money to Ottawa than they receive in services.

Federalism in Practice

• This arrangement not only allows provincial governments to respond directly to the interests of their local populations, but also serves to check the power of the federal government.

• The federal government determines foreign policy, with exclusive power to make treaties, declare war, and control imports and exports; Provincial governments oversee the provision of education, health care, social services and the creation of municipalities.

Federalism in Practice

• Neither level of government can subordinate or overrule the authority of the other.

• The power of the central authority (i.e. the federal government) extends throughout the country and is “higher” than the power of each regional authority

• In the event of inconsistency between federal law and a provincial law, it is the federal or national law that prevails.

Money and Federalism

• Fiscal and administrative arrangements are a key component of federal-provincial relations.

• How much and who gets what is the defining question of the Dominion of Canada.

• Politics plays a key role, but there are other elements.

Federal Activism

• Since World War II, Feds increasingly involved themselves in Provincial affairs.

• Used transfer payments to coerce the provinces into adopting new national programs.

• Conditional grants can distort provincial budgetary priorities.

• The federal government can increase their influence in areas of Provincial jurisdiction.

Equalization Payments

• Equalization payments have mostly been criticized by leaders of the wealthy provinces. Premiers of oil rich Alberta and Ontario with its large manufacturing base have both criticized the drain on their citizens' finances.

• Some economists also believe that they have contributed to the Martimes' longstanding economic backwardness. Under the current system there is no encouragement for an area to develop new profitable industries.

• Example: Newfoundland and Nova Scotia off-shore oil deals (Atlantic Accords)

Equalization Payments• What is Equalization?

– Equalization is the Government of Canada’s most important program for addressing fiscal disparities among provinces. Equalization payments enable less prosperous provincial governments to provide their residents with public services that are reasonably comparable to those in other provinces, at reasonably comparable levels of taxation.

– The purpose of the program was entrenched in the Canadian Constitution in 1982:

"Parliament and the government of Canada are committed to the principle of making equalization payments to ensure that provincial governments have sufficient revenues to provide reasonably comparable levels of public services at reasonably comparable levels of taxation." (Subsection 36(2) of the Constitution Act, 1982)

– Equalization payments are unconditional – receiving provinces are free to spend the funds according to their own priorities.

http://www.fin.gc.ca/FEDPROV/eqpe.html

Equalization Payments• Equalization reduces fiscal disparities among

provinces. • Equalization payments enable less prosperous

provincial governments to provide their residents with public services that are reasonably comparable to those in other provinces, at reasonably comparable levels of taxation.

• Newfoundland, British Columbia, Saskatchewan and Alberta not to receive Equalization payments.

• Currently at $14.7 billion a year.

Equalization Payments• Until the 2009-2010 fiscal year, Ontario was

the only province to have never received equalization payments; in 2011-12, it will receive $2.2 billion in equalization, up from $347 million in 2009-10

• Quebec receives $7.8 billion. Why?• http://greenparty.ca/blogs/18270/2011-07-20

/ontario-and-equalization-payments-have-not-actually-means-has-no-oil

• http://ca.news.yahoo.com/blogs/canada-politics/ontario-premier-dalton-mcguinty-changes-tune-equalization-payments-203439161.html

Impact of Federalism on Business in Canada

• Industrial incentive programs may accrue to multinational companies in foreign countries.

• Could lead to ‘bidding wars’ between neighboring provinces or countries to secure the relocation of large companies.

• Government intervention can create artificial marketplaces.

What is Protectionism?• Using Tariffs or other non-tariffs barriers to

lower importation of goods.• Attempts to strike a competitive balance

between imports and domestically produced goods.

• Contrasts with the free trade model, the goal of which is to eliminate barriers to trade.

What is Protectionism?• Protectionism tied to Mercantilism.• Sought to achieve a positive trade balance

by limiting imports.• Modern economists feel protectionism

impedes economic growth.• Most modern nations turn to protectionism

to help industries deemed to be of great political importance.

Arguments for Protectionism

• To develop new industries and allow them time to become competitive.

• To ensure that required goods will not be impacted by war.

• To protect against product dumping.• To influence the redistribution of income.• To expand employment

The History of Canadian Protectionism

• The Reciprocity Agreement of 1854• The National Policy of the 1870’s• The Reciprocity Agreement of 1911• The General Agreement on Tariffs and

Trade in 1947 (GATT)

GATT

• General Agreement on Tariffs and Trade functions as the foundation of the WTO trading system.

• It is an international agreement that intends to limit tariffs and other trade barriers.

• http://www.youtube.com/watch?v=27J3CByXKow

World Trade Organization• The WTO was created on January 1, 1995

to replace the General Agreement on Tariffs and Trade.

• Deals with regulation of trade • Formalizes trade agreements• Dispute resolution panels • 153 members, representing 97% of the

world’s population, including Canada, currently belong to this organization.

Offshoring and Outsourcing

• Offshoring is the physical relocation of a plant or business to another jurisdiction.

• Outsourcing is the removal of part of a businesses internal process to an external company; in this context, that means to a company in another jurisdiction.

Offshoring and Outsourcing• What has the effect been in Canada?

– Both have seen the transfer of jobs to other jurisdictions.

– Increased demand in Canada for skilled workers, as most jobs affected are low- or unskilled jobs.

– Low value-added processes (payroll, call centres) are often outsourced.

– High value-added processes (human resources, financial strategy) stay here.

Offshoring and Outsourcing• The net result has been limited job losses

(low-skilled jobs replaced by high-skilled jobs).

• Requires a re-education of the existing workforce.

• Canada, due to its proximity to the US, can in fact lose some of its higher level functions to the US.

An era of Nationalization and Canadianization

• Nationalization is the act of taking assets into state ownership

• Occurs when government purchases an existing company or creates a new one

• Done to enable the government to manage the economy better in terms of long-term development and medium-term stability

• Give a recent example of where this is happening in the world?

An era of Nationalization and Canadianization

• The creation of crown corporations in the 1960’s and 1970’s, plus the ever expanding role of government after World War 2 helped kick start this era of Nationalization (Canadianization)

Critics of Nationalization• Claimed that government measures

distorted market values and resulted in inappropriate compensation.

• The impact of the recessions of the 1970’s and 80’s left governments broke.

• Governments turned from expenditure to inflation and budgetary control.

• Rise of Neo-Conservatism

The Neo-Conservative Movement

• The welfare state is important but no longer affordable. Causes structural problems in the economy.

• The public sector is too large and too expensive. Reductions are needed.

• Too much red tape and regulation.• Privatize crown corporations.• Need to cut taxes and balance the books.

The Welfare State

• Term first coined during World War II• Becomes very prominent in Canada in the

1960’s• Has three main provisions:

– Minimum income– Protection from economic insecurity due to

sickness, old age or unemployment– A variety of social services

The Welfare State

• While important, it is costly.– Deficits grew as government became involved in

more aspects of peoples lives.– Government grew; every new program needs

workers to administer it.– Governments became almost broke.

Crown Corporations• A common target of government for privatization is crown

corporations• A crown corporation is any enterprise that is substantially

owned by the government• It is an institution brought into existence by government to

serve a public function• It may function in many ways like a private company• The theory behind a Crown Corporation is that it is more

efficient than a government department because it is arm’s length from the government, allowing it to be run like a business

Crown Corporations

• Have the following characteristics:– A majority of the ownership must be vested in government– Management of its affairs must be relatively independent

from government– Its primary role must be to provide goods or services to

the private sector, not to the government– The prices its sets for these goods and services must

reflect the costs of providing them

Why does government create Crown Corporations?

• As nation building tool in the promotion of transportation, communication and resource development.

• As a means to promote regional development.• Unwillingness or inability of private firms to provide

important services.• Where the industry may lend itself to a natural monopoly

(power, water).• Where the industry might experience wide price

fluctuations and incomes (natural resource sectors).• Control industry that has “undesirable elements” in it

(alcohol distribution, gaming).

Some examples of early Crown Corporations

• Hudson’s Bay Company: while not owned by government, managed the majority of the land in Canada on behalf of the British Crown.

• Canadian National Railway: Created to prevent a bankruptcy and monopolization of an important industry.

• LCBO: Created to control the sale of alcohol (seen as an undesirable commodity)

Canada’s First Crown Corporation: CN

• Let’s set the stage:– Canada was in the middle of World War I– There were political divisions between English and

French Canada– 3 Transcontinental railways helped to create “The

Railway Mess”– Royal Commission on what to do with the

Canadian Northern Railway

The Railway Mess• 3 transcontinental lines for a population of 8 million lead to

overcapacity. The lines were not economically sustainable.• The government already had an equity position in the

Canadian Northern Railway from a bailout in 1913 and took over part of the Grand Trunk in 1915.

• The railways all had substantial debt.• Inadequate rolling stock.• Great Britain bans the export of capital.• Canada’s creditworthiness as a nation and its ability to

continue in the war effort were being called into question.• CNR and GT continued to ask for bailouts.

The Railway Mess

• To allow these two railways to collapse would have been devastating financially to Canada.– Provincial governments had provided financial

guarantees.– The Bank of Commerce would likely have failed as

CNR was heavily indebted to it.

The Crown Corporation: CN

• The Royal Commission minority report gave three options to Prime Minister Borden:– CNR take over the GT in the west– GT take over CNR in the east– The Government run the uneconomical linking

railway between Quebec and Manitoba

The Crown Corporation: CN

• The majority report recommended the government take over all rail lines except those operate by Canadian Pacific.– CP was worried about having to compete against a

government owned railway.– Ultimately the government agreed to this

recommendation.

The Crown Corporation: CN• The creation of this Crown Corporation was the best of

many undesirable choices:– The government was heavily invested in these railways already.– Collapse of the railways would have been devastating to our

banking industry and to our creditworthiness as a nation.– Pressures due to the war were contributing factors to the

failings of the railways.– Ultimately it was the government’s allowing for the creation of

the third line that brought the railways to the edge of disaster.• Government had no choice but to fix the problem them helped create.

The Attack on Crown Corporations

• Crown Corporations were attacked by their critics as being:• Costly• Bloated• Unresponsive• Unaccountable• That they compete unfairly against the marketplace.• They have outlived their useful lives

Privatization of Crown Corporations

• The reasons that government undertakes privatization are:• To improve efficiency• To reduce public sector borrowing requirements• To reduce government involvement in decision making• To gain political advantage

Foreign Investment in Canada

• Foreign investment is larger in Canada than anywhere else in the world.

• Why is this?– Proximity to the much larger US– Holdover from our days as a British colony

Foreign Investment in Canada

• The British supplied capital to help establish Canada, looking to reap the benefits of the natural resources here.

• Americans opened branches of their domestic companies, often to better access Canadian natural resources, or to avoid the tariffs of the National Policy.

• Foreign investment then has a long history in Canada, so when it came to cars this was considered a normal way to do business.

Foreign Investment in Canada

• Why didn’t Canadians start their own companies?– US firms had the enormous advantage of much

greater capital and experience and strongly established, valuable connections in the larger US marketplace.

– A Canadian firm catering only to the domestic market could not compete with the economies of scale enjoyed by US branch companies.

Foreign Investment in Canada

• Why didn’t Canadians start their own companies?– Canadians were already familiar with American

products through advertising in American publications readily available in Canada and due to the extensive travel that Canadians did to the US.

– Given these advantages, Canadian firms had a tougher time establishing themselves.

– Many that did become successful were ultimately purchased by larger US firms.

Negative Aspects of Foreign Investment

• Higher level functions (research and development, finance, marketing) are often done at the parent company’s head office depriving Canada of this high skilled labour.

• Any profits from the business activities conducted in Canada reside with the parent company, meaning these profits are leaving Canada.

Why does Canada encourage Foreign Investment?

• Foreign investment is preferable to no investment.

• Canadians reap the benefits of foreign investment through jobs, taxation and access to lower priced goods due to increased competition.

Globalization: What is it?• Describes the changes in societies and the world economy

that result from dramatically increased international trade and cultural exchange.

• A “shrinking of the state” in face of more world-wide pressures.

• Technology, particularly in communications and transportation, has increased this level of inter-activeness.

• Industrialization, advanced transportation, globalization, multinational corporations, and outsourcing are all having a major impact. Increasing international trade is the primary meaning of "globalization".

Globalization: What is it?

• Globalization in its complete form eliminates nation states.

• Globalization became more prevalent after World War II. The establishment of GATT and the WTO are examples of globalization taking root.

• Neo-conservative movements in the 1980’s are made possible through the development of globalization.

The principles that influence international trade

• International trade is the exchange of goods and services across international boundaries.

• For centuries under the belief in Mercantilism most nations had high tariffs and many restrictions on international trade.

• In the 19th century a belief in free trade became paramount and this view has dominated since then.

• In the years since World War II multilateral treaties like the GATT and World Trade Organization have attempted to create a globally regulated trade structure.

International Trade

• Enables a country to specialize in those goods it can produce most cheaply and efficiently

• Enlarges the potential market for goods of an economy

• Major force of economic relations among countries

• Is an extension of governmental policy

Reasons for Trade

• Resources are not completely distributed across the globe.

• The climate and terrain of a state.• The skills of its labor force.• The advantages of specialization

More on International Trade

• In 1990, International trade was approximately $8.76 trillion (US), double that of 1980. In 2005, that number has risen to $12.4 trillion (US) (this includes both services and manufactured goods)

• Driven by inflation and higher prices for commodities, the value of international trade in the United States increased nearly tenfold between 1958 and 1985. By 2006, the total dollar figure of international trade (both imports and exports) reached $312.5 billion (US)

On International Trade: Adam Smith

• Smith believed that international trade encourages a nation to:– specialize in production, leading to increased

output.– produce only those goods in which a country has

absolute advantage.

David Ricardo on the Theory of Comparative Advantage

• Comparative Advantage is the ability to produce a good at a lower cost, relative to other goods, compared to another country.

• Goods and services which a country should produce and trade with other countries is the goods and services that it produces more efficiently than other countries.

Economic Benefits of the Theory of Comparative Advantage

• International trade leads to more efficient and increased world production (best use of resources)

• It results in the expansion of markets (as specialization occurs, the need to trade with other nations to have access to certain products increases)

• It leads to growth in domestic employment (specialization leads to greater output)

• It stimulates the modernization and innovation of domestic companies (in order to keep your competitive advantage over others, you need to stay at the forefront of technological and innovative advances, or risk losing your position)

The Importance of International Trade

• Some countries export only to expand their domestic market or to aid economically depressed sectors within the domestic economy.

• Other countries depend on trade for a large part of their national income and to supply goods for domestic consumption.

What is a central bank?

• A central bank is a government created public institution that:– Issues currency– Regulates money supply– Controls interest rates– Has supervisory powers over the banking industry

• Regulates them• Imposes reserve requirements• Acts as a lender-of-last-resort to mitigate things like bank runs

– Is usually separate from government to protect it from political interference

Issuing currency• Money has a long history as a means of exchange. The value

of money was formerly tied to the value of the metal it was made out of (i.e. copper, silver or gold).

• Paper notes eventually replaced coinage as the main source of money, mainly because the weight of coins made them cumbersome for usage when large amounts of money were required.

• Currently, the central bank holds assets (foreign exchange, gold or other valuable assets).

• Based on the value of these assets, and on the sale of bonds to the public, currency notes are issued.

Money Supply

• Money supply is the total amount of money available in the economy.

• Money supply data is recorded at the central bank.

• This can be modified by purchasing financial assets or lending money to financial institutions.

• Commercial banks then increase this through fractional reserve banking.

Fractional Reserve Banking

• Banks maintain a portion (fraction) of their total customer’s deposits at the central bank in the form of a reserve.

• The central bank requires that banks keep a minimum amount in reserve, to cover the normal demand for withdrawals.

• The central bank oversees the activities of the commercial banks, provides deposit insurance to consumers and acts as a lender of last resort to commercial banks to bail them out in a time of crisis.

The Bank of Canada

• Canada followed the British banking system, with a limited number of larger banks with multiple branches.

• In the US independent local banks was the norm.• With our relatively small population spread out

in rural centres, the British model made more sense:– Branch banks required less capital than a full

independent bank.

The Bank of Canada

• The branch banking system lead for a very stable banking system since the branches spread the risk around the country.

• There was little need for a lender of last resort:– In the US, with its small banks they would often

find themselves with seasonal cash flow problems, and a central bank (the United States Federal Reserve) was a necessity.

Monetary Policy

• Monetary policy deals with the amount of money in circulation in the economy.

• The central bank adjusts short term interest rates to stimulate monetary expansion by helping to maintain a low and stable rate of inflation.

• The Bank of Canada sets the overnight interest rate.

Overnight Interest Rate

• This is the rate that banks use to borrow and lend to each other in short term transactions.

• Each day, banks have numerous business transactions. At the end of the day, depending on the day’s activity, they may end up with a surplus or a deficit.

• Banks with surpluses lend to those that have deficits.• The Bank of Canada sets this target once a month,

with a +/- difference of 0.25%.

Overnight Interest Rate

• The Overnight Rate is directly tied to the liquidity of the economy; i.e. the more money available in the economy, the lower the rate is.

• Liquidity is the access to cash or credit.• The Overnight Rate ends up affecting the entire

spectrum of interest rates:– The lowered overnight rate increases the demand for

credit.– Banks give out more credit.– The reverse is also true.

Increasing Credit Levels

• The more credit available, the more financial transactions occur for goods and services.

• The more that people are buying, the more physical money is needed.

• Banks buy new bank notes off of the Bank of Canada by selling government securities.

• These securities are assets for the government; bank notes in circulation are liabilities.

Inflation

• Inflation is the rise in the cost of goods and services in the economy over a period of time.

• If the cost of goods goes up faster than the rise in wages, the consumers buying power is less than it was previous.

• High inflation is bad for the economy.• An excessive growth in money supply can cause

inflation. If money supply occurs faster than economic growth, inflation will result.

Regional Economic Disparity

• Economic activity in Canada is localized.– 40% of economic activity in Canada occurs in

Ontario.– The majority of manufacturing occurs between

Windsor and Oshawa.– The financial services sector is headquartered in

Toronto.

Regional Economic Disparity• Remember Equalization Payments?

• Equalization reduces fiscal disparities among provinces.

• Equalization payments enable less prosperous provincial governments to provide their residents with public services that are reasonably comparable to those in other provinces, at reasonably comparable levels of taxation.

• Newfoundland, British Columbia, Saskatchewan and Alberta not to receive Equalization payments.

• Currently at $14.7 billion a year.

Regional Economic Disparity• This regional economic disparity is the reason

we have equalization payments.• The diversity of our country, its historical

development and the allocation of natural resources plays a major role in this disparity.

Regional Economic Disparity and Natural Resource Economics

• Obviously, natural resources occur in varying levels across the globe.– Ontario is blessed with minerals– Alberta is blessed with oil

Alberta Oil and its impact on Regional Economic Disparity

• Alberta’s growing energy-based wealth further heightened RED

• Our dollar is tied to the rise and fall of oil prices– When prices go up, our dollar falls– When prices go down, our dollar rises

• As Canada becomes more important globally as an exporter of oil, our dollar becomes increasingly tied to it.

Alberta Oil and its impact on Regional Economic Disparity

• A rising dollar hurts Ontario– Canada's economy is dependent on exports, with

about 85% of its exports going to the U.S. – Because of this, the Canadian dollar can be greatly

affected by how U.S. consumers react to changes in oil prices.

– A high dollar makes it profitable to sell oil to the US, but not manufactured goods.

Alberta Oil and its impact on Regional Economic Disparity

• Ultimately, the success of Alberta has come at the detriment of Ontario.– Ontario’s manufacturing sector had a comparative

advantage when our dollar was low relative to the US dollar.

– The increased reliance on the US to Canadian oil (it was in 2000 that we surpassed Saudi Arabia as the US’ largest importer of oil) has erased this comparative advantage.

The National Energy Program• In 1979-80, there was a 160% increase in global oil prices.• Inflation was high, as was unemployment in Eastern Canada• The federal government, in an attempt to garner more of the

economic benefits being generated by Alberta oil, introduced the National Energy Program.

• The main elements to this program were:– Oil self-sufficiency– Maintain oil supply– A greater Canadian ownership of the oil industry– Lower prices– Increase revenues by raising taxes on oil and gas– Encourage the use of alternative energy sources

The National Energy Program• Under the BNA, natural resources falls under the domain of

the provinces.• Albertans felt that this was an intrusion into provincial affairs

by the federal government.• It was seen as a benefit for the eastern provinces at the

expense of the west.– This was brought in by Pierre Elliott Trudeau and the Liberal Party, who

at that time did not hold a seat west of Manitoba.– Was this a crass political move to shore up Liberal support in the east,

or a sound public policy?

The National Energy Program• During the years of the NEP, it has been estimated that

Alberta lost between $50 billion and $100 billion.• Housing prices in Alberta dropped almost 40%• The bankruptcy rate in Alberta rose 150%• Brian Mulroney successfully campaigned on ending the NEP

and won the support of the West in the 1984 campaign– The NEP further alienated the West from the Liberal Party and was a contributor to the

rise of the Reform Party, forever altering Canadian electoral politics.

NAFTA and Oil

• NAFTA prohibits the Canadian government from imposing (under normal conditions) any restriction that causes U.S. imports of Canadian energy to fall.

• In essence, therefore, NAFTA does prevent the Canadian government from imposing a policy like the National Energy Program in the 1980s.

NAFTA and Oil• NAFTA does require that all buyers in North America have

equal rights to buy those products.• This means we cannot sell Canadian oil cheaper to Canadians

than we can to Americans.• This keeps our price of oil tied to the global price system.

– In fact, most oil used in the Maritimes is imported from overseas. Import costs are cheaper to the Maritimes via shipping than by rail from Alberta.

– So while we are predominantly an exporter of oil, due to regional differences and distances Canada still imports oil to certain areas.

Foreign Direct Investment

• When a company from one company makes a physical investment into another country, that is Foreign Direct Investment.

• FDI plays a major role in the international business community.

• It can provide a firm with new markets, new technologies and cheaper production.

• It provides the host country with new jobs, technology, capital and products.

Foreign Direct Investment

• Some of the Foreign Direct Investments we have discussed to date:– General Motors of Canada and Ford Motor

Company of Canada (Week5) – Sears, WalMart and Hudson’s Bay(Week 7)– INCO and the various oil companies (Week 8)

Foreign Ownership in Canada

• Canada has a high level of foreign ownership compared to other industrialized nations

• Manufacturing is the area with the most foreign ownership

• Foreign ownership of Canadian companies is preferable to no investment

Foreign Ownership in Canada

• Canada’s business leaders want foreign ownership rules for companies that own primary resources, like water, gas, and farmland, tightened to ensure Canadian ownership.

• For other industries, business leaders are seeking a loosening of rules and restrictions

Benefits of Foreign Ownership• Opens up Canada to the global market• Free trade also means free investment• Successive governments have crafted a tax and

regulatory system that is guaranteed to stifle home grown enterprise while, at the same time, making it essential to import the capital and talent that we fail to produce ourselves.

• Loosening the market to foreigners could result in so many positive outcomes, as long as the government authorities are able to protect the national interest.

BDO Document on Foreign Ownership http://www.bdo.ca/en/library/polls/documents/1213.pdf

Problems Created by Foreign owned Subsidiaries

• Concerns around foreign ownership of Canadian companies and interests are:– The ability of head office to establish prices for both inputs

and outputs or to transfer assets to their subsidiaries.– “The possibility of a foreign government less than fully

committed to free-market economics, law and liberalism. Such a company might attempt to tie politics and business, or might exert pressure to secure preferential treatment for a state-owned company operating in Canada.”

http://www.conferenceboard.ca/press/2005/OpEds/041201_FDI_Op-ed.asp

Problems Created by Foreign owned Subsidiaries

• Executive “brain drain” as Canadian executives are moved out of the country.

• Ancillary operations often done outside Canada: Research and Development, Marketing, etc.

• “While our free-market system sees competition and profit-maximizing behaviour as the best guarantors of economically efficient outcomes, a foreign government owning Canadian resources might choose to make an inefficient use of those resources for the sake of propping up government-controlled firms or sectors at home.”

http://www.conferenceboard.ca/press/2005/OpEds/041201_FDI_Op-ed.asp

What is the truth about FDI in Canada?

• Canada has been slipping behind as an attractive place for FDI.

• Canadian companies have branched out, and now own more foreign based business than ever before.

• Foreign investment is like trade in that it flows in two directions.– If Canada were to limit FDI here, the same could

be held against our firms.

What is the truth about FDI in Canada?

• In spite of concerns against FDI, Canada’s economy is outperforming most of the world.– Regional offices still provide many high level activities in

Canada.• In the case, “A New World at Inco” we are told that in

1972 the headquarters of Inco were in New York City! So there is no guarantee that a Canadian company will keep their head office in Canada.

• FDI introduces new capital.• Most manufacturing jobs in Canada are with multinational

firms.

Canada’s Black Gold

• The National Policy encouraged FDI– We saw that with the automobile sector

• Even in the resource industry, this was the case. However Canadian interests are protected through licensing agreements.

• Much of the oil that has been found has been so because of FDI encouraging prospecting for oil by foreign companies. They assume most of the risk, yet Canada shares in the benefits.

Canada’s Black Gold

• Foreign firms have invested in the refining process in Alberta.– Most of the petroleum that gets exported has

been refined.– In the case of mining, in many cases it is the raw

materials that are exported for refining elsewhere.– Oil and gas then lend themselves to an added

value business.

Regulatory Oversight and Reporting of the Canadian Financial Services Sector

• Both the federal and provincial governments share jurisdiction over the financial services sector.

• Banks are regulated by the federal Bank Act (way back in Week 1).

• 90% of life and health insurance companies are regulated under the federal Insurance Companies Act, but are also required to follow regulations of each province they do business in.

Regulatory Oversight and Reporting of the Canadian Financial Services Sector

• The federal government oversees financial institutions through the Office of the Superintendent of Financial Institutions (OSFI).

• This is mainly on deposit taking institutions, insurance companies and private pension plans.

Office of the Superintendent of Financial Institutions (OSFI)

• OSFI was established in 1987.• It was created through the merger of two

other agencies – The Inspector General of Banks (OIGB) and the Department of Insurance (DOI).

• The OIGB was established in the mid-1920’s, and the DOI was established in the very late 19th century.

Office of the Superintendent of Financial Institutions (OSFI)

• The government in 1984 stated its intention to review Canada’s financial system.

• Rapid change in the global financial system required that Canada modernize its oversight.

• The failure of the Canadian Commercial Bank and the Northland Bank in 1985 further spurred the need for change.

Office of the Superintendent of Financial Institutions (OSFI)

• The OFSI has two real functions: regulation and supervision.

• Regulation includes helping to develop and interpret legislation with regards to the financial services industry, issuing guidelines to financial service businesses and reviewing and approving requests from institutions regulated by the overarching legislation.

Office of the Superintendent of Financial Institutions (OSFI)

• Supervision is the assessing of the soundness of the institutions and pension plans, to make sure that they retain sufficient capital to operate in an effort to protect the rights and interests of all of those whose wealth is being managed by them.

Banking Regulation

• Why does the government regulate banks?– Consumers deposit their savings into banks. The

government wants to ensure that their money is protected from undue risk caused by actions taken by the bank.

– They also do so to root out criminal activity (like money laundering) that can happen through the bank).

– And as a means to ensure that there is sufficient credit available to keep the economy robust.

Banking Regulation

• Banks are given minimum requirements in which to be able to operate.

• Banks are required to have a certain amount of capital, determined by a measurement system (called the Basel Capital Accords) to minimize risk to the institution.

• The fractional reserve requirement discussed earlier in the course also applies.

Banking Regulation

• Other requirements include a strict set of corporate governance guidelines, financial reporting and disclosure guidelines and credit rating requirements (i.e. a rating from a rating agency such as Standard and Poor’s that indicates to investors and depositors how much of a risk this financial institution is).