Some Observations on Canada-U.S. Economic Relations

So the best I can do today on this issue of foreign ownership is to summarize my views on the subject, which generally are against the prevailing trend of imposing restrictions on foreign investment. But before I summarize my position I want to make clear the basis from which I speak.

First, I am not against doing things in response to national sentiment and aspirations. If there is a well-founded national sentiment in Canada for Canadians to own more of the economic activity of the country, then I would hold it is legitimate and appropriate to respond to that sentiment. That is part of the democratic process. A country should be what the voters want it to be but--and this is an essential "but" only after full investigation of the facts and full debate and airing of the issues. Let us not respond before we know what the best response is. It is the responsibility of all those who have thought long and hard about the issues to ensure that the debate takes place and to make their voices heard before a decision is taken.

So I am not against responding to a legitimate and informed national sentiment. What I am against are inappropriate, harmful methods founded on bad arguments or inadequate information for bringing about what is wanted.

As I said just a little over a year ago at an institutional investor conference in New York: "Despite the economic benefits- faster economic growth and a higher standard of living--that foreign direct investment brings to Canada, it is understandable that Canadians may have a sense of uneasiness when a large proportion of Canada's economic activity is owned and controlled by non-residents. Even without this uneasiness, it is natural enough for Canadians to want to own more of the economic activity in Canada, or at least to prevent a further reduction in the degree of Canadian ownership and control. The crucial question then becomes: Can this national sentiment be satisfied without imposing restrictions on foreign direct investment and ownership and without undertaking costly buy-back schemes that would reduce or cut off the benefit of foreign direct investment?"

I answered my own question in the affirmative.

Basically, the way to greater Canadian ownership, I argued and still argue, is to eliminate artificial constraints on Canadian ownership such as may inadvertently exist in our laws, regulations, or institutional arrangements. In addition, we should do everything we can to continue to develop our entrepreneurial talents, our capital markets, and the growth of our economy.

This led me to the following conclusion at the New York conference:

"In general, given sound policies at home and a reasonable legal and economic framework, the course of economic growth and development should bring Canada naturally to a stage of greater economic maturity, at which time Canadians will be able to own as much, or as little, of Canada as they wish."

It is my hope that every opportunity will be granted to test the validity of this conclusion.

I make this plea because there are those who doubt that any reduction in foreign ownership and control in Canada can be achieved by natural means. They pessimistically conclude that once a substantial proportion of economic activity passes under the control of foreign-owned corporations, it may become impossible to reverse the situation. In support of this pessimistic conclusion, references are made to the large size of foreign-owned operations and their concentration in faster growing areas of the economy.

However, I would not rule out a changing economic and social climate making it not only natural but attractive for ownership to shift gradually from foreign to Canadian hands.

And what is there to say that size of enterprise is any necessary barrier to change? For one thing, size does not necessarily guarantee efficiency. For another, the economic future of Canada may lie not with the giants of today but with the medium-size firms of tomorrow, in which Canadian ownership might be the more natural thing.

In any event, my own inclination is to continue with a basically "open-door" approach to foreign investment, relying on the natural forces of change to determine how much or how little the door should remain open.

It is, after all, not very flattering to picture the Canada of the future as a country where its residents only own what they do by virtue of Government decree. As a Canadian, I would like to think we are developing an economy that can stand on its own without the support of special protective measures. I hold that Canadians are capable, over time, through their own efforts, of owning more of their own economic activity, without needing to rely on artificial restrictions to bolster these efforts.

Now, some may say that it is all very well for a banker to speak in this way, for after all are not the Canadian banks protected from foreign take-over and foreign competition in Canada?

It is true that the changes made in the Bank Act in 1967 now prevent foreign banks from setting up in Canada or taking over existing Canadian banks. The Act now also severely limits non-resident share ownership in Canadian banks. However, these foreign investment restrictions were imposed on the banks without consultation; they were not requested by the banks and were neither wanted nor thought necessary by many of us. The Government view prevailed.

It is, of course, natural that some might assume that banks would favour shutting out foreign banks from Canada. Others might say "the less competition the better, so how can any banker be against curbing competition from foreign banks?" Well I for one am! I am against curbing competition from foreign banks in Canada on the simple grounds that such an approach is very shortsighted. If Canada excludes foreign banks, it will be only a matter of time--indeed it is now happening in some parts of the world--before Canadian banks are excluded from or restricted in operating in other countries. And Canadian banks, as is well known, have a long and distinguished history of providing banking services outside this country, particularly in the Caribbean and South America.

Furthermore, in this world of multi-national corporations, we need multi-national banks. If Canadian banking is to continue to give the kind of world-wide service that a modern economy requires, Canadian banks must continue to grow internationally. Excluding foreign banks from Canada is not the way to guarantee this. In particular, I would welcome them on a reciprocal basis. That is, let them do in Canada what Canadian banks are variously permitted to do in foreign jurisdictions.

There are also some other misunderstandings concerning Canadian banks and foreign ownership in Canada. Emotional statements are made criticizing Canadian banks for financing the take-over of Canadian firms by nonresidents. It is said we are providing the funds for the sellout of Canada. I am not at all sure that we are.

But what if we are? Is the criticism justified?

The criticism implies that if financing from Canadian banks were not available the foreign take-over would not go through. Such is not the case. A multi-national corporation buying into a Canadian operation makes its decision on the merits of the case. Financing is a secondary consideration. A multi-national corporation has many ways of financing its acquisitions. Borrowing from Canadian banks is only one. It is a tribute to the efficiency of a Canadian bank if it can compete with a whole host of foreign financing sources and win the business. It means that something gets done in Canada rather than elsewhere. It means that a Canadian financial institution increases its profit to the benefit of its depositors, and shareholders and, alas, to the Government through paying more taxes. If Canadian banks could not do the financing it would be done elsewhere, and the acquisition would still go forward.

Moreover, financing mergers and take-overs need not and does not deprive other bank borrowers of funds. Normally, there are enough funds to take care of all credit-worthy borrowers at going rates. In those distressing times of extremely tight money when credit rationing has to be imposed, it will be the loans for the special situations, such as for take-overs, that will be declined--be they Canadian or foreign takeovers.

There is also some misunderstanding of the merger and acquisition services provided by the larger Canadian banks. Canadian banks do try to bring potential sellers of Canadian firms and productive assets in touch with potential buyers, some of whom are bound to be nonresidents. In providing this type of service--and there are others more active in this than the banks--Canadian banks are helping sellers of Canadian assets to obtain the highest price--a right it is generally agreed that any owner and developer of an asset is entitled to. But there must first be potential sellers. Without them, nothing can be done.

I have also heard it alleged that Canadian banks in their lending activities favour non-resident owned enterprises in Canada over Canadian ones. This is not so. In lending funds, Canadian banks assess the competence and strength of the management and the soundness of the loan. Merit, not nationality, determines the loan.

Specifically, what counts, apart from safety, is the use to which the funds will be put in furthering profitable and productive activity in Canada. Loans wisely made, and made on that basis, contribute to economic growth, development, and employment in Canada, regardless of the nationality of the borrower.

And this must hold even in the case of offering financing to merger groups, where the potential acquirers may include both resident and non-resident bidders.

After all, I believe that foreign-owned enterprises in Canada are as good corporate citizens as Canadian-owned enterprises. Where problems do arise they are usually the result of external laws or misunderstandings, and these can be dealt with more easily, and in less costly ways, than through outright prohibitions on foreign ownership or through complicated buy-back arrangements.

The question of foreign ownership is, of course, an important issue in Canada-U.S. economic relations. It has been a relatively longstanding one. But two other issues have come into prominence over the last few months as a result of international monetary developments. These involve the matter of bi-lateral negotiations between Canada and the United States, and the Canadian dollar and foreign exchange reserves.

The current issue of bi-lateral negotiations between Canada and the United States is tied in with the so-called Smithsonian agreement of last December covering the multinational currency re-alignments. These negotiations, on what are billed as trade irritants, are still uncompleted. This is most unfortunate in this election year--for sure in the United States, probably in Canada. Election times are never the best of times for bringing about understanding or promoting cool reasoning, if for no other reason than that a government fighting an election cannot be seen to be giving ground to another country.

Fortunately, the stability, or lack of it, in the current international monetary situation does not depend on the outcome of the Canada-U.S. negotiations. Canada with her "clean" dollar is not one of those countries still accumulating U.S. dollars. And it is these continued involuntary accummulations at the present time that pose the threat to the stability of the international monetary system.

This is not an argument for Canada not to negotiate with the United States. But recalling that the fate of the world does not depend on such negotiations helps to relieve some of the sense of urgency and anxiety. It should also help to put these negotiations in a better perspective.

We should by all means negotiate with the United States but the negotiations should be relevant. They should be relevant in terms of what it is proper for Canada to negotiate with the United States.

Where, for example, we have joint agreements with the United States, and these call for review, we obviously must in good faith negotiate when the other party so wishes. Hence, we must negotiate when asked, on such things as the auto agreement and the defence-sharing pact. We should also be ready to participate in multi-lateral negotiations to reform the international monetary order.

But matters that are the exclusive responsibility of an individual country and not the subject of special agreements are not the proper concern of bi-lateral negotiations between Canada and any country. For example, increasing Canada's customs' exemption for returning resident travellers whether considered a crucial matter or an unimportant one, or a question of encouraging "truth in declaring" or of discouraging smuggling--is something that should be decided by Canada alone and not in consultation with some other country. To do otherwise is to surrender sovereignty. And in general I am not in favour of Canada bartering away any of its sovereignty for favours or concessions.

Related to negotiating with the United States are the current discussions about what to do with the Canadian dollar and Canadian exchange reserves.

The United States, I presume, would be pleased to see an even stronger Canadian dollar and would, no doubt, be happy if Canada artificially pegged its dollar above existing market values. But to keep our dollar artificially appreciated would mean tight money--high interest rates--and holding back our economy to give strength to our exchange rate. This is not a very palatable policy and seems unnecessary for bringing about international monetary stability.

Within the country, however, some would counsel pegging the Canadian dollar at much below current levels. This would require stimulating the economy, through very easy money, to weaken the Canadian dollar with resultant fanning of the still-smouldering fires of inflation. But we have had enough problems in the past in trying to maintain an artificial level for the Canadian dollar much below where the market would have it. I need only refer to May 1970 as the last time Canada encountered difficulties because of this.

But the fundamental question for exchange rate policy that a government has to decide on, in my view, is not at what level the exchange rate should be, but whether the exchange rate should be fixed or floating. Only when a government decides that it will choose a fixed rate does it then need to answer the subsequent question of what that rate should be.

If, however, a country opts for a clean floating rate, the government does not have to decide what the rate should be. The market will answer that question. The market answer--that is, the free level of the rate--will reflect a country's relative productive efficiency and its economic policies, including monetary policies.

Now I know there is some reluctance to accept passively a market level for the exchange rate. There is a tendency to let the level of the exchange rate dictate or determine the proper course for monetary policy. For example, if the authorities take a view of an exchange rate level as being too high, they may let that influence them to adopt an easier monetary policy, for that reason alone.

I do not consider this dirty floating. Cleanliness here, to me, means staying out of the exchange market either as a buyer or as a seller other than for smoothing purposes. But I do consider it inappropriate to let the exchange rate determine monetary policy.

I believe that monetary policy should be determined by the way the economy is performing. That is, if over-all domestic conditions call for easy money, then easy money it should be. The level of the exchange rate will be the outcome of that decision, as it should be. This is letting the exchange rate be determined by what should be done at home rather than letting the exchange rate dictate what is done.

Accordingly, to adopt a view of what a free exchange rate should be and to act on that view is to give up the right of a cleanly floating country to determine its own monetary policy for internal purposes.

There has also arisen in some quarters the unfortunate and completely unnecessary, indeed unworkable, suggestion that exchange controls be established. With controls, it is argued that the monetary authorities can impose the kind of monetary policy they want for domestic reasons, while preserving the exchange rate at some desired level. For example, it is suggested that these days we might want tighter monetary conditions but to act on that basis would mean a Canadian dollar stronger than some people think appropriate. Hence, goes the misguided argument, impose exchange controls to keep the Canadian dollar from rising when monetary policy is tightening up.

Now, admittedly, exchange controls are only being suggested for short-term capital flows. But can short-term capital flows be that easily identified? How do you tell them from long-term capital flows or from normal commercial payments without looking at all transactions?

I doubt that any such thing as partial exchange controls is feasible. Some may remember war-time exchange controls, their complications and their fostering of black markets in foreign exchange. And that was with the support of war-time psychology.

Do we want to revert to all that? Do we want a situation where we have to get a permit to finance a week-end in New York or even a drive to Buffalo?

Is this what we want? More controls, more regulations? Yet, this is what might come if we try to hold the exchange rate at a level inconsistent with the monetary policy we want.

Questions concerning the proper use of exchange reserves are also being raised at this time as well. Since the formal closing of the U.S. gold window last August, a number of "dollar-disposal" schemes have been advanced.

What are countries to do, it is asked, with holdings of U.S. dollars considered excessive now that the prospects of an early return of the U.S. dollar to convertibility into gold seem remote?

In a way the question intrigues me. In the days of gold convertibility the only thing countries could think of doing with their U.S. dollars was to convert them into gold. Now gold, despite its many fine qualities, is not a particularly productive asset. Some countries were content to hold it, even though it yielded no interest. Now that this non-interest bearing asset is no longer available, it suddenly seems important for countries to do something better with the U.S. dollars they do not want.

But why? U.S. dollars invested at interest are a better yielding asset than gold, at least in my opinion; so I wouldn't see the need for any country to do anything more with its excess U.S. dollar holdings than invest them wisely in short-term U.S. Government securities.

To use U.S. dollar holdings in a more aggressive way, such as to buy up U.S.-owned assets, either at home or abroad, is more likely to be upsetting than settling. It would get rid of the dollar "hang-over" all right, but it might kill the patient in the process. Retaliation and currency wars, dirty floating, and disorderly markets could all be the outcome.

In Canada's case, I would see nothing to be gained, and much to be lost, by the suggestion recently made in some quarters that the Canadian Government use some of its exchange reserves to buy up, through the New York stock market, shares in U.S. parent companies of Canadian subsidiaries. Even if a controlling interest could be acquired in this way in some of them, I doubt that this roundabout buyback Canada scheme would mean any beneficial change in the operations of the Canadian subsidiaries. Would you believe that a government could operate these businesses more successfully than businessmen trained for the job and motivated by the desire to be efficient and profitable?

And to use our exchange reserves for a direct buy-back Canada scheme would be even worse. It would mean, in some cases, forced sales by unwilling sellers and government ownership of Canadian firms. Do we really want the Government to own some of our major companies? If we do, that should be a decision we make openly, not under cover of using up our exchange reserves. Again, the basic decision is not one of financing, but one of determining what the objective is.

Should the objective be to return some day to a fixed rate which, of course, I would not advocate, the investment of our exchange reserves in non-liquid forms would rule that out. If some Minister of Finance, at some future date, wanted suddenly to peg the Canadian dollar again, and our exchange reserves were not available to support his intentions, he would really be in a fix. Because, of course, a fixed exchange rate means ultimately another exchange crisis. That has been the history of fixed exchange rates everywhere and, in this case, history would be bound to be repeated. However, I will resist the temptation to endorse the proposal for non-liquid investments of our exchange reserves as an appropriate manner of safeguarding us from any ill-considered move to put Canada back again on a fixed exchange rate.

If I were a frivolous person, which I hope I am not, I would suggest that if we wish to use up our exchange reserves in a productive or constructive way, we could do so by giving them to the United States as a grant in aid. Our plea might be "take our reserves and leave us alone"--a "buy-off" rather than a "buy-back" approach. But I do not believe in bargaining for our rights. What is ours by right, we press for, and what is relevant to negotiate for, we negotiate willingly.

So, if there is a message to be extracted from these observations on Canada-U.S. economic relations, it would be this.

National sovereignty is guaranteed not through discrimination against foreign investment, not through "horsetrading" bi-lateral negotiations, and not through taking a view of the exchange rate--it is guaranteed by using the impetus to growth provided by foreign investment to further our national aspirations, by taking full advantage of a clean floating exchange rate to set monetary policy solely according to domestic economic conditions, and by negotiating on relevant issues To do more is to surrender national sovereignty; to do less is to forgo opportunities to be sovereign.

Mr. McLaughlin was thanked on behalf of The Empire Club of Canada by Mr. Sydney Hermant.

EDITOR'S NOTE: Mr. McLaughlin was the eighth speaker before The Empire Club in the 1971-72 season who spoke on the controversial issues of foreign ownership and our relations with the United States. His address should be read therefore in the context of the other addresses in this volume on the same subject. (See Editor's Note on page 57.)