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Archived - 2. Canada in a Global Context

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The global economic landscape has changed markedly in recent decades. Canada and our companies are adapting to these new economic realities, and must continue to keep pace with the rapid evolution of global commerce.

Globalization, in the economic sense of the word, refers to the sustained and rapid rise in trade and capital market flows between and among nations, along with an increase in international foreign direct investment (FDI). Global FDI stocks have increased dramatically in the past 25 years, with both inward and outward FDI reaching roughly US$12 trillion in 2006.2 (Figure 1) Trade volumes have also increased significantly, with world exports doubling in the past decade. World merchandise and commercial services exports rose by more than 10 percent in 2006, reaching US$11.7 trillion and US$2.7 trillion, respectively.3 Global export levels are also expected to increase in 2007 and 2008. Together, increased trade and investment flows have led to the greater integration of economic activity between countries and around the world.

Many factors have contributed to the sweeping forces of globalization. Transportation costs have fallen, resulting in an expansion of both the range of goods that can be exchanged and an increase in the distance over which they can be profitably traded. Advances in information and communication technologies fuel a radical change in how commerce is conducted, and drive the globalization of economic activity. As the costs of these technologies decline, firms have increasingly been able to spread their activities between and across continents.

Experience has shown that the opening of borders and increasingly vigorous competition spur innovation and an accompanying increase in productivity. This results in greater economic efficiency and generally higher-quality products available at lower prices. However, intense global competition also requires adjustment to new dynamics, and often a relentless restructuring of productive activity to reflect changing competitive realities.

When the Canada-U.S. Free Trade Agreement came into force in 1989, Canada embarked upon a new and ambitious path of globalization and openness to trade, one that built upon the positive experience of the Auto Pact. The Free Trade Agreement fundamentally changed the Canadian economic context – our economy became more integrated into the U.S. economy. In 1994, the North American Free Trade Agreement (NAFTA) advanced this integration a step further. These agreements reduce barriers for Canadian enterprises to expand in North American markets, but also submitted them to the discipline of competition on a continental, rather than on a national, basis.

Adjustment to the new competitive realities presented by the Free Trade Agreement and NAFTA posed challenges for certain industrial sectors. However, the overall effect has been positive for Canada and Canadians. Our economy has been reoriented from simply focussing on competition within the Canadian market to competing in a North American context. Globalization demands a similar reorientation, one where Canada and its firms change their frame of reference to competition on a global scale.

Globalization of Value Chains

One response to these new competitive realities has been a trend towards the globalization of value chains. The value chain describes the broad range of activities that are required to bring a good or service from its initial conception to the marketplace. Previously, a firm might conduct all the activities in the value chain within its home country. The global era, however, has been typified by the disaggregation of this chain of activity, with constituent elements of a single product being designed and produced in different countries and on several continents, raising the competitiveness of the overall production process.

Many Canadian firms have recognized the new global dynamic and have adapted their operations in response. Some firms have become multinational, detaching the labour-intensive activities of their operations and relocating them to countries where labour costs are more competitive. China and other Southeast Asian economies have been primary destinations for production work in the manufacturing sector, while India has been a prime destination for such work in service-oriented sectors. Other Canadian firms will compete by becoming parts of other firms' value chains.

In this context, the goal for Canada should be to make this country the locationof choice for the higher-value elements of these global value chains – whether led by Canadian firms or as part of others' supply chains – as higher-value productive activity translates into higher wages and salaries, more occupational choice and a better quality of life for Canadians.

How Canada Ranks against Global Competitors

With increased competition on a global scale, and different national jurisdictions competing to attract global capital, it is important to assess how Canada ranks against other global competitors.

Productivity Performance

A nation's ability to compete on the world stage is tied to a combination of factors that determine its level of productivity. Productivity is a measure of how well a nation's economy utilizes available resources such as capital, labour and raw materials to produce goods or services. Higher productivity translates into better economic performance and therefore a higher standard of living. In other words, productivity is intrinsically tied to national wealth and well-being.

Overall, Canada has shown signs of strong economic performance. However, Canada's productivity growth has been declining, particularly relative to that of the U.S., and continues to lag that of our main competitors. From 2001 to 2005, Canada's average annual productivity growth ranked twenty-first, well below the Organisation for Economic Cooperation and Development (OECD) average, and second lowest in the G7.4 (Figure 2) In 2006, Canadian labour productivity per hour worked was only 81.4 percent of U.S. levels, down considerably from 87.4 percent as recently as 2001.5 (Figure 3) The output per hour in the Canadian business sector grew by only 1 percent annually over the past five years, in contrast with 3 percent annual growth in the U.S. over the same period.6

Various factors have contributed to Canada's poor productivity growth. One contributing factor is an apparent underinvestment in machinery, equipment and technology, which are all important drivers in boosting productivity, because new technologies enhance efficiency while also spurring innovation and enabling the creation of new products and technologies. As well, Canadian businesses have lagged in workplace reorganization and worker training.7

Given demographic changes in Canada, with projections of an aging population and slower growth of the labour force, Canada's productivity performance will grow in importance as a determinant of the future well-being of Canadians.

Competitiveness Rankings

According to the World Economic Forum (WEF), in 2006 Canada ranked sixteenth among 125 countries in terms of competitiveness.8 This is down from thirteenth in the previous year. While the method used by the WEF has been modified over the past seven years, Canada has fallen markedly in the rankings, having been ranked third in 2001. A large part of this drop can be attributed to technology and innovation. In particular, Canada ranks below the OECD average when it comes to business expenditure on research and development (R&D), ranking second last among the G7.

In 2007, the Conference Board of Canada released their report card benchmarking Canada's competitiveness performance.9 The Conference Board called Canada's performance "mediocre" and ranked Canada fourteenth out of 17 comparator countries with respect to innovation. Switzerland, Sweden, Finland, and the U.S. respectively occupied the top four positions in the Conference Board innovation rankings.

Both the Conference Board and WEF reports agree that Canada's relative strengths lie in the areas of education and health, with a large pool of skilled workers, high-quality research institutions, and strong primary and secondary education.

Global business leaders from eight Canadian investor markets (Brazil, China, France, Germany, India, Japan, the United Kingdom and the United States) were interviewed early in 2007 as part of an Ipsos-Reid study titled Looking Towards Canada. Interviews were conducted with top-level executives at some of the world's foremost companies and, although Canada was generally perceived in a positive light, many respondents felt Canada lacked a "cohesive investment identity." Canada's R&D environment and superior workforce were primary strengths, and Canada's multicultural society and open immigration policies were noted as important building blocks for success in today's global economy. Commonly mentioned challenges to investment were Canada's small domestic market, and a perception of high business costs, including high taxes and high costs for lower-skilled labour. Overall, the Canadian brand, and Canada's specific investment advantages, were not well known.10

Globalization: Implications for Canada

While there have been challenges, it is clear that Canada and Canadians have benefited from globalization. Over the past decade Canada has performed well across a range of economic indicators. Domestic inflation has remained low. Our state of trade is healthy, with Canadian exports reaching an all-time high in 2006. Rising commodity prices have benefited Canada as a resource-exporting nation. The federal government's fiscal situation is solid, with ongoing budget surpluses and a decreasing debt burden. Unemployment is low compared with previous decades, and Canada continues to enjoy sustained economic growth that compares very favourably with many other leading nations.

The "Hollowing-out" Debate

Despite Canada's strong economic fundamentals, the recent increase in FDI inflows into Canada, particularly in the form of mergers and acquisitions (M&As), has raised concerns about diminished control and influence by Canadians over the domestic economy.

These concerns are the result of the pace of foreign takeovers of large, well-established Canadian companies – the so-called "hollowing out" of the Canadian economy. While a certain level of anxiety about foreign influence on the Canadian economy has always been present, this concern has been exacerbated by a recent series of significant takeovers, as Canadians have witnessed the acquisition of a number of prominent Canadian firms by investors from outside the country. From mining companies like Falconbridge and Inco, to retailers like the Hudson's Bay Company, foreign investors have found attractive takeover opportunities in Canada. The firms being acquired often have long histories in Canada, and have been anchors of communities across the country. The concerns that these takeovers have raised among Canadians are both natural and understandable.

In particular, these events have resulted in concerns in Canada about the effectiveness of the regime the government has in place to assess foreign investment. The rise in M&A activity has also fuelled a debate in Canada about the importance of domestically-controlled corporations and the benefits of the presence of company head offices. These worries centre on the loss of head-office functions and the valued-added jobs, decision-making power, research and development activity and commitment to building Canada that accompany a corporate headquarters, as well as associated functions such as high value-added consulting, legal and accounting services, and financial and underwriting services.

Concern has also been expressed about the impact that the loss of Canadian control of these firms will have on the wider communities in which they operate. Large firms are not only significant employers. They are often generous and influential donors to charities, and sponsors of community activity, and their executives are often community leaders. Many Canadians question whether foreign owners will demonstrate the same level of dedication to their communities, and continue to provide career opportunities for young Canadians.

Commentators have noted that, adjusted for the size of the economy, the number of Canadian companies acquired from 2001 to 2006 was the second largest total in the world after Australia, and the value paid was the second highest after the United Kingdom. They have also pointed out that since the beginning of 2006 the value of acquired Canadian companies leads all countries.11

Ontario's Institute for Competitiveness and Prosperity examined Canadian-owned globally competitive companies (defined as Canadian owned and headquartered firms that rank in the top five of their respective industry, as measured by the worldwide revenue earned in their industry, and having more than C$1 billion in annual sales in that industry12). Canada had only 14 such global leading firms in 1985, but this number had grown to 46 by 2003.13

The Institute also noted that the number of global-leading Canadian firms has declined since 2003, falling to 39 such firms at the end of 2006.14 This decline has coincided with several recent high-profile foreign takeovers. There has nevertheless been a significant net increase since 1985 in the number of Canadian firms that are global leaders.

This net growth, more than doubling the number of category-leading Canadian firms since 1985, suggests that Canada has benefited from globalization, building leading-edge globally-competitive companies. However this growth has been far from smooth. As a result of two decades of corporate consolidations and foreign acquisitions, several of Canada's global-leading companies operating in 1985 were no longer global leaders in 2005. In other words, while Canada has created a sizeable number of new global leaders in recent decades, the Canadian economy has also lost several leading companies.

Foreign Direct Investment: Recent Trends and Implications

FDI is a form of investment involving ownership which provides investors a significant voice in the management of an enterprise outside their own country. FDI can occur through M&As, new greenfield and brownfield investment, reinvested earnings, and cross-border loans and capital transactions between related firms. For operational purposes, a direct investor is defined as having at least 10 percent ownership of the voting equity in an enterprise.

Rising Global Value of FDI

Foreign direct investment has grown substantially in recent years, with global FDI inflows reaching US$1.3 trillion in 2006, against reported global FDI outflows of US$1.2 trillion.15 Similar to trends in the late 1990s, the recent surge in FDI reflects a greater level of cross-border M&A activity. The value of cross-border M&As reached US$880 billion in 2006, and the number of transactions rose to 6,974. These levels are close to those achieved in the cross-border M&A boom of 1999-2001.16 An additional feature of the recent global M&A boom is increasing investment by private equity and related funds.

Inward FDI

Canada ranked as one of the top 10 global destinations in terms of the total value of inward foreign investment flows between 1996 and 2005. Despite being the smallest economy in the G7, Canada nonetheless ranked fifth in terms of inward FDI flows over this period, ahead of larger economies such as Japan.17

FDI has for decades been a significant contributor to Canada's economic performance. As such, Canada's total stock of inward FDI as a proportion of gross domestic product (GDP) is high among mature industrialized countries, reaching 31.4 percent in 2006, much higher than the proportion in the U.S. (13.5 percent) or in Japan at only 2.5 percent.18 (Figure 4) Canada's share of North American inward FDI stock was 16.3 percent in 2005, an increase from 12.6 percent in 2001. This followed extremely high levels of inflows in the 1960s and 1970s.19

Canada's net inflows of FDI are also relatively high, accounting for 2.2 percent of Canada's GDP between 2001 and 2005, ranking third in the G7 behind the UK and France. Nevertheless, the OECD has highlighted Canada's high level of formal restrictions to inward FDI, and noted that the Investment Canada Act and various sectoral investment regimes impede Canada's ability to attract FDI.

The U.S. is Canada's top source of FDI investment. American FDI investment accounted for 61 percent of Canada's total in 2006, down from a share of 67 percent in 1995.20 (Figure 5) Other top investors included the UK, France and the Netherlands.

In terms of composition across industrial sectors, Canadian assets under foreign control have been relatively stable at approximately 21 percent since 2000.21 FDI in manufacturing is about 49 percent of total output. The other main sectors with a relatively high foreign presence are oil and gas, at almost 40 percent, wholesale trade at 37 percent, transportation and warehousing at almost 26 percent, and finance and insurance at about 15 percent.22

Mergers and Acquisitions

The most commonly reported subcomponent of FDI is M&A investment. M&As are a general term referring to the consolidation of companies. Cross-border M&As involve a foreign company making an ownership investment in a domestic company. In this way, M&As differ from other forms of FDI such as reinvestment of earnings and intra-company loans between parent and affiliate enterprises.

Recently, the largest part of the FDI flows into Canada is M&A activity. Canada accounted for 5.2 percent of world M&A activity at the end of 200623, higher than its share of the global economy (3.2 percent24). Recent firm and industry growth has been driven by M&A activity as many global industries seek to grow rapidly through consolidation. This has been the case in recent years in Canada with takeovers in the metals, minerals and energy sectors.

According to data from Statistics Canada, M&As accounted for 51 percent of inward FDI into Canada between 2001 and 2006, but accounted for 71 percent of inward FDI in 2005 and 2006.25 (Figure 6) By contrast, Canadian direct investment abroad in recent years has not been driven by M&A activity, instead primarily occurring through other investment flows such as the investment of capital into existing foreign affiliates.

According to these data, Canada's M&A investments abroad accounted for only 31 percent of average outward FDI between 2001 and 2006, and averaged only 16 percent of outward FDI between 2005 and 2006.26 (Figure 7) This implies a significant M&A imbalance in the past two years, with foreigners acquiring more of Canada's corporate assets than Canadian businesses acquired abroad.

Over a longer, six year time horizon from 2001, the data present a somewhat different picture of whether Canada is being disproportionately affected by the increase in foreign takeovers. Annual M&A activity rises and falls sharply from year to year and the value is considerably affected by a few high-value transactions. Between 2001 and 2006, Financial Post Crosbie: Mergers & Acquisitions in Canada shows that Canadian companies acquired 1993 foreign firms at a combined value of approximately $300 billion. Over this same period, 864 Canadian companies were acquired by foreign firms, at a combined value of $286 billion.27 (Figure 8)

With respect to head offices, a report by Statistics Canada has concluded that there was no decline of head office functions in Canada between 1999 and 2005.28

Longer-term Trends

Overall, the stock of Canadian direct investment abroad currently exceeds the stock of foreign direct investment in Canada. Statistics Canada indicates that Canadian direct investors held foreign assets totalling C$523 billion at the end of 2006, whereas FDI in Canada reached only C$449 billion.29 Americans are still the lead investors in Canada, and directly held investments of C$274 billion in 2006. Canadian direct investment in the U.S. totalled C$224 billion in 2006, an increase of C$19 billion from 2005. (Figure 9) This was mostly the result of capital outflows from Canadian firms to existing operations in their U.S. affiliates.30

The overall result is that despite a sizeable increase in recent foreign investment flows into Canada, since the mid-1990s Canadians have maintained a net advantage, building a larger net stock of investments abroad than foreigners investors have in Canada.31

As for M&A activity, the number of foreign firms acquired by Canadian firms between 2001 and 2006 significantly exceeded the number of Canadian firms acquired by foreigners. However, the total value of Canadian acquisitions over this period was only slightly higher than the total value of foreign acquisitions of Canadian firms, despite significant foreign acquisitions of Canadian companies in 2005 and 2006.32

Looking Ahead

The Panel is interested in understanding the factors that might make Canada more attractive than other countries as a location for company formation and development. The challenge is to create a business climate that will attract greater economic activity, including head office functions.

The Panel observes that the emergence of global supply chains and product mandates as a result of globalization and free trade has given rise to a new feature of business organization which sits at an intermediate point between the global, corporate head office and the production site. This intermediate point is the global product mandate centre, or divisional head office. The Panel is aware of some research on the social and economic significance of such entities, as well as anecdotal evidence thereof. However, the Panel would like to better understand this development and its implications for Canada, in particular, the extent, if any, to which public policies foster or hinder the attractiveness of Canada as a location for divisional head offices. The Panel also wishes to understand the advantages for Canada in being home to a divisional head office or lead R&D facility of a globally integrated company.

Small and medium-sized enterprises (SMEs) play a significant role in the Canadian economy. To improve their competitiveness, Canadian companies, no matter their size, must increasingly take a global perspective, including making acquisitions of foreign companies. As well, for some SMEs, being acquired by a larger firm, whether Canadian or foreign, is a welcome development; merging with a larger player is often the most effective growth strategy for small firms. The question is how to create the conditions for Canadian SMEs to further participate in global commerce.

While foreigners continue to find attractive investment opportunities in Canada, including acquiring leading Canadian firms, Canadian firms and investors are also making investments abroad. A question is why Canadian investors in the past few years have been relatively less likely to participate in cross-border M&A activity, instead focussing on portfolio investment and other forms of FDI.

International investment flows are typical of the global economy, and Canadian firms will need to continue to participate in global transactions in order to prosper. The challenge for Canada and our businesses is to ensure that we are prepared to compete globally: What policies would make Canada more attractive as a destination for human and economic capital while at the same time enhancing the potential for home-grown firms of all sizes to become global champions with head offices in Canada?

Globalization is real, and the implications for Canada's future are significant. This is not a time for complacency; developments in the global economy compel us to consider how best to move forward.


  1. Should Canadians be concerned about foreign takeovers of Canadian firms? How important is domestic control and ownership of Canadian business activities to Canada's economic prospects and ability to create jobs and opportunity for Canadians?
  2. How important are company headquarters to Canada's economic prospects and ability to create jobs and opportunity for Canadians? How important are global divisional head offices? What factors influencetheir location?
  3. How do Canada's policies impacting direct investment, both inward and outward, affect Canada's competitiveness as a destination for FDI and as a platform for global growth?
  4. Do Canada's economic policies appropriately reflect our increased integration with the North American and global economy? How might these policies be changed to better reflect this new competitive environment?