Transcript Related and Supporting Industries

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:
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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
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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
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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
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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/18270/2011-0720/ontario-and-equalization-payments-have-notactually-means-has-no-oil
• http://ca.news.yahoo.com/blogs/canadapolitics/ontario-premier-dalton-mcguintychanges-tune-equalization-payments203439161.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
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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=27J
3CByXKow
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:
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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:
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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 interactiveness.
• 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:
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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).