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The Benefits of Foreign Investment in Canada, 1950 TO 1956*

Published online by Cambridge University Press:  07 November 2014

Rudolph G. Penner
Rudolph G. Penner*
Affiliation:
University of Rochester
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Extract

During the 1950's and 1960's the high level of foreign investment in Canada has provoked a continuing public debate, but for the most part the controversy has raged unrestrained by any quantitative information on the potential benefit of foreign capital. The lack of data is understandable, for in attempting an estimate one encounters a multitude of conceptual and empirical problems that militate against any sort of precision.

Although it is impossible to be exact, I believe that the importance of the problem warrants making some rough guesses, and that is the task of this paper. My tools will be crude and there will be many compromises with reality, but by choosing my assumptions so that they impart an upward bias to my estimates, I can at least attempt to establish an upper bound to the true benefit of foreign investment. Even if the numerical estimates are not too reliable, making them forces us to separate the many issues related to the problem and to speculate on their relative importance.

It must be noted initially that the models of this paper consider only the benefits conferred by the inflow of real resources financed by foreign capitalists, and they do not take account of the technical knowledge and skilled personnel often accompanying direct foreign investment. My first model assumes that some new knowledge is implemented by foreign investment, but no more than would be implemented by the same amount of domestic investment. I consider neither the possibility that the technical change associated with foreign investment proceeds at a faster pace than that associated with domestic investment, nor the possibility that techniques introduced by foreigners have external effects. I take this narrow approach not only because it would be virtually impossible to isolate the impact of technical change introduced by foreigners but also because I do not think that foreign investment is necessary to the international transmission of technical information.

Les avantages de l’investissement etranger au canada, 1950–56

Les avantages De L’Investissement Etranger au Canada, 1950–56

L'objet de cet article est de mesurer grossièrement l'importance de l'investissement étranger au Canada. A cette fin, l'auteur suppose que le flux financier de l'investissement étranger est converti en entier en capital réel. L'effet de ce capital sur le revenu national est ensuite estimé suivant diverses hypothèses quant au rôle de la formation de capital dans la croissance économique. L'importance de l'investissement étranger est la plus grande quand on suppose que tous les changements technologiques sont incorporés au stock de capital. Le modèle indique que le produit intérieur brut de 1956 eut été réduit de 1.1 milliard en dollars de 1949 si l'investissement étranger net avait été éliminé au cours de la période, la main-d'oeuvre restant la même. Toutefois, comme la rémunération aux capitalistes étrangers a été accrue de $0.3 milliard à cause de l'investissement étranger, l'effet net de cet investissement sur le produit national n'est que de $0.8 milliard, soit 3¼ pour cent du PNB de 1956.

Une fois établi cet estimé de base, l'auteur examine l'effet de changer les hypothèses relatives au revenu étranger, le taux et la nature du changement technique. Seule l'hypothèse quant à l'incorporation du changement technique s'avère importante. Si le changement technique est neutre et totalement indépendant du stock de capital, l'avantage de l'investissement étranger tombe à $0.34 milliard, ou 1.4 pour cent du PNB de 1956.

Type
Research Article
Information
Canadian Journal of Economics and Political Science/Revue canadienne de economiques et science politique , Volume 32 , Issue 2 , May 1966 , pp. 172 - 183
Copyright
Copyright © Canadian Political Science Association 1966

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Footnotes

*

An earlier version of this paper was delivered at the Conference on Statistics held by the Canadian Political Science Association in June 1965. I would like to thank S. F. Kaliski for his many useful comments on that occasion without implicating him in the remaining deficiencies of the paper. The present version of the paper was completed while the author was visiting Princeton University.

References

1 An estimate of the effect of foreign investment on Canada's growth rate for the years 1956 to 1959 was made by R. J. Ball, but his methods are even cruder than mine. See “Capital Imports and Economic Development,” Kyklos, XV (1962), fasc. 3, 610–23.Google Scholar

2 Foreign subsidiaries often make royalty payments to their parent plant, and often they pay a portion of the parent plant's research expenditures. In other words Canada does not receive technical information from foreign investors free of charge, although the price is probably below the market price. See Lindeman, John and Armstrong, Donald, Policies and Practices of United States' Subsidiaries in Canada (Washington, 1961), 61–2.Google Scholar

3 Solow, Robert, “A Contribution to the Theory of Economic Growth,” Quarterly Journal of Economics, LXX, no. 1 (02 1956), 65–94.CrossRefGoogle Scholar

4 Foreign investment can provide an additional benefit to countries maintaining a fixed exchange rate by easing the balance of payments restraint on employment policy, but since Canada maintained a flexible rate for almost all of the period studied this benefit is not relevant for our purposes.

5 Denison, Edward F., The Sources of Economic Growth in the United States, Committee for Economic Development, Supplementary Paper 13 (Washington, 1962).Google Scholar

6 “Investment and Technical Progress,” in Arrow, K. J., Karlin, S. and Suppes, P., eds., Mathematical Methods in the Social Sciences, 1959 (Stanford, 1960), 89–104.Google Scholar

7 Labour's share is defined as the national account's “wages, salaries, and supplementary income,” excluding that earned in agriculture, plus .68 of non-farm unincorporated business income divided by non-agricultural, non-residential GDP. The figure of .68 is that used by Hood, Wm. C. and Scott, Anthony in Output, Labour, and Capital in the Canadian Economy, Royal Commission on Canada's Economic Prospects (Ottawa, 1957), 57.Google Scholar It is based on a 1950 census estimate of labour's share of unincorporated business income.

8 To deflate gross domestic product the effect of changes in agricultural prices was removed from the implicit price deflator for GNP used by the Dominion Bureau of Statistics.

9 The estimate was made for the years 1948 to 1956. The earlier years were included to reduce the effect of some wide scatter in 1950 and 1951.

10 This is the highest value obtained by Solow for the United States. See “Investment and Technical Progress,” 95.

11 See the appendix for the derivation of (7).

12 DBS, The Canadian Balance of International Payments, 1960, and International Investment Position, 50.Google Scholar

13 Two minor points should be noted. First, the numerator and denominator of the ratio include inventory investments whereas my production function does not. Since there are not sufficient data to remove inventory investment from the numerator, I must assume that foreign-financed inventory investments were the same portion of foreign investment as total inventory investments were of total investment. Second, the ratio is calculated from money data, and therefore I must assume that price changes affected foreign and domestic investment in the same way.

14 S. F. Kaliski has pointed out that my time lag assumptions also bias my estimate of g downwards. However, in my calculations I use a value of g much higher than the estimated value, and I would guess that I have more than compensated for any bias from this source.

15 See MacDougall, G. D. A., “The Benefits and Costs of Private Investment Abroad: A Theoretical Approach,” Economic Record, XXXVI, no. 23 (03 1960), 13–35.CrossRefGoogle Scholar My entire approach owes much to MacDougall's article.

16 For an interesting discussion of this problem, see Denison, The Sources of Economic Growth, chap. 1.

17 Lookirig at changes in the rate of growth can be somewhat misleading. Changes in the inflow of foreign capital are similar to changes in the average propensity to save in the Solow model, and the latter do not change the equilibrium rate of growth but only move the growth path upwards.

18 Large inflows of short-term capital encouraged by an overly tight monetary policy undoubtedly played a role in intensifying the recessions of the late 1950's and early 1960's.

19 See Intriligator, M. D., “Embodied Technical Change and Productivity in the United States,” Review of Economics and Statistics, XLVII, no. 1 (02 1965), 65–70 CrossRefGoogle Scholar, and David, P. A. and van de Klundert, T. H., “Biased Efficiency Growth and Capital-Labor Substitution in the United States, 1899–1960,” American Economic Review, LV, no. 3 (06 1965), 357–94.Google Scholar

20 Depreciation was estimated by comparing Hood and Scott's estimates of additions to the capital stock with real investment. I retained Hood and Scott's assumption that capital retained all of its initial productivity until it was discarded and assumed that all of the foreign-financed capital between 1950 and 1956 would have survived until after 1956.

21 Hood and Scott, Output, Labour, and Capital in the Canadian Economy, Appendix 6B.

22 This accords with Richard Nelson's study of the importance of varying the elasticity of substitution. See Aggregate Production Functions and Medium Range Growth Projections, Rand Corporation Memorandum RM-3912-PR (12 1963), 49–55.Google Scholar

23 Laursen, S. and Metzler, L. A., “Flexible Exchange Rates and the Theory of Employment,” Review of Economics and Statistics, XXXII, no. 4 (11 1950), 281–99.CrossRefGoogle Scholar Their proposition has often been attacked. For example, see Pierce, I. F., “A Note on Mr. Spraos' Paper,” Economics, New Series XXII, no. 86 (05 1955), 148.Google Scholar

24 “The Costs of Protectionism with High International Mobility of Factors,” this Journal, XXX, no. 4 (Nov. 1964), 512-25.

25 Immigration could conceivably result in a higher proportionate change in production than in population, but I think this highly unlikely.

26 Mining and Mineral Processing in Canada (Ottawa, 1957, 346.Google Scholar

27 I studied the cyclical effects of long-term foreign investment in “The Inflow of Long-Term Capital and the Canadian Business Cycle, 1950 to 1960,” this Journal, XXVIII, no. 4 (Nov. 1962), 527-42. The conclusions would be altered by the inclusion of short-term capital flows.

28 It must be remembered that foreign investment in already existing assets does not have a direct expansionary impact. Ibid., 532–33.

2& The Sources of Economic Growth.

30 Harberger, A. C., “Taxation, Resource Allocation and Welfare,” in The Role of Direct and Indirect Taxes in the Federal Revenue System, NBER Conference Report (Princeton, 1964), 25–70 Google Scholar, and “The Incidence of the Corporation Tax,” Journal of Political Ecoonmy, LXX, no. 3 (06 1962), 215–40.Google Scholar

31 Young, J. H., Canadian Commercial Policy, Royal Commission on Canada's Economic Prospects (Ottawa, 1957).Google Scholar