Industry Committee on May 6th, 2010

[Charlie Angus, NDP, Timmins—James Bay, ON]

Thank you.

I'm very glad to be sitting here this morning. I'm not an economist. My father was an economist, though. At the age of 40, a working-class kid, he went back to school and became an economist. So I used to ask my dad about economic theories, and he said, “Well, son, the one thing you should remember is it's all horseshit. You have to see what's out in the real world.” So I am always a little careful when I—

[Mike Wallace, Conservative, Burlington, ON]

Is that on the record?

[Charlie Angus, NDP, Timmins—James Bay, ON]

Yes, I'd like that on the record.

So we go back to the Adam Smith thing, that there are butchers and there are bakers and this little model village that is economic theory. But the butchers can't get their stuff at the independent grocers because they can't get shelf space because it's controlled by a few large giants. If you run a little milk company, you're going to get put out of business pretty quickly. If you set up a small cattle operation, Cargill can sit on 10,000 head of cattle and they can drop the price just like that. So we don't have competition unless it's sometimes regulated. Sometimes we have to make competition in the marketplace. I think this is one of the things we have to start to look at.

We have a few very large players in our market, and they don't tend to give us very good service. I pay extremely high rates for my cable, and my daughter said she got better wi-fi service in Rwanda than she did in downtown Ottawa, so obviously we have a problem.

But the question is, is simply opening this market going to bring in a lot of competition, or are we going to see what's being speculated in The New York Times right now, that we're looking at a whole new wave of major buyouts, where we've created these two, or three, or four very large entities that are actually fairly small on the global scale, but they could then simply be picked up by somebody much bigger? So we then don't end up with any more competition; we just end up with a much bigger player controlling our market from someplace else. How do we actually ensure competition?

[Prof. Randall Morck]

I agree with you. Economics, like most academic fields, has a high scatological content.

Is that going to be okay for the minutes?

[A voice]

It's on the record. You're okay.

[Prof. Randall Morck]

And I think you're completely right about incumbents. But government can make the problem of entrenched incumbents better or worse.

The reason I think you're right is that I published just last year some research with one of my PhD students, Kathy Fogel, and Bernard Yeung of New York University, where we looked at the list of leading companies in every country in the world in 1975, and then we looked at how many of them died. What we found is that countries whose leading firms of 1975 were more likely to die during the subsequent decades had much higher productivity growth than countries that kept the same leading firms decade after decade.

What that says, I think, is that Joseph Schumpeter is right about innovation. Innovation where creative firms rise up and destroy stagnant firms is where growth comes from. So both the rise of RIM and the fall of Nortel are signs of a healthy economy.

Government can come in with regulations that entrench incumbents, and you asked, for instance, is this going to be the only thing we need to do? Absolutely not. We have to look at the way we regulate the whole telecom industry, because we can allow foreign entrants, but if we give incumbents the power to exclude people from that final loop of copper wire into people's homes or to charge exorbitant rates for it, the entrants aren't going to do much good.

We need to look at how other countries do this, how other countries allow joint ventures between the owners of the copper wire and other companies to upgrade equipment, and so on. But I do think foreign ownership is a first and very important step towards getting our telecom sector to become more productive, and I do worry that our foreign entry restrictions make the incumbent entrenchment problem worse than it would otherwise be.

[Charlie Angus, NDP, Timmins—James Bay, ON]

I guess one of the problems we're dealing with in telecoms is this--and again, as economists you like to just look at the widgets and not necessarily the cultural inputs. Telecom was allowed to become very concentrated, and government supported that at every step of the way. So if telecoms wanted to buy up newspapers and get into radio and television, they were allowed to do that. Now we have, again, a few very tightly concentrated entities that, while providing our cable, basically control the media in Canada.

You made a suggestion to throw it all out and it will all work great, and my God, all of the Conservative members were nodding and cheering; they think getting rid of any of the Canadian content rules is a great thing. But there's a public policy issue here. I come from the music business, and in the seventies you could never hear a Canadian song on radio until it became public policy that you were going to hear it. Now we have a market that is international in scope because public policy made it.

So if we're going to allow foreign entrants into the telecom market, are you suggesting that we simply allow them to take over, or ditch the Canadian content requirements? Because they're not going to meet them. If you're suggesting that the present ones don't like meeting them, how can we expect that they're going to meet them out of Europe or the U.S.? Should they be carved off, or should those obligations just simply be removed?

[Prof. Randall Morck]

Well, I worry that the CRTC is like generals fighting the last war. The biggest and most important websites in the U.S. now include things like Hulu and Netflix. What is Hulu? Hulu is a place where you can point and click on any TV show you want and then watch it on your computer. And you can connect your computer to your big screen TV, so you can watch it on your big screen TV without going through a cable company, or Comcast, or satellite TV. Netflix does the same thing for movies. Hulu pays for it with commercials that you have to watch when you watch the thing over the web; Netflix charges per viewing. In a world like that, how are you going to have Canadian content percentage restrictions, where instead of listening to a radio station or looking at TV channels on a cable lineup, people simply point and click and listen to whatever they want?

I think technological change means that if we're going to protect Canadian culture, we have to think about it in new ways. What I said before wasn't intended to be flippant. I think you could get rid of the regulations we have now, which impose a huge economic cost, and I think the increased economic activity would let you raise the tax base sufficiently that you could fund direct production of Canadian culture through the CBC, the National Film Board, or whatever.

Canadian music.... It seems to me that's an industry that doesn't really need protection anymore. It's grown up. There is an argument in economics that you protect infant industries, but once the industry grows up, you have to let it go out on its own. You don't want to have these 30-year-old industries living in your basement.

[The Chair, Conservative, Michael Chong]

Thank you very much, Mr. Angus.

We'll now go to Mr. Rota.

[Anthony Rota, Liberal, Nipissing—Timiskaming, ON]

Thank you.

I want to thank both of you for being here this morning. It was interesting studying history, Frontenac, as you mentioned earlier. I went to a French school, so I got a different view of Canadian history than those who went to an English public school. One of my favourite quotes was Je répondrai par la bouche de mes canons, which was basically Frontenac answering the British cry. He was protecting what he had at the time, Canadian sovereignty or New France sovereignty, and the fight was over resources, and resources were somewhat limited, much as they are today. He understood the importance of sovereignty and control.

As parliamentarians, what often happens is that we try to do what's best for all Canadians, not just a select few who are good at financial markets and do extremely well in trading stock and building up wealth. But that concentration isn't exactly healthy. I'm sure once you get past Economics 101 you will agree with me that the concentration of wealth is not necessarily good for the economy, and in the long term may hinder the economy, especially when that wealth is concentrated outside a country.

One of my concerns, and I'll throw this out, is if we allow foreign ownership at a level that concentrates all our major telecom companies, if they get bought out by foreign owners--it's not foreign investment. Foreign investment, in my mind, is when a company comes in, invests in R and D, builds infrastructure, and there's something there. What I'm seeing more and more of is foreign ownership buying out existing companies.

What I've heard as well, either from OECD or others who have presented, is that in Canada there should probably be two or three providers nationwide for telecom, let's say, wireless, not the numbers that Adam Smith would speak of that would create very good competition. Things have changed from the 1700s, when Adam Smith wrote The Wealth of Nations, to what's happening in the 21st century.

My concern is, how do we regulate that? Or if we open ourselves wide open, what's to stop a foreign owner doing whatever he wants with the Canadian market? He has maybe 90%, 80%, or even 50% of the Canadian telecommunications coverage, but it really only represents 3% of his global holdings. How do we protect ourselves from that?

[Prof. Randall Morck]

You've asked several questions.

How do we protect ourselves from an abusive, monopolistic provider? We have an anti-combines act, the Competition Act, and we should use it.

[Anthony Rota, Liberal, Nipissing—Timiskaming, ON]

Regulation is the way to go then.

[Prof. Randall Morck]

Absolutely. If no regulation, if no government, were the way to get a prosperous economy, surely Somalia would be the richest country in the world, not having had a government for 20 years.

[Anthony Rota, Liberal, Nipissing—Timiskaming, ON]

I make the same argument about some of the southern states in the United States.

[Prof. Randall Morck]

Sure. I think the point is quite right. Firms in Massachusetts are not flooding into Arkansas because the taxes are lower. The problem is, you get government services for taxes, and good government is about providing cost-effective services for the taxes. That's what we need to think about.

In terms of the concentration of wealth, I think you're also right. I've done some work on this. Economists like to talk about an efficiency-equality trade-off, that if you have a little bit more inequality, you can get more efficiency and the economy grows faster. It turns out my research shows that's true if you look at inequality due to new wealth, due to entrepreneurs like Bill Gates or like the guys in southern Ontario who made Research in Motion come true. If you look at old money wealth, if you look at the amount of inequality that's due to inherited wealth, you get both inequality and inefficiency at the same time. You escape that trade-off, and not in a way anybody would want to.

I worry that by restricting Canadian ownership.... We're now seeing our cable companies passing on to second- and third-generation control; they're becoming old-money family companies. I'm afraid the evidence is that old-money wealth isn't a good way to do corporate governance. My own research shows that old-money inherited corporations, both in Canada and around the world, tend to perform relatively poorly--barriers to entry entrenchment, just what the previous question was about, I think.

[Anthony Rota, Liberal, Nipissing—Timiskaming, ON]

We see a lot of that globally, old money that just keeps going on and expanding and just buying up. It's exactly what you're saying. You're saying that what we're doing is buying up new companies with old money. The old inefficiency, let's say, just gets plunked on to the new takeover.

How would we as Canadians be able to regulate that when it's coming from another country? That could be either to you or Professor Hejazi.

[The Chair, Conservative, Michael Chong]

Why don't we go to Professor Hejazi to answer that?

[Prof. Walid Hejazi]

There are several points I'd like to make here.

First, by allowing foreign companies to come into the Canadian market--as you mentioned, these large global multinationals--the evidence clearly shows that when you have a foreign company operating in Canada, they're able to use the R and D, the innovation that's in the network. So they're able to access these global networks of R and D and of innovation that Canadian companies in and of themselves cannot do. That's point number one.

Secondly, I think the way to regulate it.... As Professor Morck said, when you have an abusive monopoly, we can regulate that because that kind of activity should be regulated and shouldn't be allowed. This is the point I tried to make earlier, and I think it's fundamentally important. The way to protect Canadian companies is to provide them with an environment where they can be globally competitive, where they can be innovative. So when you restrict foreign entry, what happens is the discipline imposed on these Canadian companies dissipates because there is no other Canadian company that's able to buy them up.

When you look at financial markets, when managers do a good job, stock prices rises. When managers do a bad job, stock prices fall. The way financial markets discipline managers is that when managers are doing a poor job, other companies could come in and buy up those companies and replace management. That cannot happen in a concentrated industry like telecom when you're restricting foreign entry.

So the best way to protect Canadian companies is to allow them to be globally competitive so that in the presence of the possibility of a foreign company coming in, they are the ones that are making acquisitions globally, as opposed to foreigners necessarily buying up the Canadian companies.

I think you're just making the assumption automatically that Canadian companies are scared, that the Canadian companies are not going to be able to compete. The evidence clearly shows that Canadian companies are doing well globally, and I would like to think that in the presence of foreign competition our Canadian companies could win.

[The Chair, Conservative, Michael Chong]

Thank you very much, Professor Hejazi.

Mr. Braid.

[Peter Braid, Conservative, Kitchener—Waterloo, ON]

Thank you to both of our witnesses for being here this morning.

Professor Morck, if I could start with you, you mentioned in your presentation that a tax on connections in the process sort of adds cost to the entire process. I presume that would include and that argument would also apply to a tax on iPods and BlackBerrys. Would that be correct?

[Prof. Randall Morck]

I haven't really thought about iPods; BlackBerrys and iPhones, maybe.

Things that let us use new technology to advance our businesses are important. For instance, the report I alluded to--it was either the OECD or the Harvard study, I've forgotten which now--had a discussion of small business connections to the Internet and the use of the Internet.

Canada actually looks pretty bad on that. Our small businesses aren't using the web nearly as much as small businesses in other countries. Perhaps it's because the service is slower, less reliable, more expensive--I don't know. That's the sort of thing that I think actually does add to our cost, reduce our competitiveness, and compromise our standard of living.

On the foreign ownership thing, I think there really is a case to be made that some takeovers are indeed megalomaniac foreign CEOs trying to build empires. But a lot of corporate takeovers.... My research with Andrei Shleifer at Harvard and Robert Vishny at the University of Chicago shows that a lot of corporate takeovers are people buying fixer-upper firms. So you find a bad firm that's badly run and its earnings are low, dividends are low, share prices are low, and you buy it. You fire the old management; you bring in new technology and new management. You fix it up the same way you fix up a house. Then you sell it back to the shareholders at a higher price and you make a profit. And you do it again and again. A lot of takeovers are like that.

If we block takeovers by foreigners, we are going to block the empire-building megalomaniac CEOs--whose corporate empires will probably fall apart anyway as soon as they retire--but we block the fixer-upper takeovers. Those fixer-upper takeovers are important for the quality of governance in an economy.

[Peter Braid, Conservative, Kitchener—Waterloo, ON]

Thank you.

Professor Hejazi, you explain that Canadian companies are becoming more competitive and more successful globally. What are some of the unique characteristics or qualities of those Canadian companies? What makes them capable of competing successfully internationally?

[Prof. Walid Hejazi]

When you look at the broad economic data, increasingly we're seeing Canadian companies move beyond the traditional market, that being the United States. If you look back, the share of foreign investment, the share of all investment by Canadian companies operating outside of Canada, outside the United States, has been growing.

I think basically companies are moving to less traditional markets beyond the United States, beyond Europe, and moving into economies like Asia. So even though Canada still lags other countries in terms of our depth of penetration in the global supply chains, what we do see is that companies that are doing well are companies that are looking beyond the traditional markets in the United States and Europe and going much beyond that.

I should say that about 40% of Canada's investment abroad is actually in finance and insurance, so financial services. It's not just traditional manufacturing. A lot of it has to do with financial services and business services.

I should mention that I spent the last month in the United Arab Emirates, in Abu Dhabi. Actually, I went to a reception that we had put on by the Ontario government at the British Club in Abu Dhabi. There were many Canadian business people there. CMHC was there. There were a lot of Canadians there that were helping the United Arab Emirates build its infrastructure. I raise that because that's a market I know well. When you look at the industries that are doing well there--infrastructure, oil and gas, transportation, business services--you see Canadian companies there in a big way. There are 28,000 Canadians operating there, and those are the companies that I see that are doing well.

[Peter Braid, Conservative, Kitchener—Waterloo, ON]

Thank you.

I'll go back to our three big telecommunications players. What are the reasons for the fact that they aren't operating outside of Canada? Can you comment on that?

[Prof. Walid Hejazi]

I don't know the answer to that, but I would say that Professor Morck alluded to this. If you look at the indicators, again, you can cut the data whatever way you want, but another source that Professor Morck didn't allude to is the World Economic Forum.

When we look at the indicators of quality and how competitive our telecom sector is, we lag a lot of other companies in other countries. Why is that? In my opinion, I believe it's the lack of foreign competition. I believe because there's concentration in the industry and because the discipline imposed by being globally competitive is not there, the Canadian telcos are more focused on being the best in Canada. They're not focusing on being the best globally, and I think that is the reason they're not operating on a global scale.

If it was very clear that international competition was coming, I believe the major players in the telecommunications industry in Canada would rise to the challenge; they would adjust their behaviour.