The federal government's decision to allocate $500-million to its auto innovation fund has added fuel to a long-standing debate in Canada around whether governments should compete to attract investments by firms.
The prospect of supporting Chrysler on a new $2-billion investment, and the Ontario government's announcement before Christmas of support for a large-scale investment by Cisco Systems Inc., have also added to the discussion. While many conservative commentators and economists are opposed to using public funds to attract firms to Canada, governments of all political stripes continue to press ahead.
The people who oppose governments competing to attract investment can be divided into two groups: Those who oppose it on principle, and those who oppose its practical implementation. The first group harkens back to Adam Smith and the so-called "invisible hand" of markets. Simple economic theory tells us that perfectly competitive markets allocate resources most efficiently, such that we get the largest number of final goods and services for a given amount of capital and labour and raw materials. Any intervention by governments, the argument goes, is a departure from this "competitive equilibrium," and results in inefficiency or wasted resources.
This simple theory is unlikely to be a good description of reality for a couple of reasons. First, it ignores how the benefits of economic activity are distributed. While a perfectly competitive market may produce the greatest number of goods and services, it may also allocate most of them to a foreign country. Who gets the benefits may seem of secondary importance to economists interested in overall market efficiency, but it is critical to the citizens and political leaders of individual countries. Second, if the market in question is not competitive (and perfectly competitive markets are rare), the so-called invisible hand may not even be the most efficient allocator of resources.
Even people who recognize the shortcomings of the simple economic model may be opposed to governments competing for investment. Their reasoning is that governments should not do it because they can't do it well. Government's can't pick winners, the saying goes, but losers can certainly pick governments. Political influences will distort governments' investment decisions, and thus such deals are rarely good for the average taxpayer. In this view, governments will generally overpay for investments or pick poor ones, so it is better simply to forgo such deals altogether.
It is certainly true that, like private sector investors, governments sometimes make bad investments. However, if other jurisdictions are competing to attract private investment, governments face a stark choice. They can pass on the competition, and probably lose out on most of the economic growth and jobs that come from attracting new investments. Or they can compete, and try to make wise decisions about which deals to bid for and how much to offer.
What are the elements of good decision making for investment attraction?
First, governments should start with a firm budget to ensure that they make the right allocation of funds between investment attraction and the other programs they provide to citizens. Second, they should build a rigorous business case for each proposal and compare opportunities to make sure they are focusing on the investment with the greatest return to the economy. Third, they should co-ordinate the actions of all levels of government to speak with a single voice and put the very best case forward regarding the advantages of locating in Canada. Fourth, they should develop an explicit negotiating strategy that is based on a deep understanding of the firm's goals and alternatives, and makes best use of negotiators and decision makers during the negotiations. Finally, they should be open and transparent about the terms of any agreed deal, so that voters can see what they are getting for their money.
Competing to attract private investment will be a fact of life for Canadian governments as long as other jurisdictions are playing the game. It doesn't have to be a losing proposition. We should compete to win – not on every deal, but on the ones that make good business sense for Canada.
Paul Boothe is professor and director of the Lawrence National Centre for Policy and Management at the University of Western Ontario's Ivey Business School. He has served as a deputy minister in federal and provincial governments.