Profile of a Rich Industrialized Underdeveloped Economy

In spite of Canada’s high income and high degree of industrialization, the country has not shared in the recent world trend towards an increase in the importance of trade in relation to domestic production. In consequence, Canada’ trade as a percentage of that of the industrial countries dropped from 9.6 percent in 1953 to 7.2 percent in 1965 and her commodity terms of trade declined from 101 in 1954 to 97 in 1965. The deterioration in terms of trade for all underdeveloped countries over the same period was from 109 to 97. ln developed countries the corresponding improvement in terms of trade was from 96 to l 04. These trends prompted Wilkinson to observe that Canada’s position resembles more closely that of the less developed nations than that of the developed ones.

The reasons for these trends are to be found in the high proportion of primary or crudely processed materials in Canada’s exports and of finished manufactures in her imports. Canadian exports are heavily concentrated in a few product lines. These are either pure raw materials such as wheat, iron and other metallic ores, petroleum and natural gas, or crudely processed manufactures such as wood pulp. newsprint. lumber, flour, aluminium, copper and metal alloys, and primary iron and steel.

In a study of 13 industrialized countries of the Western world it was found that end-products accounted for 60 per cent of exports. For Canada the comparable ratio is 19 per cent . Although there was an increase of 12 per cent in the share of highly manufactured goods in Canada’s exports in the last decade, the increase for other relatively small industrialized countries over the same period was 37 per cent.

In 1954 Canada was exceeded only by New Zealand in value of trade per head. By 1964 Canada ranked eighth, exceeded by Belgium-Luxemburg, Holland. Switzerland, Denmark, Norway and Trinidad-Tobago, in that order. In none of these countries with the exception of the last-mentioned, do crudely processed materials account for as high a percentage of exports as thev do in Canada.

Recent trends in Canada’s imports are equally suggestive of structural under­ development. The share of consumer goods in imports rose from 29% in the mid-fifties to 34% in the mid-sixties, mainly due to increased imports of automobiles and new-technology manufactures. End-products increased their shar in import from 50% to 54% over the same decade. The indication in that technological advance abroad of a type that results in new products not produced in Canada together with initiative demand by consumers and producers are an important factor in explaining Canadian import patterns. It should be noted that the heavy inflow of direct investment to Canada’s manufacturing industries has coincided with a rise in manufactured imports relative to domestic production. This ratio rose from 18% in 1954 to 21% in 1965, reversing a contrary trend in operation since the mid-1920s.

World trade in highly manufactured goods is rising more rapidly than trade in industrial raw materials and primary products.

Canada appears unable to share in the gains which these trends offer to other industrialized countries:

”If Canadian trade follows this pattern then total imports which are heavily concentrated on highly processed commodities will lend to rise more rapidly than will total exports, which are largely raw and crudely processed materials”. (Wilkinson).

Such expansion in the export of manufactured goods, as has occurred in recent years is strongly related to the Defence Production Sharing agreements of 1959 and the automobile agreements of 1963. The proportion of highly processed exports which fluctuated between 11% and 14% in the 1950’s, rose to 19% in 1965. When we consider only inedible end products, we note that these rose from less than 3% of total Canadian exports in 1959-60 to a level of 15% in 1963. Most of the expansion consists of sales to the U.S. market.

While the devaluation of 1962 undoubtedly resulted export expansion, the special bilateral arrangements involving governments of Canada and the United States accounted for the greater part. These dealings are a manifestation of increasing corporate and governmental integration between the two countries. The industries directly involved are the automobile, aircraft, electrical, chemical and machinery industries – all heavily controlled by U.S. corporations. Sales in the United States have been gained at the expense of economic and political vulnerability associated with trade arrangements which are not normal commercial transactions.

The Defence Production Sharing Agreements, whereby Canadian firms are permitted to bid on equal terms witl1 U.S. firms for American war contracts, accounted for $260 million of Canada’s exports in 1965. 30% of all Canadian inedible end-product exports to the U.S. In 1966, U.S. defence contracts placed in Canada had increased to $317 million. Although these sales are small in relation to the total Canadian economy, the concentration of employment in a few manufacturing industries exposes Canada to the possibility of severe unemployment in given areas in the event if the termination of this agreement. As Minister of External Affairs. Paul Martin explained:

“Think of the impossible position we would be in if the Defence Production Sharing Agreements we-re abrogated … to pull out would be to endanger our economy and safety”.

It should be noted that tl1e foreign exchange earned by these defence exports is pre-empted by the undertaking of the Canadian government to purchase American war supplies. Thus in 1966 Canadian defence purchases in the U.S. were $332.6 million. Of greater importance than the defence arrangements are the automobile agreements which lifted exports of cars and parts to the U.S. from a level of $36 million in I003 to $231 million in 1965 and some $800 million in 1966. The quid pro quo for these automobile exports, however. took the form of increased import., from the corporations involved. The net effect of the automobile agreements on Canada’s balance of payments has been an increase in the deficit on commodity trade in cars and parts from $551 million in 1963 to $714 million in 1965.

The expansion of normal commercial sales of highly manufactured goods abroad has thus been extremely modest. This is so in spite of efforts to promote exports, including the provision of export credit. the work of the Export Finance Corporation, the promotional efforts of the Department of Trade and Commerce and strings on foreign aid which require 80 to 90 per cent Canadian content.

The difficulties of expanding commercial manufactured exports are compounded by the low level of industrial research and development expenditures in Canada and their high concentration in industries which service the special requirement of the U.S. defence department.

Canadian expenditures on research and development are smaller in relation to its Gross National Product (1.1%) than that of most countries of Western Europe and very much smaller than expenditures in the U.K. (2.3%) or the U.S.A. (3.4%).

What is more, in Canada 79% of such research is performed by government and only 12% by industry, compared with the United States where 28% is performed by government and 54% by industry. The bulk of industrial research expense) in the U.S. are, however, subsidised by public funds. The situation in Canada was summed up by Dr. Steacie, President of the National Research Council in the following words:

“Because of the financial. relationship between Canadian and American firms, most Canadian plants are essentially branch plants and research is normally done by the parent organization outside the country. A, a result Canadian industry has been largely dependent on research done in the U.S. and Britain.”

The most recent survey conducted by the Dominion Bureau of Statistics reported a total of $264 million spent on industrial research and development. Thirteen firms accounted for half of these expenditures and they were heavily concentrated in the electrical, aircraft and chemical industries. Electrical and aircraft industries alone accounted for 47% of total research and development expenditure and these same industries received 83% of federal funds “1llnted to industry for research. Four companies alone received 55% of total federal support. We already, observed that these Canadian government subsidies are heavily directed towards industries in which foreign firms predominate. The huge utility industry is, according to the Dominion Bureau of Statistics’ Report, entirely self-financing, as regards research.

Industrial research in Canada is also strongly biased towards applied rather than basic work. The Dominion Bureau of Statistics survey reports that only 356 scientists and engineers were engaged in basic research in Canadian industry in 1965.

Another measure of technological dependence of Canadian industry is the nationality of patent applicants. Here we find that 95% of all patents taken out in Canada over the period 1957-61 were by foreign applicants. This is probably the most remarkable statistic of dependence. Similar figures for other industrial countries were 47% for the U.K., 59% for France, 32% for West Germany.

Commenting on technological dependence, as revealed by these figures the authors of the Watkins report note that:

“the very ease with which Canada has been able to obtain technology through the route of the direct investment firm has reduced the pressure that might otherwise have been exerted, particularly on government, to sponsor more research and development in Canada including more industrial research and development performed by industry’.”

 The effect of branch plant economy on the structure of domestic industry is by now well established: too many rums producing too many product lines at high unit cost. The result is that the entire manufacturing industry catering to the domestic market, both foreign and locally–controlled, tends to be inefficient. When branch plants come into a tariff-protected country we get what Dr. English has named the “miniature replica” effect. The spill-over of advertising and other corporate overheads related to product differentiation and promotion make it profitable for foreign companies to assemble or sell a large range of their metropolitan products in the hinterland. The case best documented is that of the refrigerator industry. Here it has been estimated that the Canadian national market of 400,000 per annum would be efficiently served by two plants. In fact there are 9 plants, and 7 of these Lll”8 U.S. controlled branch plants. In 1966 these accounted for 80% to 85% of refrigerator production, compared with 71% in 1960. These Canadian subsidiaries almost duplicate in number the plants producing refrigerators for the much larger American market. All of them operate well below optimum size.

It is not true that the Canadian domestic market is too small to support a diversified manufacturing industry. What is true is that the combination of tariff protection and branch plant organization of manufacturing industry results in the inefficient production of too many similar products and stands in the way of rationalization and specialization. The unilateral reduction of the Canadian tariff on a select number of commodities would certainly help to make Canadian industry more efficient.

There is a widely held belief that Canada needs direct investment because the country is “capital-hungry” and that domestic savings are inadequate to finance expansion of the resource and manufacturing industries which attract direct investment. While it may be to the advantage of Canada to borrow portfolio capital which does not transfer control, there is no conclusive case for the commonly held view that direct investment is necessary because the Canadian economy cannot generate sufficient savings. Nor, given more imaginative approaches to Canadian private and public entrepreneurship, is there a convincing case for the view that direct investment is necessary because entrepreneurial opportunities cannot be exploited without it.

In fact the inflow of new funds £or direct investment constitutes a very small fraction of total gross national saving in Canada. In 1965, which was a year of relatively heavy new direct capital investment, the flow of new foreign funds into Canadian subsidiaries was under $500 million, or less than 5 per cent of total Canadian savings which exceeded $10 billion in that year. These new funds, however, are a minor source of finance for expansion by the subsidiaries. The major portion is provided by the re-investment of profit, by depreciation and depletion allowances and by borrowing from Canadian financial institutions.

According to the U.S. Department of Commerce, over the years 1957 to 1965 American direct investment companies in Canada obtained 73% of their funds from retained earnings and depreciation, and a further 12% from other Canadian sources. Only 15% of funds came from the United States. (See table 17). While the mining industry received 19% of total funds from the U.S. and the petroleum industry 22%, manufacturing branch plants obtained only 9% of funds from the U.S. throughout the period. These figures indicate that 85% of gross investment expenditure of the firms was financed from Canadian savings. The leverage of new foreign funds is obviously very great: by the laws of compound interest and the rationale of new mercantilist market expansion in inflow of 15 cents has mobilized hinterland resources of about 55 cents towards the financing of foreign-controlled investments. It is to be noted that future profit earnings will accrue almost in total to the metropolitan corporation.

1957 1958 1959 1960 1961 1962 1936 1964 1957-1964
From the US. 26 25 20 21 13 10 8 5 15
Invested Profit 35 32 39 45 41 43 45 49 42
Depreciation 26 30 30 35 34 32 33 30 31
From Canada 13 14 11 -1 12 15 14 17 12


In the year 1964, for example, of a total investment of $2,557 million by U.S. subsidiaries in Canada $1,244 million was financed from retained earnings. $764 from depreciation allowances, $423 million from Canadian and third country borrowing and only $126 million from fund from the United States. Of the funds obtained in Canada, only $71 million was issue of equity stock.

Canada’s Bureau of Statistics has estimated that, in the 19 period 1946-64, the accumulation of undistributed earnings added $5.2 billion, or 40% to the increase in Canadian external indebtedness. Well over half of these investments accrued to manufacturing.

We have estimated that gross internal saving of foreign controlled firms constitute about 15% of total annual Canadian savings. The proportion of profit whicl1 is ploughed back is much higher in the branch plant sector than in the rest of the Canadian economy. Thus about one third of total Canadian retained earnings accrued to foreign-controlled companies. These internal savings are pre-empted for investment in the concerns in which they are generated. If the parent companies do not wish to reinvest profits in these subsidiaries they transfer funds out of the country. Such funds, whether re-invested or transferred, are not available to finance the expansion of other sectors of the Canadian economy.

The study conducted by the Canadian Department of Trade and Commerce on foreign owned subsidiaries in Canada found a similar pattern of financing. For 1965 a total of $1.8 billion was available to these companies for investment expenditures. Of this amount, $1.2 billion was generated within. the subsidiaries by retained earnings and depreciation. The remaining $658 million was raised from source external to the subsidiaries; $274 million in loans from parents; $ll3 million in equity holdings by parents; $254 million in bank loans and long term borrowing and only $37 million in equity holdings by independent shareholders.

Barriers to the expansion of Canadian enterprise do not lie in a global shortage of savings but rather in the structure of the goods market and the capital market which place the independent enterprise at a disadvantage with respect to branch plants. Often the former do not have access to sales outlets because market are firmly controlled by existing corporations. The Watkins report notes that:

“in the primary resource industries, a guaranteed long term market in the parent for at least some of the subsidiaries output has, often been the critical factor in the decision to exploit the resource sometimes much more important than the supply of capital or of technology.”

They note that in some resource developments “resident–owned firms were prominent in the early phase but sold out to non-residents later.” The reason is often related to the necessity to obtain an assured market. The1e is no evidence that foreign business is more efficient than Canadian.

A statistical investigation undertaken by the authors of the Watkins report found “nationality of owners hip is irrelevant to economic performance and that foreign ownership does not produce above-average benefits that can be perceived from data on productivity. In other words, foreign-controlled firms. Nor are they less efficient. Where then does their competitive advantage lie? The conclusions of the report confirm out own assessment in the previous chapter:

“One of the advantages which the foreign firm has is the trademarks and brand names of its parent . . . some part of what is often seen as the technical superiority of the foreign firm is probably attributable to this marketing advantage. Indeed, technological progress proper and product innovation to create a differentiated product for marketing advantage are often inextricably intertwined.”

They further comment that:

“At the national level; consumer attachment to foreign brands may inhibit the growth of domestic firms with domestic brands; the absence of national brands and distinctive national product may affect national media and export prospects”

Obviously, the nature of the capital market places the foreign branch plant at a decisive advantage in obtaining funds. For this reason they can also take· more risks. Although they typically rely strongly on internally-generated capital, large expansion can be financed by transfers from parents and affiliates in the form of loans or equity purchase by the parent. Here the small branch plant enjoys a very strong advantage vis-a-vis the small independent firm.

The Royal Commission on Banking and Finance, 1964, noted that “Resident firms have more difficulty at all times in obtaining long term finance than do those which are subsidiaries of large and well financed Canadian or American corporation. It is interesting to note that more than a third of Canadian-controlled firms with assets under $1 million reporting to a C.M.A. Questionnaire reported sources of long-term capital as inadequate. This compares to one out of twenty-nine non-resident firms in the same size-category.”

Canada enjoys a highly developed set of financial institutions geared to mobilize savings and channel them into investments. Whereas in the past the assets of these financial intermediaries included virtually no equity stock, in recent years there has been an inadequate supply of attractive Canadian equities to meet the sharply growing demand by life insurance, pension and mutual funds for high-earning risk-bearing assets.

Since 1961 Canadians have become net buyers of foreign securities. There has been considerable re-patriation of foreign-held Canadian securities and heavy Canadian buying of foreign, mainly American stock in the technologically-oriented “glamour industries”. These include data processing, photocopying, research, electronics, space technology and airlines and are tightly under the control of foreign subsidiaries in Canada. There are virtually no listed Canadian stocks. The author of the Watkins report estimated that institutional investors who held $3 billion Canadian equity in 1966 will require more than $6 billion Canadian stock or $800 million per annum for the next eight years.

They suggest that the only way Canadian savings seeking equity investment can be channelled into Canadian industry is by incentives which would make all large Canadian private companies offer equity shares. Very many, although not all of these are wholly-owned subsidiaries of foreign corporations, such as British Petroleum, General Motors, General Foods, I.B.M., Canadian International Paper and many others. It is doubtful how many of these firms would respond because. as the authors of the report themselves admit, “the commitment of some firms to the wholly-owned subsidiary is too strong to be shaken by any feasible set of incentives. “It is estimated that a 25% minority share in all corporations with asset over $25 million or more would be $3.5 billion or $4.5 billion at a minimum. Even if some of the capital so raised were transferred abroad, there would be an increase in Canadian minority participation, and n reduction in the long run drain of dividends abroad.

Apart from the fact that there seems to be little enthusiasm by U.S. subsidiaries for selling part of their equity to Canadians there is an obvious need to develop new Canadian-controlled enterprises. The Watkins report observes that the ‘technology-gap’ alleged to separate most of the world from the United States may in fact be largely a ‘managerial gap’. To encourage entrepreneurial capital of a kind which takes an active part in the development of enterprises in which it invests, the report suggests the implementation of the Canada Development Corporation which was proposed by Wolter Gordon five years ago. This would be a large quasi-public holding company with entrepreneurial and management functions. It would organise and participate in consortia of investors, both domestic and foreign, so that large projects beyond the capacity of n single institution could be undertaken under Canadian control. There would presumably be emphasis on joint venture, on rental of foreign licenses and patents, where necessary, and on arrangements in which controlling interests would remain Canadian.

For reasons which reach back into the economic and commercial history of Canada, the generally laissez faire federal administrations of the past two decades 1ave stood firm in protecting the financial sector from foreign control. Federally-incorporated banks and other financial intermediaries and the communication media are fully under Canadian control. Further, public control here is strong. Other instruments of policy, including those proposed by the authors of the Watkins report, can be devised without difficulty. The real question is whether there exists the will to regain control over the economy. This is not n question which economists can answer. This fact does not, however. relieve them of the responsibility of asking it.