Foreign ownership restrictions on telecommunications companies hurt Canada’s economy

Among developed countries, Canada has one of the most restrictive regimes when it comes to inward foreign direct investment (FDI)—that is, investments by foreign companies who have operating control of the Canadian assets they acquire. The telecommunications sector is no exception.

If telecommunications carriers, including Internet service providers, that own and operate transmission facilities hold a 10 per cent or greater share of Canada’s annual communications market revenues, they are subject to foreign investment restrictions including mandated Canadian ownership of 80 per cent of a company’s voting shares. As well, Canadians must hold 80 per cent of director positions and there must be no indirect control by non-Canadians. If the corporate investor is a subsidiary, the parent company must be incorporated in Canada and Canadians must hold a minimum of 66.6 percent of the parent company’s voting shares.

The restrictions on inward FDI effectively mean that foreign-owned telecommunications companies must either enter the Canadian market as resellers (i.e., non-facilities-based carriers) or be content with having a relatively small share of the Canadian market and likely operating below efficient scale. Consequently, efficient foreign-owned telecommunications companies are unlikely to enter and compete in Canada’s telecommunications sector, which is essentially the goal of the regulation.

Ironically, the telecommunications sector in Canada has been a particular focus of concern about anti-competitive behaviour and performance. The important role that competition plays in spurring innovation and productivity growth has also been widely acknowledged, especially in prominent infrastructure sectors such as telecommunications. Hence, initiatives to promote competition in key sectors such as telecommunications have been identified as part of the solution to Canada’s weak productivity performance.

An important point to emphasize is that competitive pressures on incumbent producers depends not just upon the intensity of rivalry among those incumbents but also the potential for new firm entry. The contestability of any product market increases as the threat of entry by new firms increases, while increased contestability promotes lower prices for consumers and faster innovation. Hence, eliminating restrictions on inward FDI in the telecommunications sector will encourage innovation and faster productivity growth in the telecommunications sector by strengthening contestability. This would directly benefit subscribers and indirectly contribute to improved overall productivity growth in the Canadian economy.

Of course, there are opponents to a more competitive marketplace. Long-standing arguments in support of restricting inward FDI include a desire to maintain domestic control of a “strategic” industry. The concept of a strategic industry is not well defined, and is sometimes conflated with the notion of national security. Clearly, telecommunications plays a critical role in modern economies, and ensuring the integrity of the domestic telecommunications system along with protecting the confidentiality of data and information stored and carried on the system are important tasks for government and regulators. However, a case-by-case evaluation of proposed inward FDI is arguably a more efficient way to carry out those tasks than broad restrictions on entire categories of foreign ownership.

The Trudeau government has introduced new legislative authority as part of a revision to the Investment Canada Act that allows for tougher national security reviews of foreign investments in sensitive sectors. The legislation allows the government to review any transaction, including minority investments, where there are reasonable grounds to believe an investment by a non-Canadian could be injurious to national security, although there’s no explicit definition of what constitutes an injurious foreign investment.

As a practical matter, the jurisdiction of origin of the foreign investor is a key factor in the national security review process. In this regard, investments by Chinese state-owned enterprises have been of particular concern. The government has also raised security concerns about foreign investments in artificial intelligence, robotics and quantum computing. Whatever the grounds for concerns about national security, they would not seem relevant to facilities-based investments in telecommunications by non-state-owned companies headquartered in countries that are members of NATO and other treaties that include Canada.

Another concern with allowing FDI in telecommunications is that it might harm the ability of governments in Canada to regulate the industry if those regulations adversely affect the profitability of firms. Foreign-owned firms might seek to sue the government on grounds that they were unjustifiably harmed by government policies. Under the United States-Mexico-Canada Agreement (USMCA) such cases would likely be dealt with in the Canadian court system in most cases, and lawsuits by foreign investors would likely be unsuccessful if the relevant regulations were applied in a uniform fashion to all industry participants.

A more nuanced argument is that increased competition would undermine “cross-subsidies” in the telecommunications sector that are explicitly promoted by Canada’s telecommunications regulator.

Cross-subsidization involves one set of consumers paying prices above the marginal cost of providing the good or service they buy, while other customers pay prices below the marginal cost of the same good or service. In the case of Canadian telecommunications, urban subscribers notably cross-subsidize rural subscribers. Increased competition can undermine regulation-related cross-subsidization by providing consumers who are “overpaying” with lower-priced alternative sources of supply. Simply put, new entrants will likely pursue the most profitable segments of the market (i.e., segments where consumers pay well above the cost of providing the services they consume). This dynamic played out decades ago when long-distance telephone charges were used to subsidize local service. Business subscribers entered into private line arrangements with carriers to bypass the domestic telephone network by routing long-distance calls through the U.S. telephone system.

In other words, competition ultimately undermines regulatory cross-subsidies. However, this should not be an argument against eliminating restrictions on inward FDI. Rather, if cross-subsidization in the telecommunications sector is socially desirable, it should arguably be carried out directly through, for example, tax credits or vouchers that make the subsidy more transparent and also discourage regulatory bypass, since all prices can be set at market-clearing levels.

There are also worries about a perceived convergence of telecommunications and broadcasting. Indeed, major Canadian telecom companies such as Bell Canada and Rogers Communications are also regulated under the Broadcasting Act. There is prominent cross-subsidization in broadcasting, whereby broadcasters enjoy direct and indirect protection from foreign broadcasters and in return are expected to spend some of their profits directly on Canadian content, or indirectly by broadcasting minimum quotas of Canadian content. One can again argue that if cross-subsidization serves a legitimate social purpose, it should be done in a transparent manner and not through a complex set of regulations.

And in fact, in a contestable broadcasting market, such cross-subsidization would not be sustainable since entry by firms will occur in segments of the industry that enjoy above-competitive profits. This is the problem facing Canada’s broadcasting regulator, which increasingly must expand the coverage of broadcasting regulations to extract subsidies from new Internet-based carriers such as Netflix and Apple to create a “level” playing field. As the history of long-distance telecommunications advises, the ability of the regulator to extend the scope of cross-subsidization is ultimately constrained by initiatives that enable consumers to bypass the regulated sector. Meanwhile, the extension of regulatory efforts to extract revenues from primarily U.S.-owned digital services is creating substantial trade tensions with the United States government.

Canada has ambitious investment goals related to the construction of new affordable housing, transitioning to green energy and away from fossil fuels, and promoting the growth of its artificial intelligence sector, among other priorities. The domestic savings rate is inadequate to fund these various ambitious goals, as well as other desirable capital investment projects at today’s interest rates. Hence, Canada must make itself a more attractive location for foreign capital. Removing foreign ownership restrictions in the telecommunications sector is a modest step towards attracting foreign capital and thereby freeing up some domestic savings for investment in other sectors of the economy.