Some Assembly Required: The Hidden Extractive Dynamics of Foreign Direct Investment

By Claire Wilson
CCI Research and Policy Analyst
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For decades, governments have seen foreign direct investment (FDI) as a surefire way to supercharge economic development. If you want to show your voters that you can attract investment and jobs or develop new knowledge and capacity, and a foreign company is willing to foot the bill, why wouldn’t you take them up on that?

But for really important, strategic parts of our economy, the logic that made FDI such an attractive proposition may no longer hold. As Canada continues to court large-scale foreign investment in areas spanning from defence to AI, it's worth considering whether today’s FDI benefits Canadians in the long term.

A recent paper by Agustin Benetrix, Hayley Pallan and Ugo Panizza finds a troubling truth about FDI and multinationals: they are often more extractive than additive for host economies. In the case of FDI in the service sector, investment actually reduces growth. These findings upend longstanding assumptions that shape how policymakers govern the economy.

The traditional FDI orthodoxy is that foreign direct investment would grow your economy if your country had the financial depth and skilled workforce to absorb it. And, for a long time, this was the case. Studies from the 1970s and 1980s do show that under these conditions, FDI led to expanded GDP growth.

But disco is dead, and it isn’t coming back. The world we live in now, and our economic realities, are starkly different from the 70s and 80s.

New information and communications technology in the 1990s made global coordination a lot easier, and this meant firms could now manage complex activities across borders. This created genuinely global value chains, where firms shed low-margin activities to subsidiaries or outsourced them entirely while keeping the real value close to home.

In this new reality, FDI expands outputs without value-added growth in host countries. This benefits the parent corporate headquarters and home country, not its recipients.

In a less globalized world, foreign firms investing in a new country had little choice but to rely on local suppliers, talent and existing industries. Now, they don’t. So, when FDI pours into a country, instead of working with local suppliers, multinationals use imported inputs and other foreign value-adding components and expertise embedded in their existing supply networks.

This means local firms fight for razor-thin margins in low value-adding tasks, with few opportunities to develop the capacities – usually control and management of intangible assets like IP and brands – that generate big returns. This makes it harder to move into higher-value activities like product design and technology development.

As Benetrix and his colleagues show, foreign direct investment can be especially harmful in the services sector. Rather than building new operations, services FDI often takes the form of mergers and acquisitions. That means foreign companies displace domestic providers instead of expanding the sector, dampening growth and squeezing out existing local firms.

FDI, by itself, isn’t a strategy to develop new capabilities in the innovation economy.

The critical question is whether it helps Canada create more value or whether it will entrench us in economic niches that don’t. Distinguishing investments based on where value gets created in a production process helps explains why Canada’s EV subsidy policy raised concerns, and why current research branch plants of multinationals in Canada warrant closer scrutiny.

In the intangibles-driven economy, research is a critical input in the development of new goods and services. Foreign multinationals often set up shop in Canada, and do lots of R&D here. In fact, in 2022, foreign multinationals accounted for over 40% of R&D spending by businesses in Canada. This might sound good at first glance - aren’t we getting around the problem of being locked into low-value roles if we’re playing a role developing cutting edge research?

Not exactly, because while Canadians are driving high-value research, that value isn’t staying here – we don’t actually control the value we’re creating or developing the entrepreneurial and managerial skills we would need to do so effectively within branch plants.

Foreign multinationals use FDI to seek capabilities abroad, poaching knowledge and talent and extracting value for their home economies. In advanced economies, the outflows of knowledge from subsidiaries exceed inflows from parent companies.

The result that the really valuable intangible assets flow out of the country, even as labs, offices and jobs remain. In this context, unquestioningly supporting foreign direct investment to bolster job numbers is not wise and risk conceding something much greater, our capacity to create lasting growth and long-term economic development.

As governments mull how best to balance maintaining Canada as an investment destination and nurturing our sovereign capabilities, they should keep this firmly in mind.

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Claire Wilson is a Research and Policy Analyst at CCI. She can be reached at cwilson@canadianinnovators.org. Mooseworks is the Council of Canadian Innovators' innovation policy newsletter. To get posts like this delivered to your inbox, sign up for CCI's newsletter here.