Canadian Branch plant economies Essay

Modern industrial organizations in Canada are synonymous with the branch plant economy phenomenon. In general, â€Å"the term branch plant economy refers to a convenient shorthand term to describe a regional economy where a large proportion of the employees are in establishments owned by firms whose head office lies outside the region† (Watts 1). In Canada, branch plant economies are subsidiaries of companies based abroad, mostly in the U.S. A branch plant economy is a strategic tool used by transnational corporations to maximize profits, avoid tariff fees and encourage exports. â€Å"Branch plant economies have been established in Canada for two essential purposes; the first is to gain access to the domestic Canadian market and the second is to gain access to Canada’s primary products† (Laxer 127). Specifically, this paper will discuss the evolution of the branch plant economy and its negative and positive effects on the Canadian auto industry and its implications on regional development. Branch plant economies exist where investment and business strategy decisions are made by an international head office of a company and not by the company itself. These economies have the traditional hierarchical model of corporate organization with strong centralized co-ordination of individual plants and subsidiaries. The private capital from international investors, mainly the United Kingdom, has always played an important part in the development of industrial countries, especially Canada. These investments not only brought money, supplies and equipment to Canada but also mass migration from the investing countries. Canada was and still remains an excellent source of primary products for many migrants and their home countries. Canada served as a primary product producing country connected to an external controller, originally the United Kingdom, but now mainly the United States. This condition has remained unchanged to this day. This philosophy has also remained imbedded in Canadian business attitudes and Canada’s macroeconomic sector since Confederation and is unlikely to change. â€Å"After the end of the Second World War almost fifty five percent of the  manufacturing in Canada was being done by foreign owned branch plants† (http://www. Canadainternationalbureauofstatistics/dominion/quart/dev/icj.html October 23, 2001). A majority of these were American owned. The phenomenon known as the branch plant economy was now evolving in Canada. As the American economy expanded in the 1950’s and 1960’s so too did the branch plants in Canada. â€Å"In 1965 George Grant, a writer, wrote a book called Lament for a Nation in which he believed that Canada’s potential for greatness had sadly passed† (http://www.Johnaboutcanada.com November 1, 2001.). Canada had switched gears to a branch plant economy all for a small piece of the American dream. This overwhelming  desire of Canadians to acquire a piece of the American dream became the target of certain jokes in the global economic community. Apparently, if a country has the potential to be overrun with foreign corporations, they call it the Canadian disease. â€Å"As the 1970’s began Canada was deindustrializing. In the 1970’s research on externally controlled branch plant economies stated that they lacked managerial authority and were functionally truncated† (http://www.Canadainternationalbureauofst atistics/dominion/quart/dev/icj.html October 23, 2001). Branch plant economies concentrated on production activities while more important actions such as research and development were expanded and conducted elsewhere within the parent firm. The result was that these branch plant economies were more likely to be deficient in high skilled occupations and technologically dependent thereby lacking innovative and entrepreneurial activity. Branch plants were also associated with lack of linkages with local companies and their vulnerability to closure during times of economic uncertainty. Canadian economists believe a high concentration of branch plant economies would be detrimental to the long-term development of the regional economy. â€Å"As the 1970’s came to a close Canada reached an all time low with only nineteen percent of Canadians being employed in the manufacturing sector† (http://www.Canadainternationalbureauofstatistics/dominion/quart/dev/icj.html October 23, 2001). Currently, Canada is economically heavily dependent on larger economic countries for research and development and new technologies. Canada also has always been dependent on the extraction of its primary products for export to other countries. â€Å"As far back as 1963 as much as sixty percent of the manufacturing industry was owned by firms whose head office lay outside the region or in foreign countries† (www.Statisticscanada/local/stateprov/ont.html. October 5, 2001). The Canadian auto industry is a model case study of a branch plant economy. The auto industry’s rich history dates back to the beginning of the twentieth century where a bright young entrepreneur named Sam McLaughlin who initially was an apprentice in his father’s carriage workshop went into the automobile manufacturing business with his brother and father. By l9l8, with increasing competition in the North American automobile industry, McLaughlin decided to sell his firm to the recently organized General Motors Company, owned by Durrant and associates. Thus, McLaughlin’s company became a Canadian subsidiary of General Motors, with McLaughlin as president and as vice-president of the American company. During this process, the Oshawa plant gained the distinction of being â€Å"the center† of General Motor’s production in Canada. Prior to the depression of the 1930’s Canada was manufacturing hundreds of thousands of cars per year. Canada was a tool in the American plight which would introduce Canadian built American cars not only to Canada but also the whole British Commonwealth. For a brief period this actually worked well propelling the Canadian auto industry to international recognition. Unfortunately the ugly head of the great depression surfaced and the era of prosperity ceased. â€Å"It was not till the end of the Second World War that the Canadian auto industry had become a branch plant economy with major American auto makers producing vehicles in Canada for the Canadian domestic market (Laxer 130)†. Many countries established productive auto industries after the Second World War; unfortunately Canada was manufacturing too many types of cars for its relatively small markets to become productive. â€Å"The problem was endemic to branch plant industry. It was known as the miniature replica effect. Every multinational company from every type of industry established its own production operation in Canada to avoid Canada’s tariff laws (Laxer 130,131)†. Canada wanted desperately to rectify this situation so Diefenbaker ordered that a Royal Commission be conducted to determine Canada’s options and to change its current state. Diefenbaker appointed economist Vincent Bladen to conduct an inquiry into the Canadian auto industry. Bladen made recommendations which influenced many developments one of which led up to the Canadian-US auto pact. The Auto Pact was established in 1965 to facilitate free trade in cars and parts for the American owned auto manufacturers which were at that time known as the Big Four: GM, Ford, Chrysler and American Motors. The Auto Pact agreement was that these four U.S. corporations would make guarantee new investments in Canada and would maintain  assembly operations in Canada in at least the same ratio to Canadian sales as in 1964. In return, the Canadian government removed all duties on cars and parts imported by these companies. â€Å"Under the terms of the Canada-United States Automotive Products Agreement of 1965, qualified motor vehicle manufacturers are able to import both vehicles and original equipment automotive parts duty-free from any Most Favoured Nation country, provided the following performance requirements, are met: The value of vehicles produced in Canada must meet or exceed a specified proportion of the manufacturer’s annual sales in Canada. In other words, if manufacturers want to sell imported cars duty-free in Canada they must also build cars in Canada. Assemblers must maintain, on an annual basis, a nominal dollar amount of Canadian value added in assembly activity of at  least that reached in 1964. Canadian value added in Canadian vehicle assembly includes direct and indirect labour, depreciation on Canadian-made machinery, eligible overhead and other expenses that can be reasonably allocated to the cost of producing the vehicles, and the Canadian value added in Canadian made parts and materials used in assembly. Inflation has rendered this requirement insignificant† (http://strategis.ic.gc.ca/SSG/am00540e.html). During the 1970s, three events dramatically changed the world automotive industry and in particular the North American industry: the oil embargo of 1973 and 1974, the Iranian oil crisis of 1979, and the emergence of Japan as one of the world’s largest  producers of motor vehicles. Nixon wanted to offset this and secure the American auto industry and therefore implemented the Domestic International Sales Corporations. â€Å"This was a low tax entity through which American products would be exported abroad. The plan provided a tax break for American domestic industry to increase its exports. Its purpose was to keep American jobs in America (Laxer 135)†. Since Canada had the most concentration of branch plants, which were American owned, this severely affected Canada. The Ontario government study of the auto pact agreement concurred that three problems existed affecting the auto industry as follows: the inability for the auto industry to enhance productivity, the consistent loss of Canada’s overall market distribution of the auto assembly activity and the overwhelming intensification of the parts trade deficit. The Domestic International Sales Corporation plan implemented by Richard Nixon encouraged companies to locate in the United States and provided them with lucrative incentives. Since the inception of the Auto Pact, Canada and the United States have created a single North American market for vehicles. The Auto Pact allowed for the rationalization of the North American market for vehicle production. Since signing the Auto Pact, the Canadian automotive industry has enjoyed unprecedented growth production where  automotive manufacturing employment has increased 200% and automotive shipments grew from $2.2 billion in 1964 to $70.7 billion in 1995. Canadian economists and the  Canadian autoworkers union view the Auto pact agreement as a savior from the small Canadian market and probably the only feasible way of offsetting the huge trade deficit. Others believe the benefits of the Auto Pact have all gone to U.S. imperialism. The subjugation of the Canadian economy to U.S. imperialism increased as a result of the pact and trade deficits increased. Canada also surrendered any possible initiative to try and create its very own all Canadian car which would have been made and sold exclusively in Canada. Branch plant economies have always had a negative connotation. Any debates always raise concerns about the potentially negative consequences for regional development because of a high degree of external control by multinational firms. It is precisely this concentration of control activities either overseas or in one region that influences a region’s economic performance. This influence on regional growth is manifested through various means. One is employment, specifically the job mix and job stability in a region and the second is technological change. Most branch plant economies are small inefficient firms that are incapable of promoting overall local development. Branch plant economies act more like an export platform which merely exist to extract valuable raw materials for export. They have little  effect on the local economy in terms of encouraging self-reliant economic growth. Branch plant economies often use capital-intensive low labour technology which does not  generate many new jobs for the local economy. Multinational corporations with branch plants in Canada tend to take their profits from the subsidiary and  send it back to the corporate headquarters in their home country rather than reinvesting it in the local Canadian economy by additional hiring of personnel or by contribution to the infrastructure. Since they are in the same business or a derivative of such as their parent company it is easier for them to maintain their competitive edge without having to liberally invest in research as their indigenous counterparts. Simply put these multinational companies take more money out of the Canada than they put in. The managerial autonomy in branch plants is minimal with dependent positions. Higher functions such as research, development and marketing are centralized within a group. The importance of the branch plant economy within a parent group is marginal or even non-existent and the quality of employment is mainly low skilled jobs, including part time and temporary positions. The link of the branch plant to the host economy is limited and the former is always vulnerable to closure, downsizing or restructuring. The worst negative effect of branch plant economies are that they have created close ties with local government and banks to gain superior access to local finance. These ties allow multinational corporations to acquire the majority of investment capital which  deters the rise of indigenous entrepreneurship. Branch plant economies have been directly accountable for Canada’s astronomical trade deficit because American branch plants have  been sucking the economic lifeblood from Canada for generations. Virtually any profits or technologies generated by Canadian workers ultimately are sent back to the United States. Presently multinational corporations are under increased pressure to lower costs because of the increased import competition from low wage countries, additional opportunities to invest in low wage countries and increasing technological change. While branch plants have played an historical role in Canada, there is a sense that these plants are more susceptible to the changes in foreign trade, foreign direct investment and technological change. Liberal economists or realists admit there are certainly some negative effects of the branch plant economy, yet they strongly believe that the advantages outweigh the disadvantages. They believe that foreign ownership and direct investment can be seen as instruments for development in that branch plant economies bring in productive new technological advances that provide an economic boost for Canada. Branch plants have traditionally played a large role in rural economies and rural economic development strategies as they have provided good stable jobs with relatively high wages and full benefits. In fact, large, multinational corporations generally look to rural areas for low wageworkers and favorable business climates. â€Å"The productivity difference between branch plants and single-unit home owned plants has increased by 57 percent between 1967 and 1992 (Watts 54)†. On average, branch plants in southern Ontario pay higher wages and are more productive than single-unit plants. This relationship holds nationally as well. The trend in wages is somewhat different. There is a large increase in the wage premiums of branch plant economies in 1982, but then it declines over the 1982 to 1992 period. Moreover, by controlling the industry and location type, we can conclude that branch plants are concentrated in more productive, higher paying industries and tend to be located in urbanized areas of the region. Other positive data relating to the branch plant economy comes from recent information which states that â€Å"the classic symptoms of the branch plant syndrome could be alleviated by organizational changes within large corporations (http://www.Entrepreneurstrategist/figure/nnt/odb.html October 11, 2001)†. Specifically, recent decentralization of managerial authority and functional responsibilities within some large corporations has led to improvements in the quality of branch plants. Consequently, branch plant economies have changed substantially over the past two decades and the negative connotation which is associated with the branch plant may no longer be an accurate representation. â€Å"A recent study shows that foreign-owned subsidiaries spend a greater proportion of revenues on research and development than their homegrown competitors. Furthermore, a United Nations study dispels the myth that Canada is one of the foremost branch-plant economies. Canada actually ranked ninth among developed nations in 1997 (http://www.Unitednationsstatistics/worlddl/cig/eco/org. October 5, 2001)†. There are however optimistic views that Canada, because of its inventiveness, skilled workforce, economic efficiencies and political stability, plays above its weight as a competitive economy and cannot therefore be dismissed as purely a branch plant economy. In general branch plants continue to contribute significantly better employment opportunities. The following are just a few sample opinions on the branch plant phenomena from the world’s leading business investment specialists: â€Å"Foreign direct investment is not just a source of capital; it creates jobs and helps us acquire leading-edge technology (http://www.Entrepreneurstrategist/figure/nnt/odb.html October 11, 2001)†. â€Å"Transnational corporations strengthen our economy, they help to create an exciting and innovative business environment for foreign investors to consider (http://www.Entrepreneurstrategist/figure/nnt/odb.html October 11, 2001)†. â€Å"Twenty years ago, many foreign governments saw foreign corporations as part of the development  problem. Today they see them as part of the solution (http://www.Unitednationsstatistics/worlddl/cig/eco/org. October 5, 2001.)†. â€Å"Canada has had and will continue to have a huge deficit in manufactured goods unless dramatic changes are implemented. One third of the finished products consumed by Canadians are manufactured somewhere either than Canada (Laxer 115)†. â€Å"Year after year Canada has always finished with a deficit in this sector. Without the surplus of our primary product exports, pulp and paper, lumber and oil our ability as Canadians to maintain a high standard of living would ultimately vanish (http://emerald.atkinson.yorku.ca/lspace35/2001y/pols3580/schedule.nsf)†. If Canada wants to foster technological literacy and enjoy the economic, social and intellectual well being in the long term it is imperative to institute an aggressive research and development program of its own. It may initially experience trade deficits, a declining share of total world exports, fewer job creations, and a decreasing industrial and technological capability, however these are just short term problems. If the country chooses to remain idle it will see an outflow of talent it cannot afford to lose. â€Å"Control of end products brings with it control of the chain innovation for all the machinery and parts  and components that go into the end product (Laxer 128)†. The net effect is that Canada would not control its own economic destiny because of invisible inflows or imports of new technologies. Canada would be at the mercy of decisions taken in the corporate interest of multinational enterprises rather than in the interest of the region or the national interest of the country. Finally, I do not believe the previous and current auto trade arrangement Canada has with the United States is not undermining Canadian regional development because we have gained considerably in the economic sector with the Auto pact of 1965, the free trade agreement and the North American Free Trade agreement. The auto industry is already 95 percent owned by the American companies and these agreements have not encouraged increased American content because the United States would have had a firm hold on the North American auto industry regardless if any of the above agreements were signed. These agreements helped Canada salvage some economic growth and prosperity. In the future, Canada should be extremely cautious when negotiating any free trade auto trading agreements given that the auto pact of 1965 is an excellent example of the potential disastrous effects of these agreements in an environment saturated with branch plant economies.