Alarm bells should ring in Canada. Business, industrial and direct foreigner investments have been pathetic over the past decade, with no reason to believe there will be a turnaround anytime soon.
As Noted By Steven Globerman, Contributor to Troy Media, Western Washington University, “From 2010 to 2019, the growth rate of investment in Canada fell significantly below that of the United States and many other developed countries.
If there is one thing that distinguishes rich nations from poor nations, it is the presence of capital investments. The marginal product of a man’s labor – his equilibrium wage in the market – comes from the capital on which he can apply.
Capital per worker is also central to neoclassical and modern theories of growth. How nations grow or stagnate comes down to a debate about the various factors that drive investment: property rights, the rule of law, savings rates, low taxes and high trust communities, for example.
Far from being something to be demonized, capital markets are brilliant enablers of resource allocation and investment. Third world countries often suffer from the absence or the narrowness of secondary markets. These are the stock markets where owners and potential buyers trade in liquid stocks that are already in circulation. Broad participation facilitates price efficiency, transparency and investor confidence.
The question we must answer, then, is why Canada’s financial markets – although modern and subject to relative legal stability – struggle to channel capital into the domestic economy. Without competitive and dynamic public markets for bonds and stocks, investors either look elsewhere or rely on illiquid, lumpy and less efficient private equity deals.
Consider that 2019, before the COVID-19 recession, initial public offerings in Canada were the lowest in a decade. As reported by the National Crowdfunding and Fintech Association, the Canadian and American markets are losing out to Asian competitors: “In 2018, 51% of all equity raised by [initial public offerings or IPOs] went to Asian companies. Today, more than half of listed companies in the world are Asian.
The TSX, Canada’s main stock exchange, has around numerous companies listed today as ten years ago and its sister TSX-V is about 20 percent less.
In the United States, the problem is even more pronounced. The total number sharp in the mid-90s and is now down about 50 percent – although larger company size makes up for this in terms of total market capitalization.
Companies that choose to forgo IPOs or delisting do so for many reasons. However, Andras Marosi of the University of Alberta affirmed in the Financial and quantitative analysis journal “The cost of regulatory compliance is a driving force behind the phenomenon of darkness. In other words, companies are finding that the benefits are less likely to outweigh the rising admission fees.
A symptom of rising barriers to entry began in July in the United States. The Nasdaq Private Market, a transaction facilitator for nominally private companies, has grown rapidly since its inception in 2013. It is now partnering with other companies for a separate platform that will be a quasi-public exchange but with fewer barriers to compliance. This doesn’t help the retail investor, but it follows the growing size and number of unlisted companies that still attract institutional investors for partial ownership.
The best that regulators can do to support the growth and proliferation of capital markets is to build confidence and provide access. It means nothing more than a light touch focused on clear title deeds, dispute resolution and transparent reporting. With rare exceptions, such as national security concerns, stock exchanges and buyers should be the only ones to decide which companies and securities can and cannot be publicly listed.
The private Nasdaq market is just the most visible presence of alternative secondary markets. Even if regulators wanted to, they would be unable to regulate new fundraising initiatives such as crowdfunding. Attempts to do so only push activities abroad, limiting access and reducing innovation.
A CD Howe Institute report published in May recommends the removal of “rules and regulations that hold back innovation and productivity in Canada’s financial sector.” Although superior financial markets are not a silver bullet for economic albatrosses such as budget deficits and equalization burdens, the financial sector “has the unique ability to boost both its own productivity and that of other sectors.”
It’s here that regulatory sandboxes make sense. They involve the removal of certain regulations for a period – two years, for example – with a review at the end to see if reinstatement is even necessary. Cryptocurrency exchange and crowdfunding spaces are calling for such regulatory relief so that they can grow and connect in Canada.
One of the advantages of Canada over the United States in this regard is at least some decentralization. Some provinces, like Alberta and Quebec, resist federal government unconstitutionality to resume capital markets. Nationalization would be a recipe for awkwardness and crony capitalism centered on Ottawa and Toronto.
As long as the provinces’ hold on regulation remains, they can make their regulatory environments attractive to new, larger and innovative financial markets.
Movements towards decentralization can bring a new generation of investors into the fold and increase transparency. These markets can then send valuable capital to where it will get the best returns, their much sought-after primary function in Canada.
Fergus Hodgson is Associate Researcher at the Frontier Center for Public Policy.
Fergus is a Troy Media thought leader. For interview requests, click here.
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