Alarm bells ought to be ringing in Canada. Business, industrial and foreign direct investment have performed pitifully over the past decade, with no reason to believe there will be a turnaround any time soon.
As noted by Steven Globerman of Western Washington University, “from 2010 to 2019, Canada’s investment growth rate dropped substantially below that of the United States and many other developed countries.”
If there is one element that distinguishes wealthy nations from poor nations it is the presence of capital investment. A man’s marginal product of labour—his market-clearing wage—derives from the capital upon which he can apply himself.
Capital per worker is also at the core of both neoclassical and modern (endogenous) theories of growth. How nations grow or stagnate distills 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 demonize, capital markets are brilliant facilitators of resource allocation and investment. Third World nations often suffer by lacking or having only narrow secondary markets. These are the stock markets where owners and prospective buyers trade liquid equities already in circulation. Wide participation facilitates price efficiency, transparency, and investor confidence.
The question we must address then is why Canada’s capital markets—although modern and subject to relative legal stability—are struggling to direct capital to the nation’s economy. Without competitive, dynamic public markets for bonds and equities, investors either look elsewhere or rely on illiquid, lumpy and less efficient private-equity deals.
Consider that in 2019, prior to the COVID-19 recession, initial public offerings in Canada were the lowest in a decade. As reported by the National Crowdfunding and Fintech Association, Canadian and U.S. markets are losing out to Asian competitors: “In 2018, 51 per cent of all equity capital raised through [IPOs] went to Asian companies. Today more than half of the world’s listed companies are from Asia.”
The TSX, Canada’s principal stock exchange, has about as many companies listed now as it did a decade ago and the sister TSX-V has about 20 per cent fewer. In the United States, the problem is even more pronounced. The total number peaked back in the mid-1990s, down about 50 per cent now—although larger company size is offsetting this in terms of total market capitalization.
Firms choosing to forgo IPOs or delisting do so for many reasons. However, Andras Marosi of the University of Alberta asserted in the Journal of Financial and Quantitative Analysis “the cost of regulatory compliance is a driving force behind the going dark phenomenon.” In other words, firms find the benefits less likely to surpass the rising admission fees.
A symptom of rising barriers to entry became apparent in July in the United States. The Nasdaq Private Market, a transaction facilitator for nominally private firms, has grown rapidly since its 2013 formation. It is now entering a partnership with other firms for a separate platform which will be a quasi-public exchange but with fewer compliance hurdles. This does not help the retail investor, but it follows the expanding size and number of unlisted companies that still attract institutional investors for partial ownership.
The best regulators can do to support capital-market growth and proliferation is ensure confidence and allow access. That means no more than a light touch focused on clear property titles, dispute resolution and transparent reporting. Except in rare exceptions, such as national security concerns, exchanges and buyers should be the only ones to decide which companies and securities can and cannot list publicly.
The Nasdaq Private Market is only the more visible presence of alternative secondary markets. Even if regulators wanted to, they would be at a loss to regulate new fundraising initiatives such as crowdfunding. Attempts to do so are only driving the activities offshore, limiting access and curtailing innovation.
A C.D. Howe Institute report published in May recommends the removal of “rules and regulations holding back innovation and productivity in Canada’s financial sector.” Although superior financial markets are not a fix-all for economic albatrosses such as fiscal deficits and equalization burdens, the financial sector “has the unique ability to boost both its own productivity and that of other sectors.”
This is where regulatory sandboxes make sense. They entail the removal of some regulations for a period—two years, for example—with a review at the end to see whether reinstatement is even necessary. The cryptocurrency-exchange and crowdfunding spaces are crying out for such regulatory relief so they can grow and establish a nexus in Canada.
One advantage Canada has over the United States in this regard is at least some decentralization. A few provinces, such as Alberta and Quebec, are resisting the federal government’s unconstitutional takeover of capital markets. Nationalization would be a recipe for clunkiness and crony capitalism centred on Ottawa and Toronto.
So long as the provinces’ hold on regulation remains, they can make their regulatory environments attractive for new, expanded and innovative capital markets. Moves toward decentralization can bring a new generation of investors into the fold and heighten transparency. These markets can then send precious capital to where it will garner the best returns, their primary function so desperately needed in Canada.
Fergus Hodgson is a research associate with the Frontier Centre for Public Policy.
