Why Mexicans Don't Drink Molson

by Andrea Mandel-Campbell

  Designed more as social policy than as industrial strategy, the tenure system is essentially a pact between government and industry that affords companies cheap access to wood in return for providing forestry jobs that average a comfortable $68,000 a year. The arrangement worked as long as Canada was the world’s pre-eminent forest-products supplier. But as new sources of cheap logs are being tapped in Russia and fast-growing trees in Brazil can be turned into pulp at half the North American cost, the hairline cracks in Canada’s forestry industry are now gaping wounds.

  In 2005, Quebec announced a dramatic 20 per cent reduction in its allowable cut following decades of overharvesting and meagre reforestation efforts. Other provinces are facing similar challenges, as companies that have no real attachment to the land they harvest have no incentive to replant more than they have to by law. And why would they? When trees take fifty years to grow, twenty-five-year licences reduce operators to renters in someone else’s home, explains Clark Binkley, managing director of Massachusetts-based International Forestry Investment Advisors and the former dean of ubc’s Faculty of Forestry.

  With no guarantee that they will ever harvest the trees they plant, loggers don’t invest in genetic research to improve seed resistance, while site preparation, planting and fertilizer regimes are much less intensive than those in the United States. “Under those kind of weak tenure arrangements, spending money on silviculture is like walking over to the boardroom window, tearing up dollar bills and throwing them out,” says Binkley. “It comes back to incentives — why do you never wash a rental car?”

  But while companies cut corners on r&d, they pay the price by being forced to maintain so many remote and inefficient mills. Consolidation is actively discouraged by provincial governments that either swoop in with bailouts or threaten to confiscate timber rights in the case of a mill closure. As a result, century-old clunkers long destined for the scrap heap are kept alive with retrofitting and costly maintenance, leaving companies unable to redeploy capital and invest in new technology.

  The government’s overwhelming, not to mention compromised presence, as both tree salesman and industry regulator, means companies focus an inordinate amount of their creative energy on managing “government issues.” Even the softwood lumber dispute, which has absorbed the industry for two decades, is a direct consequence of the fact that Canadian timberland is owned by the Crown. This situation leaves companies little time to notice what’s happening in the rest of the world and keeps them from honing the skills required for competing globally.

  “The overwhelming focus on government issues means management spends a huge amount of time dealing with the government instead of concentrating on how to create wealth, how to improve production or how to expand the value of the company by moving to China,” says Binkley. “These are not exportable skills. It’s not going to help you deal with the Chinese government or give you a competitive advantage elsewhere.”

  The problem is exacerbated by competing provincial jurisdictions that discourage movement within Canada while a reluctance to allow mergers stops companies from acquiring the scale and scope needed to compete internationally. According to Russell Horner, chief executive of Vancouver-based Catalyst Paper, unless the industry is allowed to retrench, the cost to Canada will be far greater than the recent round of job losses. “If we don’t do the necessary restructuring, it is going to be much more painful and much more damaging,” he says. “We need players that are going to come out of this as robust companies. Otherwise, we’ll just be picked off by offshore players.”

  It’s already happening. Just look at what remains of the once-mighty MacMillan Bloedel. The forestry giant founded in the 1920s by H.R. MacMillan had all the makings of an industry leader. At its apex in the 1960s and 1970s, MacBlo marketed one third of B.C.’s lumber exports and had operations worldwide. One of the originators of oriented strandboard (OSB), the now-ubiquitous plywood substitute, MacBlo opened the world’s first waferboard plant and invented a reconstituted lumber product called Parallam. But despite its innovation and rich resource base, MacBlo was never able to capitalize on its leadership.

  While many of the world’s most profitable forestry firms owe their success to the flourishing osb business, MacBlo failed to market and develop its inventions. And although it was a large forestry company in British Columbia, it was relatively small in the global scheme of things. That didn’t stop the provincial government and the public from alternately attacking MacBlo for its size and blocking local acquisitions while accusing it of exporting jobs when it expanded abroad.

  By 1999, MacBlo had been adrift for over a decade when Weyerhaeuser, from neighbouring Washington state, bought it. In 2005 Weyerhaeuser dismantled the company, selling off its coastal B.C. timber assets to Toronto-based Brookfield Asset Management. “We have ourselves to blame,” says Richard Haskayne, MacBlo’s former chairman. “We had a base to work with, but we didn’t capitalize on it.”

  The same could be said about Domtar. Less than a year after closing its Cornwall plant, the century-old company was acquired by Weyerhaeuser, which took a 55 per cent stake in the struggling firm and reincorporated it south of the border (where the majority of its mills are located).

  Forestry watchers like Clark Binkley, however, aren’t ready to give up just yet. Canada has a lot going for it, including its location so close to the U.S. market, more than a third of the world’s installed capacity and two centuries of know-how. The B.C. interior, where operators are racking up record profits despite the costly softwood lumber dispute, is an instructive case in point. Forced to cut costs in the wake of 27 per cent U.S. duties, companies began merging and building some of the biggest, most technologically advanced mills in the business. “Canada has got the core ingredients,” says Binkley. “If we can’t figure it out, shame on us.”

  Back in Cornwall, Claude Macintosh is less optimistic. Most people here only have a high school education, and the biggest employers are the hospital and the municipality. As for the private sector, well, Wal-Mart, the U.S. retailer, opened a massive distribution centre with nine hundred employees. The other big money maker is smuggling. The city, complacent in its ephemeral potential and confident that well-placed members of Parliament would win it government contracts, never really worried about its future.

  “It’s like World War ii, when the Nazis invaded Poland,” says Macintosh. “All the signs were there. When you look back you say, ‘How did we miss it?’ I guess we just didn’t want to see.”

  BANKING ON PROTECTION

  In 1982, Citigroup was teetering on the brink of bankruptcy. The American behemoth and world’s ninth-largest bank by assets had overextended itself with big loans to shaky Third World countries that suddenly became worthless in the wake of huge debt default and currency devealuations.

  The timing was ripe for a takeover and some of the Canadian banks, well endowed with cash and assets, even flirted with the idea of taking a run at the distressed institution.

  The Bay Street Boys never took the bait, but miraculously had a second chance less than a decade later when Citigroup once again got itself into hot water over risky overseas investments. The bank went around the world seeking potential investors to provide it with a life-saving capital injection. The Canadians were sitting right there, but never answered the call. Instead Saudi Prince Alwaleed bin Talal al Saud stepped forward, taking a leap of faith that would transform Citigroup and global financial markets forever. With operations in over 100 countries and $1.7 trillion in assets, Citigroup is now the world’s largest company, according to Forbes magazine, and a prime mover in the dramatic consolidation that has resulted in a clutch of global banks increasingly dominating the financial sector worldwide.

  Sadly, the Canadian banks are no longer members of that elite club. After taking a pass at arguably their best chance to enter the global big leagues, the Big Five are small potatoes on the world stage. The venerable Royal Bank of Canada, the country’s second-largest company
by market capitalization, was ranked forty-ninth among world banks in 2005,83 with assets of $457 billion. At one time bigger than Chase Manhattan, Credit Suisse and JP Morgan, Royal’s assets add up to just one quarter of Japan’s Mitsubishi UFJ and Switzerland’s ubs. In the past two decades, the major Canadian banks have sat back and watched as they’ve been surpassed by Holland’s ing Group, London-based HSBC and even the Spanish and the Belgians.

  While the Spaniards reconquered Latin America, Citigroup scooped up insurers and brokerage firms and HSBC circled the globe, Canadian banks, despite their enviable financial strength, could barely bring themselves to cross the border. In 1984, Bank of Montreal bought Chicago’s Harris Bank and has not made a major acquisition since. The others bided their time until as late as 2004, when TD finally took the plunge with the us$3.8 billion purchase of a bank headquartered in Maine. It can now proudly lay claim to being the ninth-largest bank in New Jersey. Yet despite their cautious entry into the United States, the banks have been roundly criticized for buying “third-rate” assets that often produced disastrous results. The Royal Bank of Canada, for example, has little to show for the $8.4 billion it has spent for Minneapolis brokerage firm Dain Rauscher and the problem-plagued Centura Bank of South Carolina.

  CIBC , however, has borne the brunt of the U.S. missteps, first selling its newly acquired investment bank, Oppenheimer & Co., and then shuttering electronic bank Amicus on losses of $700 million. It became ensnarled in a string of scandals, paying out us$2.4 billion to defrauded Enron investors — the largest settlement of any bank— while in 2004 a CIBC manager in New York was led away in handcuffs over improper mutual fund trading. The shell-shocked bank retreated to the safety of Canada, reflecting a general global retreat begun in the late 1980s, when a wave of Third World debt crises prompted many Canadian banks to close representative offices around the globe.

  The one exception to the rule has been Scotiabank, with its string of acquisitions in Latin America. But even there, its strategy has been cautious and largely peripheral to blockbuster deals by the Spanish, Citicorp and HSBC . The banks can afford to be extraordinarily careful, even incurious, when it comes to branching out abroad; they have a monopoly on one of the most profitable markets in the world. The Big Five banks control more than 80 per cent of the Canadian market — the highest market concentration among developed countries outside Sweden and the Netherlands. It’s an almost guaranteed licence to print money, and they don’t have to worry about sharing the spoils.

  Canadian banks don’t have to compete on their home turf because of government restrictions that effectively ban foreign banks from entering the market. Although foreigners are no longer technically barred from buying big Canadian banks, in practice they are, due to ownership restrictions that prevent a single shareholder from controlling more than 20 per cent of a bank’s voting stock and 30 per cent of its non-voting float. At the same time, foreign financial institutions have been discouraged from opening retail bank branches in Canada, thanks to onerous rules requiring them to establish a separate Canadian incorporated subsidiary. As one Australian banker observed, “The Canadian banking market is probably the most protected in the developed world.”

  The upshot is what some observers describe as “a gentlemen’s agreement” to carve up the market, in essence an oligopoly that allows the banks to earn above-average returns. The Big Five consistently rank among the world’s top ten in profitability, and as BMO’s chief financial officer noted in 2006, they “are sitting on more excess capital than any other banks in the world.”84 It’s a striking achievement, considering that Canadian banks are less efficient than their international peers. They not only lack the economies of scale of the big global players, but invest a third less in technology on a per worker basis than do their U.S. counterparts — a gaping differential that is considered to be at the heart of Canada’s lagging productivity.85 Labour productivity in the Canadian financial-services sector is not only 60 per cent that of the U.S., but has grown by less than half the rate of Canadian manufacturing over the last decade. “We’ve never exposed the banks to full competition. It’s no wonder they are not as productive as the rest of the world; they don’t have to be,” says Glen Hodgson, chief economist at the Conference Board of Canada. “The market is carved up, so their principal concern is domestic market share.”

  It’s a great deal if you can get it, but it has come at an incalculable cost. The banks’ sheltered existence has made them exceedingly risk-averse and psychologically ill-equipped to operate in less reliable financial markets (that is, every country outside of Canada, with the exception of maybe Sweden). “It’s not easy to work in foreign markets. You have to have staying power and be able to stick it out through thick and thin,” says Troy Wright, managing director of capital markets for Scotiabank Inverlat. “The Canadian market is protected, so when things don’t go well it’s natural for banks to pull back to a safe haven. It’s the easiest thing to do.”

  The banks were quick to high-tail it out of Latin America during the debt crises of the late 1980s, and even Scotia distinguished itself as the first foreign bank to pull up stakes in Argentina, preferring to take a $540 million writedown rather than soldier through the spectacular debt default and banking crisis of 2002. But while banks are overly cautious abroad, their predilection for taking the easy way out is equally apparent at home. They are overwhelmingly focused on retail banking, a steady and reliable source of income, but essentially a commodity compared with the more sophisticated and riskier investment banking sector.

  In Canada, the absence of a single major Canadian investment bank along the lines of a Merrill Lynch or a Goldman Sachs means that huge swaths of the national economy are either ignored or are increasingly being serviced by more aggressive foreign banks. A case in point is the growing popularity of joint “public–private” partnerships to fund sorely needed infrastructure projects. The Canadian banks, used to cherry-picking safe, short-term financing deals, weren’t interested in offering the riskier, long-term financing needed to underwrite big projects. The Europeans and Australians swooped in and now account for most of the market, financing projects like British Columbia’s Sea-to-Sky Highway and Ontario’s 407 toll road.

  Ironically, once the Canadian banks realized they were losing out on all the business, their reaction was not to try to compete, says one foreign banker. Rather, they tried to lobby government to either block the structured deals or modify them to better suit their way of doing business. “They tried to lobby against public–private partnerships and almost get special treatment,” says the banker. “It says something about the mindset. Rather than acting commercially, their first port of call is to phone their political lobbyist instead of their financial analyst. They see it as a problem they would rather make go away than as an opportunity to make money.”

  To be fair, they’ve been taught to think that way — by overweening government minders that see fit to decide on the wisdom of their business decisions. Why? Because, as Queen’s University economics professor Thomas Courchene explains, the government ultimately views them as “social institutions” rather than inherently economic ones. That was the trade-off, after all. Like the logging companies that are forced to operate sawmills where the government gives them cutting rights, the banks are expected to provide retail services to every corner of the country in return for their monopoly. Regulations make it almost impossible for banks to close branches, even though Canada has more atm machines per capita than any other country on the planet.

  The formidable branch system is arguably an even greater barrier to foreign entry than are the ownership restrictions initially introduced in 1967 to block Citibank’s attempts to buy a Canadian bank. But while few foreigners can afford to build a branch network from scratch— each outlet costs an estimated $1 million — the system has also shackled the banks to Canada. “For the banks, the branches were a perfect barrier to competition,” says David Bond, a leading industry expert. “Now it�
��s a millstone around their necks.”

  When Canadian banks attempted to lighten the load with a proposed merger involving four of the five major banks in 1998, they were slapped down by the federal government. The banks argued they needed to join forces so that they would have the bulk to buy into foreign markets without betting the company. Ottawa, in vetoing the move, maintained the banks would first have to prove the mergers met the requirements of the “public interest,” code words for cheap and accessible retail banking services.

  Stanley Hartt, chairman of Citigroup Global Markets Canada, calls the decision “bad policy.” A former deputy finance minister under Brian Mulroney, he recalls former prime minister Jean Chrétien sitting in his Bay Street office declaring that he would never let mergers happen. Instead, as the us$58 billion tie-up between J.P. Morgan Chase and Bank One in the United States created industry giants, Ottawa equivocated through task forces, policy white papers, Senate reports, a House of Commons study and public consultations without ever issuing merger guidelines. “The long-term policy implications are enormous,” says Hartt. “The attitude towards bank mergers is a symptom of the absence of policy, and as a result they are condemned to be small players in a very small pond.”

  That might be okay for the dairy industry or even forestry, but an inward-looking and hamstrung financial sector has massive implications for the country’s long-term prosperity. When Rick Waugh headed up Scotiabank’s corporate banking operations in New York from 1985 to 1993, the Canadians could go head-to-head with any of the big Wall Street bankers. Back then, Scotiabank ranked among the top ten in syndicated lending in the United States. Now it’s dwarfed by the likes of Merrill Lynch and J.P. Morgan. “When I was down there we could compete with Chase, Manny Hanny [Manufacturers Hanover Trust] on anything,” says Waugh, now Scotiabank’s CEO . “We were on a more equal footing with the American banks. We are no longer. We lost that one . . . because the other guys have gotten bigger.”