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Northern Exposure

Christopher Sands

Canadians and Americans are collaborating on a historic mission to explore the surface of Mars. Enabling that cooperation is the British Columbia-based space division of MacDonald, Dettwiler and Associates (MDA), Canadas largest space technology firm. MDAs participation in the U.S. space program goes back decades. In 1999, it acquired the robotics division of Edmontons SPAR Aerospace, which famously created a device (known as Canadarm) that allows for remote manipulation of objects when attached to NASA space shuttles.

MDA has long been an object of Canadian pride. So many Canadians cheered last month when their industry minister, Jim Prentice, announced that Ottawa would intervene to block the sale of MDAs information systems division to Minnesota-based Alliant Techsystems (ATK) for $1.3 billion. The unexpected move to block Alliants investment reveals some important realities about Canadian attitudes toward U.S. investors.

Canadas history of economic nationalism

Like many British colonies in the 19th century, Canada relied heavily on foreign direct investment (FDI) to build critical infrastructure, such as continent-spanning railways, and to tap into the vast resource wealth of the Canadian interior. Canada preferred investment from London, but with competition for its bond issues from other large colonies like India, South Africa, and Australia, it had no choice but to seek venture capital in the United States. Of course, the United States was and is both a rival for Canada and also an overwhelming influence that threatens Canadas independent identity. The result was a historic pattern of ambivalence toward FDI from the United States that carried over into the 20th century.

In 1974, the economic nationalists in the center-left Liberal government of Pierre Trudeau established the Foreign Investment Review Agency (FIRA). All foreign acquisitions of Canadian firms and all foreign companies seeking to establish a presence in Canada were required to get FIRA approval. In 1980, the Trudeau government went further, attempting to claw back U.S. ownership of the rich oil sands of Alberta through pressure for divestiture and the creation of a national oil company, PetroCanada, which had guaranteed rights to explore oil resources anywhere in Canada.

The Reagan administration made the elimination of these policies a priority. In 1984, it found a willing Canadian partner in Brian Mulroney, who became prime minister of a Progressive Conservative government that strongly backed free trade. Mulroney proposed the U.S.-Canada Free Trade Agreement (FTA), which was approved in 1988. It was one of the first U.S. trade agreements to incorporate an investment chapter.

But the FTA did not mention certain industries; and when the Liberal Party returned to power in 1993, it pursued a campaign of protectionism for Canadas so-called cultural industries: film and television production, books and periodicals, broadcast and satellite services. The Liberals claimed that the 1988 U.S.-Canada FTA had explicitly exempted culture; in fact, U.S. and Canadian negotiators had simply agreed to exclude these items from the negotiation at Canadas request. The result was that throughout the 1990s, Canada attempted to protect cultural industries from U.S. competition and American investment, and a series of trade disputes quickly followed: Sports Illustrateds Canadian edition, an attempt by Borders Bookstores to open branches in Canada, and DirectTVs proposal to partner with Power Corporation of Montreal to expand its service in Canada all ran afoul of Canadian regulators.

Free trade and national security

Although postwar Canadian governments adopted investment protectionism in many sectors of the economy, defense technology has been an exception. The defense industries in Canada and the United States have long been closely interconnected. The 1956 Defense Production Sharing Agreement stipulated that for the purposes of military procurement, products of Canada and the United States would be treated equally by the two governments. Like the European Coal and Steel Agreement, the DPSA was a historic agreement to integrate a major sector and build a continental economy. But the combination of free trade and national security did not work for Canada in a crucial case that led many Canadians to argue for Ottawa to intervene once again.

In 1953, a Canadian company named Avro Aircraft Limited began development work on an advanced fighter aircraft, the CF-105 Arrow. The Arrow started taking test flights in 1958, and impressed many experts with its performance. However, the Canadian air force did not require enough planes to make the production of the Arrow commercially viable, and neither the United States nor the United Kingdom would place orders for it. After all, the Americans and the British had their own firms producing competing aircraft. In 1959, the Arrow project was halted when the Progressive Conservative government of John Diefenbaker stopped funding its development.

The Arrow had been a source of Canadian pride, and its cancellation fueled bitter recriminations and conspiracy theories that continue to be heard today. Many of the Canadian aeronautic engineers who had worked on the Arrow moved to the United States and found work at U.S. defense companies and at NASA, which led some Canadians to argue that Americas intention all along had been to spur a brain drain.

But the lessons of the Arrow project were not lost on Canadian defense contractors. Canada alone simply could not purchase enough advanced equipment to justify the skyrocketing costs of research and development in the defense technology sector, and the DPSA did not guarantee sales, only market access. In order to remain competitive, Canadian firms that were not already subsidiaries of American parent companies sought partnerships with their U.S. rivals. Many opened facilities in the United States, and some even relocated there. This helped promote friendly bilateral defense relations until the end of the Cold War.

Then, in the 1990s, the Clinton administration made it tougher for Canadian firms to participate as suppliers on U.S. defense contracts. U.S. enforcement of congressionally-mandated International Trafficking in Arms Regulations (knows as ITARs), which restrict technology transfers to firms whose personnel might pass along sensitive military secrets to U.S. enemies, had been relatively lax with regard to Canada. The threat of terrorism had convinced the U.S. government to take a broader view of what types of technology could qualify as sensitive under ITARs. However, some Canadians saw the strict enforcement of ITARs as U.S. protectionism in the guise of security.

Since September 11, 2001, orders have grown as military customers demand technology innovation and volume delivery in a hurry at rock-bottom prices. Firms are now looking globally to acquire advanced technology or extraproduction capacity.

This has accelerated the worldwide trend toward consolidation of defense contractors. Much like its automotive suppliers, Americas independent defense firms have restructured themselves into supply chains that flow from customers to prime contractors and then to tier-one suppliers, tier-two suppliers, and so on. European defense firms went through a similar consolidation during the 1990s, although in Europe the resulting firms were more often multinational amalgamations of several national champions. Canadian defense firms are somewhere in between: some have sought a U.S. partner, while others have looked to join an international team.

MDA shareholders overwhelmingly supported the sale of the space technology division to Alliant. As part of a U.S. defense firm, the engineers and researchers there would gain access to a network of marketing assets that could lead to more and steadier work. Meanwhile, MDA could concentrate on its other businesses, including real estate information systems. But the Canadian government blocked the sale anyway.

Will Canadas gamble pay off?

Canadian Prime Minister Stephen Harper heads a Conservative Party government that is considered pro-business and friendly to the United States, at least by Canadian standards. Yet Harper supported his industry minister in rejecting Alliants bid for the MDA space division, citing Canadas national security interest in maintaining a domestic Canadian capacity in space imaging technology.

Canada appears to be gambling that it can protect MDA without scaring off U.S. investors and jeopardizing inflows of FDI into its defense technology sector. But there are other factors hindering U.S.-Canadian technology transfers: the Bush administration has kept up pressure on Canadian firms over ITAR compliance, and stricter border inspections have increased delays for people and goods traveling between the two countries. Canadian firms hoping to sell to the Pentagon may react by relocating or shifting their operations to the United States; meanwhile, U.S. defense contractors may begin to look elsewhere for technology partners.

Of course, if MDA continues to thrive without Alliants investment, it could lead to renewed confidence in the Canadian space sector. Thats surely what Harper is hoping for. But hes taking a significant risk.

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