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Article Excerpt
The Study in Brief
With Parliamentary review of the Export Development Act due in 2008, the federal government should seize the opportunity to streamline the operations and priorities of Export Development Canada (EDC). Straightforward economic reasoning and ongoing developments in the global financial services industry call into question the scope of financial services now marketed by EDC. Policymakers should consider restructuring EDC's operations to create a truly competitive export finance and export insurance environment for Canadian companies.
This Commentary contends that the privatization of EDC's short-term insurance portfolio is an overdue and easily implemented option. Withdrawing from the short-term credit insurance market would make EDC a more streamlined organization, enhance government revenues and bring Canada's export-credit insurance regime in line with international norms. More importantly, the withdrawal of the government-backed insurer from the market would level the playing field and spur the development of a more robust private credit insurance market. Ultimately, this will benefit Canadian exporters.
Highlighting the experience of other OECD countries, this Commentary contends that EDC's withdrawal from short-term credit insurance would not adversely affect Canadian exporters. Indeed, expanded competition would enhance companies' access to these financial tools. Although this Commentary concedes the inevitability of government involvement in some export financing and insurance--principally due to political considerations--a restructuring of a portion of EDC's activities would constitute a first step in ensuring a more vibrant credit insurance industry in Canada to the benefit of exporters and the economy.
Export credits have been called the "financial lubricant" of international trade (Moravcsik 1989, 176). However, selling goods on credit to foreign customers carries many risks--a buyer may become insolvent, a war might break out or a foreign government may impose currency controls. Export credit insurance offers companies a simple way to manage such risks. By insuring their accounts receivable, exporters can reduce their exposure to commercial and political risks.
Two characteristics distinguish the Canadian market for export credit insurance. First, unlike the practice in most OECD countries, a state corporation--Export Development Canada (EDC)--enjoys a dominant market share in both short-term and medium-term credit insurance. Second, also unlike in most OECD countries, EDC competes with private insurers in marketing its services to Canadian companies. While some observers may consider a competitive state corporation as benign, many also recognize the market distortion that EDC's activities entail, especially if they crowd out private competitors. Together, these peculiarities make Canada's export credit insurance regime anomalous and anachronistic.
Globally, export credit insurance has emerged over the past two decades as a primarily private-sector activity, with most governments withdrawing to underwrite only extreme and speculative risks. In Europe, for example, private insurers account for 95 percent of export credit insurance. Some countries, such as the United Kingdom and Australia, have privatized large segments of their previously government-administered programs. In Canada, however, the Export Development Canada, markets and underwrites the bulk of export credit risk. International experience suggests that government intervention in export credit insurance markets--and in short-term, export credit insurance in particular--is not necessary. The Government of Canada should reduce this sphere of EDC's operations. Such action would spur the development of the private insurance market in Canada, add a modest source of tax revenue to the federal government, result in insurance being offered on unambiguously market terms, remove a distortion from the Canadian financial market, and bring Canada more in line with its OECD peers and trading partners.
The EDC
Export Development Canada is Canada's official export credit agency. The Crown corporation provides financial facilities--such as insurance on accounts receivable, export loans and direct financing--to Canadian companies and to foreign buyers of Canadian goods. EDC enjoys a broad mandate to promote Canada's export trade, and it has considerable leeway in the types of financial transactions it pursues (see Box 1 for an overview of EDC's main services). Although this Commentary's focus is on insurance, EDC's other services should be kept in mind to appreciate the corporation's scope of activities.
Box 1: EDC's Main Financial Products Insurance Products * Accounts Receivable Insurance (Export of Goods) * Single Buyer Insurance (Export of Goods, Short-term coverage) * Performance Security Insurance (Export of Capital Goods, Services, Long-term Projects) * Contract Frustration Insurance (Export of Capital Goods, Services, Long-term Projects) * Political Risk Insurance (Export of Capita] Goods, Services, Long-term Projects) * Domestic Trade Credit Insurance (offered jointly with COFACE) Financing Products * Pre-Shipment Loans * Business Promotion Loans for small and medium enterprises * Foreign Buyer Financing * C-TPAT Compliance Loans * Accounts Receivable Guarantee * Products aiding companies seeking factoring services * Equity investments * Note Purchases * Direct Foreign Investment Products * Leasing Bonding Services * Guarantees to allow Canadian companies secure bonds or letters of guarantee. Credit Information Services * Information about foreign buyers. Canada Account Services * Insurance and loans offered as Canada's official Export Credit Agency (ECA) with transactions explicitly underwritten by the Government of Canada.
History
EDC began as the Export Credits Insurance Corporation (ECIC) in 1944 to aid the financing of exports to Europe following the Second World War. (2) ECIC's mandate was broadened in 1969 with the creation of the Export Development Corporation, which was re-branded in the early 2000s as Export Development Canada. The most notable change in EDC'S operations occurred following the 1993 review of the Export Development Act. The 1993 reforms allowed EDC to offer a wider array of products and gave the corporation
greater leeway in the financial transactions that it pursues. (2) In retrospect, the reform drastically shifted EDC's operations--for example, since 1993 EDC's average credit-insurance premiums have declined by more than 50 percent and EDC's staff has grown commensurably to meet the corporation's expanded operations (Figure 1). Furthermore, since 1993 the risks underwritten by EDC have grown approximately seven times to $58.5 billion in 2006 and correspond to about 12 percent of Canadian exports (Figure 2). (3)
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An early review of EDC noted five reasons guiding legislators in the corporation's creation (Raynauld et al. 1983). First, the promotion of exports was seen as desirable: exports created jobs, improved Canada's balance of payments and allowed for the implementation of strategic industrial policy. Second, EDC could be used as a tool for diversifying the destinations of Canadian exports by facilitating trade with riskier or developing markets (Funatsu 1986, Schich 1997, Eeckhoudt and Louberge 1988, Rienstra-Munnicha and Turvey 2002). Third, EDC could help change the composition of exports favouring, for example, the development of manufacturing industries. Fourth, financing channelled through EDC could allow Canada to match other countries' export-subsidy programs. Historically, this point has been salient in the aerospace industry. Finally, the Crown corporation could fill a perceived "market void." At the time, few insurance companies in Canada offered export credit insurance and the government-backed EDC was seen as a supplement to the private market. However, subsequent studies have challenged all of these justifications--not uniquely advanced in the Canadian context--on policy and economic grounds (see for instance Niskanen 2001; Stephens 1999; Ray 1995, ch. 1; Raynauld et al. 1983; but cf. Moser et al. 2006, Egger and Url 2006, Abraham and Dewit 2000).
Current Activities and Structure
Today, EDC remains an Ottawa-based Crown corporation with a staff of about 1,030. The corporation's administrative expenses in 2006 totalled $203 million and its total net income was $1.2 billion. (4) EDC's operations can be divided into two classes. First, EDC manages the Canada Account, which file federal government uses to provide explicitly government-backed financial support to exports deemed to be in the country's national interest. Historically, the Canada Account has been used to offer both loans and insurance to Canadian exporters. Canada Account transactions are approved by both the ministers of International Trade and of Finance and are accompanied by a withdrawal from the Consolidated Revenue Fund. Examples of past Canada Account transactions include several sales of Bombardier aircraft and the financing of Romania's purchase of a CANDU nuclear reactor. Recently, the Canada Account's use has dwindled as more transactions are performed under EDC's Corporate Account.
The Corporate Account is EDC's main business focus. Transactions booked under this account are nominally backed by EDC, and the associated terms are said to be consistent with the principles of the market; that is, premiums, fees and conditions are claimed to be equivalent to what one would find if a private company offered the same service. No explicit, contemporaneous government appropriation is used to finance specific Corporate Account transactions. Rather, EDC uses its retained earnings, initial government investment and status as a Crown corporation to raise capital to finance Corporate Account operations. (5) That said, such an operating structure suggests an implicit annual appropriation of public funds to EDC. For instance, until 2006 EDC treated its profits as retained earnings and reinvested these funds into the corporation. The government could have, in principle, chosen to allocate these funds elsewhere, but chose instead to allow EDC to retain them (Figure 3).
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Several contentious issues arise from these practices. Foremost, EDC's insistence on offering services on market terms introduces an inherent tension or paradox. Notwithstanding possible regulatory complications, given the apparent profit generated by EDC's corporate portfolio, the same bundle of services--loans, insurance, etc.--should, in principle, be readily available from private sector actors; however, it is not. The conclusions of an early review of EDC's operations continue to be relevant today: "Why, then, do [private institutions] refuse to provide services identical to those of the EDC? The contradiction is irreconcilable. The answer to the question is obvious: EDC claims notwithstanding, the agency does not operate on a commercial basis" (Raynauld et al. 1983, 7).
Assessing the degree of EDC's departure from operating on a strict commercial basis is difficult due to the possible cross-subsidization across and within various product lines, the lower cost of capital that it enjoys and the different regulatory setting in which it operates as a semi-autonomous arm of the federal government. These are, of course, issues that one encounters when examining the operation of most Crown corporations.
Regulatory Setting
The Export Development Act and related regulations define EDC's mandate and powers. The corporation is accountable to Parliament through the Minister of International Trade and is audited by the Auditor General of Canada. As a federal Crown corporation, EDC is considered an agent of the Government of Canada; therefore, any obligations that it assumes are guaranteed by the federal government. This allows EDC to raise capital from the market at better rates than available to private-sector competitors. With the government as the corporation's owner and guarantor, the Canada Account/Corporate Account distinction may become blurry at times. All of EDC's funds are ultimately Canada's funds, but the Corporate Account does not need a minister to sign off on transactions. The corporation has a...
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