First Nations Tax Commission – Commission de la fiscalitè des premières nations
Understanding Market Failure

Understanding Market Failure

A root cause of the First Nation fiscal imbalance is market failure on First Nation lands. The investment market has failed on First Nation lands. Investment is subject to prohibitively high facilitation costs and as a result socio-economic disparities persist despite large public investments to address these.

Research sponsored by ITAB found that an investor will spend four to six times longer seeing a project through from proposal to final approval when it takes place on First Nation land. This issue affects every First Nation in the country and its removal is a pre-condition to creating more self sustaining First Nation governments oriented towards good governance and accountability regimes.

The causes of high investment facilitation costs are not simple. ITAB research found that additional costs arise at many different stage of the investment facilitation process. The complexity arises because these costs have emerged for three different, but related, reasons:

  1. The Indian Act effectively removed First Nations from the economic union and created the following impediments to investment. The Indian Act assigned governance powers to a bureaucracy that is far removed and does not have an investment agenda. The Indian Act created a system of property rights and land use decision making that is slow and does not provide certainty. The Indian Act structure has resulted in a considerable uncertainty about the assignment of jurisdiction and expenditure responsibilities among governments. The result has been substandard services and more uncertainty. The fiscal arrangements that currently support First Nation government do not create an incentive for First Nations development and they handicap First Nations with respect to the means for attracting investment.

  2. The removal of First Nations from the economic union for over a hundred years has created the second problem. There has been an atrophying of the expertise and governance policies that would ordinarily support investment. For example, until relatively recent times, there were very few investment specialists who specialized in capitalizing on First Nation opportunities. Similarly, there was little understanding of the imperative of investment within the Department of Indian Affairs or of what is required to facilitate investment. Policy was made without reference to its impact on investment. This same problem is even more pronounced within First Nations. The removal of First Nations from the economic union shifted the political orientation of First Nations almost exclusively towards strategies for securing more public resources. To our knowledge the “schools” teaching First Nations public administration do not even teach basic investment facilitation skills.

  3. Finally, the atrophying of investment on First Nation lands has created conditions where people are unable to take advantage of business and job opportunities themselves. For example, they are unable to access home equity which is the principle source of equity for business startups. They have lacked exposure to work place experiences. They lack business contacts. The prevailing attitude is that job opportunities are produced by the public sector. The key to creating market forces on First Nation lands is to simultaneously address all three types of problem listed above. There have been attempts to address individual aspects of the issue. However, these have been largely uncoordinated and piece meal. For example, consider the First Nations Land Management Act. It gave First Nations jurisdiction to substantially streamline the process by which developers get approvals to use land. This jurisdiction created the potential to provide investors with substantially more certainty. However, most First Nations lack the awareness and capacity to use these powers towards these ends. Similarly, there have been capacity building exercises aimed at improving administrations. However, for the most part these were not driven by the imperative of developing a sound investment climate.

Even if the first two issues can be surmounted, initiatives are still needed which will allow First Nation members to take advantage of the resultant job and business opportunities and First Nations to take advantage of the resultant fiscal opportunities. Without this last step, First Nations political support will not be forthcoming.

The urgency of this issue and its impact on the rest  of Canada should not be underestimated. The fiscal, economic, and political costs of market failure on First Nation lands are large and growing. We estimate the economic costs of First Nation disparities will reach $20 billion per year by 2020 because our share of the working age population is rising so sharply.

Investors on First Nation lands face considerably higher costs in terms of time and money when choosing to develop on First Nation lands. Consequently, First Nation investments tend to be less profitable and more risky. A First Nation attracts far less investment than other jurisdictions from an equivalent investment of property tax revenues. It therefore earns a much smaller return from an equivalent investment in public infrastructure.

High costs of investment facilitation are the underlying reason that Canada has been unable to significantly improve conditions on First Nation lands. It is easy to recognize reserves because they remain barren, even in vibrant locations. These costs also explain the familiar observation that monies that flow into reserves will flow out quickly and without producing lasting benefit.

In the absence of a strategy that allows the investment market to work, it will be enormously expensive to remove First Nation disparities. It would cost $12.5 billion in new annual funding to remove income disparities for aboriginal people in 2006 with their present levels of productivity. By 2020 this number will grow to over $20 billion.

Market failure on First Nation lands is imposing fiscal and economic costs on Canada in five ways.

  1. First Nations people are impoverished. Poverty impacts the fiscal balance. High investment facilitation costs affect off reserve people as well as on reserve. Many migrate to cities seeking opportunity but are disadvantaged because they grew up in poverty. The poverty of these people creates direct fiscal costs because many social programs, such as income assistance, are poverty driven. First Nation poverty reduces the fiscal flexibility of all governments and directly impacts the federal government’s ability to improve the fiscal balance of the federation.
  2. First Nation poverty impacts the fiscal balance of the federation indirectly. It impacts the equalization formula. Off reserve migration in search of employment impacts federalprovincial transfers. Market failure on First Nation lands is the root cause of the underemployment of First Nation lands and people. First Nations lands and people are the most underemployed resources in Canada and also the fastest growing component of the Canadian work force. This means large losses of economic activity.
  3. Market failure on First Nation lands has made it more difficult to resolve issues concerning aboriginal title for major investment projects. High investment facilitation costs mean First Nations are less able to share in the induced investment that large investment projects bring a region. For example, the service industry that supports a large resource development deal will not locate on First Nation lands. This makes it more difficult to close deals where projects affect First Nations traditional territories.
  4. Any federal or provincial initiative aimed at reducing First Nation or aboriginal, economic and social disparities implies enormous program costs in the absence of greatly improved commercial and residential investment on First Nation lands. We estimate it would cost $12.6 billion to bring Status Indian incomes to the national average using income transfers,even assuming such a direct transfer program created no disincentive effects.

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