Canada’s great auto slide

During the past half-century, the share of manufacturing as a percentage of Canadian GDP has declined from just under 25 percent to 10 percent. The declines are also recorded when measured by employment levels or the number of new auto assembly plants. (Photo: Tom Freda)

During the past half-century, the share of manufacturing as a percentage of Canadian GDP has declined from just under 25 percent to 10 percent. The declines are also recorded when measured by employment levels or the number of new auto assembly plants. (Photo: Tom Freda)

Since the recession of 2008 and 2009, increasing concern has been expressed by politicians, union leaders and analysts concerning the decline of manufacturing in Canada. Indeed, during the past half-century, the share of manufacturing as a percentage of Canadian GDP has declined from just under 25 percent to 10 percent. The declines are also recorded when measured by employment levels or the number of new auto assembly plants.
However, when OECD data over the same period are examined, we discover that this trend is a reality in all western countries. Nonetheless, there are genuine problems that affect Canadian automobile manufacturing that are unique to Canada.
The problems facing Canada’s automotive manufacturing sector can be traced to the origins of the industry, when the first automotive plant was opened in 1904 in Walkerville, Ont., near Windsor. It was established under the regime of Canada’s first prime minister, Sir John A. Macdonald, and his national policy of high tariff barriers. Automobiles were no exception, with a 35-percent tariff established for imported autos. The national policy ensured that manufacturing took place in Canada with small production runs mostly for the Canadian market, which in turn meant much higher prices as economies of scale in the small Canadian market simply could not be achieved.
PREVENTION_6-28-2016_0046The infamous U.S. Smoot-Hawley Tariff Act of 1930, and the decision of the R.B. Bennett government in Canada to reciprocate, increased tariffs to their highest level in more than 100 years and ensured that subsequent trade collapsed amongst countries by more than 50 percent during the Great Depression. Decades later, Professor Ben Bernanke, who went on to become chairman of the U.S. Federal Reserve, stated that “economists still agree that Smoot-Hawley and the ensuing tariff wars were highly counterproductive and contributed to the depth and length of the global Depression.” Donald Trump should note that Senator Reed Smoot, congressman Willis Hawley and Bennett were each defeated in the next election.
However, the good news was that at the beginning of Franklin Roosevelt’s second term in office, his administration started to incrementally undo the most pernicious effects of the protectionist policies that caused so much damage to western economies and which many believe led to the Great Depression. The U.S. Reciprocal Trade Agreements Act of 1934 led to a bilateral agreement between Canada and the U.S. in 1935 and these agreements in turn provided the broad framework that led to the establishment of the GATT (now the WTO) immediately following the Second World War.
It was during this period, immediately after the war, that William Lyon
Mackenzie King’s Liberal government secretly negotiated a free-trade agreement with the U.S. that was revolutionary for its breadth and depth. However, at the last minute, King experienced buyer’s remorse and rejected it. This was unfortunate. From this time until the Auto Pact of 1965, Canada experienced significant auto-trade deficits with the U.S., notwithstanding the 17-percent tariff on U.S. auto imports, as the small production runs in Canada ensured extremely high prices for automobiles.
Throughout the 1950s and 1960s, Canada focused its trade policy on multilateral agreements, principally successive rounds of the GATT. While this certainly pleased the internationalists at the federal external affairs department, it failed to address Canada’s increasing dependency on a bilateral relationship with the U.S., with Canada on the losing end.
Nowhere was this more apparent than in the Canadian automotive manufacturing industry. As Carleton University professor Michael Hart argued in his book, A Trading Nation: Canadian Trade Policy from Colonialism to Globalization: “The weak competitive position of the Canadian automotive industry flowed from a variety of factors including technological developments, the revival of the European industries, the weakening benefits of traditional links to British and Commonwealth markets and the structure of the Canadian industry.”
DIPLOMAT_6-28-2016_0047Indeed, the government of John Diefenbaker appointed Vincent Bladen, an economist at the University of Toronto, to evaluate the industry. He concluded that the principal problem facing the industry was short production runs in an industry characterized by very large capital costs and suggested it needed long production runs to achieve the necessary economies of scale. It did not require an economist to understand that Canada could not meet this strategic imperative in a small, closed market behind high tariff barriers.
Industry studies at the time found that a firm needed to produce 600,000 cars a year to achieve maximum economies of scale. The largest Canadian firm, GM Canada, was producing 175,000 cars a year — not even close.
Bladen recommended the industry narrow the number of cars produced in order to specialize and increase production runs. The policy instrument proposed was duty remission on imported parts for the cars that were exported. The proposal was, in fact, the embryo of the Auto Pact (actually Automotive Products Trade Act or APTA). And in 1965, prime minister Lester B. Pearson signed the Auto Pact treaty with U.S. president Lyndon Johnson.
It became a truism of Canadian politics that the Auto Pact was “free trade in automobiles” and thus a precursor to possible future trade deals. In fact, it was anything but. Instead, it was cleverly disguised protectionism, for it protected the Canadian market for the U.S. Big Three (GM, Ford, Chrysler), which is what the WTO ruled in 2002 when it struck down the treaty as illegal.
DIPLOMAT_6-28-2016_0048The U.S. sought to rationalize the automobile manufacturing industry by extending U.S. manufacturing hegemony to Canada while Canada wanted to ensure that it participated in the rationalization of the auto manufacturing industry. As Hart notes in A Trading Nation: “Canada agreed to make its protection more efficient, and the United States agreed to exempt Canadian-origin parts and vehicles from its protection.” Canada’s auto manufacturers were given duty-free access to the U.S. market for vehicles that met a minimum of Canadian- or U.S.-made content. The Canadians promised to ensure that 75 percent of cars sold in Canada were made in Canada — using high tariffs against vehicles not made in Canada or the U.S.
DIPLOMAT_6-28-2016_0050For the next third of a century, Canada prospered under the Auto Pact, generating substantial trade surpluses with the U.S. in contrast with the auto-manufacturing deficits experienced prior to 1965. The U.S. produced more vehicles in absolute terms as its economy and population were 10 times larger. However, Canada produced proportionately more vehicles year after year.
In 1989, Canada signed the historic free-trade agreement (FTA) with the U.S. While the Auto Pact was a sectoral agreement in automobile production, the FTA was a comprehensive agreement that applied to goods and services in most sectors. However, Canada agreed to give up its right to use duty remission as a tool to protect firms located in Canada.
In 1992, negotiations lead to the inclusion of Mexico and the signing of NAFTA that came into law in 1994.
It has become fashionable to blame NAFTA in Canada and the U.S. for job losses in the auto industry. Yet, as Queen’s University professor John Holmes has shown, Canada experienced a trade surplus in automobile production between 1993 and 2007. In his words: “Between 1982 and 2006, Canada enjoyed a positive balance on its automotive trade with the rest of the world. The trade surplus peaked at $14.6 billion in 1999, but by 2007, on the eve of the global financial crisis, the balance had turned negative. By 2014, the deficit stood at $10.3 billion. Over the seven years between 2008 and 2014, Canada registered an average annual automotive trade deficit of $9.5 billion.”
In short, for the first 14 years of NAFTA, Canada did very well. However, starting in 2003, Canada’s auto export surplus started to contract and disappeared in 2007. Why did this contraction happen  after so many years of success in manufacturing and exporting automobiles? For that answer, we turn to the Deloitte annual survey of manufacturing competitiveness. Two of the most important drivers in manufacturing are costs and productivity. So, we then examine a singularly important metric in manufacturing called “unit labour costs per hour.” It’s similar to retail sales per square foot because it allows comparisons across firms, across countries, in the same sector. This metric calculates the wage rate per hour, the productivity per hour of that activity and the exchange rate of that country to produce the “unit labour cost per hour,” which can then be used to compare that industry or sector to the same industry or sector in other countries.
Canada’s dramatic deterioration really started in 2003. When we compare Canada’s unit labour cost per hour to other manufacturing countries, we realize Canada’s problem is very serious indeed. (See Chart 5.8.)
Indeed, these data are corroborated by the Ontario Ministry of Finance in its budget, as seen in Chart 5.2.
Finally, when we examine the location of new assembly plants over the last two decades — the places that produce the vehicles to be exported — we discover that most of them have been built in the U.S. South. (See Chart 6.)
Notwithstanding the strong protestations by UNIFOR, the Canadian labour union that represents workers in communications, media and manufacturing, the data clearly reveal that Canada’s automotive manufacturing industry has become uncompetitive in terms of its unit labour costs. Indeed, in the last two  years, the CEOs of Ford, Chrysler and GM have each publicly stated that Canada is a very high-cost country in which to manufacture automobiles.
UNIFOR, consultants and elected officials claim that the solution lies in providing more government support. However, the empirical data clearly reveal why new assembly plants are not being built in Ontario, but instead are being located in the U.S. South and Mexico.
In turn, this suggests that UNIFOR must demonstrate leadership with its members to educate them about the need for wage restraint and productivity increases. If unit labour costs in the Canadian auto manufacturing industry do not become competitive, it can be safely predicted that Canada will eventually follow Australia and exit the industry.

Ian Lee is an associate professor at Carleton University’s Sprott School of Business. Laura Ierfino-Blachford is an instructor at the Sprott School of Business at Carleton University and has a PhD in management from McGill University.

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Ian Lee is an associate professor at Carleton University’s Sprott School of Business. Laura Ierfino-Blachford is an instructor at the Sprott School of Business at Carleton University and has a PhD in management from McGill University.

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