Cover image from April Issue 2017.Click image to enlargeby Andrew Brooks

Is Canada's automotive manufacturing industry growth sustainable?

 

Like baseball, the automotive sector is a game of statistics. Given its scale and its importance to Canada’s economy, it’s not surprising that the numbers–growth, sales, production, jobs, year-over-year trends, dollars invested, etc.–are closely tracked. Those numbers dominate any discussion of the automotive sector, but over the last few months the political dimension, never far in the background, has taken centre stage.

The top story, of course, has been the election of Donald Trump as President of the US. The unpredictable, tough-talking billionaire has promised drastic action to protect American jobs, and has focused on the auto sector with a promise to impose a huge tariff on Mexican-made cars coming into the country. He has also lambasted the North American Free Trade Agreement (NAFTA), saying it favours Canada and Mexico at the expense of the US, and has promised to renegotiate the terms.

Politicians talk tough all the time, but Trump’s rhetoric has many observers worried. It comes at a time when the North American automotive market is showing signs of an upturn, and many fear that even rhetoric could have a chilling effect.

The upturn is real enough. Scotiabank’s “Global Auto Report,” issued in January, notes that global auto sales “accelerated sharply” at the end of 2016 and are expected to continue growing into 2017, though at a slightly slower pace. Sales will post an eighth consecutive record year in 2017, Scotiabank says.

Scotiabank’s “Auto News Flash” of February 1 brought further good news: Canadian auto sales for January set a new record for the month. If the pace holds through 2017, Scotiabank says, the year will set a new annual record, breaking the two million mark. Sales are strong for both domestic and import models, with light trucks leading the way.

That’s not all. In January, Honda announced an investment of nearly $500 million over three years to improve and upgrade its huge plant in Alliston, ON. Alongside that announcement, the federal government announced welcome changes to its Automotive Innovation Fund (AIF), allowing the program to provide non-repayable funding for the first time ever.

The AIF was originally designed to offer repayable funding for “strategic, large scale research and development projects in the automotive sector that support innovative, greener and more fuel efficient vehicles.” The auto industry has been after Ottawa for some time to introduce non-repayable funding, i.e. grants, saying that requiring repayment made funding recipients uncompetitive with competition in Mexico and the low-cost southern US states.

On the labour front, Unifor, the huge private sector union that represents some 23,500 Canadian workers at Ford, Fiat Chrysler and GM, claimed a huge win last November when it secured promises of nearly $1.6 billion in new investment from the Big Three, most of it to revamp three plants the union identified as under threat: GM’s Oshawa assembly plant, Fiat Chrysler’s Brampton assembly plant, and Ford’s Windsor-area engine plant.

It sounds like good news all around for Canada’s auto sector. But the industry is vast and complex, and negative indicators can coexist with positive ones. For example, vehicle production in Canada is faltering. A year-over-year comparison shows car production falling from nearly 80,000 units in November 2015 to just over 74,000 units in November 2016. Light, medium and heavy trucks did a bit better; in November 2015 141,100 of them were built here, while 142,900 were built in November 2016.

Dennis DesRosiers, president of DesRosiers Automotive Consultants, says while Canadian governments have done a good job in dedicating resources to help the country’s automotive sector, getting new investment is still a challenge and we’ll be doing well if we hold on to what we have.

Despite the decline, Canada still punches above its weight when it comes to vehicle production. While Canada accounts for only around nine per cent of North American auto sales, some 13 to 14 per cent of vehicles built in North America are made here. But that doesn’t translate into similar success in the auto parts sector.

“We get more than our share of vehicle production,” Desrosiers says, “but our auto parts sector has rarely gotten much more than six or seven per cent of North America production. And it’s down in the five per cent range now, well below what you might consider our ‘natural’ share.”

Overall, Canada’s auto sector is still struggling to recover to where it was before the 2008 financial crisis. Despite a partial recovery, the industry is still a long way from getting back to that level, DesRosiers says.

“Our recovery is very weak compared to the US and Mexico. One reason is that basically the US southern states and Mexico are providing better options for suppliers. They’ve both been huge winners in the last decade. That acts as a magnet to drive the supplier sector into those jurisdictions. So they’ve grown at the expense of Canada.”

Another reason is the falloff in automotive-sector investment in Canada following the cancellation of the Auto Pact in 1989. “That may seem like a long time ago,” DesRosiers says, “but the investments under the pact carried us forward into this century. The investments that didn’t come after the cancelling of the Auto Pact were still hurting us a decade later. Most multinationals left Canada. They were here primarily because of Auto Pact rules. There are very few of them left. They consolidated into the US and Mexico.”

Jonathon Azzopardi, chair of the Canadian Association of Mold Makers (CAMM) and president of compression mould maker Laval International, sees direct competition from Mexico and the low-cost “right-to-work” states in the US south as a huge challenge for the sector in Canada. Mexico and the southern states have recently seen an upsurge in new auto sector investment, which comes at the expense of high cost jurisdictions like Ontario.

The province still boasts an unprecedented concentration of automotive sector work. Ontario hosts five auto OEMs–Ford, Fiat Chrysler, GM, Toyota and Honda–more than any other province or any US state. It also hosts more than 700 parts suppliers and more than 500 tool, die and mould makers in what some have called “North America’s Other Silicon Valley.” It’s an infrastructure that is the envy of many other jurisdictions.

There are good reasons for Ontario’s pride of place, but there are problems too, even though, as Azzopardi points out, the province’s auto sector is highly productive and is renowned for high quality. “We produce a lot and we produce it fast,” he says. “But it comes at a cost. Now, if Ontario’s high labour cost was the only problem, you’d probably still win based on the other metrics. But there’s inflexibility, red tape, the unions that are involved–all those different layers of labour complexity can discourage companies from making major investments.”

Azzopardi also believes positive signs in the automotive sector could actually represent a temporary adjustment to excess capacity instead of indicating genuine growth. “What you’re seeing right now is the absorption of excess capacity. An example of that is right here at Laval. We were running two shifts before, and now we’re going to run a third shift to sop up excess capacity.” It’s a pattern that he says is occurring across the automotive sector, at the OEM, Tier 1 and Tier 2 level.

“It’s good, don’t get me wrong, but they’re taking advantage of the situation, not necessarily investing in the future. Whereas we’ve seen the opposite in the southern US. We’ve seen new substantial investment at all levels with big OEMs like Volvo and BMW moving in and bringing their entire supplier base down.”

While Azzopardi has issues with how the automotive sector and related portfolios like energy are being managed by Canadian governments, when it comes to cross-border negotiations he says he’s encouraged by how Ottawa has reached out to the industry. In particular he sees a sound response shaping up to Trump’s tariff threat, mentioned below (see Untouchable Intergration).

Azzopardi describes recent meetings with Canadian and Mexican NAFTA negotiators as probably the best discussions he’s ever had on any free trade agreement. “I wasn’t around for NAFTA, but I was around for TPP [Trans Pacific Partnership] and CETA [The Canada-European Union Comprehensive Economic and Trade Agreement]. The government didn’t engage with the industry far enough in advance to be able to have any impact at that time. But this time they’re talking to us before they even go into negotiations. They’re asking for opinions, asking for public statements, asking for good ammunition to take with them to the negotiating table,” Azzopardi says.

“I have other complaints about the Liberal government, but I believe that this shows a great deal of support and forward thinking.
It’s very encouraging.”

Untouchable Integration?
The North American auto industry has become a political football following US President Donald Trump’s declaration that he would slap a 35 per cent tariff on Mexican-produced cars entering the US as a way of forcing automakers who have offshored their plants there to relocate in the US. And his promise to renegotiate the “failed” NAFTA trade agreement between Canada, the US and Mexico has created uncertainty in economic relations between the three countries.

But the sheer efficiency of the auto industry, and its tight integration between the three countries, may be one of the most effective guarantees that no head of state can shake things up as much as they’d like. That, at least, is the view of Dennis DesRosiers, president of DesRosiers Automotive Consultants.

Trump’s promises shouldn’t worry people too much, DesRosiers says. As he points out, the integration of the North American auto sector got underway in 1965 when Canada and the United States signed the Auto Pact. That integration became closer in 1989 with the signing of the Free Trade Agreement, and even closer in 1994 when Mexico was admitted under NAFTA.

“We have over 50 years of a 100 per cent integrated auto industry in North America,” DesRosiers says. “The US president simply isn’t powerful enough to undo that. He can’t de-bundle it. The genie is out of the bottle. And he’d be foolish to do it. I think he knows it would be a job killer.”

Even if US President Trump does follow through on his promise to renegotiate NAFTA, as far as DesRosiers is concerned the auto sector will probably be left alone. “The auto terms have been fair to all three countries. It’s unlikely that he could touch those. If he did he’d be doing himself more harm than good, and I think he knows that.”

How likely is Trump to introduce his massive tariff on Mexico? “I don’t think he can do it. Remember there are four million vehicles made in Mexico now, and more than three million of those sell into the US. Trump may not like that, but it’s why vehicles have been so affordable in the US,” DesRosiers says.

“We have this integrated industry that operates very efficiently–possibly the most efficient industry in the world. To put any sort of border restrictions on that would kill that efficiency and drive vehicle prices up, who knows, maybe 10, 20, 30 per cent. Which would kill the market–and kill US jobs.”

Jonathon Azzopardi agrees that a tariff of that scale would create stagnation or worse in the tightly integrated North American auto sector. Azzopardi is president of Laval International, an Ontario based compression mould maker. He’s also chairman of the Canadian Association of Mold Makers (CAMM) and serves on the board of the Automotive Parts Manufacturers Association (APMA).

Azzopardi uses Laval as an illustration of North American integration. “Half of our sales today are exported to Mexico,” he says. “As Mexico has grown, we’ve doubled the size of our company, and the Mexican industry was growing as it was exporting to the United States. So even a 20 per cent tariff on Mexican companies exporting to the US will actually hurt Canadian companies like ours, who are exporting into Mexico. And I don’t believe our situation is unique.” SMT

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