11-010-XIB
Canadian Economic Observer
May 2007

Canada’s Changing Auto Industry

by Francine Roy* and Clérance Kimanyi

One of the most significant changes in the global economic landscape over the last two decades has been the growing popularity of autos built by Asian firms. Following their success in sales, Asian producers began shifting production to North America. This article looks at how Canada has fared in attracting these factories and whether these firms behave differently in buying parts locally and trading internationally from the traditional producers.

Members of the Japan Automobile Manufacturers Association (JAMA) of Canada (Toyota, Honda and Cami) have made more inroads into the market of North American manufacturers than in most other countries. While the Japanese manufacturers increasingly build autos in Canada, widespread plant closures by the three major traditional North American auto makers (GM, Ford, Chrysler) have firmly installed in the public’s perception that there is a crisis in the auto industry.

The shift away from the traditional Detroit-based firms has many wide-ranging implications, from how consumers finance their new vehicle purchases to where they get these vehicles serviced and repaired to how they are sold into the used vehicle market. This article focuses on the implications of the rise in sales by Japanese brands for production and international trade in Canada.

This article shows that overall the auto industry in Canada remains on a solid footing despite undergoing significant changes. The first section reviews the extent to which Japanese-based manufacturers have filled much of the gap left by the traditional North American auto makers in production in Canada. The second section shows that this followed a similar trend in sales. In the third and fourth sections, previously unpublished data reveal that the behaviour of the new domestic and traditional producers in exports and in importing parts are comparable.

The transportation equipment industry is very important to Canada, but for Ontario it is fundamental. While transportation equipment makes up just over 15% of Canada’s total manufacturing production, it dominates the Ontario economy with more than $100 billion of output every year, equal to one-third of all manufactured goods produced in the province. Most of this transportation equipment is automotive products. Moreover, 274.6 million hours were worked in the auto industry in Ontario in 2005 (compared with only 18.3 million in Quebec and 9.1 million in Manitoba) out of the Canadian total of 319 million hours. The arrival of the Japanese-based manufacturers has reinforced Ontario’s lead in the North American automotive industry (partly because they have not opened any plants in Michigan).

Production

An overview of Canadian auto production reveals major differences between manufacturers based on their country of origin. It is well known that Canadian auto buyers increasingly prefer foreign brands, but what is less understood is that this change in preference has had a larger impact on auto production in Canada than elsewhere. Figure 1 illustrates how overseas-based auto makers have set up shop more in Canada than in the United States. Several overseas manufacturers had built plants in North America by the early 1990s.¹ However, the growth in Canada of these new domestics was much stronger, doubling since 1998 to more than 900,000 vehicles in 2006 (Figure 2). Another difference is that production in Canada by overseas auto makers is exclusively Japanese, whereas in the US, the German companies BMW and Mercedes-Benz as well as Korea’s Hyundai also have plants (which buy parts from Canada).

Figure 1

Figure 2

The increase in auto production in Canada by Japanese-owned manufacturers has helped offset cuts by the traditional North American producers (GM, Ford and Chrysler). Since 1999, the new domestics have raised output by exactly one-third, the mirror image of the one-third cut by the Detroit-based firms from 2.4 in 1999 to 1.6 million units in 2006 (Table 1). Most of this drop originated in trucks, where only half as many were built in Canada in 2006 as in 1999. This sharp drop partly reflects that Japanese manufacturers have not entered this market until recently.

Table 1 Production and sales (units)

Figures 3 and 4 illustrate that while the Japanese have only a toe-hold in the truck market, they are close to taking the lead for passenger cars. Of the 900,000 vehicles they built in 2006, 844,000 were cars. The increase has been so marked that almost as many cars were built in Canada in 2006 in their plants as in the traditional Big 3 plants. When the new Toyota plant in Woodstock begins operating in 2008, these trends could very well intersect for the first time: by adding 150,000 more units to capacity, this should bring the total number of cars built in Canada by the new domestic vehicle manufacturers to more than 1 million units per year. It is likely that all this new capacity will be needed, as the Japanese-owned plants are currently operating at full capacity, which is why Toyota is building a new plant and Honda announced an increase in its production schedule.

Figure 3

Figure 4

Sales

Japanese companies ramped up their production in Canada partly to keep up with the surge of sales in North America, rather than boosting imports. It is noteworthy that Canadians have embraced Japanese brands more than most parts of the world over the past two decades. Still, Japanese auto imports have not risen much over the last 15 years because of their shift to producing here (Figure 5). The shift to foreign brands is a long-term trend that is gaining ground in many other countries, but Canada is well ahead of the pack. In both the United States and Europe, consumers are increasingly turning away from domestic brands.²

Figure 5

On the whole, Canadian consumers are now buying almost as many overseas models as North American brands (Figure 6a). Only because North American manufacturers still dominate the truck segment (Figure 6b) are they still a major player in total sales. In the car segment, more foreign than North American models have been sold in Canada every year since 2001, and this gap is growing (Figure 7a). Even in the popular sport utility vehicle segment, overseas brands have practically caught up with the traditional Big 3 (Figure 7b).

Figure 6a

Figure 6b

Figure 7a

Figure 7b

It is difficult to identify the precise reasons behind this change in preference. Observers are always divided between the role of a vehicle’s appearance and more objective criteria such as safety, reliability and fuel consumption when it comes to consumers choosing a vehicle. What is certain is that the price of overseas models has dropped compared to North American models since the second half of the 1990s, coincident with the boom in sales of foreign models (Figure 8).³

Figure 8

But not all of the productive capacity built by the Japanese-owned manufacturers was designed solely to meet growing sales in Canada. A substantial part was intended for export to the US. The next section looks at the international trade generated by these firms.

International trade

As with sales and production, the trend in international trade flows also reveal major differences between manufacturers in Canada based on their country of origin. Whereas exports by the traditional North American manufacturers tumbled (along with sales and production), exports by the Japanese-owned manufacturers picked up much of this slack. Between 1997 and 2006, the growth of net exports of vehicles (including chassis) by the new domestic manufacturers in Canada helped offset the slump for the traditional North American firms. Both the level and the growth of exports have posted considerable changes. For example, in 2006 the net exports of Toyota, Honda and Cami together equalled 68% of the net exports of the Detroit-based manufacturers: as recently as 1997, their share was negligible (Figure 9). Only a shortage of production capacity slowed the growth of their net exports in 2006.

There are also important differences between the new and traditional manufacturers in their exports and imports. While exports of the traditional Big 3 firms peaked at $51.0 billion in 1999 before falling by about one-third during the 2000s, those of the new Japanese-owned manufacturers rose from $10.1 billion to a peak of $16.4 billion in 2005 (Table 2). In 2006, they dipped to $15.9 billion, as strong sales in Canada exceeded their capacity to produce here, resulting in a rebound in imports. According to JAMA, almost 50,000 more Honda and Toyota models were sold in Canada last year than in 2004, for many reasons ranging from new models to more dealers to higher gas prices. The US market for certain Canadian-made models also surpassed domestic capacity limits. This helped boost US imports of Japanese vehicles from 1.7 million units in 2005 to 2.3 million units in 2006.

Table 2 Trade in passenger cars, trucks and chassis (millions of dollars)

Conversely, imports into Canada by the traditional Detroit-based manufacturers increased much more than imports by the new domestics for 1997 to 2004, before shortages forced the direct importation of more vehicles from overseas. Like the traditional manufacturers, the new domestic manufacturers ship most of their exports to the United States.

Source of inputs

Not only are the new domestic manufacturers catching up to the Detroit-based firms in net vehicle exports, but they are behaving the same in terms of parts imports. These new manufacturers have built many parts plants in North America. So, even though they are producing many more vehicles, this does not mean that more parts are being imported from overseas. This contradicts the impression held by many that the Japanese-owned plants in Canada only assemble high value-added parts such as engines imported from abroad (in reality, most Japanese firms make their engines locally).

In the mid-1990s, it was true that the overseas-based manufacturers imported auto parts in such large numbers that they offset their growing revenues from auto exports. In other words, what was gained in assembled vehicle exports was counter-balanced by higher parts imports. As a result, these JAMA manufacturers had a trade deficit of $549 million in 1997.⁴

Since then, however, the situation has completely turned around, with Japanese-owned manufacturers posting a surplus of $5.9 billion in 2006. Figure 10 shows that these new domestic auto makers used fewer imported parts in their vehicle exports than the traditional Big 3. The ratio of net parts imports to the value of net auto exports was 0.46 for the new domestic manufacturers, compared with 0.77 for the traditional Big 3 auto makers. The ratio of net parts imports to production shows a similar difference, with the new domestic manufacturers again just ahead of GM, Ford and Chrysler in domestic content.

Figure 9

Figure 10

The new domestic manufacturers developed the capacity to produce most of their parts themselves in Canada or to buy supplies from other Japanese-owned operating here. For example, even before Toyota officially announced its plans for a new plant in Woodstock, its seat supplier Araco of Japan had opened a plant in Ontario; Honda’s suppliers, such as Musashi Seimitsu and Ube, are currently also expanding.⁵ The Nikkei Weekly⁶ reported that the North American share of the parts Honda uses in its North American production is about 80% today. Toyota reportedly uses 90% local parts to make the Lexus RX330 SUV at its Cambridge, Ontario plant (the first Lexus model to be built outside Japan).⁷ Clearly, both the new domestic and traditional auto makers are about equally supplied by companies located in North America.

Not only are the Japanese and Detroit-based manufacturers behaving similarly in terms of parts imports, but the origin by country of these imported parts is also comparable. The traditional North American auto makers are supplied slightly more by imports from the US than the new domestic manufacturers (90% versus 80%), which use overseas suppliers only slightly more. Since the transportation costs of these goods are high in a world of just-in-time inventory systems, it makes sense for all producers to source their supplies locally. Table 3 shows the origin of parts imports by manufacturer. While importing mostly from the US, Japanese-owned producers have boosted the share of parts imports from China and Mexico to 6% and 5.2%. However, these gains were at the expense of Japan, whose share fell from 21.3% in 1997 to 9.0% in 2006. The US share remained around 80%. In 2006, the shares for the traditional North American auto makers were essentially the same as a decade earlier. Mexico was their second-largest supplier in 2006, with 5.9% of parts imports.

Analysts should interpret data on imported parts with caution. These data include only the share of parts imported directly by manufacturers, and therefore they could conceal trade in parts purchased from companies that themselves do business overseas. As a result, this could have implications for the hypothesis that Japanese-owned manufacturers have the same behaviour in importing inputs. There is a substantial overseas trade in ‘after-market’ auto parts such as brakes by businesses outside of the original equipment auto manufacturers. For example, according to the National Accounts input-output tables, consumers spent close to $10 billion in 2003 for after-market auto parts (before margins and taxes).

Table 3 Top five countries for part imports, New domestics (millions of dollars)

Table 4 Top five countries for part imports, Traditional Big 3 (millions of dollars)

However, the data indicate that this trade in consumer auto parts by firms with no production in Canada showed a slight surplus of $1.8 billion in 2006. Most of this surplus was with the United States and Mexico, which makes it unlikely that production in North America was hampered by the arrival of manufacturers from overseas.

Conclusion

The last two decades have been tumultuous for Canada’s auto industry as a result of globalization. Overseas models have rapidly increased in popularity, to the point where they dominate the market for passenger cars and have nearly pulled even in SUVs. Even the distinction between foreign and North America firms has been blurred by the German takeover of Chrysler.

The downsizing of the traditional Big 3 firms has been widely-publicized, reflecting the traumatic impact on their employees and their suppliers. Less-appreciated, however, is how rapidly Japanese firms have ramped up production more in Canada than in the US, to offset many of these losses. These new domestic auto manufacturers behave much like the traditional firms in terms of exports and imports. They have sustained output, investment and employment in this industry at a high level, with the prospect of further growth.

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Notes