Regional and Bilateral Initiatives
| The
Government of Canada commissioned an independent study regarding
the impact of changes in Canada’s trade policy on the
automotive sector.
To read the full report (pdf)
This report is also available in Microsoft Word. Should
you wish to receive a copy please send a request to GATS@international.gc.ca
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The Canadian Automotive Market
Johannes Van Biesebroeck
Note: The views expressed in this report are those
of the author only. They do not necessarily reflect those of the
Government of Canada and may not be attributed to it.
Executive Summary
Introduction
The automotive sector is Canada’s largest manufacturing sector,
accounting for 12% of its manufacturing GDP and 25% of its manufacturing
trade. The principal objective of this study is to calculate the
impact of changes in Canada’s trade policy on the automotive
sector. The study is organized in five sections: the first identifies
current and future trends in the industry; the second contains an
econometric model to analyse the market effects of four trade policy
scenarios on automobile production; the third identifies the impact
of trade policy on foreign direct investment; the fourth contains
an analysis of the market effects of trade policy changes on the
aftermarket auto parts sector; and the last section of the study
discusses the future direction of the automotive industry.
Current and
Future Trends in the Industry
Despite record sales in North America over the past few years,
the long-term trend for the automotive industry is weighted towards
higher growth rates in lesser developed economies, particularly
China, Korea, Mexico, Brazil, India and Thailand. While global production
increased by a factor of six between 1950 and 2004, combined production
in Canada and the United States less than doubled over the same
time period. Even though Canadian exports of finished vehicles remain
very strong, there is a significant reliance on the U.S. market.
From a policy perspective, there is little Canada can do about this.
The export potential for vehicles produced in Canada is effectively
driven by the type of vehicles foreign-owned manufacturers decide
to produce in their Canadian assembly plants.
The larger growth area for the Canadian automotive industry in
recent decades has been in parts and components which, by 2002,
had reached 66% of total automotive employment, up from 55% in 1991.
Exports of automotive parts, while also very concentrated in the
United States, are slightly more diversified than is the case for
vehicles.
Market Analysis:
Automobile Production
The Model
The econometric analysis of the impact of trade policy on the vehicle
assembly sector was conducted in three steps. First, a nested logit
model was used to estimate demand at the vehicle level based on
seven nests. This model selection results in higher elasticities
of substitution between models in the same segment than across segments.
Second, the demand model was used to calculate a number of quantities
that influence the effect of policy changes in particular: (i) own
and cross-price elasticities for each model with respect to all
other models in the market, and (ii) the marginal costs for each
vehicle that are consistent with the estimated price elasticities
of demand and the observed prices. To calculate the elasticities
and marginal costs, it is assumed that firms are playing a price-setting
game (i.e., firms compete by setting prices strategically) in differentiated
products. Third, using the estimated demand parameters, price-elasticities
and marginal costs, simulations of market equilibria that would
have taken place in 2005 if the alternative trade regime had been
in place, are conducted to examine the impact of elimination of
Canada’s 6.1% import tariff on non-NAFTA vehicles.
There are four trade policy changes simulated using this model:
(i) an FTA with South Korea; (ii) an FTA with Japan; (iii) an FTA
with the European Union (EU); and (iv) unilateral abolition of the
Canadian tariff on imported vehicles. An FTA is assumed to include
the elimination of tariffs on imports from the partner country.
Note that throughout, it is assumed that Canadian exports (predominantly
to the U.S., and which account for approximately 84% of Canadian
production) are not affected by any of the four alternative trade
regimes.
An FTA With Korea
The results of the model’s application to elimination of
tariffs with Korea is a decrease in average prices, an increase
in average markups for Korean firms and a slight decrease for foreign
firms, and an increase in aggregate vehicle sales. Korean imports
are estimated to increase by 9.72%, while all other foreign suppliers
lose. As well, production in Canada for the domestic market declines
by 0.53% (2,137 vehicles).
An FTA With Japan
While the analysis of an FTA with Japan is similar to that of an
FTA with Korea, one notable difference is that due to compositional
effects, i.e. Canadian consumers purchase more upmarket Japanese
models as their prices decline, the average sales weighted Japanese
price ends up higher with an FTA. Another is that the largest effect
of this FTA would be a 3.14% decrease in imports from the EU because
they compete with Japan-made cars in all luxury segments. In the
end, Japanese imports are estimated to increase by 15.11%, while
production in Canada falls by 0.94%.
An FTA With The EU
Due to the higher demand elasticities of the median European car
in every segment, an FTA with the EU brings even stronger compositional
effects than an FTA with Japan. In this scenario, the average price
is estimated to increase as the generally expensive European vehicles
gain market share. The increase in imports from the EU is estimated
at 28.32%, while Canadian production is estimated to decrease by
0.74%.
Unilateral Tariff Elimination
Under unilateral tariff elimination by Canada, Canadian production
is estimated to decline by 8,668 units annually (2.16%). While this
is not nearly enough to noticeably impact assembly plant capacity
decisions, employment would be affected, including in supplier plants.
In addition, while Korea, Japan and the EU all benefit under this
scenario, the import gains go disproportionately to the EU, which
sees its imports increase by almost 24.53% versus only 7.68% for
Korea.
As demonstrated in the following table, there are increases in
consumer surplus that would accrue in each of the above scenarios.
However, overall domestic welfare is estimated to decrease marginally
in each case. This is mainly due to the large decreases in government
tariff revenues.
Foreign
Direct Investment
While a tariff on final vehicle imports provides incentives for
foreign firms to establish local production capacity to avoid the
tariff, current tariff levels are sufficiently low and the overcapacity
in the market sufficiently large such that no significant investment
impact would be expected from any of the scenarios analysed in section
two. In addition, the probability that any firm will expand assembly
capacity in North America beyond the currently announced plans is
relatively small. A future expansion of Canadian exports of finished
vehicles to the rest of the world also seems an unlikely proposition,
in part due to likely increases in exports from low wage countries,
only a marginal phenomenon for the moment.
Market
Analysis: Aftermarket Auto Parts
In order to assess the impact of trade policy changes on the more
diverse parts and components sector, a number of methodologies are
used to estimate demand and supply elasticities. Simulations are
then conducted to examine the impact on Canadian exports in the
event of FTAs with China, South Korea and the EU. The estimated
changes in Canadian exports of automotive parts range from 10.4%
to 22.2% for an FTA with China; 8.4% to 11.6% for an FTA with South
Korea; and 3.4% to 7.9% for an FTA with the EU in view of the fact
that current trade protection for the parts sector in Canada is
very low. If giving up the limited protection that exists would
result in lower overseas trade barriers (which tend to be higher),
the net effect would likely be positive.
Future Directions
and Concluding Comments
There are many factors that are likely to affect the future direction
of the automotive industry in Canada, including: the types of fuels
that cars will be using; whether current trends towards keeping
manufacturing close to the location of the final customer remain
constant; future sales volumes in North America; the location of
research and development; and government policy. However, among
the limited areas where government intervention may have an effect
on the automotive sector, intervention in the area of trade policy
is likely to have a more limited net effect on welfare than alternatives
such as investment, research and development, and infrastructure
support.
The study concludes that changes to Canada's trade policy would
have a minimal net impact on Canada as a whole. In particular, while
elimination of Canada's automotive tariff may have a modest impact
on Canadian production, these losses are expected to be offset by
consumer gains.
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