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Published online by Cambridge University Press: 07 November 2014
In an earlier article, it was noted that a change in automotive policy might possibly meet the approval of both protectionists and free traders: the change might lead both to an increase in the volume of domestic production of the item in question, and to a decrease in the total excess costs of production. (In the event of both these results being achieved, the percentage decrease in per unit excess cost would of necessity be greater than the decrease in total excess costs.) This paper evaluates the probable effects of the US-Canadian automotive agreement of 1965 on the basis of these two criteria. In addition, the distribution of efficiency gains from this agreement will be discussed. Equity is an obvious consideration here, and there is also some question whether the division of gains may jeopardize the competitive position of the Canadian industry after 1968.
Même si l'accord signé par les Etats-Unis et le Canada au début de 1965 prévoit le passage de véhicules et de pièces originales en franchise de douane entre les deux pays, il y a un certain nombre de restrictions au principe du libre échange qui viennent compliquer l'évaluation des effets économiques éventuels qu'entraîne un tel accord. Plus spécifiquement, le gouvernement canadien limite les droits d'importation en franchise de douane aux producteurs d'automobiles qui doivent:
1) maintenir le rapport des véhicules assemblés au Canada aux véhicules vendus au Canada à un niveau au moins égal à celui de 1964;
2) maintenir, dans la production de véhicules au Canada, un niveau absolu de valeur ajoutée au Canada aussi élevé qu'en 1964;
3) accroître la valeur ajoutée au Canada de 60 pour cent de l'augmentation du marché canadien, plus $260 millions (partagé entre les compagnies) pour les modèles de l'année 1968.
Ces trois conditions requièrent un niveau de production canadien plus élevé que celui qui aurait prévalu sur la base de l'ancien arrangement. Comme le Canada a produit, dans le passé, des automobiles à un coût plus élevé, il semble bien que l'on s'éloigne du principe de libre échange. Il y a cependant des gains importants qui font plus que compenser ce genre de frais. En effet, même si la première condition requiert le maintient au Canada de lignes d'assemblage, èlle permet une plus grande spécialisation des opérations d'assemblage. En effet, une compagnie peut se concentrer sur l'assemblage d'un ou deux modèles et expédier une proportion considérable de ces voitures aux Etats-Unis en franchise de douane pour ensuite importer tous les autres modèles des usines américaines. De la même façon, la deuxième condition permit une certaine spécialisation dans la production des pièces canadiennes.
Des difficultés peuvent cependant surgir dans les applications de cet accord. Des problèmes pourraient se présenter en particulier si la position de la société American Motors continuait à se détériorer, puisque l'accord est basé sur le postulat que les quatre grands producteurs vont continuer à croître.
1 Wonnacott, Paul, “Canadian Automotive Protection: Content Provisions, the Bladen Plan, and Recent Changes,” this Journal, XXXI, no. 1 (02 1965), 98–116.Google Scholar Other analyses of the 1965 agreement may be found in English, H. E., “Automobility—Predicament or Precedent?” Canadian Banker, 72 (Summer 1965), 23–35 Google Scholar; and US Senate, Hearings before the Committee on Finance on H, R. 9042, 09 14–21, 1965, pp. 58–80 and 397–443.Google Scholar
2 Defined as the amount by which the cost of producing autos in Canada exceeds the cost at which they could be imported duty-free. Although excess costs are not the only penalty of protection, the trend in these costs is the most important issue from the free trade viewpoint. Protection also results in a distortion of consumption, that is, a loss in consumers' surplus over and above the total of excess costs of production. The possibility of reducing this consumption cost is closely dependent on what happens to excess costs of production.
3 Tires could, however, pass duty-free when mounted on new automobiles.
4 The first two of these conditions were laid down in the definition of manufacturer in the Canadian Motor Vehicle Tariff Order 1965, a definition included in Annex A to the US-Canadian agreement. The text of this agreement may be found in a news release of the Canadian Department of Industry, Jan. 15, 1965, or in US Senate, Hearings, 17–21.Google Scholar Commitments (3a) and (3b) were included in the letters of undertaking by the four major Canadian automotive producers to the Canadian government, sent just prior to the signing of the intergovernmental agreement. These letters are reproduced in a news release of the Department of Industry, April 26, 1965, and in US Senate, Hearings, 45–55.Google Scholar
5 As defined in section 273 of the Customs Act. For complications raised by the details of this definition, see US Senate, Hearings, 50–51.Google Scholar
6 Where imports of completed vehicles exceed the limit set by this condition, the manufacturer can maintain his generally duty-free status by paying the tariff on those vehicles over the limit. Because the popular Mustang was not produced in Canada, Ford exceeded the limit of imports under condition (1) in 1965, and paid duty on the over-quota Mustangs. See ibid., 217.
7 The italicized phrases are essential to an understanding of this commitment. Previous content requirements had been a percentage of the value of cars manufactured in Canada.
Ford anticipated some initial difficulty with this condition. Ford was in the process of concentrating its Canadian production of engines, greatly expandng the volume of a limited range, and terminating the production of other engines. Although this involved an increase in Canadian production of engines, it created difficulty in meeting the level of Canadian value added in Canadian-built cars, since both exports and imports of engines were increasing. In addition, economies of scale were resulting in lower costs per engine, decreasing the contribution of each Canadian engine in meeting the Canadian value added requirement. The combined result was that Ford expected a shortfall of $22 million in its Canadian value added in model year 1966. Ford therefore declined to be bound firmly by condition 2, offering to make compensatory purchases of components from Canadian vendors.
Ford pointed out another problem involved in meeting content provisions. Because cars must be imported by Ford at dealer price (a Canadian anti-trust provision), an imported vehicle costs Ford of Canada more than an identical, domestically produced vehicle. Hence, as the proportion of the Canadian market satisfied by imports increases, the valuation of Canadian sales increases (even though no more vehicles are sold). Hence, Ford's content provision becomes more difficult to meet. See ibid., 50–52.
The potential difficulties in maintaining Canadian content in the event of an increase in the efficiency of Canadian operations were discussed in Paul Wonnacott, “Canadian Automotive Protection.”
8 Although the absolute level was not to increase with a growth in the market, a downward revision in the absolute level of Canadian value added is to be made in the event of a decline in sales below the level established in the base year. See US Senate, Hearings, 46.Google Scholar
9 The 60 per cent applies to the “big four” automobile manufacturers, whose letters of undertaking have been published. We understand that Volvo, whose letter has not been made public, undertook a commitment of only 40 per cent. As Volvo production is much less than 10,000 units per annum, this 40 per cent is in line with previous content requirements.
10 For simplicity, the analysis of this first condition is being confined to automobiles. Similar conclusions follow for trucks and buses, which are also included in the agreement.
11 Unlike this Canadian content requirement, the US origin restraint in Annex B, Section 3a, of the agreement did not limit competition within the integrated North American market. Rather, this US origin provision was included to limit the import of autos from outside countries through Canada into the US. Specifically, Annex B provided for duty-free entry of automotive products into the US from Canada only if they contained at least 50 per cent North American content (40 per cent prior to January 1968).
The possibility of Japanese or European companies establishing assembly plants in Canada as a way in which to achieve duty-free penetration of the US market was one of the grounds for opposition to the agreement in the US. See, e.g., US Senate, Hearings, 272, 291.Google Scholar Because the Canadians technically maintained most-favoured-nation treatment by providing duty-free automotive imports from all countries by companies meeting the specified conditions, this duty-free Japanese-European entry into the US via Canada is possible under the agreement, provided that 50 per cent value is added in Canada. This indirect leakage through the US tariff wall may be desirable from a free-trade standpoint, although it may involve an indirect support of the Canadian industry at the expense or a decline in the duty revenue of the US government. A broader reciprocal arrangement with these countries would be a preferable and less capricious way of reducing US auto tariffs on third countries.
12 I.e., prior to the Export Incentive Program of 1962. The situation prior to 1962 is used as the basis for comparison for two reasons: the 1962–64 period may be considered unstable in the sense that US countermoves were a distinct possibility; and the net effects of the export incentive program on total Canadian excess costs in the automotive industry were unclear.
13 The companies are not absolutely bound by this condition. However, tariffs must be paid on over-quota imports. See n. 6, above.
14 Under this first condition, efficiency in automobile assembly is promoted in approximately the same way as efficiency in parts production would have been promoted under Bladen's extended content plan. There is, however, one obvious and major advantage of the present arrangement over the export incentive program it replaced: US automotive tariffs are eliminated, and therefore the scope for rationalization and specialization in the Canadian industry is greatly enhanced.
On the potential contribution of the Bladen Plan to efficiency in the production of parts, see P. Wonnacott, “Canadian Automotive Protection.” For a more critical interpretation, see Johnson, Harry G., “The Bladen Plan for Increased Protection of the Canadian Automotive Industry,” this Journal, XXIX, no. 2 (05 1963), 212–38.Google Scholar
15 This point is discussed in Wonnacott, R. J. and Wonnacott, Paul, Free Trade between the United States and Canada: The Potential Economic Effects (Cambridge: Harvard University Press, forthcoming), chap. 13.Google Scholar
16 The more rapid the growth in Canadian auto assembly, the greater can be the reduction in the number of different parts produced in the fulfilment of condition 2; hence, the greater can be parts specialization.
17 Although, it should be noted, the literature in favour of free trade is replete with the argument that tariffs should be eliminated in stages as a means of smoothing adjustment. The Canadian conditions may be considered an alternative (and preferable?) means of smoothing the adjustment process–provided, of course, this scheme does lead towards free trade.
18 The first two conditions ensure only that total Canadian value added in autos and parts production remains at its absolute level in 1964 (condition 2). (Conceivably the assembly provision (condition 1) might ensure some growth in total value added, but only if Canadian automobile sales increase at an extraordinary rate.) On the other hand, this third condition ensures a very rapid growth of Canadian auto and parts production by about 60 per cent of any increase in Canadian sales, plus $260 million.
19 I.e., prior to the Export Incentive Program of 1962.
20 While most of the congressional objections to the agreement were based on the US abandonment of the most-favoured-nation principle and on the failure of the agreement to provide really free trade, there were a number of objections on the protectionist ground that US producers could not compete with less expensive Canadian products. This protectionist objection was made on behalf of bearing manufacturers and the makers of extruded rubber products. See US Senate, Hearings, 290–302, 305–8.Google Scholar
Other parts in which Canadian producers are competitive might also be mentioned, e.g., springs.
21 Bain, Joe S., Barriers to New Competition (Cambridge, Mass., 1956), 245.CrossRefGoogle Scholar
22 Both because of inherent locational disadvantages, and because the “free trade” agreement does not cover all products which are inputs into the auto industry.
23 Bain, , Barriers to New Competition, 245.Google Scholar
24 Either through an increase in scale of existing lines, or through an increase in the number of lines produced in Canada. Large increases in Canadian production might lead to a general rise in automotive wages, and higher Canadian costs.
25 Primarily because of lower Canadian wages.
26 In chapter xiii of our Free Trade between the United States and Canada, we have estimated that, if Canadian automotive producers could gain all the economies of scale, then the total cost of Canadian automobiles would fall by betwen 6 and 9 per cent. (Thus, with a Canadian content of 60 per cent, the cost of the Canadian value added would drop by 10 to 15 per cent.) As noted above, Canadian car makers cannot gain all these economies at current levels of production simply by concentrating production on one or few models; however, Bain's estimates suggest that they could gain most of these economies. Suppose we take a low estimate of 4 per cent to represent the reduction in total cost of Canadian-built vehicles which will result from specialization. The $260 million increase represents less than one-fifth of Canadian automotive production in 1964; thus, for the excess costs of (2) to exceed the gains from (1), the $260 million would have to be produced at a cost of more than (5 × 4=) 20 per cent above US levels. Canadian costs in the automotive industry are on the average less than 20 per cent above US levels at present. Therefore, the gains from (1) would exceed the excess costs of (2) even on the most unfavourable assumptions regarding (2). That is, even if, in producing the $260 million, the Canadian companies picked “average” items rather than those in which their comparative position was strongest, and even if there were no gains in efficiency in these parts as a result of the increases volume of production, (1) would still exceed (2) in magnitude.
27 There are, in addition, a couple of other minor structural effects which are only noted here in passing. First, the scheme discriminates in favour of the use of Canadian machinery by the Canadian auto industry, since the auto companies can count depreciation on this as value added; but they cannot so count depreciation on imported machinery. GM pointed out that this discrimination would tend to raise Canadian auto costs and make reorganization more difficult. (See US Senate, Hearings, 47.Google Scholar) Second, replacement parts remain protected; however, their production in Canada is no longer subsidized in the sense that it was under the prior export incentive scheme.
28 See, for example, Chrysler's projections in ibid., 233.
29 In model year 1965, over 31,000 Valiants were sold in Canada.
30 Although the downturn in Canada did not come until 1965. In (calendar) 1963, American Motors produced 30,167 cars in Canada; in 1964, 35,129; and in 1965, 31,347. In contrast, the total Canadian production of cars rose from 559,392 in 1964 to 709,567 in 1965.
31 The possibility that there might be some absolute decline in US production of some specific parts was, however, to be anticipated as a result of the agreement. There was a presumption that such displacement would be concentrated in the areas where Canadian costs were already lower than US costs.
32 We choose not to discuss the well-established objections to dealing with a (real or imagined) balance of payments problem by restrictions on the exchange of a single good with a single trading partner. These objections are by now so well known that they scarcely require repetition. But they should be kept in mind in the discussion of this section.
33 Excluding replacement parts, which were not included in the agreement.
34 And, strictly speaking, less the change in inventory.
35 I.e., about 4:1; see US Senate, Hearings, 126–33.Google Scholar
36 This figure for the 1964 Canadian market for North American vehicles was derived by subtracting Canadian auto exports to and adding imports from the US (Dominion Bureau of Statistics, Trade of Canada) from Canadian domestic production (derived from Dominion Bureau of Statistics, 42,001 and 42,209).
37 SpecificaUy, Ford presented estimates of its Canadian automotive market and its merchandise balance over the four-year term of the commitments. The upper and lower market growth rates considered were 7.7 per cent and —3 per cent; 2.6 per cent was taken as a median estimate. With these rates, the negative merchandise balance of Canadian Ford in (model year) 1968 was estimated to lie betwen —$106 million (US) and —$160 million (US) compared to —$183 million in model year 1964 and —$125 million in model year 1963. See US Senate, Hearings, 211–12.Google Scholar
38 For our free trade study, we requested comparative price data for the 1964 model year from Canadian automobile manufacturers. The rather fragmentary information we received indicated that Canadian factory prices (excluding taxes) were 4.8 to 9.5 per cent higher than US prices of comparable models. This was a lower differential than had existed in model year 1962, prior to the Canadian devaluation. See Free Trade between the United States and Canada, chap. xiii.
39 The US Senate Subcommittee on Antitrust and Monopoly uses the elasticity estimate of —1.2 to —1.5.
40 Or, in the absence of a price cut, a 9 per cent per annum growth is achieved in the Canadian market.
41 Senator Douglas, in particular, stressed that if Canadian prices were not cut, the growth in the Canadian market would suffer, and the required increase in Canadian production would be reflected in a decrease in the US. See US Senate, Hearings, 200, 228.Google Scholar
Nat Weinberg, representing the UAW at the Senate Hearings, suggested that the agreement be amended to increase pressures on the Canadian companies to cut prices. This could be done by providing for duties on Canadian cars in the event that the difference in price (ex tax) between Canadian cars sold in Canada and Canadian cars sold in the US exceeded the difference in costs of production between Canada and the US. The UAW firmly stressed, however, that they did not want dumping duties applied, since a rationalization of production required Canadian cars to be sold more cheaply in the US than in Canada during the adjustment period when Canadian costs exceeded US costs. Ibid., 246-58.
The effects on the US balance of payments of price stickiness in Canada are not entirely adverse. Higher profits of US-owned automobile manufacturers are reflected in higher dividends. On the balance of payments implication of profits, see the testimony of Assistant Secretary of the Treasury, Merlyn Trued, ibid., 368.
42 I.e., Canadian protection prior to the export incentive scheme of 1962.
43 This would have also raised Canadian auto costs and prices, and reduced Canadian auto sales. The costs of such a policy to Canada are obvious. Yet the Canadian negotiators seemed to have impressed the Americans with their willingness to exercise this option.
44 Much of this sunk cost might appear to fall on the auto companies; but in fact their capital expenditures during 1964–68 may be financed largely by the gains in efficiency made possible by the agreement.
45 Because individual Canadians are not allowed duty-free import, Canadian domestic prices can still be set by the auto companies above the US level.
46 However, as US anti-dumping provisions require proof of injury, it is not likely that they will be invoked. (In contrast, the countervailing duties in response to a direct or indirect government subsidy, which appeared possible following the introduction of the export incentive program, do not require proof of injury.)
47 By and large, this took the form more of a US price increase than a Canadian price decrease. For example, in the 1966 model year certain extras were included as standard equipment in both countries, but US consumers were assessed higher prices on these items than Canadians.
48 Associated with the rationalization of the industry. Thus, these should be defined to exclude model change-over costs, which occur in any case.
49 Even though factory prices were to be equalized, costs to consumers would not become identical. Differing transport charges might leave a differential of about 1 per cent, and sales and excise taxes differ.
50 If and when free trade is initiated in other (supplying) industries, auto wages could rise even closer to the US level.
