Key Takeaways:
- The U.S. trade war has highlighted the problems with Canada’s economy, and the automotive industry is facing a reckoning with the dismantling of free trade in vehicles and parts.
- The Automotive Products Trade Agreement (Auto Pact) of 1965 between Canada and the U.S. could serve as a model for a new trade agreement that preserves the integrated auto sector.
- A new agreement could incentivize companies to balance trade and invest in Canadian operations, while also providing an incentive for companies to minimize duty penalties.
- The priority should be to come to an agreement with the U.S., with Mexico’s involvement being secondary.
- Managed trade, using the Auto Pact as a model, may be the least bad option that serves both countries’ needs.
Introduction to the Crisis
The U.S. trade war has brought to the forefront the problems with Canada’s economy, and the automotive industry is facing a significant challenge. The imposition of tariffs on automotive imports has led to a reckoning, with the dismantling of the free trade in vehicles and parts that has prevailed for decades. This means that instead of having one auto plant making 150,000 cars for North America, using parts from across the continent, there will be one plant in each country making some fraction of the total, using parts sourced mainly domestically. This will result in production inefficiencies and higher costs, impairing the competitiveness of North American automakers against low-cost, high-quality manufacturers, notably from China.
The Historical Context of the Auto Pact
In 1965, the Lyndon Johnson administration agreed to implement a bilateral treaty with Canada, known as the Automotive Products Trade Agreement (Auto Pact). The Auto Pact removed tariffs between the two countries, allowing vehicle companies to spread production between the countries and source parts and build plants in locations that made the most financial sense. To ensure that Canada did not lose investment and jobs, companies had to maintain minimum domestic production levels roughly equivalent to vehicle sales. This led to a wave of investment in Canada, largely in vehicle assembly, and bilateral trade exploded in both vehicles and parts. The Auto Pact was eventually phased out, leading to unfettered duty-free trade under the North American Free Trade Agreement (NAFTA) and subsequently the current United States-Mexico-Canada Agreement.
The Current State of the Auto Industry
The Canadian auto industry has contributed significantly to the country’s economy, with $17-billion in 2024 and employing over 125,000 people directly and 427,000 indirectly. However, the industry is facing a huge challenge in competing with low-cost, high-quality manufacturers from China. The federal government’s new plan to mitigate the consequences of the U.S. protectionist policy is to offer preferential market access to foreign carmakers if they produce in Canada. However, this plan is inefficient and does not offer benefits to the United States to try to preserve the integrated auto sector.
A Potential Solution: A New Auto Pact
A potential solution to the current crisis is to revisit the Auto Pact model and create a new agreement that preserves the integrated auto sector. This could involve a bilateral treaty between Canada and the U.S. that incentivizes companies to balance trade and invest in Canadian operations. For example, if a participating company had sales of $500-million in Canada, it would need to generate the equivalent amount of domestic content in vehicle and in-house parts production, plus parts procurement from Canadian suppliers to qualify for duty-free imports of vehicles and parts. This would provide an incentive for companies manufacturing in the U.S. but not in Canada to invest in Canadian operations in order to qualify for duty-free trade.
The Way Forward
The priority should be to come to an agreement with the U.S., with Mexico’s involvement being secondary. A new agreement could be negotiated that uses the Auto Pact as a model, with the main resulting negotiation between governments centering on duty rates at the margin for non-compliance by participating companies. Companies that choose not to participate in the scheme would pay full duties on bilateral trade. This approach may be the least bad option that serves both countries’ needs, preserving the integrated auto sector while also providing an incentive for companies to invest in Canadian operations.