INDU Committee Report
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Figure 3
Finally, the motor vehicle parts manufacturing industry experienced much the same fate as the motor vehicle manufacturing industry in this period, but its contraction was slightly more pronounced (see Figure 3). The automotive parts manufacturing industry declined by about 20% between 2002 and 2008, whether measured in terms of its contribution to GDP or employment. A Global Recession and a Credit Crunch In autumn 2008, the U.S. economy began a relatively unexceptional slowdown that, by the end of the year, would accelerate to a pace unprecedented since the Great Depression of the 1930s; it would also encompass a greater breadth of the economy than most recessions. At its origin was the unexpected and huge losses incurred on U.S. subprime mortgages or asset-backed commercial paper (ABCP) that had sparked a financial crisis in the summer of 2007 and would eventually set in motion a string of failures of several prominent global financial institutions. These most recent high profile corporate collapses have led many observers to suspect the liquidity crisis has grown into a solvency crisis. Declining confidence in financial markets would next spill over into housing markets, consumer products markets and, through trade markets, would channel the recession from the United States to all other major advanced economies of the world, including Canada. The fourth quarter of 2008 marked the beginning of a rather abrupt and deep global recession that is expected to further deteriorate throughout the first half of 2009, if not the entire year. Canadian exports of manufactured goods to the United States and elsewhere that had already been weak and declining (due to the rapid appreciation in the value of the Canadian dollar) began to plunge further in response to the global economic downturn. Indeed, in December 2008, Canada recorded its first merchandise trade deficit since March 1976. The contraction in demand did not stop at Canadian borders, however. Reductions in real income related to the sudden and pointed decline in commodity prices, the reduction in household net worth, and lost consumer and investor confidence also contributed to a decline in domestic demand. Keeping with the automotive industry example, light vehicle sales in Canada, whose growth performance had been rather flat since 2003, began to crash in November 2008 (see Table 5). January and February 2009 sales were also down 25.3% and 27.7%, respectively, over the same month in 2008, with the “Detroit Three” nameplate vehicle sales down 36.7% in these two months over the same two months in 2008. This decline and that of the demand for all other goods and services have adversely affected overall production in the country: Canadian GDP declined by a startling 3.4% annual rate in the fourth quarter of 2008. Many forecasters now predict a long and slow period of economic recovery in Canada beginning either in late 2009 or in 2010, but all forecasts of economic recovery are predicated on the stabilization of the global financial system. Table 5
Part and parcel with any recession will be a contraction in both the demand for, and the availability of, credit. Referring to the Bank of Canada’s most recent Senior Loan Officer Survey, the balance of opinion on credit conditions – that is, the percentage of people who reported a tightening minus the percentage of people who reported an easing of credit conditions – reached a record high in the fourth quarter of 2008 (see Figure 4). Most firms reported that the tightening came in the form of higher borrowing costs. So it seems that, in Canada as elsewhere, the supply of credit has contracted more than the demand for credit with the onslaught of the recession. Figure 4
If credit conditions are too tight, it can pose a threat to the economic well-being of a country. Indeed, without access to funding, consumers are less likely to purchase homes, automobiles or many other big-ticket items. Without access to credit, businesses will find it harder to finance inventories, exports or investment in machinery and equipment or, as in the current predicament of the “Detroit Three”, finance the necessary restructuring of their businesses – an undertaking that cannot be avoided. Without a doubt, the flow of funds or credit is an important lubricant of commerce. It allows the gears of the economy to turn effortlessly and, without sufficient access to financing, the economic engine can seize up. In fact, such a situation appears to exactly describe the current circumstance of the North American motor vehicle manufacturing industry. The Road to Economic Recovery: Monetary and Fiscal Stabilization At the outset, it should be acknowledged that the financial crisis is global in nature and began beyond Canada’s borders; so most solutions will not likely be found in Canada but in other countries or at the international level. Moreover, the Canadian banking system does not face the same challenges as those in the United States, Europe or Japan, because Canadian banks were not significantly involved in the U.S. subprime market (like others were) and thus had only modest exposure to the ABCP market meltdown. Many major banks in the United States and Europe face enormous pressure to scale back their assets and liabilities to bring them into line with their capital – and some of them have even required either significant capital injections by governments or nationalization in order to successfully complete the restoration of their balance sheets. Canadian banks, on the other hand, are better capitalized and less leveraged than their peers in other countries, but they too have had to raise private capital to grow their businesses. In the past year, Canadian banks have raised more than $15 billion in Tier 1 capital from the private capital markets. Thus, while Canada’s more robust financial system – in October 2008, the World Economic Forum declared that Canada has the soundest financial system in the world – translates into better credit conditions than elsewhere since the onset of this global recession, some unprecedented monetary and fiscal actions were needed to cope with this recession. Monetary Policy Actions and the Short Term Pursuant to its own Act, the Bank of Canada is charged with conducting monetary policy to achieve a number of objectives, but the relevant ones in the current situation are: (1) price stability; and (2) the regulation of credit. In terms of the first objective, the Government of Canada and the Bank of Canada have formally agreed to an annual inflation target of 2%, bounded by a floor of 1% and a ceiling of 3%. In terms of the second objective, the Bank of Canada discharges its role as “lender of last resort” by routinely providing liquidity to facilitate payments settlement and responds in a number of ways to exceptional or emergency situations. Under current economic conditions, the Bank of Canada’s inflation-targeting and lender-of-last-resort responsibilities are complementary. Inflation falls in a recession or in the wake of a financial crisis, so there is no conflict or trade-off in attempting to achieve both objectives. A monetary expansion is called for on both counts. In terms of interest rates, the Bank of Canada has lowered its policy rate, the overnight rate, by 375 basis points from 4.25% in December 2007 to 0.50% in March 2009. Given that interest rates are rationally zero-bounded, on this count the Bank of Canada has little room left to manoeuvre. Furthermore, it is worth noting that the Bank of Canada’s overnight rate reductions have largely been passed on to credit facilities with short maturities. For example, the prime rate charged by Canadian chartered banks has fallen by 350 basis points over this same period and it currently stands at 200 basis points above the overnight rate, which is slightly above the average difference between the two interest rates of 174 basis points between January 2000 and March 2009. However, the chartered banks have been somewhat slower and have fallen far short in passing on reductions in the overnight rate on to credit facilities with longer maturities. The reason is obvious. The Bank of Canada’s overnight rate has much less influence on the market for longer-term interest rates charged by financial institutions since the costs to banks of raising longer-term funds are more likely to be influenced by bond market prices and costs of longer-term borrowing through guaranteed investment certificates (GICs). The costs of these funds are significantly higher than the overnight rate, and the growing spread between long- and short-term interest rates reflects the perceived greater risk which would be based on expected increases in loan default and bankruptcy rates that usually accompany an economic recession. In addition, the Bank of Canada has provided the financial system with more liquidity through term purchase and resale agreements (PRAs), without resorting to an expansion of the monetary base. Term PRAs provide liquidity (for up to three months) to key financial institutions against a wide range of securities. The Bank of Canada is also in the process of introducing two new loan facilities aimed at providing liquidity to a broader range of participants against a broader range of eligible securities. Moreover, one of these new facilities is expected to provide indirect support to credit growth in Canada by improving secondary-market liquidity and increasing demand for corporate securities. Although the Bank of Canada’s liquidity operations are focused on short-term financing facilities, the Government of Canada has introduced a number of measures aimed at supporting medium- and long-term financing for businesses and consumers – to which the next subsection turns. Fiscal Policy Levers and the Medium Term The International Monetary Fund has suggested that countries in a position to do so should inject fiscal stimulus of 2% of GDP to reduce the adverse economic effects of the global recession. The Government of Canada agreed with this suggestion and presented its budgetary plan in February 2009. This plan includes program spending of $206.8 billion in fiscal year 2008-09 to grow to $229.1 billion and $236.5 billion in 2009-10 and 2010-11, respectively. Planned program spending is, therefore, projected to grow by 14.4% over the next two years. With annual budgetary revenues falling and not expected to recover to $239.9 billion until 2010-11, the Government of Canada projects a deficit of $33.7 billion and $29.8 billion in 2009-10 and 2010-11, respectively. The cumulative deficit over the next four fiscal years is projected to reach $83.8 billion. Consequently, the federal government’s debt-to-GDP ratio is expected to rise from 28.6% to 32.1% between fiscal years 2008-09 and 2010-11, after which the government projects it to return to a downward track. The Government of Canada further estimates that its budgetary plan will provide an economic stimulus of $29.3 billion and $22.3 billion in 2009-10 and 2010-11, respectively. These estimates represent 1.9% and 1.4% of GDP. Of particular interest to the business sector is the federal budget’s planned contribution to arresting the “credit crunch” that has been imposed on Canadian consumers and businesses. According to its budget plan, the Government of Canada intends to provide up to $200 billion through the Extraordinary Financing Framework to improve access to financing for Canadian households and businesses. Two programs are particularly noteworthy in this regard: (1) the Insured Mortgage Purchase Program (IMPP); and (2) the Canadian Secured Credit Facility (CSCF). The Government of Canada will extend the Insured Mortgage Purchase Program by authorizing the purchase of up to an additional $50 billion in insured mortgages in the first half of 2009-10. This authorization is in addition to the $75 billion to be purchased in 2008-09. Extending and enhancing this successful program is intended to reassure lenders that stable long-term financing will continue to be available, helping them to continue lending to Canadian consumers and businesses. The Government of Canada will also create the Canadian Secured Credit Facility (CSCF). The credit facility will be allocated up to $12 billion to purchase term asset-backed securities (ABS) backed by loans and leases on vehicles and equipment. This facility will be priced on commercial terms, and will therefore be expected to generate a positive return for the Government of Canada. The Road to Industrial Renewal: “Detroit Three” Restructuring Plans Structural Overcapacity and “Detroit Three” Problems With current annual demand forecast to be in the range of 10 to 11 million units and production capacity in the vicinity of 16 million units, there is an estimated production overcapacity of approximately 5 to 6 million vehicles per annum across North America. North American automotive assembly plants cannot continue to run at two-thirds capacity, on average, for long. Plant closures and business reorganizations are a prerequisite for survival going forward, particularly for companies experiencing shrinking demand for their products (i.e., the “Detroit Three”). The huge loss in combined market share of the “Detroit Three” at the hands of the “New Domestics” signals, at the very least, troubles in the business model of the “Detroit Three”. What exactly is the problem? Consumers or industry experts have not mentioned nor complained about the pricing of the “Detroit Three” products relative to the pricing of the “New Domestics” products. Product pricing per se is, therefore, not likely the problem. Furthermore, given that the “Detroit Three” have production facilities that are well placed or highly ranked in terms of their labour productivity, one cannot infer that the organization of their plants and production facilities are, in the main, the problem. Industry observers and experts have identified a number of issues facing the “Detroit Three”:
These problems are hard to quantify. What is known is that, in 2008, workers engaged in the assembly segment of the industry were paid a starting wage of $24 per hour and a top wage of about $34 per hour. Wage rates are comparable across the “Detroit Three” and the “New Domestics”. Legacy costs of the “Detroit Three” are higher than those of the “New Domestics”, which presents a difficulty for the “Detroit Three”. On the other hand, witnesses provided conflicting evidence on the issue of non-wage benefits for existing workers that suggests there is either no gap or a gap of up to $20 per hour in favour of the “New Domestics” over the “Detroit Three”. Although all “Detroit Three” companies are well down the road to restructuring their businesses, only two of them have requested government financial support to help them see their plans to fruition. A very brief description of both plans follow. General Motors Restructuring Plans General Motors of Canada Ltd. submitted a restructuring plan to both federal and Ontario governments that:
General Motors has requested US$22.5 billion in loans from the U.S. government, of which US$13.4 billion has already been advanced, and should total U.S. motor vehicle sales in 2009 deteriorate further than forecasted, it is requesting an additional US$7.5 billion for a total of US$30 billion. General Motors of Canada is requesting a loan from Canadian governments (federal and provincial) equal to 20% of the loans provided by the U.S. government, which equates to $5-7 billion. Chrysler Restructuring Plans Since Cerberus Capital Management assumed controlling interest in Chrysler LLC, a number of restructuring actions were taken, including:
Chrysler LLC has recently signed a non-binding agreement to pursue a strategic alliance with Fiat S.p.C. of Italy. The proposed alliance would provide Chrysler with substantial cost saving opportunities, as well as provide Chrysler with distribution capabilities in key growth markets. The proposed Chrysler-Fiat Alliance would also further help Chrysler achieve fuel economy improvements as it gains access to Fiat’s smaller, fuel efficient platforms and powertrain technologies. Chrysler Canada intends to continue with investments in Windsor and Brampton assembly plants:
Chrysler LLC Viability Plan further includes a $3 billion investment in new fuel-efficient vehicle platforms, 24 new product launches, and the development of five electric vehicles to be ready for production in 2010. This plan also includes concessions on behalf of dealers, suppliers, unions, second lien debt holders, and shareholders. Chrysler has requested US$7 billion (or approximately $9 billion in Canadian funds) in loans from the U.S. government, of which US$4 billion has already been advanced. Chrysler Canada has requested about $2.3 billion in loans from the Canadian governments (federal and provincial), as well as prompt resolution of its transfer pricing disagreement with Canada Revenue Agency (CRA). In 2007, the CRA issued assessments for 1996 through 1999 asserting that Chrysler Canada should have earned greater profits than reported in Canada and correspondingly should have reported reduced profits in the United States. When Daimler sold the controlling interest in Chrysler, Daimler agreed to indemnify Chrysler against, among other things, these transfer pricing tax assessments. Chrysler Canada then became obligated to post cash and assets to secure 50% of the assessed amounts until the dispute is resolved. This obligation to pay or secure these assessments has severely affected the company’s ability to operate at this critical time. Finally, the Committee is aware that Industry Canada has requested more information from Chrysler Canada regarding the expected benefits to Canada of its restructuring plan and, therefore, General Motors of Canada’s request is, at this time, more advanced than that of Chrysler Canada. |
