 | | Michael Burt
Associate Director
Forecasting and Analysis |
With more than eight out of every ten vehicles produced in Canada destined for the U.S. market, it is not surprising that the health of Canada’s auto industry is tied at the hip to the U.S. consumer. The good news is that U.S. consumers have proven surprisingly jovial about car buying this year despite the fact that unemployment remains elevated. U.S. light vehicle sales are on track to exceed 13 million units this year, a nearly 30 per cent increase over where they stood at their nadir in 2010. Sales are expected to expand further over the next three years as the market returns to more normal conditions. The rub lies thereafter. The strong Canadian dollar and the mature North American market mean that the long-term growth prospects for Canada’s auto manufacturers are limited.
Despite improving consumer demand, the near-term prospects for Canadian auto production do face one major constraint. The Japanese earthquake and resulting tsunami that devastated the northeast of Japan will have large, although temporary, impacts on Canada’s automotive assemblers. Only 3.3 per cent of auto parts imported to Canada are from Japan, but missing just one component without an available replacement can stall the auto manufacturing process. The disruption has hit Toyota and Honda the hardest, but the Detroit Three automakers have not been immune. However, these effects will have largely dissipated by the fall of this year, and U.S. demand will once again be the key determinant of production.
In this respect, the current news is surprisingly good. For example, The Conference Board conducts a monthly consumer confidence survey in the U.S., and one of the questions asked is whether consumers are planning on buying a new vehicle in the next six months. Prior to the supply disruptions caused by the earthquake and tsunami in Japan, nearly 5 per cent of respondents were answering yes to this question, the highest share in 12 years. Buying intentions eased modestly in the most recent survey, but they remain high. This rise in demand is occurring despite the fact that the U.S. labour market is still relatively weak, and indicates that a significant amount of pent-up demand has been building.
Ordinarily, vehicle and home sales are excellent indicators of the health of the economy, since they are both big-ticket items that take years to pay off. As such, when both are falling, a recession may be at hand, but when both are rising, an economy is generally healthy. At present, the U.S. is experiencing the unusual situation where vehicle sales are recovering, but home sales are not. The extraordinary bust in the U.S. housing market is one reason for this divergence, but another factor is the fact that vehicles wear out much more quickly than homes do.
Vehicle sales in the U.S. have been unusually weak over the past two years—so much so that the fleet of vehicles on the road has actually been shrinking as more vehicles have been scrapped than have been purchased. As a result, the average age of the fleet has been growing as people continue to put off buying a new vehicle. But unlike housing, where people can put off buying a new home almost indefinitely, people will eventually need to replace their vehicles. It is this growing need that is now driving buying intentions higher.
So how high will U.S. vehicle sales eventually go? If the rate of vehicle ownership in the U.S. is to remain unchanged going forward, sales need to rise to about 16 million units a year. This is based on a scrappage rate of 13.5 million per year, and the fact that population of driving age expands by 2.5 million people per year. At present, there is approximately one vehicle for every person of driving age in the U.S. Sales may temporarily exceed 16 million given the amount of pent up demand that has been built in recent years, but there are also a number of factors that may detract from sales.
One of these is the decline in the use of incentives to sell vehicles. Prior to the recession, dealer and manufacturer incentives combined amounted to more than US$6,000 per vehicle. At present, they are closer to US$4,500 per vehicle. This, combined with other factors, such as reduced access to leasing and financing options, has reduced the affordability of vehicles. As well, federal fuel efficiency standards will rise considerably in the coming years, which could lead to higher prices and a further reduction in affordability.
Canada’s auto industry will enjoy strong growth over the next few years, as sales continue to experience a post-recession bounce. However, production will not fully recover. Challenges include the fact that the North American market is mature, and the strong Canadian dollar makes Canada a high cost producer, which will limit investment here. Consumer tastes are shifting towards hybrids and other vehicles types with higher fuel efficiency; without ongoing investment to produce these new vehicles, Canada will struggle to maintain its market share.