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Cablegate: Auto and Aircraft Manufacturing Investment:

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 03 OTTAWA 000822

SIPDIS

STATE FOR WHA/CAN - BREESE
AND HOLST STATE PASS USTR FOR CHANDLER
USDOC FOR 4320/OFFICE OF NAFTA/GWORD/TFOX; 3134/OIO/WESTERN
HEMISPHERE

E.O. 12958: N/A
TAGS: ETRD EIND EINV CA
SUBJECT: AUTO AND AIRCRAFT MANUFACTURING INVESTMENT:
CANADIAN GOVERNMENTS REJOIN THE SUBSIDY GAME

REF: (A) TORONTO 0430 (C) 04 TORONTO 0786
(B) TORONTO 0264 (D) CALGARY 068

SUMMARY/INTRODUCTION
--------------------

1. The GOC and the provincial government of Ontario will
contribute hundreds of millions of dollars toward
investments announced recently in central Canada's auto
plants. The federal, Quebec and Ontario governments
are also offering large new incentives to the aerospace
industry. This marks a significant return to the
industrial subsidies game by Canadian governments,
after a bipartisan trend toward more market-based
policies since 1984 (and a tough bout of deficit- fighting
since 1995).

2. In large part, these subsidy decisions reflect continued
competition among North American and European jurisdictions
for major auto and aerospace investments. (It bears noting
that U.S.- based firms, such as GM, Ford, and Pratt & Whitney,
are top beneficiaries of Canada's industrial incentives).
However, governments are also responding to anxiety
about Canada's manufacturing competitiveness, which is
fostered by several trends:

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-- Canada's recently declining share of North American auto
manufacturing, as new plants locate increasingly southward;

-- Post- 2001 slumps in aerospace and information technology
exports;

-- Concerns about backsliding toward being an exporter of
energy, forest products and minerals, after decades of
struggle to increase the proportion of higher-value-added
exports;

-- The uncertainties faced by intensive users of the
U.S.-Canada border (a problem codified by Industry
Minister David Emerson as "border risk"), which are
thought to be deterring some foreign direct investment;
and

-- The appreciation in the value of the Canadian dollar
since early 2003.

END SUMMARY/INTRODUCTION

THE ANNOUNCEMENTS
-----------------

3. Ontario provincial funds are provided through the
"Ontario Automotive Investment Strategy" which was
unveiled in April 2004 with funding of C$500 million
(US$400 million) (ref A). GOC funds are provided
mainly through Industry Canada (notably a program
called Technology Partnerships Canada - TPC) and also
through Human Resources and Skills Development Canada.
The TPC fund provides funding for corporate research
and development which is nominally repayable if
products succeed commercially. In practice, TPC mainly
funds the aerospace industry and little is repaid. The
WTO-consistency of TPC's precursor was successfully
challenged in the mid-1990's by Brazil's Embraer, which
competes directly in the jet aircraft market with
Canada's Bombardier, and that dispute prompted the
program's reinvention as TPC.

4. AUTOS: On March 2, flanked by representatives of the
federal and Ontario governments, General Motors of Canada
Limited announced the "Beacon Project" -- C$2.5 billion
(about US$2 billion) in investments in its Canadian
facilities. Beacon will draw C$235 million in funds from
Ontario and C$200 million from the GOC. In November 2004,
Ford Motor Co. of Canada announced that it would receive
C$100 million from Ontario and a similar amount from the GOC
to redevelop its operations. DaimlerChrysler is reportedly
planning an auto plant investment which would also draw
government support. The key target for governments is a
possible investment by Toyota in a new assembly plant in
Ontario, which has not attracted a new auto plant in more
than a decade (ref C).

5. AIRCRAFT: TPC's single largest beneficiary is Pratt
& Whitney Canada Inc., which has received some C$500
million (US$400 million) from TPC. On January 13,
2005, the GOC announced a further C$207 million in TPC
funding for Pratt & Whitney to support various
aerospace research and development programs. On
February 22 the GOC announced C$115 million in TPC
funding for Bell Helicopter Textron Canada Limited.
Meanwhile, Bombardier, the world's third largest
aircraft maker after Boeing and Airbus, is playing
Canadian and British jurisdictions against each other
to manufacture its new C Series jet. The GOC, Quebec
and Ontario have all pledged hundreds of millions in
support. Bombardier is based in the Montreal area,
like Pratt & Whitney and Bell Helicopter, but it has
some facilities in Ontario which stand to win C Series
contracts.

EXPORT TRENDS: BACK TO LOGS AND ROCKS?
---------------------------------------
6. Canada's development was driven by successive waves of
natural resource extraction (fish, fur, timber, grain,
minerals, energy). A core mandate of Canada's trade and
industrial policies has always been to reduce this reliance
on natural resource-based exports. From the 1890's onward
this was approached through high tariffs on imported
manufactures, but Canada shifted to a trade-liberalizing
policy for autos in the 1960's and for most other goods in
the 1980's. By the late 1990's the "value added" goal
seemed to have been reached. Canadians built more than
twice as many cars as they purchased, and they were
successfully exporting not only vehicles but jet aircraft
(by Bombardier), telecommunications systems (by Nortel) and
nuclear reactors (by AECL).

7. Since 2000, a number of factors combined to deflate
this success. Simultaneous worldwide slumps in both
telecoms and aviation hit Nortel and Bombardier hard (along
with many related firms), with sharp and sustained drops in
their exports.

8. With a lack of major new investments in the auto
sector, combined with the closing of some older facilities,
Canada's ratio of "vehicle production to sales" - a simple
indicator of export success - was slipping (it had peaked in
1995 at more than 2, but by 2003 it had fallen to 1.6).
Flattening investment in the auto sector, which could be
overlooked while Nortel and Bombardier were setting export
records, became a concern when they lost their sparkle.

9. Meanwhile, the Canadian dollar appreciated strongly
in 2003-04, from under 65 cents to over 80 cents U.S.,
sharply trimming the competitiveness of Canadian
exports in the U.S. market. Ontario policymakers view
this as a key cause of recent downgrades in the
province's growth outlook (ref A).

10. In this context, the impressive run-up in demand and
prices for energy, building materials and other commodities
over the past few years is a mixed blessing in Canada: good
for the resource hinterland, but bad for the manufacturing
heartland. Strong commodity demand has resource exports
booming in both value and volume. In just three years from
2001-2004, exports of oil and gas grew 49 percent; refined
petroleum products, 49 percent; iron and steel, 68 percent;
and wood panel products, 99 percent. But for manufacturers,
the resource boom has not only driven input costs upward,
but can also be seen as a major cause of the currency
appreciation that hurts them in both foreign and domestic
markets.

11. In the past two years, oil, gas and refined petroleum
products overtook finished motor vehicles as Canada's main
export category. While this is an amazing upset in terms of
Canada's development since World War II, it is partly
explained (at least for now) by price and currency
movements. But with foreign investment (including Asian
investor interest) in Canada's oilpatch on a strong upward
track (ref B), the reversal could threaten to last unless
investment in autos and aerospace makes a comeback.

COULD "BORDER RISK" KILL INVESTMENT?
------------------------------------

12. Canadian Industry Minister David Emerson, an economist
and former industry CEO, has fretted publicly about Canada's
trade-dependence and competitiveness since he joined the GOC
at the end of 2003. Emerson was quick to acknowledge that
the world had shifted since the heyday of the rules-based
trading system in the 1990's. "We were in Nirvana because
we were trade-dependent, more so than anybody else in the
world. All of these institutional arrangements that were
being set up were really quite nice for us. . . . The
balance is starting to shift - and it's shifting in
worrisome ways."
13. Referring to "creeping protectionism" in the United
States, Emerson says it has gradually defeated the dispute
resolution model. "We can be five, six, seven years out and
we're still paying the duties. We're still paying the
lumber duties today, and we're getting hit on beef, and
we're getting hit on pork . . . And then along comes 9/11. .
. You realize that today the border is back. The border is
back with a vengeance. It's not fading anymore. It's
become a fundamental source of risk. . . Think about global
supply chains. . . . You're going to make an investment that
is designed to serve the North American if not the world
market . . . If those investments are systematically and
continuously biased toward the United States because of
border risk, we've got some big, big problems in Canada."

14. Canadian media have been quick to apply Emerson's
analysis to Toyota's impending decision about where to
locate a new assembly plant - suggesting that Canada could
be knocked out of contention for this and other plum foreign
direct investments because of "border risk. Meanwhile,
while he stresses that assembly plants are the industry's
"anchors," Emerson recently expressed a willingness to
assist parts manufacturers as well.

POLICY RESPONSE: DIRECT SUBSIDIES
----------------------------------

15. Liberal Parties currently hold power in the GOC as well
as in Ontario and Quebec. According to observers who are
close to the auto sector, the willingness of these
governments to put large subsidies into the auto industry
reflects three factors:

-- An appreciation that Canada has done
disproportionately well in attracting auto industry
investment in the past, and in leveraging this
investment into broader economic strength, and that
this success is worth holding onto;

-- The numbers and concentration of votes represented
by auto and aerospace workers in politically critical
areas; and

-- A view that there is no alternative but to "play the
game" and compete with other jurisdictions (primarily
U.S. States but also overseas locations) for auto and
aerospace plants.

COMMENT
-------

16. Comment: In retrospect, Canadian federal and
provincial governments' retreat from "industrial policies"
during the 1990's appears to have been driven more by
deficit problems than by a permanent change in philosophy.
Certain industries - such as autos, aerospace, and the
"cultural" sectors - will continue to have a political claim
on public resources. If nothing else, the across-the-board
retreat provided an opportunity to push a few industries -
such as shipbuilding, textiles, footwear, and some
agriculture - out of the tent.

DICKSON

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