Firms in the Global Economy 171 Case Study Intra-Industry Trade in Action: The North American Auto Pact of 1964



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Case study 1. Intra-Industry Trade in Action



CHAPTER 8
Firms in the Global Economy
171
Case Study
Intra-Industry Trade in Action: The North American Auto Pact of 1964
An unusually clear-cut example of the role of economies of scale in generating benefi-
cial international trade is provided by the growth in automotive trade between the
United States and Canada during the second half of the 1960s. While
the case does not fit our model exactly since it involves multinational
firms, it does show that the basic concepts we have developed are use-
ful in the real world.
Before 1965, tariff protection by Canada and the United States pro-
duced a Canadian auto industry that was largely self-sufficient, neither
importing nor exporting much. The Canadian industry was controlled
by the same firms as the U.S. industry—a feature that we will address
later on in this chapter—but these firms found it cheaper to have largely
separate production systems than to pay the tariffs. Thus the Canadian
industry was in effect a miniature version of the U.S. industry, at about
1
/
10
the scale.
The Canadian subsidiaries of U.S. firms found that small scale was
a substantial disadvantage. This was partly because Canadian plants
had to be smaller than their U.S. counterparts. Perhaps more impor-
tantly, U.S. plants could often be “dedicated”—that is, devoted to
producing a single model or component—while Canadian plants had
to produce several different things, requiring the plants to shut down
periodically to change over from producing one item to producing
another, to hold larger inventories, to use less specialized machinery,
and so on. The Canadian auto industry thus had a labor productivity about 30 percent
lower than that of the United States.
In an effort to remove these problems, the United States and Canada agreed in 1964
to establish a free trade area in automobiles (subject to certain restrictions). This al-
lowed the auto companies to reorganize their production. Canadian subsidiaries of the
auto firms sharply cut the number of products made in Canada. For example, General
Motors cut in half the number of models assembled in Canada. The overall level of
Canadian production and employment was, however, maintained. Production levels for
the models produced in Canada rose dramatically, as those Canadian plants became one
of the main (and many times the only) supplier of that model for the whole North
American market. Conversely, Canada then imported the models from the United
States that it was no longer producing. In 1962, Canada exported $16 million worth of
automotive products to the United States while importing $519 million worth. By 1968
the numbers were $2.4 and $2.9 billion, respectively. In other words, both exports and
imports increased sharply: intra-industry trade in action.
The gains seem to have been substantial. By the early 1970s the Canadian industry
was comparable to the U.S. industry in productivity. Later on, this transformation of the
automotive industry was extended to include Mexico. In 1989, Volkswagen consolidated
its North American operations in Mexico, shutting down its plant in Pennsylvania. This
process continued with the implementation of NAFTA (the North American Free Trade
Agreement between the United States, Canada, and Mexico). In 1994 Volkswagen
started producing the new Beetle for the whole North American market in that same
Mexican plant. We discuss the effects of NAFTA in more detail later on in this chapter.
The Ambassador bridge connects
Detroit in the United States to
Windsor in Canada. On a typical
day, $250 million worth of cars
and car parts crosses this bridge.

Document Outline

  • Part 1 International Trade Theory
    • 8 Firms in the Global Economy: Export Decisions, Outsourcing, and Multinational Enterprises
      • CASE STUDY: Intra-Industry Trade in Action: The North American Auto Pact of 1964

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