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: 
 
-- 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