Get new episodes right on your device by following us wherever you get your podcasts:

Click for the podcast transcript

From microchip shortages to volatile demand to supply chain issues — Canada’s auto sector has been through a lot the last few years. Scotiabank Economist Laura Gu is our guest this episode. She’ll answer our questions about why used car prices are up over 50% from pre-pandemic levels, the rental market and catch us up on the state of Canada’s auto sector.

Key moments this episode:
0:58 — Quick summary of the rollercoaster ride over the last few years in the Canadian auto market
1:50 — Used car prices now vs pre-pandemic
2:25 — Are people still having to wait to get new vehicles?
3:09 — Microchip shortage 101
4:42 — What is just-in-time inventory and why is it used?
5:00 — What other factors are affecting supply and is that changing?
5:40 — What has all of this meant for vehicle prices?
6:18 — Why have used car prices gone up so much compared to new car prices?
7:42 — Rental car prices
8:42 — How healthy is Ontario’s auto industry?
10:03 — Where do we go from here? Will the price of vehicles come down again?



Stephen Meurice: Have you been in the market for a car over the last few years? If so, you probably noticed a couple of things. Prices are up, for one. In the case of used cars, more than 50% from pre-pandemic levels — and supply can be hard to find.

Microchip shortages, volatile demand, supply chain issues. Canada’s auto sector has been through a lot.

So, what’s going on now? Is that new SUV you had your eye on going to be available at a price you can manage? What's it going to be like renting a car for the holidays? And what exactly is a microchip shortage, anyways?

Scotiabank Economist Laura Gu is our guest this episode. She’ll answer these questions and catch us up on the state of Canada’s auto sector.

I’m Stephen Meurice, and this is Perspectives.

Laura, thanks so much for joining us.

Laura Gu: Thank you, Stephen. Excited to be here.

SM: So, like everything else during the pandemic, the auto industry has been on a bit of a roller coaster ride. I know this might be tricky, but could you sum up what's happened in the auto market over the last couple of years?

LG: So, it is indeed a roller coaster ride for the automotive industry during the past two years and the way I see it is more like little fires everywhere. It started when the COVID-19 pandemic hit. Production halted and sales took a hit in the year 2020. It picked up for a good couple of months before another round of production disruption which was caused by the semiconductor shortage that plagued the global supply chain. Which led to the inventory shortage. And an accumulation of the pent-up demand from the consumers. So since then, we've been seeing vehicle prices going way up and becoming less and less affordable. This year, sales continue to drop for the most part of the year. And so far, the year-to-date sales in Canada has contracted compared to last year but slowly has been catching up because of the recovering, in the supply chain. And meanwhile, as we all see in the headlines, vehicle prices have been rising rapidly, especially in the used car sector where prices were up over 50% relative to pre pandemic levels.

SM: Wow.

LG: Yeah, this is mainly due to you know, strong demand, weak supply and I would call it a supply-demand imbalance, which is a classic case of Econ 101.

SM: Right, of course. And I do want to talk about used cars in a minute. But when it comes to new cars, are people still having to wait a long time to get the car they want?

LG: Yes, we do see that continue to be the case. Has that been changing? I would say slowly but surely. And here in North America we see the inventory levels still at very low levels and the sales are still sort of strained by production. Which has been picking up slowly this year in North America but at a speed that's slower than anticipated, which can be seen in the manufacturers around the world has been really slashing their sales target for most part of the year and around 30% of that comes from North America. So yeah, the supply chain has been recovering but at a very slow speed and it's still not catching up with the demand yet.

SM: Okay, another thing we've been reading in headlines is about a shortage of microchips. How much of the supply chain problem is from that particular component? And I've heard a lot about this issue but still don't understand what's causing the shortage. Can you explain that one to me?

LG: Yeah, the microchip shortage is a long story. It is essentially the result of a series of shocks on the semiconductor production and the supply chain. As we recall back in 2019, even before the pandemic, former President Trump started a series of trade wars with China which had reportedly put pressure on imports and exports of semiconductors. And apparently 75% of global chip manufacturing capacity comes from China and South Asia. So, the trade war has definitely put pressure on the semiconductor supply. And more recently, back in 2021 last year there was a bunch of weather events, fire and some pandemic closures that has disrupted production in Japan, Taiwan and the U.S. So that has also disrupted the semiconductor supply. And another thing to sort of keep in mind is the nature of the semiconductor supply chain which is just-in-time inventory management that the producers adjust production levels according to demand and auto demand is very cyclical and it's very volatile. So, sometimes producers do cut production according to demand. It just makes the auto industry very vulnerable to these series of supply disruptions.

SM: Right. So just-in-time means they only make what they need at a given time. Right? They don't have warehouses full of these parts.

LG: Yes, that is correct. And that's based on the fact that the semiconductor chips for auto, it has a relatively lower margin and they do this to protect the profit margin.

SM: Ok, so is that sort of the main factor that's causing the bottleneck in terms of supply or are there other things that enter into it as well?

LG: Yes. Other than the chip shortage, there has been a shortage of raw materials and labour shortage, as well as some levels of disruptions in terms of transportation and logistics and the supply chain, which all resulted in the substantial deterioration in supply delivery time which we have been tracking. But that was more of the story last year and for the earlier part of this year and the supplier delivery time, we see a pretty substantial pick up in recent months. So that has been improving, which is a really encouraging sign.

SM: Okay, so a little bit of good news there. So, what has all this meant for prices of vehicles? I mean how much more expensive is the average car now than it was, say, in 2019 or just before the pandemic?

LG: Yes. So, the prices have been accelerating for new vehicles. You're looking at CPI Data in Canada, it is around 13% higher than the pre-pandemic levels and the U.S. is a bit higher. Around 18% for new vehicles. But the real sticker shock sort of happened in the used car segment which, in the U.S., the used car prices were up over 50% since the start of the pandemic and it should be a very similar scale in Canada as well.

SM: So why is that? Why so much more of an effect on used cars than on new ones?

LG: So, recently we've been seeing some softening in the prices of used cars, but it's still at very elevated levels. Although, there are clear signs of peaking in the used car prices. And in terms of why there has been these astronomical increases in used car prices. So first of all, through the supply channel, as we know, the used cars mainly come from trading in, lease returning, foreclosures and all these sources have been drained up quite a bit starting in 2021. And this is partially due to the lack of inventory and the low level of new car sales during the pandemic. So those have really drained up the supply for used cars. And there's also the demand channel which also supports the high pricing of used cars. And especially given the fact that the new car supply is being heavily strained since last year. So, some buyers, some potential buyers turn to used cars. That's one side of the demand story and another side of the demand story comes from the rental companies. Because of the scarcity of new vehicles, some rental companies were sort of forced to turn to high-quality used cars to really address this rebound in travel demand, which sort of created this competition with other kinds of buyers on the used market, which just exacerbated the demands intensive market.

SM: I had heard — and I don't know if it's anecdotal — that the prices of rental cars were higher this summer as a lot more people were starting to get back to traveling and doing road trips and so on.

LG: Yeah, that is definitely related to the supply and demand issue. According to the latest CPI inflation number, rental prices in Q2 is still elevated and in Canada it's 30% higher than same quarter last year.

SM: Wow.

LG: But yeah, keep in mind that the peak in rental prices was later last year in the third quarter and this year in summer the price was very close to that peak last year. So, it's still very elevated in Canada. And in the US, rental car prices have come down from last year's highs but it's still at a pretty high level compared to the pre-pandemic years. So yes, it's still true that the rental car companies are still grappling with fleet replenishment and the shortage of rental cars is still in play.

SM: Wow, okay. Now, Ontario is a pretty big player in the auto manufacturing sector. What impact would you say all this, what we've been talking about has had on the car makers. How healthy is that industry now?

LG: So, in Canada, employment in the auto sector has been picking up. But at the same time the job vacancy rate in the auto sector is at a much higher level than pre-pandemic. Which means there has been a shortage in the auto sector and this could easily translate into wage pressure for the auto manufacturers in Ontario. This coupled with pressures from transportation costs and raw material costs, as we can see from the producer price index, that motor vehicle parts prices are still accelerating. So, this is all to say that there will definitely be challenges for automakers in Ontario in terms of costs and profits. Also bear in mind that there will probably be some relief in the market tightness. The rising interest rate may remove some of the pent-up demand and in this case, we believe that the power of automakers to pass the high cost of raw materials and labour cost to consumers, they will have less power essentially, perhaps next year when production catches up.

SM: Well, that's a good segue into our last question, which is where do we go from here? Can we expect prices of new and used vehicles to start to come down again? Or will this be the new reality going forward? Will supply start to catch up with demand?

LG: As we have been seeing substantial improvements in terms of supply chains. Production is — without further disruptions — supply should be catching up and that's our baseline scenario. But in the meantime, headwinds for auto demand are mounting. And with the combination of you know, the weak consumer sentiment, and heightened inflationary pressure, weaker financial markets, which all likely weigh on sales and also defer purchases, especially once production catches up. In the meantime, we've been seeing rising interest rates and there has been talks about the global recession that's coming up due to weakness from China and Europe. This would all contribute to a weaker demand and potentially remove some of the pent-up demand from the past two years. But so far these impacts have been masked by still limited inventory. Although there has been anecdotal evidence of reduced backlog orders from auto makers. And this could be seen as an early sign of a demand erosion which could alleviate some of the market tightness and hence sort of remove some pricing pressure in new vehicles.

SM: Right. So maybe the bad news on the economic front is good news if you're a car buyer, if it does help to drive the prices down.

LG: Yes. So, in a way it is true, this macroeconomic bad news are helping with removing some tightness from the market. And in the meantime, we do see some demand buffer on the consumer side. At least in Canada, the household balance sheet is still very healthy and we still have a very tight labour market. And so those would help maintain a certain level of demand going forward as well as, you know, the pent-up demand that's accumulated during the past years due to the production shortage. So, these are all really encouraging signs for the auto sector on the back of a slowdown in the economy.

SM: We will leave it there. Laura, thank you so much for joining us today. We really appreciate it.

LG: Thank you, Stephen.

SM: I've been speaking with Laura Gu, an economist at Scotiabank.