Trade war: buckle up
It's lose-lose, but Canada stands to lose more than the US
TLDR: Trump is saying that as soon as he takes office on January 20, 2025, the US will impose 25% tariffs on all imports from Mexico and Canada. Canada depends on trade, with exports of goods accounting for about 25% of Canada's GDP, and about 75% of those exports going to the US. The US imposing tariffs would be lose-lose, with US households paying higher prices, and with severe disruption to firms that rely on imports from Mexico and Canada. But Canada stands to lose more than the US.
Canada’s first priority over the next few weeks is to negotiate some kind of settlement with the US to avoid tariffs, which may include threatening tariffs of our own. If that fails, Canada will need to expand trade elsewhere, particularly with Europe and Asia.
Basics of Canadian foreign policy
The most fundamental principle of Canadian foreign policy is to maintain national unity. See Louis St. Laurent’s 1947 Gray Lecture, The Foundations of Canadian Policy in World Affairs: “A disunited Canada will be a powerless one.”
In international politics, the key divide isn’t between good and evil. It’s between those countries which support the status quo, and those which are opposed to the status quo and seek to overthrow it. E. H. Carr. Canada depends on trade and international stability, so we have a strong interest in supporting the status quo. This is why Canada fought in World War I, World War II, and the Korean War, and why Canada is a member of NATO.
Given the disparity in power between Canada and the US, Canada has a strong interest in multilateral institutions, like NATO and the UN, so that we’re not negotiating with the US one-on-one.
Canadians are accustomed to taking our national security for granted. With the US (the strongest status quo power) headed towards isolationism, and with China under Xi Jinping (the strongest power opposed to the status quo) following a “might makes right” approach to foreign policy, we’ve entered more dangerous times. Illustration by David Parkins, used with his permission:
Canada has a self-image of being especially virtuous, which I would describe as an unhelpful illusion, especially in a less friendly world. This has a long history. In 1966, Dean Acheson described Canada as “the stern daughter of the voice of God”; this was not a compliment.
Personally, I prefer this description, from a review of Chris Haddock’s show Intelligence (2005-2007):
Intelligence largely rejects fantasies of national innocence and victimhood. Canada deserves protection by Mary Spalding, and Mary is redeemed by her efforts, not because Canada is pure of heart. Indeed, if Mary herself is any sign, Canada has a nasty streak it’s rather proud of. Canada deserves protection because it’s Canada. What Mary defends her country against is disrespect, the blatant violation of Canada’s sovereignty by agents of its southern neighbor. Mary doesn’t complain about this disrespect, or even mention respect at all. She merely claims a degree of it back through stealth and orneriness.
Basics of trade
Trade is win-win. When the US sells goods or services to Canada, like cars or gasoline, we pay them in Canadian dollars. Canadian dollars are like Canadian Tire money - they need to be used to buy Canadian goods or services, like oil or lumber. We have more oil and lumber than we can consume ourselves, and we need more cars and gasoline than we can produce ourselves, so we both benefit from this trade.
Having guaranteed access to a larger market means that producers can benefit from specialization, economies of scale, and investments in physical assets like factories, instead of being smaller and less efficient producers behind a tariff wall. Canada’s economic integration with the US goes back to the 1965 Auto Pact.
The benefits of trade are most easily shared when you have good public services and social insurance, funded through taxes.
Because of transport costs, you tend to have more trade over shorter distances. That said, maritime transport is remarkably cheap compared to land-based transport: once you can get your products to a port, you can ship them worldwide.
Noah Smith observes that there’s a close connection between manufacturing and readiness for war. During peacetime, there’s a limit to how much you need to produce, but during wartime, you need to be able to produce war material fast enough to replace everything that’s being destroyed. The Biden administration’s approach was to pursue “friendshoring”: importing less from China and more from friendly countries.
Trump's beliefs about trade and foreign policy were formed back in the 1980s, when US auto manufacturers were being hit hard by Japanese competition. He’s suspicious of trade - why couldn’t the US just keep making everything (like cars) domestically? The US economy is large enough that this is more plausible than it would be for Canada. He’s particularly suspicious of trade deficits, which is presumably why Canada is on his hit list.
What now?
The top priority for Canada is negotiating some kind of settlement to avoid the threatened tariffs. The three elements of diplomacy are persuasion, compromise, and pressure:
Emphasizing the costs to US households and manufacturers, who will end up paying more for energy and for raw materials.
Concessions that provide a political win for Trump, like putting $1.3 billion into additional border security. Global News. New York Times. A press release from Trump’s team: “President Trump is securing the border and he hasn’t even taken office yet. Facing an uproar among his own citizens, embattled Prime Minister Justin Trudeau just announced a billion-dollar plan for major border security improvements and increased border patrols.”
Threatening retaliatory tariffs that would hit specific US exports to Canada.
Trudeau flew down to Mar-a-Lago and met with Trump the same week: Global News. Melanie Joly and Dominic LeBlanc met with Howard Lutnick (the incoming secretary of commerce) and Doug Burgum (secretary of the interior) last Friday: CBC.
Trudeau’s been coordinating with the provincial premiers. The general approach is that right-leaning premiers will lobby Republicans, and left-leaning premiers will lobby Democrats. CBC.
If that doesn’t work, and Trump goes ahead with the tariffs, we’ll need to expand trade elsewhere, and look for other ways to improve Canada’s economic productivity. I’d suggest that our overall approach should be to listen closely to economists.
TMX and LNG Canada will be helpful in redirecting energy exports to Asia. Heather Exner-Poirot.
The EU is likely to be facing similar pressures from the US, and looking to expand trade elsewhere. Guardian. Canada and the EU have a free trade agreement, CETA. Trevor Tombe on trade negotiations with the UK.
There’s also the TPP, which includes Japan, Vietnam, Singapore, Australia, and New Zealand, as well as Mexico, Chile, Peru, and the UK.
Reducing interprovincial trade barriers would help. Business Council of Alberta.
Simplifying Canada’s tariff system, by eliminating a lot of tiny tariffs that don’t generate much revenue, would reduce compliance costs. Mike Moffatt.
Tax reform would help to draw investment and thus improve productivity. The Nordic countries follow a textbook approach: high taxes on consumption (a 25% value-added tax) and low taxes on capital income, with income taxes somewhere in between. Stephen Gordon.
Allowing more housing in expensive cities (especially the GTA and Metro Vancouver) would help to reduce housing costs, raise real incomes, and reduce labour shortages. David Schleicher.
More
On trade being win-win: see Joseph Heath’s explanation in Chapter 5 of Filthy Lucre.
Canada’s exports and imports: Observatory of Economic Complexity. Our exports look like this:
Library of Parliament report on trade and investment between the US and Canada, by Anne-Marie Therrien-Tremblay.
Canada’s GDP in 2023, in 2023 dollars, was $2.9 trillion. Statistics Canada, Gross domestic product, expenditure-based, provincial and territorial, annual (x 1,000,000).
Canada’s merchandise exports in 2023 were $768.2 billion. Statistics Canada, Canadian international merchandise trade: Annual review 2023.
Trump’s November 25 announcement that he’s planning to impose 25% tariffs on all imports from Mexico and Canada.
The implications for the Canadian economy:
What do Trump’s threats mean for working Canadians? 2.4 million jobs are exposed to U.S. tariffs. Trevor Tombe, The Hub.
Thread by Joseph Steinberg, summarizing results from an economic model.
The Economist has a whole series of articles on the incoming Trump administration, and on his threatened tariffs on Mexico and Canada specifically.
Welcome to Trump’s world, November 9. In the 1920s and 1930s, the United States was “hostile towards immigration, scornful of trade, and sceptical of foreign entanglements.”
How to avoid Oval Office humiliation, November 16. Some advice from diplomats who have dealt with Trump in the past.
The biggest losers from Trumponomics, November 16. Describes how Trump’s policies will reshape the flow of goods (using tariffs to limit imports from countries running trade surpluses), capital (with lower taxes and deregulation attracting investment in the US), and people (mass deportation of illegal immigrants, restricting skilled immigration). Mexico, China, and the EU are all likely to suffer economically.
Trump wastes no time in reigniting trade wars, November 30. On Trump’s November 25 announcement.
Whether Mr Trump actually will implement tariffs is a more difficult question. It is not just his apparent change of heart after his conversation with Ms Sheinbaum. In 2019 he announced his intention to raise tariffs on Mexico to 25%, but dropped the plan a week later, when the Mexican government agreed to send troops to turn back migrants from Guatemala who were heading for the American border.
Such is the fickleness with which businesses relying on cross-border trade must now contend. They are not taking any chances. Many are already building stockpiles of the sort of imported goods that might soon face steep tariffs. America’s National Retail Federation, an industry group, expects import volumes to rise by 14% year-on-year in November, compared with a 1% increase it forecast before the election. Mr Trump’s latest announcement is likely to accelerate this stockpiling.
Although threats to the commercial relationship between America and China have attracted more attention, the economic damage to America’s neighbours has the potential to be far greater. Last year only 15% of China’s goods exports went to America directly, compared with 78% of Canada’s and 80% of Mexico’s. Most of their trade travels by land, and will be difficult to redirect to alternative markets.
Mexico and Canada brace for Donald Trump’s tariff thrashing, November 30.
“Mexico’s Claudia Sheinbaum and Canada’s Justin Trudeau are taking different approaches to looming trade war.”Does Donald Trump have unlimited authority to impose tariffs?, November 30.
The likeliest constraint on Mr Trump will not be legal. It will be fear of backlash from the markets and the public. “More than half of our fresh fruits and vegetables are from Canada and Mexico ... Super Bowl season is right around the corner. Do we really think Trump’s going to impose a 25% guacamole tax on his first day in office?” says Scott Lincicome of the Cato Institute, a libertarian think-tank. He suspects that Mr Trump is issuing tariff threats as a negotiating tactic to force concessions that he can then tout before his inauguration even begins.
Mr Trump campaigned on resolving the plight of carworkers, farmers and consumers angry about the price of everyday staples. He would quickly run out of goodwill if he were to make imported goods much more expensive. The court of public opinion is probably the only one that can curb Mr Trump’s instincts.
How painful will Trump’s tariffs be for American businesses?, December 7. “Their options range from hoarding goods and raising prices to rewiring supply chains.”
The coming disruption may be more widespread and less predictable than many American businesses expect. On November 25th the president-elect announced on Truth Social, his social-media megaphone, that he would impose a 25% tariff on all products flowing from Mexico and Canada and raise the rate on goods from China by 10%. Mr Trump’s intention to follow through with his threat against Mexico and Canada was then thrown into question by subsequent posts in which he described “wonderful” and “productive” meetings, respectively, with the leaders of the two countries.
That has not been comforting. If Mr Trump were to slap tariffs on America’s northern and southern neighbours, the impact on American companies would be devastating. Businesses from Mattel, the maker of Barbie dolls, to Whirlpool, a home-appliance manufacturer, have factories in Mexico. Around three-fifths of America’s imported aluminium and a quarter of its imported steel come from Canada, with large volumes of steel also coming from Mexico. According to Citigroup, a bank, Mr Trump’s tariffs would raise the price of steel for American manufacturers by 15-20%.
Among the hardest hit by the suggested tariffs would be American carmakers. General Motors, for example, imports over half of the pickup trucks it sells in America from Mexico and Canada. About a tenth of the value of parts for cars produced in America also comes from the two countries. According to Nomura, a Japanese bank, the tariffs threatened by Mr Trump would wipe away four-fifths of the operating profit of General Motors next year. Foreign carmakers, such as Toyota, would also be hit.
Trump for Dummies, December 14. “Step 1: Identify a real problem. Step 2: Hyperbolise the problem. Step 3: Promise extreme measures. Step 4: Count on Steps 2 and 3 to derange your opponents, including the left-leaning press.”
The Art of the Deal: global edition, December 14. “In his second presidency, Donald Trump will wield tremendous power over allies and countries that profit from ties with America. With adversaries ready to burn relations with the West to the ground, his grip will be less sure.”
On a lighter note, why does Trump keep talking about annexing Canada? With his suspicion of trade, I suppose he finds it incongruous that Canada and the US are closely integrated economically, but not politically. I think it’s safe to say that he’s joking, since annexing Canada would tilt the US political balance considerably towards the Democratic side.
I’m always reminded of OverSimplified’s video on the Pig War, particularly the gloriously deranged ending: