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Economic News

US tariffs: A death by a thousand cuts

Economic insight provided by Alberta Central Chief Economist Charles St-Arnaud. 

 Key takeaways

  • Canada managed to secure a one month of reprieve in the implementation of US tariffs. However, President Trump recently confirmed that tariffs would start, as planned, on March 4th. While further delay seems unlikely at this point, it remains possible.
  • What is certain is that President Trump and his advisors have suggested various reasons for imposing tariffs. These can be divided into four categories: 1) bargaining chips to extract concessions or favours from other countries, 2) means for other countries to pay for US’ services, such as its “security umbrella”, 3) to gain access to resources or a new territory, and 4) repatriate production and investments to the US.
  • Contrary to his first term, President Trump faces much less opposition and guardrails to implement his agenda. Moreover, with a majority of Americans believing that “the US lost more than gained” from global trade, public support for tariffs is relatively strong, as long as they do not reignite inflation.
  • Considering President Trump’s many reasons for imposing tariffs, it would be a mistake to view them solely as a bargaining chip during negotiations.
  • While the proposed tariffs of 25% on all goods and 10% on energy from Canada have attracted most of the attention because of their potentially severe impact on the Canadian economy, President Trump announced or expressed his plan for other ways to impose tariffs that would affect imports from Canada. This includes tariffs on steel and aluminum, reciprocal tariffs against any perceived unfair trading practices, and tariffs on car imports.
  • It seems almost certain that some sort of tariffs will be implemented. The uncertainty lies in how long the tariffs will be in place and whether Canada is willing to pay the price required to avoid them.
  • Many commentators have suggested that Canada should retaliate as forcefully as possible to these threats. While fighting back may feel satisfying and justified, Canada has a limited scope to inflict significant pain south of the border without causing self-inflicted damage at home.
  • Whereas the US exports the equivalent of about 1.6% of its GDP to Canada, roughly 25% of Canadian GDP is exported to the US. Hence, as trade shocks would have a significantly bigger impact in Canada than in the US, any retaliatory measures Canada puts in place could end up hurting the Canadian economy more than its intended target.
  • Instead, Canada should respond to tariffs by significantly improving its investment attractiveness, competitiveness and productivity. Canada should also actively engage with allies to diversify its markets and invest in critical infrastructures to support trade diversification.
  • While the impact of tariffs on the Canadian economy has been well documented, even without tariffs, the Canadian economy may still end up substantially affected by the extreme level of uncertainty caused by tariff threats, as businesses and consumers hold back on their investment and spending.
  • The longer uncertainty persists, the broader and more persistent the impact will be on investment and the economy.
  • Interestingly, by maintaining high uncertainty without imposing tariffs, President Trump may still be partly reaching his objective of repatriating production and investment back to the US while avoiding a sharp rise in inflationary pressures that tariffs would trigger.
  • Whether the tariffs are legal or not under the USMCA is completely irrelevant. This is because it would take years for the courts to provide a judgment against any unlawful tariffs and award reparation. In the meantime, some permanent changes could be made to the Canadian-US relationship, such as a permanent diversion of some production and investment to the US.

On February 1st, after weeks of warning, US President Donald Trump signed an Executive Order imposing 25% tariffs on all imports from Canada; this order excluded energy imports, which will face a 10% levy. The implementation of tariffs was ultimately delayed until March 4th, following the Canadian government’s action on border issues. Nevertheless, on February 24th, President Trump confirmed during a press conference that “The tariffs are going forward on time, on schedule.” Although this suggests no further delays should be expected, the situation may change.

Why does Trump want to impose tariffs?

Unfortunately, there is no singular answer. President Trump and his advisors have suggested various reasons for imposing tariffs, explicitly or implicitly, through their actions. Nevertheless, the attraction to import levies can be seen through different lenses.

  1. Transactional Trump. As seen during Trump’s first term and, more recently with Colombia – where a potential trade war was avoided after the Columbian government agreed to the US’ demands – and the delay in implementing tariffs against Canada and Mexico, the threat of tariffs is used as a bargaining chip in an effort to extract concessions or favours from other parties. A transactional President means that Canada could avoid tariffs by resolving what Trump sees or perceives as irritants, such as the need for increased military spending on border security, the supply management system, the digital sales tax, etc. However, if Canada were to address all of his irritants, it is not clear where his demands would stop.
  2. Isolationist Trump. It is becoming clear that the President is steering  the US to a more isolationist superpower. This means the US will be much less willing to intervene in global issues unless it has something to gain, or other parties provide payments or favours. In this context, tariffs are viewed as a way for a country to repay for the protection provided by the “US security umbrella”. This is likely one aspect the President is contemplating when he says that Canada is taking advantage of the US. Similarly, Trump’s obsession with the US trade deficit is also partly explained through this angle.
  3. Expansionist Trump. Initially viewed as a bad joke, President Trump’s constant reference to Canada as the 51st state can no longer be dismissed. This also applies to his intention to annex or buy Greenland. It becomes clear that the President dreams of extending America’s territory and gaining access to critical resources, such as oil, critical minerals, water, etc. that may be achieved through tariffs.  In the case of Canada, broad-based tariffs have the potential to cause a deep recession with significant job losses. As the Canadian economy is vulnerable to household income shocks due to layoffs (see 2025 Outlook: Searching for the terminal rate and Will it be a hard landing or a soft landing? The labour market will decide), this would cause significant negative spillovers to the broader economy. This is likely what the President has in mind when he says that he’s ready to use “economic force” to subjugate Canada.
  4. Industrialist Trump. There is a growing consensus amongst Trump’s economic advisors that the global trade and financial system is working against the US economy. In their view, the result has been a strong USD that has led to a hollowing out of the US manufacturing capacity to the benefit of China, Mexico, Canada and other countries with a trade surplus with the US. Moreover, many advisors also recognize that the situation threatens national security, as the US is dependent on the global supply chain and disruptions could be highly detrimental during a geopolitical crisis. Tariffs are viewed as a tool to level the playing field and render US-made goods competitive against foreign rivals and, as a result, attract production and investment back to the US.

An important difference in the current context relative to Trump’s first term is that the President faces much less opposition and guardrails compared to his first mandate. As such, many Republicans who publicly opposed Trump in the past are no longer in politics; these past barriers have been replaced by politicians who fully support the “MAGA” movement. In addition, the President, having won the popular vote and control of both chambers, likely considers that he has a strong mandate to implement his views. According to findings from the Pew Research Centre a majority of Americans, especially Republicans, say that “the US lost more than gained” from global trade; this suggests that the general public likely supports tariffs as long as it does not reignite inflation.

Considering President Trump’s many reasons for imposing tariffs, it would be a mistake to view them solely as a bargaining chip during negotiations. However, it also means that there is a lot of ambiguity about the tariffs’ precise aim, making it difficult for Canadian officials to develop an effective strategy to push back.

Tariffs come in a variety of flavours

Although the primary focus has been on the broad-based tariffs of 25% on all imports from Canada, except for 10% on energy products announced at the beginning of the month, there are numerous other ways that the US could impose tariffs on Canada. President Trump has either signed or floated various ways to do so, each with varying degrees of impact on the country. The main ones are:

  1. 25% on all imports, except for 10% on energy imports. This was signed on February 1st but was delayed until March 4th. As we wrote (see The US imposes tariffs on Canada. What’s next?), because of the lower rate on oil and gas exports, the effective rate is about 20% for the country. Regionally, however, Ontario and Quebec face an effective tariff rate of almost 25%, while Alberta has an effective rate of 13%. Despite this lower rate, Alberta will not be the least affected province. Instead, because of its high dependence on exports to the US, Alberta is estimated to be the fourth most affected province after Ontario, Quebec and New Brunswick in terms of output and employment.

  1. 25% tariffs on steel and 10% on aluminum. This is very similar to what President Trump put in place in 2018 during his first mandate. The US accounts for about 90% of Canada’s steel and aluminum exports. Nevertheless, the impact of these tariffs on the broader Canadian economy would be much smaller than in the 25%/10% scenario. As such, steel and aluminum account for about 0.5% of Canada’s GDP and a roughly equal share of employment. In Quebec and Ontario, the two most exposed provinces, these industries represent 1.0% and 0.6% of GDP, respectively, while Alberta would be less affected.
  2. Reciprocal tariffs. The “Fair and Reciprocal Plan” orders the examination of all non-reciprocal trade relationships (i.e. where other countries impose higher tariffs on US goods than the US imposes in return), investigation of any perceived unfair trade practices of its trading partners, and proposal of remediation measures by April 1st, 2025.

What constitutes an unfair practice is extremely vague and covers almost all aspects of international trade relations, including:

  • tariffs imposed on US products;
  • unfair, discriminatory or extraterritorial taxes imposed by US trading partners, including a value‑added tax;
  • costs arising from non-tariff barriers or measures and unfair or harmful acts, policies or practices, including subsidies, and;
  • burdensome regulatory requirements on US businesses operating in other countries.

In the Canadian context, there are some areas where the US could find reasons to retaliate; primarily:

  • the supply management of milk, eggs and poultry;
  • the GST, which is a value-added tax;
  • the digital tax, which affects many US tech companies;
  • the foreign ownership threshold in some sectors, notably banks, telecom, airlines, and;
  • any retaliatory tariffs from Canada.
  1. 25% tariffs on cars. Although no Executive Order has yet been issued to impose tariffs on car imports, President Trump said that they would come into effect on April 2nd. The same idea was floated back in 2018. At the time, the Department of Commerce had found, following a national security investigation, that imports displaced domestic production, weakened the domestic economy and impaired national security. The auto industry is the main manufacturing sector in Canada and directly employs 125,000 people; including indirect employment, the number rises to approximately 500,000 workers. It is estimated to represent about 20% of Ontario’s GDP.

President Trump has plenty of choices on how to impose tariffs on Canada, from the milder tariffs on steel and aluminum to the much more impactful broad-based tariffs. It also means that the likelihood that some sort of tariffs will be implemented is almost a certainty. Where the uncertainty lies is how long the tariffs would be in place.

These options and consequences also raise the question of how much Canada is willing to pay to avoid tariffs if Trump is using them as a coercive tool to extract significant concessions from other countries; this question may come to the fore upon the renegotiation of the free-trade agreement between the two countries.

Retaliations feel good but could end up hurting Canada more

Shortly after the announcement of tariffs by President Trump on February 1st, PM Trudeau held a press conference announcing a 25% tariff on $155 billions of US goods. Many politicians and commentators are suggesting that more retaliation should be announced and implemented. While fighting back may feel satisfying and justified, Canada has limited scope to inflict significant pain south of the border without causing self-inflicted damage at home.

Compared to Canada, international trade is a much smaller share of the US economy, with exports representing 11% of GDP and imports almost 16%.  In contrast, exports and imports each account for slightly more than 30% of Canadian GDP.  Moreover, whereas the US exports the equivalent of about 1.6% of its GDP to Canada, roughly 25% of Canadian GDP is exported to the US. Hence, as trade shocks have a significantly bigger impact in Canada than in the US, any retaliatory measures Canada puts in place could end up hurting the Canadian economy more than its intended target.

With this in mind, the retaliatory tariffs on $155bn of US goods announced by the Canadian government could be the most Canada could do without hurting its economy. Putting these numbers into context, $155bn represents about 20% of Canadian imports from the US or about 6% of Canadian GDP. On the flip side, this accounts for only 0.4% of the US GDP.

Moreover, with US tariffs likely pushing inflation higher due to the resulting depreciation in the Canadian dollar, any retaliatory tariffs imposed on imports from the US could exacerbate the increase in prices. The stronger the inflationary pressures, the less likely the Bank of Canada will be able to provide monetary stimulus to ease the burden of US tariffs on the economy.

This is a reminder that, no matter how tempting, retaliations are likely to adversely impact Canada more than the US. This is even more the case if the US responds to the retaliation by raising tariffs higher or broadening their scope. This is why Canada needs to be strategic and use targeted actions.

Instead, Canada should respond to the tariffs by significantly improving its investment attractiveness and its competitiveness and productivity. This would include greater clarity on the approval process and timelines for big projects, tax reforms to incentivize R&D and productivity-enhancing investments and removing barriers to interprovincial trade. It also means actively engaging with allies to diversify our markets and investing in critical infrastructures supporting trade diversification, such as ports, rail lines, highways and pipelines.

While some fiscal support will be required to help workers and businesses negatively affected by US tariffs, we believe the aid provided shouldn’t take the shape of blanket income replacement similar to those put in place during the pandemic; this is because the impact of tariffs is likely to be more permanent.

Uncertainty could be as damaging as tariffs

It has been well-documented that broad-based tariffs would significantly impact the Canadian economy. Bank of Canada Governor Macklem recently warned that US tariffs could permanently lower Canadian GDP by about 2.5%. While the Governor did not provide any estimates with respect to employment, such a scenario will translate into important job losses; according to our estimates, these losses could reach between 250k and 325k.

Tariffs with a narrower scope could inflict severe impacts on some sectors; in fact, without tariffs being imposed, the Canadian economy may still end up substantially affected by the uncertainty.

The level of uncertainty in Canada is at extreme levels. Looking at the “Economic Policy Uncertainty Index”, developed by Baker, Bloom and Davis[1], the measure is at its highest level on record and much higher than during the initial phase of the pandemic (Fig 3). It shouldn’t be surprising that uncertainty reached extreme highs in January.  In addition to the threat of US tariffs, January saw the resignation of PM Trudeau, the start of a leadership race for the Liberal party, and a federal election before the end of 2025 that is likely to lead to a change of the governing party.

This environment is not conducive to either business investment or businesses, especially those that have a sizeable share of their activities linked to the US; these businesses are likely to postpone any decisions regarding capital expenditures or long-term strategy implementation until there is more clarity regarding the future. Similarly, some businesses may even reconsider their Canadian operations altogether. Hence, high uncertainty is likely acting as a headwind on growth.

For now, this unprecedented level of uncertainty is mainly impacting new investment. For example, a manufacturer may delay committing to build a new production plant in Canada until there is more clarity regarding tariffs.  In an even worse-case scenario, some producers may also simply build their new production capacity in the US to avoid the risk of tariffs altogether.

The longer uncertainty persists, the broader the impact will be on investment and the economy. As such, while new investment decisions are likely the first to be affected, eventually, firms will reconsider their decision to produce in Canada. This means that any investment to modernize a current production facility could be diverted to producing in the US instead, in addition to investment into new facilities. There are already seeing signs of this happening, with global automotive company Stellantis pausing some of its activity in Canada and sharing that it is reassessing its production strategy in North America.

This heightened uncertainty is also affecting consumers. According to the Bloomberg Nanos Confidence Index, which tracks consumer confidence on a weekly basis, there has been a sharp deterioration in confidence since the beginning of February; in fact, it is close to its lowest level in more than a year. Relatedly, households have become increasingly pessimistic regarding their economic future since President Trump was elected, with the expectations subindex reaching its lowest level since Spring 2023. This suggests that households could be restraining their spending. The surge in new housing listings and decline in housing transactions in January could be pointing to increased worries.

We believe that elevated uncertainty is here to stay and that, until  tariffs are imposed, the Canadian economy will continue to face rolling threats. In order words, if we are facing a “Transactional Trump”, it means that each time the deadline for tariffs approaches, they could be delayed. Hence, the Canadian economy will continue to face serious headwinds for months. The question is: once tariffs are put in place, will they be reversed or will they become permanent? However, some of these headwinds may be offset by businesses rushing to stockpile on goods that will be affected by tariffs.

Interestingly, by keeping uncertainty high, President Trump could partly be reaching his objective of returning some production and investment back to the US. Additionally, by leveraging this environment of uncertainty instead of using tariffs, the risk of a sharp rise in US inflation – which would fuel US public anger against the President – is significantly reduced.

Whether tariffs are illegal or not is irrelevant

Some have argued that the fact that tariffs would be illegal under the USMCA would deter President Trump from imposing tariffs. We believe this view is wrong. In our view, it would make complete sense for the US President to impose tariffs, even with the knowledge that they would likely be illegal and struck down by the courts. This is because it would take years for the courts to provide a judgment against any unlawful tariffs and award reparation if judged illegal. In the meantime, some permanent damage can be inflicted to the Canadian-US trade.

The saga of the current Canada-US dispute regarding softwood lumber serves as an example. Businesses cannot wait years for a court judgement before adapting their operations and shifting, at least partly, some of their production to the US to avoid being affected. This means that, by acting illegally, the US could force a permanent repatriation of some production, thereby satisfying one the objectives of the tariffs.

This is also an important caution for those who have expressed the need to start the renegotiation of the USMCA as soon as possible. The current trade agreement between the US, Canada and Mexico was negotiated and signed during President Trump’s first mandate. The violation of the terms of this agreement shows that a renegotiated accord does not guarantee protection against future tariffs unless Canada is willing to make significant concessions.

Conclusion

The Canadian economy is already being negatively affected prior to any tariffs taking effect. At the moment, the high level of uncertainty is causing severe headwinds on domestic growth, as businesses hold back on investment and households become more hesitant with their spending. The longer this acute situation persists, the more likely it is to have some permanent impact on the Canadian economy. We believe that, ultimately, some sort of tariffs will be put in place after a prolonged period of uncertainty. However, the question remains whether the tariffs will be reversed within weeks or months after taking effect or whether they will become permanent.

 

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Independent Opinion

The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any organization or person in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication.

 

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