US-Canada Trade War: Why New Tariffs Threaten Both Economies

For the past century, Canada has been a crucial partner to the United States in terms of security, culture, and economy. The two nations share one of the world's largest bilateral trade relationships, with nearly a trillion dollars in goods crossing the border annually. They also have a long history of international cooperation. Historically, Americans and Canadians held overwhelmingly favorable opinions of each other. However, this relationship has recently deteriorated.

Over the last 20 months, the US has repeatedly proposed, imposed, paused, reversed, and re-implemented tariffs and trade deals with Canada, totaling 30 separate instances. This is in addition to new tariffs and threats to annex Canada, cut off vital resources, rename Lake Ontario, block Canadian companies, and even imply superiority in ice hockey. The US has also moved to block Canadian private jets to prioritize its own manufacturers. These actions raise questions about their justification and potential consequences.

Justifications and Their Flaws

The US has offered various justifications for these actions, though many appear tenuous. Even assuming tariffs work as intended and that Canada has been an antagonistic trade partner, there are significant problems with the current approach.

Outdated Trade Philosophy

The current US trade strategy seems to operate on a mercantilist view of trade, where the goal is to export more and hoard wealth, treating trade as a zero-sum game. While the US does have a trade deficit with Canada (meaning Canada sells more to the US than vice-versa), this doesn't mean the US is simply losing money.

Complex Supply Chains

A significant portion of the trade between the US and Canada involves complex supply chains where goods cross the border multiple times. For example, a single component might start as raw aluminum from Quebec, go to Michigan, then Ontario for casting, back to the US for finishing, to Mexico for further processing, Wisconsin for assembly, and finally back to Michigan for installation into an engine, which might then be sold back to Canada. Blanket tariffs on every crossing compound costs, making such manufacturing untenable.

While some might argue this could bring jobs back to the US, it would likely make American products less competitive. Companies like Ford optimize their supply chains by leveraging regional advantages, such as Quebec's cheap hydroelectric energy for aluminum smelting.

Services Trade Surplus

While Canada sends more physical goods to the US, the US maintains a substantial services trade surplus with Canada, amounting to approximately $28 billion annually. This means Canada pays the US significantly more for services like financial work, consulting, technology usage, and intellectual property. Services typically have much higher profit margins than manufactured goods, which incur costs for materials, energy, labor, tooling, and shipping. Therefore, even if the raw numbers of goods crossing the border favor Canada, the US often profits more from the services it provides.

The Broader Global Context

Focusing solely on the US-Canada trade relationship in isolation is a narrow perspective.

Oil Imports

Canada is a critical supplier of crude oil to the US. Even before recent global events, Canada accounted for roughly 60% of all US crude oil imports, and approximately 73% of crude for Midwest refineries comes from Canadian pipelines. This oil is refined in the US into products like diesel, plastics, and gasoline, which are then sold domestically and internationally, often at a markup, including back to Canada. If these oil imports are excluded, the US actually has a trade surplus with Canada.

Treating this as a deficit is akin to a supermarket complaining about a trade deficit with a farmer; the supermarket's business model depends on these raw material supplies. Given that the US Strategic Petroleum Reserve is at its lowest level since 1982, maintaining a good relationship with its largest oil supplier is prudent. The US is already the largest oil producer globally, so Canadian imports are not undercutting domestic industry.

While oil has often been exempted from tariffs, Canada's historical reliance on the US as a reliable purchaser is changing. Canada recently expanded its Trans Mountain pipeline, and non-US Canadian oil exports have more than tripled, with Asia projected to take up to 70% of its capacity. Canadian leaders are also pushing to develop their own refining capacity to add value to their supply chain, rather than relying on an "unreliable" partner.

Other Critical Raw Materials

The US also depends on Canada for other essential raw materials that are difficult to source elsewhere:

• Potash: The US imports about 93% of its potash, a mineral used for agricultural fertilizers, with Canada supplying roughly 80% of that. Potash deposits are geological, meaning tariffs won't create domestic sources.
• Uranium: Canada covers about a third of the US civilian nuclear fuel supply.
• Aluminum: Canada supplies around 68% of US aluminum imports, largely from Quebec, utilizing its cheap hydroelectric power.

While potash and some other materials have been exempted from certain tariffs, this implicitly acknowledges the US's reliance on these resources. Continued antagonism risks disrupting these vital supplies.

Canada's Retaliatory Measures

Canada has not been entirely passive. They have implemented over $20 billion in retaliatory tariffs, removed US goods from government purchasing, and imposed import bans on dairy, alcohol, and motorcycles. Ontario has also placed a 25% surcharge on electricity exports to Michigan, Minnesota, and New York, affecting approximately 1.5 million American homes and businesses.

Furthermore, Canadian institutions hold around $460 billion worth of US Treasury securities. In a worst-case scenario, Canada could begin selling these bonds, driving up US borrowing costs beyond current record levels. While the US economy is larger, these actions demonstrate Canada's capacity to inflict economic pain.

Misplaced Accusations and Strategic Blunders

The US justification for these actions often stems from concerns about global manufacturing pressure, particularly from Asian competitors like China, and accusations of unfair trade tactics. However, Canada does not fit this mold.

The accusation that Canada manipulates its currency to make exports artificially competitive is unfounded. Canada has a free-floating currency and has not intervened in its value since the 1990s. Even if it were true, a weaker Canadian dollar would effectively be a discount on inputs for US businesses, which would be beneficial.

The real competition for US industry comes from countries with lower wages, government backing, and looser environmental standards. Attacking Canada, a close ally and reliable supplier, in this context is counterproductive. It's akin to a shop owner attacking their suppliers when a cheaper competitor moves into town.

A more strategic approach would be to strengthen relationships with upstream suppliers and downstream customers to create a robust economic network that can withstand external competition. Instead, the US is alienating its allies and potentially pushing them towards other global powers like Beijing.

Public Opinion and Democratic Resilience

Most Canadians perceive these US actions as an attack, with 41% now viewing the US as an enemy and 73% supporting their government's retaliatory tariffs. In contrast, most Americans do not understand why the US is fighting its northern neighbor, with 57% opposing tariffs on Canada.

This disparity in public opinion suggests that Canadians may be more willing to endure economic hardship to resist US pressure than Americans, who largely question the rationale behind the conflict. As democracies, the sustained will of the Canadian populace could prolong the dispute.

In conclusion, the US's current trade policies towards Canada appear logically indefensible, undermining a historically strong alliance and potentially harming US economic interests in the long run.