Donald Trump’s 25 Per Cent Tariff Threat

Bigly beyond belief

It is still eight weeks before Donald Trump returns to the U.S. Presidency, but with a single statement he has already cast a dark shadow on North American economies. Announcing that he will impose 25 per cent tariffs on all Canadian and Mexican imports into the U.S., on his first day in office, has confirmed fears that it will not be business as usual with our American neighbour. The potential impacts would be severe, in a way that economic models have difficulty quantifying.

The sheer scale of the potential impacts makes it hard to believe they would fully take place on January 20. This could be a heavy-handed negotiating tactic, or a stunningly naïve take on how Canada’s and Mexico’s economies work with U.S. interests—or both. Either way, however, it will lead to tense times for businesses, policy makers and consumers over the next two months.

The Conference Board of Canada has conducted numerous studies and simulations of tariff increases over the years. They conclude net negative results for all countries involved, but with Canada faring worse than the U.S. because of our larger dependence on cross-border trade. The strongest negative impacts are felt first, but longer-term effects soften as economies restructure around new price and currency values.

Results of our pre-COVID modelling of 25 per cent tariffs on non-energy goods suggest a 1.5 to 2.0 per cent loss in Canada’s GDP. And, unfortunately those losses grow if Canada retaliates with heightened tariffs of our own. The Bank of Canada¹ estimates that the most extreme example of the U.S. imposing 25 per cent tariffs on every country worldwide, and all countries retaliating in-kind would result in a long-run loss of 33 percent of Canada exports and 3.1 percent of real GDP.

Trade, where it hurts most

Merchandise exports represent more than 25 per cent of Canada’s GDP. Canada’s annual goods exports to the U.S. were close to $440 billion in 2023. The goods sector is dominated by oil and gas, along with other natural resource-based outputs like forest, mineral, and agricultural products. Higher-value manufactured goods are also important, led by the auto and parts sector, with nearly 93 per cent of motor vehicle and parts exports shipped to the U.S. in 2023.

Trump’s proposal means that all of these products would be up to 25 per cent more expensive in the U.S. market starting January 20th. This would cause a near immediate reduction in Canadian exports and would also create a variety of secondary effects.

Auto manufacturing would be particularly hard hit by universal tariffs given that inputs often cross the border multiple times. This would be especially true if Canada retaliates with a blanket tariff policy of our own. Higher prices for American-made vehicles would be the initial effect, but longer term, we expect investment and production capacity would shift to within U.S. borders. Canadian auto production could be rendered uneconomic.

Trade dependent sectors would of course be affected most directly, but the spinoff implications would wash through the economy in its entirety—upending investment plans, wage and employment levels, and consumer spending.

Shrinking investment opportunities

Canada’s investment attractiveness is already frayed. In recent years, we have struggled to stimulate investment in productive capital. The 2017 U.S. tax cuts under President Trump, coupled with uncertainty about access to American consumers, have diverted investment southward. Business investment as a share of GDP lags far behind the United States. While Canada has recently attracted investments in battery plants and electric vehicles, these successes relied on substantial subsidies. Whether intentional or not, President-elect Trump’s recent announcements are likely to further challenge Canada’s efforts to bolster investment, given the critical importance of access to U.S. consumers for auto manufacturing.

Investment in other sectors would suffer the same fate, which would have major implications on Canada’s productivity. A lack of competitiveness at the manufacturing level would quickly translate into reduced investment opportunities elsewhere in sectors like commercial construction. These effects would also make their way into the consumer sector, where wages and employment lose their lift.

The loon swoon

Financial markets would be one of the ways tariffs are transmitted through the economy—and how they would potentially lead to economic restructuring in the longer term. Trump’s plan would erode the Canadian dollar, both in the near-term and longer term, as American consumers switch to U.S. sourced goods, and long-term capital flows favour the U.S. over Canada.

A depreciation of the Canadian dollar, however, would also help dampen the effects of the tariff longer term, eating away at the 25 per cent penalty. We also would expect Canadian interest rates to rise, as Canadian inflation accelerates, and the relative value of Canadian assets weaken.

High inflation and weaker employment are a bad recipe for consumers

Job losses would be inevitable, as export-oriented businesses scale back or close. The depreciation of the Canadian dollar would increase import costs, raising the prices Canadian households pay for goods from the U.S. and other countries. Examples would include motor vehicles, consumer electronics, and fresh fruit and vegetables. Supply chain restructuring in the wake of large tariffs would compound inflationary pressures, with much of the cost passed on to consumers.

The result would be a substantial drop in employment and a decline in purchasing power. This would have further negative effects on domestic industries as Canadian consumers are forced to tighten their belts. Given the magnitude of the decline, it would take years for economic activity to adjust to a new balance.

Tariffs would not be good for the U.S.

The tariffs’ impacts are not restricted to Canada. We expect that significant disruptions to U.S. based interests would also take place. Supply chains in the United States that rely on Canadian inputs would be most affected. Many U.S. oil refineries, for example, are tuned to the specific chemistry of Canadian crude. Tariffs would substantially raise their costs and be pushed downstream to the consumer. Consumers’ sensitivity to prices at the gas pump is a major reason why this policy is unlikely to be implemented.

The plant footprints of the North American auto production are also firmly set and reliant on a complex and highly choreographed flow of parts and finished products across borders. None of these flows can change overnight, which would see an immediate increase in the prices of American-made autos. To prevent a major improvement in the cost competitiveness of Japanese, Korean and European-made vehicles equivalent tariffs would also need to be applied.

These are but two examples of how tariffs instituted by the U.S. would result in negative consequences for Americans. Just as in Canada, consumers and businesses could expect higher prices, elevated interest rates, lower demand, and reduced employment.

The U.S. based Tax Foundation has collected estimates that real U.S. GDP growth next year could be downgraded anywhere between 0.2 per cent to 1.0 per cent if a 10% universal tariff was imposed.² A larger tariff would yield even larger results if applied across all countries. For example, a Bank of Canada working paper found that U.S. prices would be 8.2 per cent higher, GDP would be 1.1 per cent lower, and exports would be nearly 70 per cent lower in a world where all countries retaliate in kind to a U.S. universal tariff of 25 per cent.³

An isolationist U.S. may be the new norm

War with free trade appears to be the endgame, but it is not clear that the incoming U.S. administration fully comprehends the implications. We don’t think they can withstand the international and, more importantly, domestic reactions to this policy as proposed. However, a complete walking-back of these measures is unlikely.

How Canada responds will also be important. Unfocussed retaliatory tariffs by Canada would create even more losses on both sides of the border. However, Trump clearly has a transactional style of leadership. Negotiations would likely yield some wins for Canada, but we are unlikely to emerge unscathed.

The bottom line is we’re in for a rocky time for the next four years, and tariffs may not be the only knuckleball the U.S. administration throws our way. It would be too optimistic, though, to assume this all goes away after the 2028 election. Canada needs to adjust its economic policies, and how it interacts with the rest of the world, to account for a more isolationist U.S.