Canada

One step closer to global trade war

Canada must diversify trade as U.S. trade spat with allies intensifies

INSIGHT ARTICLE  | 

Effective June 1, four weeks after declaring trade spats on hold, the Trump administration slapped tariffs of 25 per cent on steel and 15 per cent on aluminum for Canada, France, Germany, Italy, Japan and the United Kingdom—all key U.S. trading partners—and promised to slap an additional $50 billion USD worth of tariffs on China beginning June 15. Canada, China and the EU have filed World Trade Organization (WTO) dispute complaints challenging the legality of the Trump administration’s metal tariffs.

In our estimation, if fully implemented, these tariffs, in aggregate, will shave 0.2 per cent from potential U.S. growth and put more than 2 million U.S. jobs at risk. This estimate may actually understate the true nature of the tariff impact due to uncertainty around likely retaliation by China, Canada and other G-7 trading partners.

Meanwhile, President Trump has also pledged to consider tariffs on all imported vehicles, which would have a significant economic impact for Canada’s economy. According to Bloomberg data, motor vehicles and parts represented about 16 per cent (C$7.4 billion) of exports over the first four months of the year, second only to energy products. At risk are 130,000 jobs in the Canadian auto industry, which contributes about C$20 billion to GDP, according to the Canadian Vehicles Manufacturers’ Association. Estimates of the hit to Canada’s growth range from 0.2 to 0.6 per cent, according to Bloomberg.

Even from a U.S. perspective, the tariffs would have major consequences for jobs and growth. The steel and aluminum industries support some 10,000 U.S. jobs. RSM estimates that the U.S. tariff structure amounts to a cost of approximately $915,000 per job to protect those industries. Similar to attempts by the Bush and Obama administrations to engage in protective trade activity, the current plan will also likely prove untenable and cause adverse outcomes for auto and aerospace businesses, as well as introduce higher costs for American consumers. In fact, near-term substitution effects by downstream producers are already causing demand for domestically produced steel to decline, the very opposite of the outcome that the policy shift sought.

MIDDLE MARKET INSIGHT: The uncertainty imposed on Canada’s industry due to the intensification of trade spats will likely mean middle market businesses will have to adjust to narrower profit margins and net revenues as they explore passing price increases on to customers.

Risks

There are two broader risks associated with the intensification of the trade spat. The first is linked to the disruption of the North American supply and value chains that have been constructed over the past quarter century. 

Based on recent RSM visits with Canadian and Mexican trade partners who have taken the risk of a breakdown in NAFTA much more seriously than their American counterparts, middle market businesses based in those economies are already well along the way toward identifying and arranging for alternative sources of inputs in earlier stages of production and intermediate goods necessary to meet demand.

The second risk is the 'uncertainty tax' linked to a general disruption of the global rules-based trading system for middle market businesses with exposure to the global economy. In our estimation, any disruption associated with the imposition of tariffs, quotas and an array of non-tariff barriers will distort patterns of gross private investment in general, and capital expenditures in particular.

While the respective trade spats are still in early stages, investors have already moved to drive prices higher. One needs to look at the price of Canadian soft lumber (one of every three pieces of wood used to construct U.S. homes is imported from Canada), which have faced a tariff since early 2017, and have increased 20 per cent this year. In the United States, this has caused the price of homes to appreciate by more than 1 per cent, an increase directly linked to the tariff. Similarly, aluminum prices are up more than 25 per cent this year, and steel prices are up nearly 30 per cent.

These tariffs may support some steel producers, but come at the cost of harming all downstream businesses that use steel and, of course, consumers who are in the process of absorbing the pass-through costs of rising prices caused by the policy.

Next steps

What can Canada do about this? First, acknowledge that isolationism is on the rise in the United States and that policy must adjust accordingly. Canadian policymakers have long talked about diversifying trade and current and previous governments have taken some positive steps in this regard, including the Canada-European Union Comprehensive Economic and Trade Agreement (CETA).

The Harper government previously initiated an Asia-Pacific strategy that included several strategic investments to upgrade rail, port and other transportation infrastructure facilitating goods movement and access to East Asian markets. This government continued this strategy and doubled down in a bold move to build pipeline capacity. It is likely Canada will need more of this, including finding ways to accelerate infrastructure developments, to support the ability to diversify trade.

For now, the Trudeau government has responded by seeking a comprehensive and progressive trade and investment agreement with China, which includes environmental and labour protections. The Chinese government, however, is likely more interested in a narrower agreement. It may be time to be less ambitious in this regard.

Taking credible steps to diversify Canadian trade will increase the country’s negotiating position, but Canadians have to come to terms with one important fact: the political environment in the United States means that it is no longer possible to take the trade relationship with the United States for granted.

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