North American Brief
Issue 21 | October 2024

Special Edition: The tariff threat no one seems to fully grasp and a preview of a forthcoming data-driven Western-centric view of North American trade.

The Western North America Brief is normally a compilation of stories and links on the United States and Mexico’s relationship focusing on stories and topics that are not always “on the front page” in national coverage.

This issue takes a detour from that format.

Since we’re about a month late in returning from the summer publishing hiatus and in anticipation of larger-than-normal challenges in the North American relationship on the horizon, this ‘special issue’ features a deep dive into an issue of critical importance that is not well-understood or just plain misunderstood – the global baseline tariff, often called the Trump tariff.

We go to the source of the idea proposed by the American Compass, a Washington D.C. think tank, to fill in missing coverage of what would be the most harmful change to trade with the U.S.

Then, we end this brief with a preview of an upcoming deep dive on what the loss of the North America trade agreement (CUSMA, USMCA, T-MEC) would mean for the West.

First up, the global tariff, aka the “Trump tariff,” aka the “starts at 10% tariff.”

We’ll open with that last point – starts at 10%. The tariff increase ‘plan,’ to use the term loosely for something so thinly documented, is an immediate tariff on all goods entering the U.S. from all sources that starts at an additional 10 per cent on top of existing tariffs and rises five per cent a year every year that the U.S. runs a trade deficit, i.e., imports more than it exports overall. In other words, it’s not a product-by-product or country-by-country calculation.

We published an op-ed last month on this tariff with our good friend and collaborator, Dan Ciuriak, one of the best economic modellers in Canada: Why a U.S. global tariff is the real existential trade threat facing Canada, Financial Post, Sept 09, 2024. Our analysis is based on learning from the earlier 1971 Nixon Shock and also the work of American Compass, the J.D. Vance and Robert Lighthizer affiliated think tank in Washington D.C. that appears to be the most authoritative source of information on the tariff.

What’s been said.

Since then, CBC has done a deep dive into the tariff, and the Globe and Mail and our good friend Trevor Tombe of the University of Calgary published an analysis which estimates that an initial 10 per cent tariff on all products entering the U.S. would cause a roughly five percentage point drop in Canada’s GDP. The authoritative Peterson Institute for International Economics has a short and a longer analysis.

What’s been missed – the most important part.

There’s a lot of good analysis out there, especially the work by Tombe. Everyone correctly cites the 10 per cent initial target. What’s missing is the most critical part — the tariff rises five per cent a year for any year that America runs a trade deficit.  We’ve linked that line to the source of this information, which we describe below. Here’s a clip of us on The Current following up on a conversation with Canada’s ambassador to the U.S. to make the distinction.

This distinction is, as Donald Trump would say, Yuuugely important.

First, the threat is undervalued by modelling of a static, one-time, 10 per cent increase. A tariff with a built-in escalation will have higher real and psychological uncertainty costs, e.g., if I survive an initial 10 per cent tariff, can I survive escalating future hits, will there be future hits, or could there be a reduction, which would happen if the U.S. ran a trade surplus for one year. The uncertainty and confusion caused by an unpredictable tariff with the potential for yearly changes is essentially the weaponization of uncertainty, a phrase we got from a paper by Dan Ciuriak. This uncertainty, as much as if not more than the tariffs themselves, is what would cause businesses to relocate production to the U.S.

Second, this is not your traditional softwood or steel and aluminum tariffs. After decades of NAFTA, Canadians tend to think of tariff impositions as one-offs, specific actions taken in response to specific problems or perceived problems with a sector or, more usually, a specific product. The global tariff is not this. It is an attempt at systemic change in the terms of trade to force manufacturing and the associated jobs back to the U.S., not to correct a perceived problem with an industry or sector. The U.S. did this in 1971 with the Nixon Shock and more successfully in the 1980s with tariffs on Japanese automakers. Here is the the view of the history and lessons of the Reagan-era fight with Japan on autos from the proponents of the Global Tariff. Then, as is the case now, the goal was to force foreign companies exporting goods to the U.S. to move production of those goods from their countries to the U.S.

Third, the proponents know that this carries a cost to U.S. consumers. That the tariffs will cost consumers is acknowledged by its proponents. The escalation and reduction mechanisms are seen as one means to mitigate those costs. There is also a belief that tariffs will partially be born by foreign producers willing to reduce profits to remain in the U.S. market. In addition, tariff proceeds can be refunded to U.S. consumers or farmers to help offset the domestic harms. The larger calculation appears to be that Americans will accept higher costs and losses if there are clear payoffs, such as farmers supporting Trump’s China tariffs as part of an existential struggle against China.

Fourth, professional disdain by economists is a feature not a flaw. That nearly every major economist thinks that the tariff idea as a means to achieve these objectives is terrifying is a feature, not a flaw, of the proposal. The global tariff is an explicit repudiation of traditional, ‘elite’ economic theory and its impact on ‘average Americans.’ The response by proponents to criticism of the tariff from leading economists is essentially: These critics are the same pointy-headed Poindexters who gave you a global financial crisis in which you lost your shirt while CEOs got bonuses, the same experts that pushed free trade that shipped your job overseas and who told you that trade with China was a good idea. The global tariff is the embodiment of populist New Right economic thinking that has come to dominate the old GOP and increasingly, in its leftist variant, the democratic party. This has not been a complete takeover on the right as, for example, tax cuts for the wealthiest – which have survived…for now.

As an aside on the new right and ‘new left’?

The major test for both in the upcoming election will be if the winner keeps U.S. Federal Trade Commissioner Lina Kahn. Keeping her is a point of agreement between the American Compass folks, GOP and MAGA Senators like J.D. Vance, Marco Rubio and, on the left, congresswoman Alexandria Ocasio-Cortez and Senators Bernie Sanders, Elizabeth Warren, et al. We’re not sure if this matters for Western Canada or whether it’s good or bad for economic policy but, in our opinion, it will matter for the future of democracy in the U.S.

Can this work?

It has clearly worked in the past and, arguably, is working now. The Nixon tariff measures were always viewed as a temporary measure and in fact, lasted only five months. The global baseline tariff would last longer. As such, the Nixon measures are not a good comparison for the global baseline tariff. The auto agreements of the 1980s are a different example, a forced negotiation instead of reliance on tariffs. That initiative did succeed with European and Japanese car makers moving production to the U.S. For Canada a more recent and more directly applicable example is in the forestry sector. As reported in the Globe and Mail (Amid fight over tariffs, Canadian lumber giants expand into U.S) and elsewhere (The closure of Canfor’s mills in northern BC is another episode of the Canada-US lumber dispute, and another blow to forestry communities) ongoing U.S. tariffs on Canadian softwood exports have been a driving factor in Canadian forestry companies closing mills in Canada and expanding operations in the U.S. Forestry management decisions by government have arguably been a greater influence on relocation but the presence and persistence of U.S. tariffs has been a major contributor.

Back to the tariff, what to do?

We cannot vote and we cannot directly intervene in the U.S., nor can we argue in public and out loud without further inflaming supporters and giving proponents ammunition. Retaliating against U.S. tariffs, should they be imposed, would only make things worse for Canada.

Hoping the measure does not come to pass may work for one election, but the idea will not die. There is a pool of individuals at think tanks and policy institutes who have been working on the idea and are available to join a Trump administration and implement a global tariff or keep the idea alive in opposition. Any global tariff will be challenged, as was the Nixon tariff which survived a court challenge.

Two quotes from the court decision upholding the Nixon tariff, United States v. Yoshida Intern., Inc. decision are striking:

“few areas of American constitutional law [are] more burdened with conflicting decisions and scholarly disagreement”

and

“Though such a broad grant (sic of power to the President) may be considered unwise, or even dangerous, should it come into the hands of an unscrupulous, rampant President, willing to declare an emergency when none exists, the wisdom of a congressional delegation is not for us to decide.”

What the courts have decided, mostly in favour of the President, is to support wide latitude in the U.S. of the law. This precedent, plus the fact that Congress reviewed the relevant laws used by Nixon in the late 1970s after the Nixon tariff ruling, further strengthens the likelihood of a challenge falling short. We covered these laws and the rulings in a policy brief: Tweet of Damocles: Even with a new NAFTA, Canada’s biggest trade threat is from below the border.

In that brief, we also lay out some potential policy responses.

  • Develop contingency plans for potential new executive trade measures before they are imposed. This starts with educating businesses about specific risks by sector. We provide an example of this in the second part of the brief.
  • Rethink and re-price the risk of trade with the U.S. in light of the cost of ongoing uncertainty potentially through measures like new forms of risk insurance.
  • Continue, or even increase, government and private sector spending and time on advocacy and alliance building in the U.S. at the federal, state and local levels to develop counterweights to executive action. (Events have obviously overtaken this recommendation.)

One addition to these recommendations has been to tailor our messaging in the U.S. to meet the new threat – the attempt to cut imports to force job relocation to the U.S. This should be easy for the energy industry – oil, gas, and electricity. In these sectors, Canada already exports jobs to the U.S. We export the bulk of our vast reserves to the U.S., where over 7,000 Americans have good middle-class jobs from Canadian gas exports and thousands more turn our crude into refined products that American companies ship overseas at great profit thanks to the discount on the oil we sell. Thousands of other Americans turn our gas into LNG for export, and tens of thousands use Canadian electricity. Yes, the story is more complex and nuanced than just described, but this is a message for politicians and the media, not for post-docs in the lecture hall. We did a longer op-ed on this in Alberta a key player in new story about Canada-U.S. trade.

NEXT, WHAT IF CUSMA/USMCA/T-MEC ENDS?

Stay tuned for an analysis of what the ending of the CUSMA agreement would mean for the Western provinces. We are in the process of conducting a deep, analytical dive and analysis. Here’s an example of what we’re finding that will be shared in an upcoming brief.

We may have already experienced the impacts of the loss of the agreement. Earlier economic modelling of the loss of NAFTA vs a shift to CUSMA done by Dan Ciuriak paints a moderate impact, only slightly worse than that which the modelling predicted for the move from NAFTA to CUSMA.

There is an easy and understandable tendency to conflate the volume of trade with the U.S. with its importance. In that standard story, the focus on trade strategy to address threats to Central Canada makes sense. It has the highest value of exports, about $11 billion more than Western Canada, and therefore, the most at stake in the U.S.-Canada relationship. So, the Canada story is a Central Canada story.

However, when the focus is shifted from exports measured by volume to a measure of impact that accounts for U.S. exports as a share of provincial economies, a different story emerges.

In terms of the importance of trade with the U.S. as measured by share of provincial GDP, Alberta and New Brunswick far outstrip Ontario and Quebec. Further, in the West, Saskatchewan exceeds and Manitoba equals Quebec in terms of impact. In the Maritimes, PEI rises above Quebec in terms of the impact of exports to the U.S. on provincial GDP.

Below is a ranking of the importance of exports to the U.S. by province using per cent of GDP.

And finally, for now, the return of the Merchandise Processing Fee (MPF) charged by U.S. Customs and Border Protection is in addition to any duty (tariff), in the case CUSMA ends, this would be WTO tariffs. This fee has been waived under Canada’s successive trade agreements with the U.S. and after close to four decades, has been forgotten by many. The cost of the MPF may have higher costs for exporters than the WTO tariffs that would replace CUSMA zero tariffs. Here’s an example for two products shipped by rail to the U.S.

— Carlo Dade, Director of Trade and Trade Infrastructure

The Western North America Brief is a compilation of stories and links on the United States and Mexico’s relationship with Canada’s Mountain West- prairie provinces focusing on stories and topics that are not always “on the front page” in national coverage. The opinions expressed in the links don’t necessarily reflect the views of the Canada West Foundation and our affiliates.