We now appear to be in a full-fledged trade war with our closest ally and neighbor.
Canada — so deeply integrated into the American economy that its energy resources are considered domestic under U.S. law — has been battered with tariffs and has responded in kind. Canada’s ruling Liberal Party that seemed headed for electoral oblivion last year has now seen its fortunes recover in the polls, as Canadians express growing anti-American sentiment. All this, while President Trump continues to repeat that Canadians should give up nearly two centuries of independence and become America’s 51st state.
Perhaps the correct response to this extraordinary rhetoric is to do something equally extraordinary.
It is well known that Trump is most concerned about the balance of trade with other countries, deeming a negative balance as either a subsidy to the other country or a rip-off. Most economists do not view it that way; in fact, many argue that countries actively pursuing trade surpluses are subsidizing us instead. Why, then, has the president has turned his ire upon Canada?
For most of the last 20 years, U.S.-Canadian trade has been roughly in balance — precisely what the president claims he wants with all countries. Even though American demand for Canadian energy has tipped the balance toward Canada in recent years, the current trade deficit of about $45 billion is the second smallest among America’s major trading partners (only France’s is smaller). It is one-fifth the size of the U.S. deficit with Mexico and one-eighth the size of that with China.
As for manufacturing, the U.S. is a net exporter of goods to Canada. Part of the reason is the highly integrated auto manufacturing sectors of the two countries — an arrangement Trump has criticized, saying he would prefer that no American cars be built in Canada. Yet even reworking supply chains so that all cars were finished domestically would raise manufacturers’ costs significantly, resulting in much higher prices for American consumers. That may be why Trump delayed his auto tariffs by a month.
Instead, the main source of the trade deficit with Canada seems to be U.S. imports of Canadian energy — particularly oil in the west and electricity in the east.
Much of the U.S. refining network is geared toward Canadian oil, so reorienting it to other sources would be costly. Ontario Premier Doug Ford once threatened a 25 percent surcharge on electricity exports, which would likely raise prices for consumers in states like Michigan and New York, but he backed off after facing threats of further tariffs.
Ford’s retreat suggests that the endless cycle of retaliations in a trade war has its limits. In that sense, it might seem the president was right when he said, “Trade wars are good and easy to win.” But maybe not. As my colleague Ryan Young notes, “Sometimes the only way to win is not to play. This is true of nuclear war, and it is true of tariffs.”
Canada could win this fight in a counterintuitive way, with a bit of political jiu-jitsu. It should not only remove its retaliatory tariffs but drop all tariff and non-tariff barriers, adopting unilateral free trade.
Doing so would instantly call Trump’s bluff, since he keeps saying he wants reciprocal or balanced tariffs, and still allow him to declare victory. By his own rhetoric, he would be compelled to concede that the U.S. should reduce its tariffs to reciprocate.
Such a move would immediately raise Canadian living standards, because prices would fall as protected industries — like dairy — adjusted to the new environment. (Indeed, American subsidies for its dairy industry would effectively become subsidies for Canadians.)
In turn, Canadians might spend these savings on their once-capable defense sector, much as Europeans are finding they must do in Trump’s new world order. Indeed, the president has included the cost of American defense of Canada in his claims of a $200 billion trade deficit. If Canadians want their nation to remain independent — as public opinion polling clearly indicates they do — perhaps they should be paying for it accordingly, rather than spending less than 2 percent of GDP on defense.
As Nobel prize-winning economist Paul Krugman noted in the 1990s, “The economist’s case for free trade is essentially a unilateral case — that is, it says that a country serves its own interests by pursuing free trade regardless of what other countries may do.” For politicians, he conceded, this is a tough sell, and Canadians would likely erupt in anger at what would be spun as surrender. National pride would take a beating.
Yet for both Canadians and Americans, the winning outcome may, ironically, be to choose economic prosperity over Pyrrhic victory in a trade war.
Iain Murray is a senior fellow with the Competitive Enterprise Institute, a free market public policy organization based in Washington, D.C.
