Greater reliance on exports: Canada and Mexico face major economic downturn in U.S.-led trade war
Canada is facing a major economic downturn after U.S. President Donald Trump hit his continental neighbours on Tuesday with the largest trade shock in nearly 100 years.
Mr. Trump’s decision to impose 25-per-cent tariffs on imports from Canada and Mexico, with lower 10-per-cent tariffs for energy and critical minerals, shatters decades of North American economic integration.
Canada and Mexico will suffer more in the trade war, given their greater reliance on exports compared with the United States, economists say. But Mr. Trump’s attempt to wrench apart continental supply chains will hammer economic growth, employment and profits in all three countries, while reigniting concerns about inflation.
The extent of the damage will depend on how long the tariffs remain in place and how Ottawa and Mexico City retaliate. Canada has put countertariffs on $30-billion worth of U.S. goods, which are slated to rise to $155-billion in three weeks’ time. If the U.S. levies are not lifted quickly, the Canadian economy will likely enter a recession in the coming quarters, according to analysis by Bay Street economists and the Bank of Canada.
“It’s a very big shock,” Douglas Porter, chief economist at Bank of Montreal, said in an interview.
“I don’t know that it ranks up there with COVID or the financial crisis of 2008, 2009. But I would rank it probably bigger than the oil price shock we went through in 2015, when oil prices went from about $100 down to $30 pretty quickly.”
Bank of Canada estimates suggest exports could fall 8.5 per cent in the first year after the tariffs are imposed, business investment could decline almost 12 per cent and consumer spending could contract by more than 2 per cent by 2027.
This would lead to a 3-per-cent drop in Canada’s gross domestic product over the next two years, compared with a no-tariff scenario, that would “all but wipe out” growth and leave the country on a permanently weaker footing, Bank of Canada Governor Tiff Macklem said last month.
Even before the tariffs took effect on Tuesday, trade uncertainty has weighed on Canadian businesses. A KPMG survey of 602 companies, conducted last week and published Tuesday, found that more than half had already begun reducing production or laying off employees in anticipation of tariffs. Around a third said their company will face “significant profit losses” if a tariff war lasts more than one year.
How the tariffs ripple through the economy – affecting production, prices and employment – will depend on how different companies and sectors respond to the shifting trade landscape. Some exporters may change their pricing to remain competitive in the U.S. market, squeezing their profit margins. Others may reduce production, lay off workers or close shop entirely.
“Fairly soon we’ll see the impacts on individual company decisions, but it will take a little longer before all that shows up in economic data,” said Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce.
“Some of the multiplier effects will take longer. So if steelworkers lose their jobs, it takes a while for that to ripple through the rest of Hamilton. They initially get severance, they spend that money. So the full impact could take a few quarters. But we would probably see a significant negative in the first quarter” after tariffs are introduced, he said.
The tariffs will be felt most acutely in Ontario, with its large export-oriented auto manufacturing sector, and Quebec, which sends metals, transportation equipment, chemicals and other products to the United States. Canada’s oil-producing provinces are heavily exposed to U.S. tariffs, but the energy industry is facing a less disruptive 10-per-cent tariff.
A trade war is a complicated shock for economic policy makers to deal with, because tariffs weigh on growth and push up unemployment, but countertariffs and a depreciating currency add to inflation. For the Bank of Canada, that means choosing between cutting interest rates to support the economy through a recession and raising them to keep inflation in check.
Mr. Porter of BMO said that the central bank will likely focus more on the hit to growth than the impact tariffs have on inflation, which could be temporary. Financial markets now expect the Bank of Canada to cut its policy rate by a quarter percentage point on March 12, to 2.75 per cent, and see at least two additional cuts before the end of the year. Mr. Porter expects at least four quarter-point rate cuts this year, with the possibility of more.
With monetary policy somewhat constrained, fiscal stimulus may need to take the lead. Ottawa and the provinces have promised a range of measures to support hard-hit businesses and laid-off workers.
While the United States is less reliant on trade than Canada and Mexico, it is still shooting itself in the foot.
“The trade war is already doing significant economic damage to the U.S.,” Mark Zandi, chief economist at Moody’s, said in an interview. He pointed to rising prices, broad-based business uncertainty and a decline in stock markets. The S&P 500 declined 1.2 per cent on Tuesday following a 1.8-per-cent drop on Monday. If the spat lasts for a few months, the U.S. is at risk of entering a recession, he said.
The U.S. auto industry is particularly exposed. Matt Blunt, president of the American Automotive Policy Council, warned in a statement on Monday that U.S. tariffs would undermine automakers’ competitiveness and raise the cost of building vehicles in the United States.
Gary Hufbauer, a non-resident senior fellow at the Peterson Institute for International Economics (PIIE), a Washington-based think tank, said he expects the trade war to push U.S. inflation from 3 to 4 per cent, which could prompt the Federal Reserve to raise interest rates. At the same time, the Fed will also be managing an economic slowdown, which could necessitate rate cuts.
“It’s either bad news through inflation or bad news through a slowdown of the economy and recession. And either of those stories is not a happy story for the stock market, which is one of Trump’s favourite indicators,” Mr. Hufbauer said in an interview.
An analysis by PIIE published in February found a trade war with China, Mexico and Canada would cost the median American household more than US$1,200 a year.
Consumers in some regions of the U.S. will also likely see gasoline prices rise in the coming weeks, both owing to tariffs and seasonal factors, said Patrick De Haan, head of petroleum analysis at GasBuddy. In northeastern states, prices will likely start to rise in a week in these regions and could go up 20 to 40 US cents a gallon, he said.
The interior of the country, which includes Midwestern states, the Rockies and the Great Lakes, are also vulnerable because they get their oil from Alberta through pipelines.
“The only good news for motorists in these areas is that the impact will be reduced, partially because Canadian producers may have to, in essence, offer deeper discounts to keep refineries incentivized to use that type of oil,” he said, adding that prices would likely rise by between 5 and 15 US cents a gallon.
Mr. De Haan said there would likely be a lag of several weeks before prices would start rising because of how long it takes to get oil from Alberta.
This article was first reported by The Globe and Mail
