Trump can remain irrational longer than Canada can stay solvent
THE CANADIAN PRESS/Sean Kilpatrick
Cabinet met in Montebello, Que., earlier this week to discuss Canada’s approach to U.S. President Donald Trump’s tariffs threats.
By the time you read this on Saturday, we may already be in a trade war with the U.S.
President Donald Trump and his administration have repeatedly warned that 25% duties will be imposed on Canada and Mexico starting Feb. 1, though skepticism remains about whether this is merely a negotiating tactic.
On Wednesday, Trump’s Commerce Secretary nominee Howard Lutnick suggested that the two countries could avoid tariffs if they swiftly met Trump’s demands regarding illegal immigration and fentanyl flows at the border. However, since then, the U.S. President has indicated at least twice that the tariffs are moving forward.
Even if the White House proceeds, implementation may take time, leaving room for negotiation and potential reversal.
Regardless of the timing, Canada will face the same critical question: how should we respond?
Most politicians fall into the “Stand Up to Trump” camp. Our federal government, opposition parties, several provincial leaders, the country’s largest private-sector union, and a broad swath of elite opinion support a forceful response. “President Trump thinks Canada will cave in. We will never, ever bow down to a bully,” Mark Carney, front-runner for the Liberal leadership, said yesterday in Halifax.
The government has pledged dollar-for-dollar retaliation, and to some extent, the issue has unified politicians across party lines. Nobody wants to appear “weak” in the face of Trump’s threats.
But is retaliation always the best response? While it can serve as a deterrent, what if it fails? If Trump proceeds with his isolationist policies regardless, does it make sense to continue imposing counter-tariffs—effectively taxing Canadian consumers and businesses—indefinitely?
Moreover, is there a risk that politics will hijack the debate, vilifying those suggesting alternative approaches—especially in the heat of a federal election cycle? “Team Canada or bust” may be a compelling political slogan, but what does it mean in practice?
Let’s break it down and walk through the argument behind retaliation to try and bring some clarity to these questions.
The economic reality of retaliation
First, Canada’s economic reliance on the U.S. market far exceeds the U.S.’s reliance on Canada. In such an imbalanced fight, a trade war would hurt Canada more than it would harm the U.S. This is as close to a fact as we get in this debate.
Second, there is little dispute that U.S. tariffs on Canadian exports would trigger a recession in Canada. Our response—retaliatory tariffs—would fuel inflation, driving up the cost of goods just as our economy contracts. In other words, retaliation would transform a deep recession into stagflation: a downturn coupled with rising prices.
Why does this matter beyond the immediate economic pain?
The inflation caused by retaliation would limit the Bank of Canada’s ability to mitigate the impact of U.S. tariffs. This was underscored by Bank of Canada Governor Tiff Macklem at a policy decision on Wednesday. “We can’t lean against weaker output and higher inflation at the same time,” Macklem told reporters.
So, if we know retaliation will worsen the economic outlook for Canadians, why do it?
The case for retaliation
There are strong arguments in favor of retaliation, with deterrence being the primary one. By retaliating, we signal our resolve and willingness to bear the economic cost of pushing back. Ideally, this deters Trump from launching a trade war in the first place. And if a trade war does begin, retaliation can prevent further escalation. Failing to defend ourselves could make us look weak and invite even more tariffs.
Another reason to impose counter-tariffs is to redistribute the economic costs caused by U.S. tariffs. It’s a way to share the burden.
Retaliation makes U.S. goods more expensive in Canada, encouraging the purchase of Canadian-made substitutes. The tax revenue generated can be redirected to support affected sectors and workers. However, this comes at a cost: Canadian consumers and businesses will face higher prices, and indebted households will endure higher borrowing costs. There are no winners here, but retaliation allows Canada to soften the blow for some industries at the expense of others.
The case against retaliation
The problem with using retaliatory tariffs as a tool for burden-sharing is that tariffs are a highly inefficient tool. There are better ways—fiscal measures—to raise revenue and support affected industries without imposing broad economic harm through import tariffs.
If burden-sharing is the goal, and you want to raise taxes to do it (because tariffs are a tax on Canadians), then why not simply increase the GST to fund a fiscal aid package for impacted businesses and workers? You achieve many of the same goals without the economic damage and internal political tensions of raising tariffs.
Which is why, to me, retaliatory tariffs only make sense as a deterrent.
If Trump initiates a trade war, the pain will take time to filter through the U.S. economy. But the hope is that as that pain accumulates, Trump may have more incentive to negotiate.
But what if no deal is possible? Or what if Trump’s demands—such as a customs union or deeper economic integration—are too high a price for Ottawa? If deterrence fails, do we continue with retaliatory tariffs indefinitely? Are permanently higher tariffs still the best strategy if Trump refuses to budge?
I don’t know. But we should acknowledge that retaliation is not a one-size-fits-all solution, and the question deserves more nuance than political soundbites allow.
Let’s remember, in the midst of the 2009 recession, as protectionist sentiments were rising elsewhere, Canada’s government chose to unilaterally eliminate over 1,800 tariffs on manufacturing inputs, machinery, and equipment to reduce production costs for Canadian manufacturers and enhance their competitiveness.
As University of Calgary economist Trevor Tombe has noted many times, we didn’t retaliate against U.S. tariffs imposed by Nixon in 1971. Nor did the Americans retaliate in 1962 when Canada imposed import surcharges on U.S. goods to help mitigate our balance of payments crisis at the time. All to point out, it’s not always automatic.
Taxing oil
A couple more points on all this.
First, we must be careful about what we threaten. At a minimum, we must be prepared to follow through on any threats. This is why vague threats are often better than specific ones—akin to Trump’s own negotiation style. The government’s explicit dollar-for-dollar threat builds in an automatic escalation that we may regret, undermining our ability to be flexible.
Another question we may be forced to deal with is: what if Trump exempts certain sectors, such as oil?
The federal government appears to be considering an export tariff on Canadian energy if the industry is kept off Trump’s tariff list, on the grounds of both burden-sharing and deterrence.
Tombe has made a strong case against this, arguing that the economic costs to Canada would be immense and could backfire by entrenching U.S. support for tariffs. Trump could blame Canada for rising gasoline prices.
In addition, I’d add that the higher the self-imposed economic costs of a trade war, the less likely we are to win it. And to paraphrase the famous saying, let’s not assume we can remain solvent longer than Trump can remain stubborn or irrational.
There are also domestic political risks to an energy export tax—deepening regional divisions and eroding national unity. Just think of how Quebeckers would react to a federal tax on their electricity exports to the U.S.
That said, raising energy costs for the U.S. would be a powerful deterrent. Because quick substitutes for Canadian energy are limited, an energy tax could generate significant revenue in the short run and hit U.S. households hard.
So, there’s plenty to consider. We are navigating a spectrum of bad-to-worse outcomes. But we still have agency. And there are paths forward that don’t require us to get stuck in a trade war that Trump clearly is asking for.
