Now That We Are in a Trade War: How Should Canada Respond?
Now that we are in a trade war with our biggest trading partner, the critical question of how to respond to this unprovoked economic attack from the U.S. has shifted from theory to reality.
I was surprised by how far President Donald Trump has gone. I had assumed this was merely a negotiating tactic, believing the U.S. president would hesitate to inflict damage on his own economy. Clearly, I was wrong. We must now assume that Trump is fully committed to tariffs.
At least initially, I don’t believe Canada has any choice but to hit back hard. Over the weekend, I wrote a piece for Means & Ways on the case for and against retaliation. It’s an important discussion to have, and we need to be clear-sighted about what we can expect to achieve by taxing imports from the U.S.
But right now, that debate needs to be put on hold until we fully understand why Trump is doing this and what exactly he’s demanding of us. False pretenses don’t provide much assurance that we know what the optimal policy response should be.
And like any country faced with an existential threat from an unpredictable and hostile neighbor, we need to view this as a national security risk. With Trump threatening annexation, we can’t negotiate with a gun to our head. Retaliation is the best response at this moment.
In the medium term, when we have a clearer understanding of the threat, we can have a fulsome debate about the future of our trading relationship, including what our tariff regime should look like with an isolationist America. Some analysts suggest moving cautiously—and we always should. Others, like Robin Brooks at the Brookings Institution, argue against retaliation, suggesting we allow our currency to depreciate instead to avoid tit-for-tat escalation.
However, as long as we can’t trust Trump and his intentions remain unclear, we must fight back.
To be sure, we need to be clear-eyed about the consequences. By retaliating, we will exacerbate an already dire economic situation.
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 will hurt Canada more than it will harm the U.S.
Second, the U.S. tariffs on Canadian exports will trigger a recession in Canada while our retaliatory tariffs will fuel inflation, driving up the cost of goods just as our economy contracts. In other words, retaliation could 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 will 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.
But despite these risks, we also need to signal our resolve and willingness to bear the economic cost of pushing back. Ideally, this would have deterred Trump from launching a trade war in the first place. But now that a trade war has begun, retaliation is the best way to prevent further escalation - despite Trump's threat that we will be punished further if we retaliate. Failing to defend ourselves could make us look weak and embolden Trump.
To be sure, retaliation is not a one-size-fits-all solution. We must always remember that retaliatory tariffs are essentially a tax on Canadian consumers, indebted households (through higher interest rates), and businesses. They should never become an entrenched part of the government’s revenue-raising toolkit.
As we gain a better understanding of the new global economic landscape, we can engage in a discussion about whether maintaining tariffs permanently is sustainable and the best strategy if Trump refuses to budge.
But for now, we simply don’t know enough to have that debate.
