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What's the worst that could happen with a U.S.-Canada trade war?


The long-term impacts on the Canadian economy if the trade war with the U.S. continues don’t look good.

As NAFTA talks drag on into the summer and tariffs continue to be imposed on the U.S. by Canada and vice-versa, experts are warning that the worst case scenarios for Canada are pretty dire.

“Further moves by the U.S. to initiate a global trade war would, unsurprisingly, be expected to tip all three countries into recessions,” economists at Scotiabank Economics state in a report, referring to Mexico as well.

It’s not just Canada and Mexico at the mercy of the United States’ trade strategy, either. U.S. President Donald Trump has ordered tariffs on $200 billion of Chinese goods, to which China has threatened “comprehensive measures” in response.

“No other major economy I’d say is militating for higher tariffs,” says Brett House, Vice President and Deputy Chief Economist at Scotiabank Economics. “It’s very much about the hub-and-spoke relationships between the United States at the centre and its trading relationships with the rest of the world.”

The good news, faint though that light at the end of the tunnel may be, is that we’re not at a global trade war  yet. But if things escalate from where they are now, the consequences aren’t looking good.

What defines a global trade war?

While it may seem the ongoing rhetoric of the U.S. president on Twitter is a sign of an all-out trade war with Canada, we haven’t escalated to that point yet.

“A trade war would really be a case where relatively high tariffs are being imposed on a wide range of goods that account for a significant portion of global trade,” says House. Currently the tariffs that the Trump administration has imposed on Canada are limited to steel and aluminum for now.

In preparation for further measures against the country, Canada has prepared a list of goods that would carry a tariff if imported into Canada from the U.S., including a variety of steel and iron goods, as well as an assortment of household goods and foods like yogurt, strawberry jam, mustard, ballpoint pens, washing machines, mattresses, lawnmowers and dishwasher detergent.

But China is much closer to a full-blown trade war with the U.S. than Canada is.

“When you see the U.S. post very high tariffs on its imports, and you’ll see other countries retaliating with tariffs, that’s when you’ll know you’re in a trade war,” says Juan Manuel Herrera Betancourt, economist at Scotiabank Economics. “Now you have the U.S. imposing tariffs on Chinese goods, which could escalate into a trade war between the U.S. and China.”

Any country that is part of the World Trade Organization (WTO) and does not have an existing trade agreement with another nation imposes tariffs based on the Most-Favored Nation clause. The MFN outlines the reasonable tariffs one country can impose on another for the import of goods.

“Essentially the trade war scenario means, the United States would be ignoring its WTO commitments across the board,” says House. “And most other countries would respond in kind.”

Recession looms

The bleakest possible timeline would see a full-on trade war with the United States, which would likely result in a recession for Canada.

“Based on our projections, if the U.S. enters into a trade war with the world, that would shrink the Canadian economy by about 1.8 per cent in 2020,” says Herrera Betancourt. “This is compared to 1.6 per cent growth forecast that we have for that year.”

“That recession would actually begin in the second half of 2019, although the overall growth rate projection for Canada in 2019 is still fairly positive,” adds House. “The second half of 2019 would see Canada sliding into recession in that scenario.”

Canada wouldn’t be the only one to fall into a recession, although the news would still be worse for the country.

“What a trade war would do is it would push the U.S. economy into a recession,” says Herrera Betancourt.  “And Canada gets hit twice, right? On the one hand because all our exports now get a 20 per cent tariff going into the U.S., but on the other hand we have about 75 per cent of our exports going to the U.S. So if the U.S. economy is doing poorly, they’ll buy even fewer Canadian goods, so it’s not good for us.”

The power of the auto sector

The most likely cause for a full-blown trade war would be if tariffs were introduced on automobiles.

“The worry right now … is that a move to impose tariffs on automobiles, which would not affect just Canada if the United States moves to impose tariffs on autos on the same rationale that they’ve used for steel and aluminum, they would apply to more countries than just Canadian automobile exports and that would be potentially the trigger that moves us to the all-out trade war scenario,” says House.

The auto sector is currently under investigation by The U.S. Department of Commerce, to see if it can be identified as a national security threat, Herrera Betancourt explains. Much like what happened with the aluminum and steel industries, if the investigation, which takes about 280 days, identifies it as a threat, tariffs could be imposed on those goods around spring 2019.

“[The United States] didn’t take well to the fact that Canada retaliated to the steel and aluminum tariffs and maybe implied the U.S. would come back with a stronger hand,” says Herrera Betancourt. “You never know what this tit-for-tat tariff position will end. So if you impose tariffs on cars, that would probably eventually lead to tariffs on all goods traded.”

The threat of auto tariffs is bad news for businesses in Canada, too.

“Right now, I think Canadian enterprises of all sizes are in a worrisome spot, even large companies, with the President’s threats to impose tariffs on the auto sector, it potentially affects companies both small and large,” says Dan Kelly, CEO of the Canadian Federation of Independent Business (CFIB), who is in Washington this week to advocate for independent business owners in Canada.

If automobiles end up hit with tariffs, not only would it likely lead to more widespread tariffs and a bad scenario for businesses, but would also result in the loss of an estimated 160,000 jobs in Canada, a report from TD states.

“This shock thus means there is the potential of losing nearly one in 10 of the jobs in this sector, or one in five in Ontario,” Brian DePratto, senior economist at TD, says.

Seeking a solution

The resolution that business leaders, workers and politicians are looking for is a resolution to the outstanding NAFTA agreement.

“We all have strong interests in assuring we can resuscitate the NAFTA agreement,” says Kelly. “We’re still a long way from that, and what I’ve observed from the U.S. President so far is that you can shift from being his best friend to his worst enemy sometimes multiple times per week.
We have to take a deep breath here, and hope the rhetoric doesn’t turn into action.”

Benjamin Tal, Deputy Chief Economist of CIBC World Markets, says that at this point, there’s no point in holding out for a perfect NAFTA agreement. The key thing is getting something put in place.

“The best case scenario is going back to the table and renegotiating NAFTA,” says Tal. “We were relatively close to some sort of an agreement two or three weeks ago, and then things changed dramatically. If we go back to this point, it would be the best case scenario. Even if, in this case, Canada would be worse off than before, but not significantly worse.”

Another potential outcome could be separate agreements between the United States and Canada, and the United States and Mexico.

“The most likely outcome – although clearly, nobody knows – is either we go back and re-negotiate NAFTA in different terms, or you’ll see separate agreements, separate trade negotiations,” says Tal. “Those are two possible, livable scenarios. But at this point it’s very difficult to predict.”

The economists at Scotiabank Economics say they believe the most likely scenario we’ll see is NAFTA negotiators returning to the table and coming to some kind of conclusion as soon as possible.

“We would assume in our baseline scenario that the auto tariffs are not imposed, because of the threat that they would imply, setting off substantial retaliation, and that the NAFTA discussions come to what could be a constructive, but at least a benign conclusion, towards 2019,” says House, adding that a ratified deal wouldn’t be likely until next year, at the earliest.

Wasting time

“The greater longer-term danger of these tit-for-tat tariffs is that they could harden the NAFTA countries’ negotiating stances and stretch talks beyond the next year or two,” the Scotiabank report states. “Although both domestic and foreign direct investment numbers in Canada and Mexico remain strong, long-running doubts about NAFTA’s future could dent business investment intentions in both countries.”

Tal says this lack of clarity is the real cost to this ongoing trade dispute and dragged-out NAFTA negotiations.

“We’re now frozen, nothing is happening, time is money,” says Tal. “It means the fog of uncertainty is not disappearing. We need some sort of closure on that, one way or another, so CEOs can make decisions. Now it seems that it’s going to last much longer.”

Tal says the worst case scenario is that these talks would last a significantly long time, as it would prevent companies from confidently investing in Canada.

“At end of day clearly there would be a winner which would be the U.S., Canada would be a smaller loser, and Mexico would be the biggest loser, because Mexico was the biggest winner [with NAFTA],” says Tal. “That’s the direction, regardless what the outcome is.

“But until you reach this point, you’ve got major uncertainty that will paralyze CEOs and corporations interested in investment.”

There is hope

Despite all the dire outcomes that are possible, there is still real hope that there will be a satisfactory resolution at the end of the trade discussions. Even the steel and aluminum tariffs that have been levied against Canada are not set in stone forever.

“For perspective, it’s worth remembering that the George W. Bush Administration imposed tariffs on steel imports in 2002, but they were lifted after 20 months following international pushback and mounting evidence that any benefits to U.S. steel producers were outweighed by losses in downstream U.S. sectors,” the Scotiabank report states, adding that even the United Steelworkers union in the U.S. opposes tariffs.

“I’m still optimistic that NAFTA has the possibility of being improved,” says Kelly. “That was the Trudeau government’s position in the beginning, when Trump initiated that NAFTA had to be re-negotiated. Rather than saying ‘no no, we have to keep it exactly as it is,’ the Trudeau government said ‘okay great, we’ve got some changes we’d like to make some changes too,’ and I think that was the right tone to take right off the hop.

“It may not solve every trade deal between Canada and the U.S., but I do think the likely scenario is that we will get to an improved agreement, but it may take some time.”

Beyond America

With 20 per cent of Canada’s GDP coming from goods exported to the United States (and about 75 per cent of our exports heading there, according to Scotiabank Economics), the dent that losing the U.S. as a trading partner would leave is sizable. But the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP) and the Canadian-European Union Comprehensive Economic and Trade Agreement (CETA) are both examples of the Canadian government seeking out new trading partners.

“The current tension puts further impetus on firms to maximize other trade agreements, and for the Canadian government to focus on increasing the number of trade agreements,” says Kelly. “That’s making sure that we are benefiting from CETA, CPTPP, that gets finalized and put in place quickly and smoothly, and the Canadian government helps build capacity for firms of all sizes to maximize the trading opportunities with other countries other than U.S.

“I think this reminds Canadians of the value in diverse markets, and not just putting all our eggs in the U.S. basket.”

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