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Trump’s tariff tactics will end badly for U.S.—and Canada

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Trump’s tariff tactics will end badly for U.S.—and Canada

Mexican and U.S. officials announced they would meet on June 5 to try to defuse a major trade conflict after President Trump announced a five per cent tariff on all products imported from Mexico, to take effect June 10.

The threat has nothing to do with Mexican trade practices. Rather, it’s ostensibly motivated by the president’s belief that Mexico is not doing enough to stem the flow of migrants across the Mexico-U.S. border. He also threatened to increase the tariff to 25 per cent until “illegal migrants” stop coming into the United States from Mexico.

Clearly, President Trump is opening yet another theatre for his war on imports. The ongoing trade conflict with China is already damaging the investment confidence of businesses and increasing the cost of equity capital as global stock markets collapse. If he, indeed, follows through with tariffing Mexican products, Trump will seriously endanger the ratification of the USMCA (the successor agreement to NAFTA), which already faces uncertain prospects of congressional approval. Surely the Mexican government would insist upon the removal of any tariffs as a condition of its approval. A two-front (China and Mexico) trade war has the potential to go global, as the president continues to threaten tariffs on autos exported from Europe and Japan.

The historical analogy to Trump’s anarchic trade actions is the Smoot-Hawley Tariff Act of 1930, which raised import duties to protect American businesses and farmers. This disastrous legislative error is credited by economists as contributing significantly to the depth and endurance of the Great Depression. Perhaps recognizing the analogy to Smoot-Hawley, Trump’s tweet about tariffing Mexican products apparently even dismayed his hawkish trade adviser, Robert Lighthizer.

President Trump clearly believes that trade blackmail is an effective tactic to pressure foreign governments to do his bidding, even when his demands are not directly trade related. He sees his leverage as control over access to the large and wealthy U.S. domestic market. However, what leverage the U.S. currently enjoys will dissipate over time as businesses both inside and outside the U.S. discount the practical relevance of U.S. trade agreements, and as U.S. economic growth stalls or perhaps sharply declines.

As foreign firms recognize that deepening their U.S.-linked supply chains creates additional hostages for U.S. trade-related blackmail, they will seek to reduce their economic linkages to the U.S. market. Besides reducing their trade and investment linkages, foreign businesses may also reduce their reliance on the U.S. dollar as the medium for international transactions, since dollar-denominated savings are also a potential hostage to currency-related sanctions.

As the importance of the U.S. market in global trade and investment diminishes, so too will the ability of Trump (and similarly-minded future presidents) to wield effective blackmail threats. To be sure, the prominence of the U.S. economy and the time it will take for organizations to reconfigure their international value chains ensures that the U.S. can, for the foreseeable future, inflict substantial direct and indirect damage on the global economy through trade actions.

Unfortunately, geography and long-standing trade linkages between Canadian firms and the U.S. mean that it will be much more challenging for Canadian firms to diversify their international business activities away from the U.S. and reduce the risk of hostage-taking.

The potential for a serious global economic crisis driven by U.S.-led trade anarchy is growing. While the U.S. economy will also suffer, the Trump administration appears to believe it can win trade wars, (although it’s unclear what winning would mean if U.S. economic growth is permanently diminished as a result).

While there’s little Canadian officials can do to alter Trump’s blackmailing calculus, our economic policymakers should focus on bolstering Canadian economic growth by implementing long-overdue domestic regulatory and tax reforms. The coming economic storm may pick up speed much sooner than economic pundits anticipate, and Canadian economic policy must get out in front of the storm to buffer the serious damage that will likely be done to the Canadian economy.

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