Don’t Cave In Trade War Canada

08/21/2025

Amidst the flurry of trade announcements ahead of the August 1 deadline to secure new tariff rates, one country ended up near the bottom of the pack, and it’s not the one you’d expect.

Canada, a close ally and one of the most consequential trading partners of the United States, now faces a staggering 35 per cent tariff, a 10 percentage point increase from the rate Trump put in place in February citing alleged fentanyl smuggling. Canadians remain perplexed by their treatment and repeated calls by Trump to annex their country, frustration that has bubbled into broader efforts to revisit Canada’s ties with the U.S.

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By Inu Manak and Victoria Fenton

Originally published in Policy Options
August 21, 2025

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As Canada continues to negotiate a resolution to the trade war, it should carefully consider the cost of caving and instead develop a concrete strategy for trade diversification that preserves critical North American linkages.

First in the trade war firing line

Trump’s trade war has hit the Canadian economy hard. From January to April 2025, exports to the United States decreased by 26 per cent. The decline is striking: In 2024, 75.9 per cent of Canadian exports went to the United States each month on average but by May 2025, the share declined to 68.3 per cent, one of the lowest on record. Imports from the U.S. have also dropped steadily since March, in part due to Canada’s tariff retaliation.

The impact on the Canadian economy is already showing. Canada lost an estimated 54,000 manufacturing jobs from January to May 2025, pushing the unemployment rate to seven per cent – its highest since 2016, excluding pandemic years.

According to Yale’s Budget Lab, Canada’s long-run real GDP is down 2.1 per cent since tariffs and retaliatory tariffs began, the sharpest decline of any U.S. trading partner. In contrast, China’s economy shrank just 0.2 per cent after Trump’s aggressive tariff policy, and the United Kingdom’s has grown 0.2 per cent following the U.S.-U.K. trade deal. Without tariff relief and more certainty in U.S. trade policy, Canada is likely to see economic losses accumulate.

Canada’s response

Canada’s response to the tariffs has been measured and swift. In March, outgoing prime minister Justin Trudeau called Trump’s tariffs “unjustified” and rightly pointed out the fact that “they will violate the very trade agreement that was negotiated by Trump in his last term.” His successor, Mark Carney, has held firm on retaliation, but also set out an ambitious agenda to diversify Canada’s economy. Notably, his first foreign visits as the incoming prime minister were to Canada’s oldest allies, France and the United Kingdom.

Canadian tariff retaliation follows a “dollar-for-dollar” approach, with some flexibility. On March 4, Canada implemented 25 per cent tariffs on $22 billion in goods in response to Trump’s 25 per cent IEEPA tariffs. On March 12, Canada announced additional 25 per cent reciprocal tariffs following Trump’s steel and aluminum tariffs. On April 8, Canada announced additional 25 per cent tariffs on vehicles imported from the U.S. in response to Trump’s auto tariffs.

However, recognizing the integrated nature of the two economies, retaliatory measures have exempted goods traded under the United-States-Mexico-Canada Agreement (USMCA), and the Canadian government has also provided relief for highly impacted industries, such as automakers. Reflecting its commitment to the multilateral trading system, Canada also challenged U.S. trade actions on steel, aluminum, and the fentanyl tariffs at the World Trade Organization.

The persistent trade drama and U.S. unwillingness to distinguish between friends and adversaries have prompted deeper reflection on the bilateral relationship. In late March, Carney declared that “the old relationship we had with the United States, based on deepening integration of our economies and tight security and military cooperation, is over.” Since then, Canada has ramped up efforts to decrease its dependency on the United States by reenergizing efforts to remove barriers to internal trade, diversifying its trade portfolio, and bolstering defence partnerships with other allies.

Those efforts may pay off. Carney has built support for domestic investments in trade expansion, and secured passage of a bill in the House of Commons to tackle internal trade barriers. In May, Canada’s exports to countries other than the United States reached an all-time high. On the security front, Canada also signed a security partnership with the European Union.

Canada’s trade policy gambit

Despite the wave of activity, disentangling from the United States is easier said than done. The U.S. is Canada’s top trading partner by far, with 75 per cent of exports landing there in 2024. By comparison, Indo-Pacific countries made up 10.5 per cent of Canada’s exports, and Europe and Central Asia 9.5 per cent. Shifting the U.S. volumes elsewhere will be challenging – in some cases, impossible.

Canada’s economy is also highly trade dependent – it makes up two-thirds of GDP. Supply chains and energy infrastructure are deeply integrated: Oil and gas pipelines and electricity transmission lines are deeply intertwined over the border and auto parts cross it an average of six times before final assembly.

Economists agree that opening trade within Canada could grow the economy by 4.4-to-7.9 per cent in the long run. But removing internal trade barriers will take time and cannot replace the U.S. market.

Canada is therefore in a bind. Still, the failure to reach an August 1 deal may not be a bad thing. By playing hardball, Canada has received lower tariffs on energy and fertilizer and received an exemption for USMCA-compliant goods.

Canadian companies have also adapted. RBC Economics reported that in April, 90 per cent of Canadian exports appear to have accessed the U.S. market under USMCA rules. To put that in perspective, in 2024, 38 per cent of Canada’s exports were traded under USMCA. Overall exports have declined, but this effort to become USMCA-compliant is a silver lining.

A firm hand and an olive branch

Canada’s best option is to hold firm and limit concessions to the U.S. Recent Trump “deals” with a handful of other countries show how little Canada is likely to receive. Canada’s strong ties to the U.S. economy give it leverage no other country has. It should not be afraid to use it.

One olive branch to consider would be to lift Canada’s retaliatory measures, which put extra strain on Canadian businesses and consumers. Instead, Canada should double down on diversification, commit to removing internal trade barriers within a decade, and build on its vast network of free trade agreements with other countries.

It should avoid further concessions and refuse to participate in USMCA review unless the United States removes the IEEPA tariffs, which one U.S. court has already ruled to be unconstitutional.

What Canada should not do is sign on to a nonbinding deal with the United States that locks in persistent high tariffs. The lack of clarity on what other trading partners have signed could leave them with buyer’s remorse. The USMCA – approved by Congress, enshrined in U.S. law – is the basis of the Canada-U.S. trading relationship. Canada should continue to resist attempts to roll back those commitments outside proper procedures.

Canada’s deep links with the United States are also Trump’s greatest weakness in this negotiation. Canada should not cave.

Inu Manak is a fellow for trade policy at the Council on Foreign Relations in Washington, D.C.

Victoria Fenton is a rising senior at Yale University studying global affairs.

This article first appeared on Policy Options and is republished here under a Creative Commons license.