A Canada-US Customs Union Would Deal With the Coming Trump Tariffs

Commentary

Trump’s most recent threat of a 25 percent tariff on all U.S. imports from Canada and Mexico is designed, as he said, to get the two countries to stop the flow of illegal immigrants and illegal drugs into the United States. I believe that Canada in coming weeks can make efforts to make this happen, strong enough to persuade Trump not to impose this tariff.

Much more serious and difficult to deal with is his earlier threat to impose tariffs of 20 percent on imports from all countries, and 60 percent (or possibly higher) tariffs on specific products from China, such as cars, steel, and aluminum. The former tariffs are designed to return manufacturing to the United States, the latter to remove the threat heavily subsidized goods from China pose for their American competitors and national security.

The imposition of the 25 percent tariffs on Canadian exports to the United States would devastate our economy. Avoiding such a calamity requires a carefully designed response. Above all, it must not provoke the proverbial elephant by challenging the tariffs on legal grounds, imposing retaliatory tariffs, or pushing the usual rhetoric about the merit of free trade. We must instead find policies that recognize reality. Whether we like it or not, Trump’s policies—such as tariffs—could end or be suspended after his four years in office. In either case, the postwar liberal economic order of free trade and capital movements, guided by the IMF, World Bank, and World Trade Organization, is likely to reemerge.

In my view, the optimum approach to dealing with this situation is for Canada to propose the creation of a customs union with the United States (USCCU), which would allow trade between the two countries to be free of any tariffs and see both countries imposing the same tariffs on imports from the rest of the world. The latter condition does not exist under the United States-Mexico-Canada Agreement (USMCA).

The exclusion of Mexico from the proposed customs union would facilitate negotiations with the United States, which is the same reason that underlies Ontario Premier Doug Ford’s suggestion that renegotiations of the existing USMCA planned for 2026 be bilateral only. At any rate, Mexico could join the proposed customs union in the future by meeting its conditions for membership.

It should be noted that a customs union between the two countries does not preclude the need to resolve disputes over the effects domestic policies have on bilateral trade such as Canada’s agricultural supply management system, soft-wood lumber pricing, and the digital services tax. These disputes would be adjudicated in USCCU courts created for this purpose.

It should be possible to convince Trump that the creation of a USCCU would be more beneficial to his country than the imposition of tariffs on Canadian imports. It would avoid higher prices for imported Canadian consumer and producers’ products, including oil and gas, and would avoid the need for more costly border controls.

The USCCU would also prevent Canada’s possible imposition of retaliatory tariffs and the depreciation of the Canadian dollar, which would cause reduced American exports to Canada. Such developments were feared when the USMCA treaty was negotiated in 2019 and caused American interests to lobby for free trade with Canada, something they are likely to do again in 2025.

The case for the USCCU is strengthened by the fact that the U.S. tariffs on imports from Canada would bring minimal stimulus to U.S. employment in manufacturing, which is the main goal of Trump’s policy. U.S. imports from Canada consist mainly of land- and capital-intensive agricultural, energy, and mineral products. Producing them in the United States would result in only small increases in the demand for labor. U.S. imports of the labor-intensively produced cars and parts from Canada has long been at acceptable levels agreed upon in the USMCA.

A final important benefit of the USCCA is that it would end the possible Canadian import of Chinese cars, steel, and aluminum, and their export to the United States free of tariffs—an issue of great concern to Trump. Canadian imports of these Chinese products would be subject to the same tariffs in the two countries.

Other important arguments in favor of the proposed USCCA are that trade relationships between the two countries that have been beneficial for many years would be preserved; the economic clout of the United States in world affairs would be greater with than without an integrated Canadian economy; the supply of energy and its cost would be lowered by imports from Canada; and the recent shrinking of U.S. manufacturing employment caused primarily by imports from China, not Canada, would end.

What about the effect of the proposed USCCA on Canada? It would likely encounter opposition from some Canadian political, social, and economic interests, but as is the case with the United States, it would be less costly than having to deal with the consequences of the expected tariffs.

Our exports would not be reduced, the value of our currency would be unchanged, bilateral trade relations would be protected from future changes in Trump tariff policies, and border controls and their costs would remain at their present level or could be simplified.

However, the adoption by Canada of the Trump tariffs on trade with the rest of the world would raise prices for consumers. Consider that if bicycles now entering Canada without tariffs cost C$1,000 and sell for $2,000 at retail, a 20 percent tariff would raise the consumer price by $200, to $2,200.

Mitigating this negative effect on consumers is that it is matched by a corresponding increase in government revenue, which can be spent on government services. It is also worth noting that the increase in the price level happens only once—in the year when the tariff is imposed—not yearly, as happens when there is general inflation caused by persistent, excessively stimulative fiscal and fiscal and monetary policies. The higher domestic price for bicycles would enable Canadian producers to increase their output, hiring more labor and paying more taxes on improved profits.

There is also the possibility that in fact the tariff could lead to a reduction in the price of imported goods such as bicycles, if one or more major foreign producers of bicycles lowered their price from $1,000, in the above example, to $800 in pursuit or the maintenance of their market shares. If this happens, consumers would be spared higher prices and, in effect, foreign producers pay the tariff, which Trump has argued would happen. Ironically, in this event the tariff would not stimulate domestic production, which is the main goal of his policy.

International economics I taught at universities for over 40 years proves that free trade maximizes world income and that the imposition of tariffs lowers it. This idea dominates most public thinking and correctly predicts that the Trump tariffs, if implemented, will reduce living standards in the United States, Canada, and the rest of the world.

However, recent world developments suggest to me that this traditional theory of international economics needs to be amended. Trade is not among countries that all have democratic governments and free-market economies. Some of the largest and most populous trading partners have authoritarian governments and use economic planning to pursue goals of political, ideological, and military hegemony at the expense of mostly Western democracies. Modification of the traditional trade model to consider national security in addition to economic well-being makes Trump tariffs much less costly, and could even bring net benefits.