Playing poker with the elephant: Canada should call America’s bluff, and raise a new trade agreement

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Andrei Sulzenko was one of the principal Canadian negotiators of the Canada-U.S. Free Trade Agreement.

A poker player would have detected a clear tell from Donald Trump’s inauguration day performance: The threat of tariffs will remain just that, a threat. His team is smart enough to know that following through with major tariffs would unleash a trade war, creating collateral damage to the American economy, largely in the form of spiked inflation.

The U.S.’s combined imports from Canada and Mexico total nearly US$1-trillion annually in merchandise, together accounting for about 3 per cent of America’s US$30-trillion economy. Major tariffs would not only affect the price of imports but also set a correspondingly higher economywide floor for pricing by American companies competing with those imports. That’s good for American business, but bad for American consumers, many of whom blamed enduring high prices on the Biden administration, and voted accordingly in the past election.

As a second-order effect, the inevitable retaliatory tariffs on imports from the U.S. would be bad for American business, with different effects based on sector of activity. The President would not be thanked for the ensuing chaos.

So, what is this really all about? As I see it, the enduring threat of tariffs has four important benefits for the United States.

First, if the tariffs are merely a threat, they cost Americans nothing except for international goodwill, and that only plays to the President’s political base.

Second, it allows him to shake countries down over specific irritants. Mr. Trump initially tied tariff action to illegal immigration and fentanyl smuggling from Mexico and Canada, but even if those broad issues are dealt with to the White House’s undefined satisfaction, further tariff action could be applied to other areas like lower-than-promised defence spending moving ahead.

Third, it promotes an accelerated timeline for the review of the existing U.S.-Canada-Mexico Agreement, scheduled to begin in 2026. Ironically, any imposition of tariffs on Canada and Mexico would constitute a unilateral abrogation of the agreement, which was hailed by Mr. Trump as the “best ever” in his first term.

Fourth, and most importantly for Canada, a continuing threat creates a risky investment environment everywhere but in the U.S., thus encouraging businesses to reshore in America, particularly their manufacturing. In these circumstances, only an overwhelmingly compelling business case would be able to persuade investors to run the risk of expanding operations outside the U.S. to serve that market.

In many ways, Canada finds itself back to where it was 40 years ago, when then-prime minister Brian Mulroney sought a free-trade agreement with the United States. At the time, though U.S. tariffs on Canada were already relatively low (averaging about 4 per cent), one of the main catalysts for Ottawa in pursuing a pact was America’s capricious use of non-tariff measures, particularly trade-remedy laws, whenever foreign producers made inroads into the U.S. market.

In fact, low tariffs negotiated after the Second World War over successive multilateral rounds drove countries to increase the use of protectionist non-tariff measures, such as countervailing duties on foreign subsidies. A case in point – and a trigger for Canada seeking a free-trade agreement – was U.S. action against Canadian subsidies for softwood lumber, which remains an unresolved issue.

Now, the world is potentially being turned upside-down, with tariff escalation back at the forefront as in the 1930s – a surefire recipe for high prices and stagnating economies.

But the main issue for Canada is the same now as it was then – how to have a stable, rules-based investment environment that ensures access to the larger market. As Simon Reisman, Canada’s chief trade negotiator at the time, said to me in 1985 in emphasizing the problem of not having a bilateral free trade agreement: “The dog does not need to bite, or even bark; it just needs to be there.”

If 2025 looks a lot like 1985, only worse, there is only one good solution for Canada now, as then: the launch of a comprehensive two-way (or three-way) settlement a few years in advance of the mandated review of the current agreement. It would be a tough slog, but we should not fear doing this before 2026’s USMCA review, as the economic laws of mutual benefit from trade liberalization have not changed.

A key feature of the launch of trade negotiations is agreeing to a standstill on any new protectionist measures. That would be a good place to start.