The first shots of a trade war among political allies have been fired and the return fire has been loaded into the cannon by Canada, ready to go on July 1.
Mexico and the European Union are also preparing their ammunition.
U.S. President Donald Trump has removed the exemption for Canada, Mexico and the EU from American tariffs on steel (25 per cent) and aluminum (10 per cent) imports.
Presumably, putting up the tariff fence — yet another Trump wall — is supposed to alleviate the national security threat posed by metal imports from these three allies. The reasoning may be absurd, yet the tariffs are real.
It’s likely a tactic for the United States to get a better trade deal from its NAFTA partners, and from the EU. In response, Canada has drawn up its own list of U.S. products to be hit with a volley of counter-tariffs. These tariffs only apply to goods produced in the United States.
From yogurt to dishwasher detergent
Canada has not limited its retaliatory tariffs to steel and aluminum. It’s included a wide variety of food products, from yogurt to orange juice, paper products to plastic household goods, domestic appliances to automatic dishwasher detergents, etc.
Together, they represent US$16.6 billion in imports, the same dollar amount as targeted by the U.S. metals tariffs.
The products chosen by Canada tend to come from so-called electoral swing states or states home to prominent members of Congress. The idea of inflicting the most pain in these districts is so that members of Congress are more likely to pressure the White House to reinstate the exemptions.
Is it the right response?
Standing up to a bully
The answer depends on your vantage point. From a tactical standpoint, the only way to effectively get a bully to back off is to demonstrate that you are not going to be steamrolled.
Read more: It's time to call the bluff on the 'Bluffer-in-Chief'
To have any hope of Trump reinstating the exemption is to fight fire with fire, namely the retaliatory tariffs. Also, politically, at home, the electorate is not going to want to see the U.S. being allowed to gang up on Canada. And so Prime Minister Justin Trudeau had to come out fighting.
However, through an economic policy lens, the best thing would have been for Canada to hold its fire and not retaliate. Instead, it should have relied upon the World Trade Organization (WTO), which will likely find the U.S. tariffs in violation of international trade law.
More economic wreckage
Even if this takes months, it’s better to wait because the retaliatory tariffs merely compound the economic wreckage. They are essentially a self-inflicted wound. Resources are less optimally employed, resulting in higher consumer prices. Price increases mean consumers can afford less.
How much prices rise depends upon a variety of factors.
To give one illustration of how these tariffs could affect the Canadian consumer adversely, let’s consider one of the food items — white chocolate.
Assume the confection can be easily obtained from elsewhere at a price cheaper than what the U.S. exporter would charge after the Canadian tariff has been applied.
Let’s say that the American exporter’s price has become C$1.10 with the new tariffs when it had been a dollar prior to the tariffs. The Canadian importer scouts the globe to see if white chocolate can be obtained for less than $1.10. It turns out that from Belgium, the same white chocolate can be brought into Canada for $1.07.
Therefore, Canadians will buy the white chocolate from Belgium for $1.07. It costs the Canadian consumer at least an additional seven cents, or seven per cent, which cannot be used to buy something else. Likely the final price will be higher as the distributor and retailer add a mark-up on the white chocolate.
Taking another example, mayonnaise, again assume that the American product would now become $1.10 after the Canadian tariff has been applied, but this time, a Canadian producer is willing to sell it initially for $1.06.
Canadians will buy the mayonnaise at home, paying six cents, or six per cent, more than they would have prior to the retaliatory tariffs. To complicate things, it turns out that the Canadian producer can’t supply all the Canadian demand for mayonnaise, which allows that company then to increase its price to $1.09 because people want it and are willing to pay.
This is still below the $1.10 price that the American mayo would cost. So Canadian consumers must pay an additional nine cents, plus any markup added by the distributor and retailer on the nine cents, which is likely given the demand for the product.
Let’s take another case — pickles. If the U.S. producer decides that it is vital to keep market share and does so, resulting in a tariff-inclusive price of $1.04, then that may still be the best price for the Canadian consumer. But it is, nevertheless, four cents or four per cent higher.
Consumer loses
In all these simplified cases, the consumer loses heavily.
Had Canada not imposed the retaliatory tariffs, the Canadian consumer would have continued to buy products from the U.S. at the cheapest price, which would represent the most efficient allocation of resources.
The more the retaliatory tariffs force a deviation from an optimum allocation of capital and labour, the worse off the consumer. The longer the tariffs remain, the greater the damage.
Read more: Why Canada shouldn't always count on special treatment from the U.S.
One good outcome of the retaliatory tariffs is to reduce the U.S. share of Canadian trade and, consequently, to force Canada to diversify regarding its trading partners. But surely this is not the way to do it.
With any luck, Canada will not have to fire the cannons and if they get fired, it will only be a brief skirmish.
On a macroeconomic level, overall these price increases on products like mayo and white chocolate aren’t likely to add substantially to inflationary forces since the products don’t represent a huge portion of the Canadian economy.
If they did start to have an impact, when added to those increases at the gasoline pump, however, it could speed up Bank of Canada interest rate hikes.
That, in turn, could have significant economic repercussions given the level of Canadian household debt — just one example of how trade wars can spiral out of control to have unintended and potentially devastating consequences.