In The News This Week: US-Canada Trade War

When the Trump Administration announced in March their plan to impose tariffs on steel and aluminum imports, there was huge uproar across the globe, but specifically from allied countries who provide the majority of such imports. This quieted after the more sensible decision to exempt American allies, namely Canada, Mexico and the EU. That all changed last Thursday when the US changed its policy, imposing steel and aluminum tariffs on imports from all three (Globe and Mail). As the US’s largest trading partner, Canada also provides the majority of steel and aluminum imports, worth $12 billion. Canada responded immediately with the imposition of tit-for-tat tariffs on $12 billion worth of American imports, including steel and aluminum, as well as American maple syrup, soy sauce, coffee and other products (CBC). The trade war has officially begun, and it’s not just between the US and China.

There is a lot to unwrap in this story, but we will start with an explanation of why this is all happening, and then move to explain Canada’s reaction.

The US tariffs were the result of a US Commerce Department investigation that was ordered last spring, and found that imported steel was negatively affecting the domestic steel and aluminum industries, and could therefore negatively impact the defense industry. This has allowed the administration to cite the official reason for the tariffs as ‘national security concerns’, an allowed exception under World Trade Organization (WTO) Article XXI (BBC).

When first elected, Trump made numerous announcements on his intention to target China for various unfair practices in trade. This is not unreasonable as examples of China’s unfair practices abound, including undervaluation of its currency, its blurred lines between the state and private sector, and its supposed theft of intellectual property from foreign countries (Economist). Thus, there are some valid reasons why a developed economy such as the US would want to challenge China for unfair practices that harm their domestic competitiveness. However, imposing tariffs on steel and aluminum imports, of which China only provides 6% (or less than $2 billion), is not a sensible way to do this (Vox).

Moreover, it makes even less sense to impose tariffs on American allies. First, it evidently does not follow that allies pose a threat to American national security. But even more than this, it makes no sense to start a trade war with your largest trading partners. Let me explain why: Trade between nations is a prisoners dilemma problem, meaning that all actors are better off by cooperating. By implementing protectionist polices, each actor will reap less benefits overall from trade.

Why will they see less benefits? This is partly a result of the principle of comparative advantage, but also a result of globalization. In today’s globalized world, companies operate using global value chains, meaning that their supply chains are no longer domestic, but globally integrated. As discussed in economist Richard Baldwin’s The Great Convergence, imposing tariffs in a global value chain is equivalent to building a wall within a factory, such that it decreases the efficiency and increases the cost of moving goods. Indeed, many free-trade advocates and the President’s own Republican lawmakers and advisors have argued that such tariffs will only hurt Americans, who will end up paying a higher cost for goods with steel and aluminum inputs, such as automobiles (Time, CNBC).

Why then would the US take this action, against all economic reason? One speculation is that Trump sees trade as a zero-sum game, not a prisoners dilemma. He believes, falsely, that America can ‘win’ a trade war (see here and here for how this is false). Another is that while his actions may have many negative ripple effects on cost for products with steel and aluminum, and on the industries penalized by Canada’s retaliatory tariffs, he will have kept his promise to his voting base of steel and aluminum workers that he will bring jobs back, no matter the cost.

To enable countries to reap greater benefits from international trade, the WTO was established with the aim of liberalizing trade. The main route to free trade is the reduction of tariffs or duties imposed by countries importing goods. Under Article XXVIII of the General Agreement on Tariffs and Trade (GATT), the predecessor to the WTO, member countries would modify or withdraw tariffs in successive negotiation rounds, creating a tariff schedule that each country would be bound by. The goal was to continually reduce tariffs in each round to eventually reach a level where no tariff would be applied, and to expand the negotiations to encompass all goods on which duties are placed (WTO).

As previously mentioned, there are exceptions that allow countries to impose tariffs beyond the agreed-to tariff schedule. With the steel and aluminum tariffs, the US invokes the national security exception. This can be challenged in the Dispute Settlement Body of the WTO, and almost certainly will be. Any affected country can bring forward a complaint, and if the US tariffs are found to be unjustified for reasons of international security, they must rescind them. If the US does not comply with the ruling, the affected countries can impose counter measures on the US of an equivalent value to the steel and aluminum tariffs (Vox).

The Dispute Settlement Body of the WTO is quite powerful and countries often abide by its rulings, however it generally takes between 2 and 5 years to secure a ruling, leaving the affected countries industries unprotected in the mean time. Of course, most countries cannot afford to let 2-5 years worth of industry damage occur, which is why Canada has pledged immediate retaliatory tariffs. In the short term, this is essentially the only option available to the affected countries, other than negotiating with the US to remove them. Given the nature of the Trump Administration and the ‘success’ of NAFTA negotiations thus far, it seems the US would be more responsive to retaliatory tariffs.

The Canadian response therefore is unfortunately the most sensible one. For his entire time in office Prime Minister Trudeau has preached openness when it comes to trade, immigration or other global cooperation issues. He recognizes the harm that a trade war will do, but cooperation on both sides is required to prevent a trade war. When your partner will not cooperate, it is necessary to protect your own industries in response.

For now, Canadian steel and aluminum producers are left with much uncertainty on the future of their industry, despite the governments attempts to reassure them (Reuters). We can only hope that Canada’s retaliation will cause level heads in the US Administration to prevail, bringing them to the negotiating table and rolling back the tariffs. The alternative is that it may provoke further retaliation and deepen this trade war, spelling potential disaster for international trade and globalization as we know it today. In our opinion, that would be a grave mistake.

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Image Source: Canadian Press/Rex/Shutterstock

 

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