Canada’s Economy Reels as US Tariffs Escalate

Deep integration with US leaves Canada vulnerable, limited options for retaliation

Canada’s economic destiny remains tightly bound to its southern neighbor, a reality starkly highlighted by escalating U.S. tariff measures. While some trade disputes have seen adjustments, the underlying tariff landscape remains more challenging than pre-trade war levels. Canada’s economy, deeply intertwined with the U.S. market, faces significant disruption with scant room for effective countermeasures without inflicting further domestic damage.

Trade Ties: A Canadian Lifeline

In 2024, Canada’s total imports and exports constituted a substantial two-thirds of its gross domestic product (GDP). This figure starkly contrasts with the U.S., where trade represented only a quarter of its GDP for the same year. A staggering three-quarters of Canada’s merchandise exports journeyed to the United States, accounting for nearly a quarter of Canada’s entire GDP. Imports from the U.S. contributed 16.7% to Canadian GDP. No other trading partner approaches this level of economic interdependence. While Canada registered a trade surplus with the U.S. of approximately C$170 billion in 2024, this was largely driven by U.S. demand for Canadian oil and other energy products. When these energy exports are excluded, the U.S. actually held a trade surplus with Canada.

Cross-Border Supply Chains Under Pressure

A significant portion of Canada-U.S. trade involves intricate cross-border supply chains, particularly vital for the automotive and energy sectors. In 2024, roughly one-third of Canada’s exports to the United States comprised oil, gas, and other energy products. Approximately 15% of these exports were in the motor vehicles and parts category. It’s estimated that 17% of Canadian merchandise exports to the U.S. were initially produced in the United States, then processed in Canada, and subsequently re-exported. The automotive sector exemplifies this, with Mexico also playing a crucial role. Auto parts traverse North American borders multiple times before final vehicle assembly.

Evolving Trade Agreements: From CUSFTA to USMCA

Historically, trade agreements like the 1988 Canada-U.S. Free Trade Agreement (CUSFTA) and its successor, the 1994 North American Free Trade Agreement (NAFTA), have shaped bilateral economic relations. While NAFTA, which included Mexico, aimed to mitigate economic dislocations associated with Mexico’s lower wages, studies generally found its impact on the U.S. to be “relatively modest,” though significant adjustment costs were borne by some American workers and firms. The CUSFTA initially led to job losses in import-competing Canadian industries, but subsequent research indicates these workers eventually transitioned to other sectors with little long-term impact on their cumulative earnings.

President Trump renegotiated NAFTA, leading to the U.S.-Mexico-Canada Agreement (USMCA), which took effect on July 1, 2020. The USMCA largely preserved existing market-opening provisions but introduced modifications to dispute settlement mechanisms. It also expanded U.S. access to the Canadian dairy market, increased domestic content requirements for autos to 75%, and strengthened labor, environmental, and digital trade regulations. The USMCA is slated for review in 2026 and will expire after 16 years.

U.S. Tariffs Impact Canadian Exports

The Trump administration has implemented significant tariffs on Canadian goods, including levies on aluminum, steel, vehicles, and energy imports. While goods entering the U.S. under the USMCA are currently exempt, these exemptions cover only about 38% of Canada’s exports to the U.S., with an additional 58% potentially eligible. However, exporters often found the compliance costs of the USMCA outweighed the benefits of low U.S. tariffs. In July, President Trump announced a further escalation of tariffs on Canadian goods to 35%, effective August 1. These actions are part of a broader strategy aimed at narrowing bilateral trade deficits and, as stated in February, countering perceived threats from illegal immigration and illicit substances.

In response to U.S. tariffs, Canada has imposed retaliatory measures on a fraction of its imports from the United States. These include a 25% tariff on certain goods, steel, aluminum, and some other imports. Canada also applied a 25% tariff on non-USMCA compliant autos and on non-Canadian and non-Mexican components of USMCA-compliant autos. However, exemptions were introduced, leading some analyses to suggest the effective increase in tariffs on U.S. imports was negligible. Studies indicate that Canada’s smaller economy and high trade openness mean retaliatory tariffs have a limited impact on the U.S. but impose significant economic costs on Canada itself.

Economic Fallout and Uncertainty

The Canadian economy is already experiencing the repercussions of these tariffs and the pervasive uncertainty they generate. Bank of Canada Governor **Macklem** has noted a decline in employment in sectors heavily reliant on U.S. exports and a weakening of business hiring expectations. The Bank of Canada cited this “pervasive uncertainty created by continuously changing US tariff threats” as a reason for cutting its policy rate in January and March 2025. Southern Ontario, home to much of Canada’s auto sector, has been particularly affected, with reports of significant layoffs in the small-scale parts sector.

Estimates for the long-term economic impact of U.S. tariffs on Canada vary, contingent on tariff levels, duration, and potential retaliatory measures from other nations. One study by the Peterson Institute projects a potential 1.25% decrease in Canadian GDP by 2027 due to initially proposed U.S. tariffs. Another study by the Yale Budget Lab estimated a long-run GDP decline of nearly 2% for Canada, significantly higher than for other countries. The Bank of Canada has also published estimates suggesting that a 25 percentage point increase in U.S. tariffs, met with a similar increase by Canada, would further depress Canadian GDP.

A 2025 report by the International Monetary Fund (IMF) noted that global trade growth slowed considerably in 2024, impacting export-oriented economies like Canada. According to the IMF’s World Economic Outlook, global trade volume grew by just 0.9% in 2024, down from 2.6% in 2023.

Navigating the Future: Diversification and Reform

Canada’s significant reliance on trade with the United States positions its economy as particularly susceptible to U.S. tariff actions, limiting its options for effective unilateral retaliation. Experts suggest Canada should focus on collaborating with the U.S. to resolve existing trade irritants, particularly in light of the upcoming USMCA review in 2026. Addressing border security and Canada’s defense spending relative to NATO objectives are also seen as critical areas for bilateral discussion. Concurrently, Canada has an opportunity to diversify and strengthen its trade relationships with other countries. The federal government is also working to reduce interprovincial trade barriers, a move supported by some provinces, which could bolster domestic economic competitiveness and productivity.