A Deal With the United States Used to Be a Deal

The tariffs Ottawa and Washington traded today are small change. What we're actually spending is Canada's belief that we're a country worth building a factory next to.

Canada’s retaliatory tariffs went into effect today. Everyone who called me over Labor Day weekend wanted to know the same thing: how bad is it?

Honestly, in the short run, it’s hardly bad at all.

And, in the long run, worse than almost anyone is saying.

First, we’ll start with the history, so you know how two countries that spent sixty years building one economy ended up taxing each other. Then the arithmetic, which is small. Then we’ll talk about car doors. Trust me — that part is important. Finally, we’ll look at what it means to pull an economy apart.

Sixty years of building one North American economy

Start in 1965, with the U.S.-Canada Auto Pact. The idea was that cars and car parts could cross the border duty-free. That way, both sides could build one auto industry that’s bigger and more productive than either could manage alone. It worked.

In 1989, the two countries signed a full free trade agreement. In 1994, they brought Mexico in, and that became NAFTA — negotiated under President Bush, pushed through Congress by President Clinton. Most goods, no tariffs, and a promise of deep integration. The promise mattered as much as the tariff schedule. Businesses will make thirty-year investments if you tell them the rules will still be there in thirty years.

In 2020, the first Trump administration tore NAFTA up.

Then, the president discovered he had nothing to replace it with. So the next part happened quietly. He sticky-taped the old thing back together, gave it a new name, and hoped nobody would look too closely. The new name was the USMCA — or CUSMA, if you’re Canadian and you like to put your own country first.

Then the second Trump administration arrived, looked at the U.S.-Canada free trade agreement, asked which idiot negotiated this, and demanded the whole thing be renegotiated.

It was negotiated by President Trump.

Why did we even start tariffing Canada?

One admirable thing about the president — and I’m being serious here — is that he ran as a tariff man. He was elected on that promise. He loves tariffs. He wanted to impose them. He was very, very clear about that.

Here’s the thing he didn’t do. Not once during the election campaign did he say that the country he wanted to target was Canada. Why?

The idea is absurd. Canada is a longtime friend and ally. We have deeply integrated manufacturing supply chains. It would hurt people in Canada. It would hurt people in the United States. And the president’s political instincts were strong enough that he understood not to run on tariffs against Canada.

Then he won the election. Many people forget that the very first trade policy action of the new Trump administration was a set of tariffs on Mexico, China, and Canada.

These were the so-called fentanyl tariffs. The stated goal was to use access to the American market as leverage to get those countries to stop the flow of fentanyl across their borders. That is fair enough, and the objective is good. There’s one problem, though. Almost no fentanyl came from Canada.

There was almost nothing Canada could do to eliminate fentanyl manufacturing or stop exports of fentanyl, because they basically didn’t have a fentanyl trade to stop in the first place. The stuff was crossing north from the United States about as often as it was crossing south.

So from Canada’s perspective — and from reality’s perspective — this was an arbitrary set of tariffs imposed because of something they hadn’t done. They retaliated with their own tariffs in March and April of 2025. Then the Supreme Court ruled the fentanyl tariffs unconstitutional, they vanished, and the president more or less forgot about Canada.

The asterisk workaround

Over the last year and a half, Canada was sometimes the number one target of the United States — the fentanyl tariffs — and it was sometimes our number one ally. Somewhere in this back-and-forth, a compromise arose. The president would announce sweeping new tariffs on the world, and buried in the announcement would be a little asterisk: except for USMCA-compliant goods.

Nobody else got that asterisk. Not our free trade agreement with Australia, not KORUS with Korea. Just Canada and Mexico. And because nearly everything those two countries send us is USMCA-compliant, the effect was that while the president was out broadcasting how much he hated Canada, Canada (and Mexico) were getting one of the best deals of any trading partner we have.

That changed about a month ago.

The president’s worldwide tariffs had been struck down, and he’d rebuilt them on a legal authority meant for balance of payments emergencies — an authority that only allows temporary tariffs, good for six months. Those six months were nearly up. The president was preparing to launch round three of his global trade war, and he needed to find a way to launch it without inviting the world to retaliate.

So, about a week beforehand, he put 50% tariffs on hundreds of Canadian goods. He said it was punishment for Canada retaliating in the past. My perspective is that this was meant as a brushback pitch to every other country. It was meant to say, “don’t retaliate or we’re going to go against you, the same way we just did against Canada.”

Why Canada? My guess is that Canada was convenient.

Canada’s response, which took effect today, is that the president’s tariffs violate the free trade agreement the president himself signed, and that Canada will be matching those tariffs dollar for dollar.

Twenty billion dollars sounds like a lot

It is a lot. I’d like twenty billion dollars.

But the useful question for an economist staring at a list of hundreds of tariffed items — hockey sticks are on there, along with a great deal of other oddities — is what share of Canada’s economy that list actually represents.

It’s about US$20 billion of goods, tariffed at 50%. Canada exports hundreds of billions of dollars’ worth of things every year. So the list is roughly 4% of Canada’s exports.

Imagine the most outlandishly bad outcome from this. Imagine Canada could never sell those tariffed goods to anyone again. They’d still have 96% of their exports. And that’s the worst case, which won’t happen — when a Canadian exporter can’t find an American buyer, they’ll probably just find a buyer somewhere else, at a somewhat worse price. Realistically, Canada keeps something like 99% of what it sells.

Canada’s retaliation covers US$20 billion of American goods, about C$27 billion, roughly equal and opposite. And the U.S. economy is about ten times the size of Canada’s. If it’s small there, it’s smaller here.

Though I’ll note the Canadians did their homework. They chose goods where Canadian buyers have easy substitutes from Europe or Asia — minimizing their own pain — and they weighted the list toward aluminum, machinery and dairy, which lands squarely on the Rust Belt. On my part of the country. On Michigan, Ohio and Iowa: purple states, live Senate and House races. States that will decide the 2028 election.

So far, the economic consequences of this are relatively small (though the political consequences may be somewhat larger). But there’s another part of this, and it’s the part I’m worried about.

A Lego set made across a border

People imagine Ford and General Motors making cars from scratch. Mostly, they don’t. They buy parts from a lot of other companies and snap them together at the end, like a Lego set. Much of the value in an American car comes from parts that somebody else made — and a lot of those somebodies are on the other side of the Canadian border.

That is the 1965 Auto Pact in action. Around a city like Detroit, a cluster of automotive specialists grew up that straddles the border and draws on American and Canadian ingenuity at once. The bet was that a cluster like that could beat any purely American or purely Canadian city on earth, and it did.

Now run a tariff wall through the middle of it. American factories can’t get the parts they need at the price they need, so they use costlier parts, or worse ones. Canadian factories lose their American customers. Both sides get weaker.

But take one super competitor and split it into two smaller ones, and the deeper loss isn’t that each half is smaller. It’s that neither half is competitive.

The car door factory goes overseas

Imagine the decisions that someone in this industry faces today. Say you make car doors. Where do you put your next factory? Ten years ago this wasn’t a decision — you built on the U.S.-Canada border, fed the world-class cluster on both sides of it, and let the parts move freely.

Today, you have to price in the possibility that this administration, or the next one, wakes up one morning and taxes your doors at 50% because it needs to make a political point. That risk doesn’t destroy your business. It destroys your business plan, which is worse, because the business plan is what the money is lent against.

So maybe you build near a port instead. And maybe you ship to Europe and Asia.

Nothing dramatic happened. No factory closed. It’s just that the cheap, high-quality car door that would have been available to an American assembly line is now on a boat headed somewhere else. Multiply that one example by every industry where the two economies are stitched together, and you have the real cost of this fight — paid slowly, by us, for decades.

The tariffs also won’t bring factories home to replace those who ship goods overseas. The president’s tariffs have a half-life of about three days. Nobody breaks ground on a plant based on a tax that will be gone before the blueprints are finished, and nobody bets a decade of capital on a policy the next Democratic president will reverse in an afternoon. We haven’t seen a factory boom. We’ve seen factory construction fall since the tariffs went in.

The European Union and North America

Step back from the border and look at the continent.

The logic of the European Union was that a group of countries that lets goods and people and ideas cross its internal borders can draw on the genius of all of them, and compete with anyone. There’s real substance to that idea.

North America had the same logic available. One integrated market, three countries, world-beating.

We are now busily converting that one market into three separate ones. And what we’re spending to do it isn’t the tariff revenue, which is trivial, and it isn’t the 4% of Canadian exports, which they’ll re-route. What we’re spending is Canada’s belief that we are a country worth building a factory next to.

We lose the cluster. We lose the investment that would have come to the border. We lose the cheap parts that made American cars competitive. And we lose the thing that takes generations to build and one weekend to break, which is the assumption that a deal with the United States is a deal.

Why Trump’s New Tariff Is Bigger Than Canada