Every good stick deserves a carrot.
In a previous blog post I wrote about my view that Canada and the US should abandon content rules of origin in a future, revised free trade agreement. In the absence of free, rules based trade I recommended eliminating import duties for companies that manufacture in each jurisdiction.
However, whether a USMCA review starts in 2026 as scheduled, or whether the Trump Administration triggers faster action, the more immediate catalyst for revising trade practices between Canada and the US will happen if the US proceeds to apply duties to imports from Canada and Canada responds with countervailing duties of its own.
Canada has to respond to the proposed Trump tariffs. Duties applied in only one direction will slow, if not halt, the flow of goods across the US border from Canada. The only case where that would not happen is if duties on Canadian products rise but by a lower percentage than a general increase on all imported goods (for example, a 10% tariff on Canada and a 25% tariff on the rest of the world). That doesn’t appear to be what Washington has in mind.
In the event that tariffs are applied to Canadian goods, one would expect that some of the added cost would be partially mitigated by a further decline in the value of the Canadian dollar and exporters would compress margins and look to modify their supply chains in order to reduce input costs. Ultimately, however, a 25% duty on a product like an automobile would be impossible to fully offset and the logical consequence would be that production would be pulled into the United States. To steal a sound bite, there would be a giant sucking sound from south of the border.
To anchor domestic manufacturing, Canada would have to commit to equal or higher countervailing duties on key manufactured goods. That would not guarantee production at pre-tariff levels as the Canadian market is not large enough to sustain manufacturing volumes intended to service the combined North American market. But alongside other trade mitigation measures it might hold the Canadian economy while a new agreement was hammered out with the US.
In this scenario, US automobile manufacturers (i.e. any company manufacturing in the United States and exporting to Canada, not just GM, Ford or Tesla) would face a cost premium in Canada. That disadvantage would not just apply in competition with Canadian made vehicles but against vehicles from all sources.
Canada participates in many more free trade agreements than the US does so the Canadian market could adjust relatively quickly to the elimination of US imports. It wouldn’t be without effort and some potential cost, but there is no reason why a German, Japanese or Korean manufacturer couldn’t shift production destined for Canada to a plant outside of the United States.
“Staying agile will be the key to finding advantage in this new trading environment”, says Canada’s leading rules of origin specialist, Brian Staples of Trade Facilitation Services in Ottawa. According to Brian, automakers that combine flexibility in sourcing along with an intimate knowledge of trade rules will be able to continue to benefit from duty free trade with Canada as US imports lose traction. But that same strategy can benefit importers of US goods. After all, the companies most directly in the crosshairs of countervailing duties would be the US headquartered automakers who have been downsizing their global production footprint, or in the case of Tesla, do not yet have good alternative production sites.
With a market roughly the size of California, Canada is seen to have less negotiating power than the US when it comes to automotive trade. That conventional wisdom may yet be proven wrong. US vehicles dominate certain product categories (the top selling vehicle in Canada is the Ford F150 pickup and Tesla towers over electric vehicle sales in Canada). That sales strength becomes a weakness in a trade war.
A quick Google search reveals that Ford sold roughly 700,000 F-Series vehicles in the United States in 2023. In the same year, over 123,000 F-150 trucks were sold in Canada. These numbers are not directly comparable as the F-Series not only includes the F-150 but also its larger, heavy duty siblings. Historically, heavy duty pickups accounted for a larger percentage share of truck sales in Canada than in the United States, so using these numbers yields a very conservative estimate. That said, Canadian F-150 sales were equivalent to almost 18% of US F-Series sales in 2023, far more than the 10:1 ratio that we often use to predict differences in the size of the US and Canadian markets.
I know that pickup truck buyers are fiercely loyal to their brands but a 25% premium on a US built F-150 over a Canadian-built Silverado would result in a massive shift of market share.
The direct sales impact is not as significant for Tesla, where US sales were estimated at roughly 655,000 vehicles in 2023 compared to approximately 59,000 in Canada. However, the loss of those Canadian sales at a time when the US market is contracting could cripple Tesla’s North American operations. In Tesla’s case, the effect is not just on production and sales but on their ability to generate the ZEV credits that they sell to other manufacturers and that are a major contributor to their bottom line (estimated by the Energy Policy Research Foundation to account for 10-30% of Tesla’s gross profits in the US or roughly a $990 premium on every vehicle sold). With national and provincial ZEV mandates in place in Canada, those credits form a key element of the Tesla business model. Growing competition in the EV space from Asian and European makers means that countervailing tariffs on American vehicles would quickly shift Canadian buyers to brands other than Tesla.
So that is the stick. What’s the carrot? The answer lies in duty remission.
Duty remission is a method of waiving or refunding the duties payable by an importer. Canada has a long history of duty remission going back to the early 1960s and coming forward to measures in effect today like the Ukraine Duty Remission Order and the selective duty remission promised in response to the Canadian government’s recent application of special duties on imports from China. Remission has often been used as a means of eliminating duties on products not otherwise made in Canada (e.g. production machinery) or to anchor Canadian production by offering cost offsets.
In the past, the auto industry had various remission orders in place that, among other things, allowed certain companies to import finished vehicles based on their volume of parts production in Canada. In a 1986 internal memo to the US Trade Representative, Canadian duty remission orders covering 10 different OEMs including Toyota, Honda, Nissan, Mazda, Subaru, BMW, Volkswagen, Mercedes-Benz, Peugeot and Jaguar were identified. The US felt that these remission orders directly undermined the interests of US manufacturers and sought to eliminate them, ultimately succeeding in the North American Free Trade (NAFTA) negotiations.
Trump tariffs would effectively negate the terms of the USMCA, which succeeded NAFTA. Arguably all bets are off in that case and remission becomes part of Canada’s strategic toolbox again. Offering companies that manufacture in Canada access to duty free imports from the United States would only make sense under those circumstances. There are currently six OEMs with vehicle assembly and major parts operations either in production or under construction in Canada. Each has also has manufacturing on the US side of the border. Offering them duty free access to their US products in return for maintaining Canadian operations would help to sustain the Canadian industry.
Remission orders have taken many forms over the years, with differing production to sales ratios and different conditions concerning the products that companies can import. But hidden in those programs are various tools that would strip away the advantages that the US hopes to gain with its tariff policy. In addition, the implementation of countervailing duties backed by remission might help point the US to a different model of permanent trading relationship based upon a quid pro quo for local manufacturing.
The first step in any effort to mitigate trade actions is to establish a common front built around mutual domestic manufacturing interests. Automotive companies should be forging those relationships now.
The US isn’t wrong for seeking to reshore manufacturing. Its mistake is thinking that it can go it alone. Both as a market and as a production base, the US is stronger when it has an integrated partner in Canada. We might just have to remind them of that fact with a little carrot and stick approach.
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