March 5, 2025
After a 30-day reprieve, the US has decided to go ahead and hit Canada with massive tariffs of 25% on all goods. Canada has responded with its own tariffs of 25% on $30B worth of goods, and more to come. This is effectively the beginning of a trade war that will have consequences on both sides of the border.
This bulletin provides a brief overview of what tariffs are and how they work. We also delve into some preliminary analysis from major bank economists on the potential impact on the Canadian economy and Ontario’s construction industry.
What is a tariff?
A tariff is a tax that one country imposes on another country’s goods. In our current situation, the United States has imposed a 25% tariff (10% on energy and critical minerals) on all Canadian products going into the US. This means that American importers (those companies purchasing Canadian products) must now pay this extra fee when they bring Canadian goods across the border. As a consequence of the higher cost, Canadian products will not be as attractive to US buyers who will likely seek cheaper domestic products.
Why tariff Canada?
President Donald Trump enacted the International Emergency Economic Powers Act (IEEPA) as means for implementing tariffs on Canadian goods. As a rationale, the President cited the inflow of illegal immigrants and fentanyl[i], in addition to a trade deficit.
Generally, tariffs are used for a variety of economic and political goals. In this case, US tariffs on foreign products can protect domestic industries and fuel the domestic economy by encouraging Americans to buy local products. Tariffs also generate a government revenue stream that will help offset the US’ proposed tax cuts as they grapple with a towering budget deficit. Finally, tariffs can be used to exert political leverage or to open up trade negotiations[ii]. While tariffs may achieve these broad objectives, they ultimately increase consumer prices for the importing country and lead to increased tensions in trade relations or flat-out trade wars.
Trying to discern why President Trump is going down this path is vague and ever-changing. Some analysts have commented the tariffs will be used as a negotiation tool for the July 2026 review of the US-Mexico-Canada Free Trade Agreement. Others suggest it is a political tool to encourage Canada to meets it’s NATO requirement of 2% of GDP in military spending. The stated reason of managing the fentanyl crisis and reducing the amount of fentanyl crossing from Canada into the US seems preposterous as Canada accounts for less than 1% of fentanyl going into the US. The US trade deficit rationale also falls flat, as Canada actually runs a trade deficit with the US[iii] when you exclude oil and gas. Regardless of the President’s end goal of these tariffs, it is agreed that they will have a significant impact on the Canadian economy.
How do tariffs affect the economy?
Simply put, tariffs make goods more expensive for the importer (the US in this case), and this reduces demand for the exporter. In turn, the exporting firms may layoff employees and those individuals would then reduce their spending on services (for example, at restaurants, movies, etc.)[iv],[v]. Business confidence and investment also drops due to uncertainty[vi] and the cost of doing business increases. Growth is negatively affected in the exporting country, while inflation increases in the importing country as it faces higher prices.
However, there are several other factors at play. The impact of the tariffs on Canada depends on how much of the tariff passes through due to exchange rate effects, the ability of producers and consumers to substitute to US made products, the ability of US producers to absorb costs, and the response of the government and central bank. The weak loonie may help to offset some of the price increase, and certain industries may be able to absorb the cost by reducing profit margins. In some sectors, there may not be a cheaper substitute for Canadian goods, or the demand may be sufficiently strong.[vii],[viii] Unfortunately, the one area which would see long-term damage would be business investment in Canada (which is already underperforming), as the uncertainty would linger well past the tariffs[ix], [x]
How has Canada responded?
Canada announced proportional retaliatory measures, with tariffs on $30B worth of imports in the first phase, and tariffs on the remaining $125B in 21 days. These tariffs on American goods have the same impact as US tariffs on Canadian goods, only in the reverse direction.
A large portion of these counter tariffs are on food items, home appliances, and furniture. RBC estimates taxes on these items will add about 2.5% to inflation assuming the full price is passed on to consumers and import volumes remain unchanged. However, the relatively lower US import share of 35% on these goods (vs 50% average) gives importers room to diversify towards other sources and consumers can substitute with cheaper local goods, thereby mitigating the inflationary effect[xi]. Broader retaliatory tariffs would, however, likely raise inflation for consumers.
What is the anticipated impact on the Canadian economy?
Given Canada’s high dependence on the US as an export destination, tariffs will no doubt weigh heavily on the economy; the US market accounts for about 75% of Canada’s exports[xii]. It is difficult to pinpoint an exact number for how tariffs could impact GDP. This is the largest trade shock to Canada since the 1930s[xiii] and there is no precedent for tariffs of such scope and magnitude[xiv]. The Bank of Canada estimates that Canadian output would fall by 3% as exports to the US fall sharply.[xv] CIBC Capital Markets estimate a 5% peak hit to growth in the event of prolonged tariffs and retaliatory tariffs[xvi]; RBC Markets predict an impact of 4%-6% over 2-3 years, with zero growth in 2025 and a -2% contraction in 2026[xvii]. On the other hand, if tariffs are removed relatively quickly, the effect could be more manageable; BMO forecasts a contraction to 0.5% growth in both 2025 and 2026, if tariffs are in place for a year.[xviii]
Who will be most affected?
Different parts of the economy will be affected more than others. In particular, the manufacturing and auto sectors will be most in harms way. Ontario will be especially hard pressed, as exports make up 17% of its GDP with most concentration in autos, machinery, and metals[xix]. Compounding this problem is the fact that auto parts, motor vehicles, and manufactured goods production chains are highly integrated with the US. Goods in these sectors cross the border multiple times at different stages of production and could be taxed multiple times. This would drive up the price of autos in both countries; BMO estimates this could add up to over $7000 extra to the final cost of a new vehicle in the US. Some disruptions are already manifesting in Ontario, as Stellantis has paused retooling work on the Jeep Compass assembly plant in Brampton[xx].
What about construction?
Effects will be felt in the construction industry as well, with rising material cost and supply chain disruptions. The Canadian Construction Association notes that this will dampen productivity, increase building costs (affecting both homebuilding and infrastructure), and put construction jobs at risk.[xxi]
What can government and the Bank of Canada do?
Coupling inflation from the retaliatory tariffs with the fact that the economy has been warming up again[xxii], the Bank of Canada will need to balance keeping inflation in check with stimulating growth. Reduced spending power and weakened employment will naturally bring prices down over time[xxiii], so it is anticipated that the Bank of Canada will continue to cut rates, and perhaps more quickly, as a way to mitigate economic slowdown[xxiv].
A government response could provide targeted and immediate relief to those Canadians most impacted by this trade war. Prime Minister Trudeau vowed to put in emergency relief measures to help those affected by layoffs and business impacted by U.S. tariffs[xxv]. Additionally, the Ontario government previously announced income replacement plans and subsidies for affected industries[xxvi], and has retaliated with non-tariff measures, such as by ordering the removal of US products from the LCBO and ripping up the $100 million Starlink satellite internet deal[xxvii].
Trade Diversification
While Canada has attempted to engage in trade with other countries at various points in time, it has not meaningfully diversified, with about 75% of exports still headed for the US[xxviii]. However, another avenue of diversification is interprovincial trade. Currently, many regulatory barriers impede trade between provinces, such as differences in health and safety, licensing, and certification, as well as limitations on what goods and services can be traded. Removing these barriers through universal recognition of licenses and credentials and reducing limitations on the flow of goods and services could boost growth substantially. However, these changes could take years to implement. More prominently, the physical distance between provinces and the lack of infrastructure to promote such east-west trade remains the largest barrier[xxix].
Bottom Line
As an incoming trade war weighs down on the Canadian economy and business confidence, the government and central bank stand by to mitigate the damage and support affected individuals. Absent any negotiations and de-escalation, Canada must diversify away from the states to other export destinations, strengthen interprovincial trade, and further support domestic industries.
As this is a fluid and changing situation, OCS will continue to monitor developments and provide economic updates as further analyses become available. We will also conduct a follow-up survey with our industry partners to assess the true impact of tariffs on the ICI construction sector in the coming months.
__________________________________
