Stephen Beatty: The real reason Trump is imposing tariffs on cars

If you have been following the auto sector over the past several years, you know government regulation has deeply influenced the car market. Zero-emission-vehicle mandates, safety standards, data privacy laws, and others are all helping to define which cars and trucks can be sold in Canada. Government edicts also determine everything from vehicle size and shape to performance and the operation of various onboard systems. Those issues are regularly covered here but, for the most part, the trade rules that determine how automotive goods move between Canada and the rest of the world have been, until very recently, seldom talked about.

But that’s changing. Starting with the debate over how to combat the unprecedented rise of China’s electric-vehicle manufacturing and the subsequent application of special import duties on Chinese EVs, Canadians have come to understand we are standing on the sidelines of an economic war that will determine the future of the global auto industry.

Given the deeply integrated nature of the North American auto sector, it was clear we needed to side with the U.S. in this struggle. What wasn’t so clear was whether the U.S. wanted to let us into the tent when it came to making electric vehicles. Canada had to raise its voice; push back against U.S. Buy-American policies; match the U.S. in setting punitive tariffs on Chinese EVs; and offer massive subsidies to companies willing to make investments in battery production and other parts of the supply chain in Canada.

Our smaller size meant Canada could not go toe-to-toe with the U.S. in attracting and subsidizing new investment. And while we did attract several promising, pivotal investments in EV and battery production, a number have subsequently been cancelled or pushed into the future as the market for EVs turned out to be not as robust as either governments or EV advocates had predicted.

Things got even more complicated with America’s threat last weekend to impose 25% tariffs on all U.S. imports from Canada. And while the American administration has been pushing fentanyl and immigration as the motivation for tariffs, the truth of these impending tariffs is a little more pedestrian, and a lot more complicated, than the headlines have been trumpeting.

The current landscape of North American duties and tariffs

Consider this: countries often have multiple, different rates of duty for similar goods depending on where they come from. However, the standard tariff countries apply to imported goods is called the Most Favoured Nation or MFN rate. Think of the MFN rate as serving the same function as the wall around a castle. You want to make that wall tall enough so trade only comes through the front door, and only does so on your terms and conditions.

For trade within North America, goods are granted access to that door duty-free, thanks to the trade rules contained in the U.S.-Mexico-Canada (USMCA) free-trade agreement. Each industry’s goods have set guidelines they must meet to earn duty-free status. In the auto industry, not only does the vehicle have to be assembled here, but the parts they’re assembled from must be predominantly North American. With a nod to Mexico, the rules also require a minimum factory wage.

However, in perhaps the least understood part of this recent tariff war, if the cost and complexity of meeting those rules is too great, importers still have the choice of climbing the castle wall and paying the MFN rate of duty.

And there’s the rub. Because the U.S. MFN duty rate on most light-duty vehicles is only 2.5%, a growing number of vehicles built in Mexico have been ignoring USMCA rules. Prior to USMCA, only about 4% of total vehicle imports from Mexico to the U.S. came in at the MFN duty rate. That number has since grown to 16% most recently, and, as Chinese manufacturers have shown a growing interest in Mexico, it raises the possibility that Mexico could serve as a back door into the U.S. market.

For the Trump Administration, the solution to this problem is clear: build that wall taller, baby! Hence President Trump’s call for a 25% tariff. The problem is, as U.S. politicians and officials have focused on this issue, they have also begun to ask themselves why they need anything Canadian inside the wall.

Auto manufacturing and its supply chain are fully integrated across Canada, Mexico, and the United States. That industry structure has formed around a series of trade agreements that began with the Canada-U.S. Auto Pact in 1965 and evolved; and expanded into full-fledged trade agreements, first between Canada and the U.S., and subsequently involving Mexico as well. In its current form, the Canadian automotive sector cannot survive the imposition of double-digit U.S. import duties on Canadian parts and vehicles.

Why tariffs matter

Here’s why Trump’s tariff threats matter so much to the auto industry: Roughly 85% of the vehicles Canada produces are shipped to the United States for sale. If the U.S. succeeds in sufficiently restricting that trade with its tariffs, the solution for most automotive manufacturers would be to simply move – lock, stock, and barrel – much of the Canadian industry to the United States, which, if you’ve been listening to the 47th president, is exactly what he wants.

As for why you should care about the auto industry: As recently as 2022, the Canadian auto sector (vehicles and parts) directly employed roughly 125,000 people. The Canadian industry was said to be responsible for an additional 426,000 jobs when you factor in the sector’s total supply-chain and spin-off jobs. Automotive is Canada’s number two export sector behind energy and, like energy, Canadian auto production is almost wholly reliant on the U.S. market.

Tariffs, by the way, are nothing new to the auto industry. In fact, before 1960, Canadian car companies lived behind our own high tariff wall. Anyone wanting to sell vehicles here had to manufacture them in Canada to avoid paying punitive duties. But Canada’s relatively small population limited the scale of Canadian manufacturing operations and reduced choice because short production runs of unique models were inefficient. As a result, the industry limped into the 1960s with low productivity, wages that were substantially below U.S. levels, and offering Canadian consumers higher prices and less choice. In 1960, the Diefenbaker government appointed Vincent Bladen, a University of Toronto economist, to study the problem.

Bladen’s report rejected free trade, arguing Canadian industry was not ready to compete in an open environment. Higher tariffs, on the other hand, would just exacerbate the industry’s problems. His alternative was to allow companies to import parts and vehicles duty-free if they also met increased Canadian production requirements (call it “conditional free trade”).

Canada experimented with Bladen’s model, imposing a 25% tariff on automatic transmissions and engine blocks while offering to waive duties (a policy called “duty remission”) on imported parts for companies that also increased local production and exports. In 1963, the policy was expanded to include all auto parts and vehicles.

Trump's solution to this problem is clear: build that wall taller, baby! The problem is, as U.S. politicians have focused on this issue, they have also begun to ask themselves why they need anything Canadian inside the wall

Faced with losing sales, U.S. parts makers called on their government to investigate whether Canada’s policy amounted to an illegal trade subsidy, and if they should take retaliatory action. Rather than starting a trade war, the two governments negotiated the framework of the Canada-U.S. Auto Pact, opening two-way trade in parts and vehicles so long as companies continued to meet certain production guarantees in both countries. And with each new trade agreement in North America, the partners tried to deepen that integration.

The road ahead

But we are at a crossroads once again. The U.S. has lost industry to Mexico and other offshore competitors, and is looking to regain control over those jobs and investment. The Trump Administration is proposing a 25% tariff on all goods from Canada and Mexico including autos. And so, like the 1960s, Canada needs to rethink its relationship with the U.S. and offer a deal that responds to America’s “What’s in it for me?” mindset.

There is a lot to unpack here, and not enough space to fully explore everything in just one article. The takeaway you should take away, if you’ve read this far, is that Canada has been granted a 30-day reprieve from Trump’s proposed 25% tariffs. These new tariffs are not an idle threat. The President, eager to move on a new economic and trade agenda, is simply using the tools available to him.

That required him to use the relatively blunt instrument of the International Economic Emergency Protection Act (IEEPA) to impose the currently-proposed tariffs. Under the IEEPA, an economic emergency must be declared before trade sanctions can be imposed. In other words, he needed a pretext. That came in the form of Canada’s alleged lax border enforcement against the illegal trade in drugs. Thus was the convoluted link between stopping the fentanyl trade and tariffs on all trade between Canada and the U.S. born.

But make no mistake about his intent. In the background, the President has issued a directive under the title of the “America First Trade Policy” to multiple U.S. departments and agencies calling for comprehensive reports on U.S. trade to be produced by April 1. Those reports are likely to trigger the statutory authority required to unlock several additional trade and tariff measures.

Last weekend, the U.S. put Canada and other trading partners on notice (and incidentally, pre-conditioned the U.S. dollar and international markets for possible trade impacts). What comes next is the real power play, and will set the stage for all future trade discussions with this American administration. A hike in MFN tariffs and a further narrowing of free-trade rules is most probably in the offing. President Trump’s quest for bigger penalties to stem the flow of non-USMCA-compliant cars currently crossing the Rio Grande will also sideswipe Canada.

Whether you work in some part of the auto industry in Canada or hope to buy a new car in the next few years, these policy developments will affect you. Jobs and investment are on the line, and the value of the Canadian dollar and interest rates hang in the balance. Canadians need to bone up on trade and industrial policy to understand the stakes, and our political and industry leaders need to come up with a plan to meet the threat head-on. The clock is ticking.

In a career that included managing the Canadian government’s legislative agenda; heading a national manufacturing association; and leading business strategy as a C-suite executive at one of Canada’s largest auto companies, Stephen Beatty has deep experience at the intersection of industry and government. He shares timely insights on his website beattyblog.ca