What are tariffs, and why is it tricky to gauge their impacts?

An already vulnerable Canadian economy is now facing the real possibility of a trade shock as the U.S. prepares to impose tariffs on our exports. So, what exactly are tariffs and why should we fret about them?

Tariffs are simply charges levied by government on imported goods and services. The initial burden of tariffs will fall on American importers, who will have to pay those charges to the U.S. government. The tariffs that are currently being threatened by the U.S. on Canada are called “Ad Valorem Tariffs” and they are based on a percentage of the value of the imported goods i.e., similar to the tariffs the U.S. imposed on Canadian steel and aluminum back in 2018. But there are other types of tariffs that the U.S. could potentially use e.g., a “Specific tariff” which imposes a fixed fee on each unit of an imported good, or a “Compound Tariff” which combines ad valorem and specific tariffs.

The impact of tariffs on the Canadian economy is difficult to forecast accurately because of uncertainties about several key factors.

The impact of tariffs on the Canadian economy is difficult to forecast accurately because of uncertainties about several key factors. For starters, the extent to which U.S. importers will absorb the tariffs and pass on the higher prices to American consumers is unclear. Also unclear is how U.S. consumers will react to any increase in prices of Canadian goods - higher prices may lead American consumers to switch to domestic alternatives, the extent of which depends on factors that are difficult to quantify e.g., price elasticity (or consumer tolerance to higher prices), availability of substitutes, and consumer preferences. A drop in American consumer demand for Canadian goods may lead to lower prices received by our exporters. The impacts are even harder to gauge if Canada retaliates with its own tariffs by making imports of U.S. goods more expensive, prompting Canadian consumers to switch to domestically produced goods, partly cushioning the blow of reduced U.S. demand for Canadian goods.

The global economy is also key in determining the impact of tariffs on Canada. If the U.S. delivers on its threats to hit other regions like China and Europe with tariffs, and they retaliate with their own tariffs (by making American goods more expensive in their markets), Canadian goods will become more competitive relative to American goods in those markets. There are also other factors that could cushion the blow of U.S. tariffs on Canada e.g., a depreciating Canadian dollar and making better use of our existing trade agreements with other countries.

The impact of tariffs on Canada’s economy will also depend on how long they are in place. If they last just a few months, the damage will be limited to short term price increases and temporary disruptions in trade flows, as we saw back in 2018. If they last longer, the damage will be more pronounced and could leave permanent scars e.g., reduced direct investment in Canada, with an accompanying decline in productivity and, therefore, industry competitiveness.

In other words, understanding and accurately gauging the effects of tariffs requires careful consideration of both short-term and long-term consequences. Even then, any forecasts would have to be interpreted with caution given the above-mentioned uncertainties. What’s clear, however, is that the impacts of tariffs are largely negative with regards to GDP, employment, productivity, and the Canadian dollar. The damage is likely to be more severe for industries that export a significant share of their production to the U.S. and which don’t have the ability to diversify away from the American market. Cattle and hog producers, for example, are particularly vulnerable and could see prices they receive decline to remain competitive in the aftermath of tariffs, although a weak Canadian dollar will cushion the blow somewhat. In the food and beverage space, the sugar and confectionery sector is particularly vulnerable given that more than 80% of its sales are generated from exports to the U.S.

Krishen Rangasamy

Manager, Economics, Principal Economist

Krishen Rangasamy is the Manager, Economics and Principal Economist at FCC. His insights and leadership help guide research on topics related to macroeconomics and agriculture, which FCC and external clients use to support strategy and monitor risk.

Prior to joining FCC in 2023, Krishen spent over fifteen years as a macroeconomic specialist on Bay Street, including at two major Canadian banks, where he advised trading desks and helped lead economic research and forecasting. He also regularly appeared on leading business TV channels and written media with his insightful commentaries on financial markets. Before going into investment banking, Krishen worked as an analyst in the energy industry in Western Canada. Krishen received his master of arts degree in economics from Simon Fraser University.