Flags of the US, Canada, and Mexico fly next to each other in Detroit, Michigan.

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US tariffs on Canada and Mexico would hurt all three economies; retaliation would worsen the damage

Warwick J. McKibbin (PIIE; Australian National University) and Marcus Noland (PIIE)

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Photo Credit: REUTERS/Rebecca Cook

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On February 1, 2025, President Donald J. Trump announced he would impose 25 percent tariffs on most imports from Canada and Mexico (except imports of Canadian energy, which faces a lower 10 percent tariff) and an additional 10 percent tariff on imports from China. He had been threatening to do so since November. His initial justification was the need to stop fentanyl and unauthorized immigrants from entering the US. Later, he complained that these countries, and many more, were “ripping us off” because they run bilateral trade surpluses with the US.

In response, Canada and Mexico announced in-kind retaliation. The mood was captured by Mark Carney, favored to replace Justin Trudeau as Canada’s prime minister, who vowed that Canada would “stand up to a bully.”

Reports from Mexico City and Ottawa on February 3 suggested that the tariffs are being “paused” to give the three countries time to work out their differences. Trump’s 10 percent additional tariffs on China, however, went into effect shortly after midnight on February 4, and China retaliated by announcing tariffs on US coal, liquefied natural gas, crude oil, farm equipment, and other US goods. It also opened an antitrust investigation into Google.

Modeling the Economic Damage from Trump’s Tariffs on Canada and Mexico and Their Retaliation

We look at what would happen to the three North American economies if the US applies a 25 percent tariff on all imports from the two neighbors and they do the same to their imports from the US. We analyze this scenario using G-Cubed, a multi-country, multi-sector hybrid dynamic stochastic general equilibrium–computable general equilibrium model (McKibbin and Wilcoxen 19992013).[1]  We find that retaliation by Canada and Mexico would worsen the effects on real GDP and inflation in all three countries. The results assume that the tariffs are permanent and regarded as such. Brief imposition of tariffs and subsequent removal would not have the same effects. (In an earlier blog, we examine the economic damage that an additional 10 percent tariff could inflict on the Chinese and US economies, including a scenario with retaliation by China.)

The impacts of the threatened US tariffs and the retaliatory Canadian and Mexican tariffs on real GDP and inflation are shown in figures 1 and 2, respectively. The US tariffs alone result in lower real GDP and higher inflation in all three countries than otherwise, or compared with their baseline forecasts. Adding the retaliatory tariffs on top of that compounds the losses for all involved. Compared with a scenario of only US imposition of 25 percent tariffs on Canada and Mexico, at its peak in 2027, retaliation reduces the size of the US economy by nearly 0.5 percent relative to its baseline forecast. Score one for Canada and Mexico. But the same action shrinks their economies relative to their baselines even more—by 2.3 percent for Canada at its peak in 2027-28 and 3.4 percent for Mexico at its peak in 2032-33. Make that an own goal.

Same story for inflation. The initial move by the US raises prices in all three economies faster than otherwise. But retaliation raises inflation rates even further in all three economies, with inflation spikes of 3 to 4 percentage points relative to baseline in Canada and Mexico in 2025. By 2028 the price level is 5.2 percent higher in Canada and 8.7 percent higher in Mexico than the baseline.

Tariffs cannot solve the illicit fentanyl or illegal immigration problems; they can only encourage negotiations to address those issues. Ironically, those concerns seem easier to address than the charge of “ripping us off,” which could lead to managed trade to directly affect trade balances, as it did with China in Trump’s first term. While it is understandable that politicians would seize upon the retaliatory measures threatened by Canada and Mexico, our analysis suggests that it would only compound the damage to everyone’s detriment.

But even if these tariffs are avoided, the US has damaged itself reputationally, and its partners may look to diversify their trade and investment away from the US. The US will have ripped  itself off.

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1. For details on the model, see Warwick J. McKibbin and Peter J. Wilcoxen, The Theoretical and Empirical Structure of the G-Cubed Model, Economic Modelling 16, no. 1 (1999): 123–48; and A Global Approach to Energy and the Environment: The G-Cubed Model, chapter 15 in Handbook of Computable General Equilibrium Modeling, volume 1, ed. Peter B. Dixon and Dale W. Jorgenson (Elsevier, 2013): 995-1068.

Data Disclosure

The data underlying this analysis can be downloaded here [zip].

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