O Canada! Time to Talk Tariffs

When flipping the global gameboard, don’t lose the pieces

Note: The tariff news is breaking by the hour. As I prepared to hit publish, the Trump administration announced that tariffs on Mexico were paused for a month. Further developments with Canada are expected this afternoon. Thus, while the specifics will keep changing, the larger point about distinguishing economic tariffs from negotiating tariffs is more relevant than ever, and I think helpful in understanding and analyzing what is happening.

President Trump’s threat to impose tariffs of 25% on Mexico and Canada, and 10% on China, effective more-or-less immediately, has created a great deal of confusion and consternation, most of which stems from the conflation of four different uses for tariffs.

Use #1: Funding. Tariffs can generate revenue. A nation wanting to use tariffs as a tax base would ideally deploy them in the broadest, most stable and predictable, and least economically disruptive way possible.

Use #2: Decoupling. Tariffs can shift supply chains. A nation wanting to reduce reliance on imports from particular countries would ideally impose a steep tariff on those particular imports, encouraging both producers and consumers to seek imports from elsewhere instead.

Use #3: Rebalancing. Tariffs can promote domestic production. A nation wanting to reduce its trade deficit and reindustrialize its economy would ideally impose a global tariff, encouraging domestic investment by giving domestic producers an advantage over imports.

All three of these uses are fundamentally economic in nature and the policymaker’s goal should be to impose them in a way that minimizes economic costs domestically (e.g., with a predictable phase-in) and creates confidence that they will remain for the long-term (e.g., by codifying them in legislation).

Then there is Use #4: Negotiating. Tariffs can provide powerful leverage. A nation wanting some other nation to change its behavior can threaten or in fact levy a tariff designed to cause more economic damage abroad than at home, creating an incentive for the other nation to comply with the demand.

Here, the goal will not be to minimize cost. All things equal, lower domestic cost is better than higher domestic cost, but the goal is to maximize cost for the counterparty. Sudden and unpredictable action may be effective, so long as it is paired with clear communication of what must be done to relieve the pressure. The executive needs flexibility to act, without waiting for Congress.

A tariff that makes no sense from one of these perspectives might be entirely wise and effective from another. Many otherwise serious economists have criticized the tariffs imposed by Trump during his first term on China—which the Biden administration maintained—for failing to reduce the U.S. trade deficit. But steep tariffs targeting particular goods from a particular country are not designed to—and will not—reduce an overall trade deficit. They single out some imports as disfavored; they do not single out domestic production as favored. Typically, supply chains will shift to other countries. And indeed, that is what happened. As the Peterson Institute for International Economics has documented, imports from China fell in direct relationship to the timing and level of the tariffs imposed.

Likewise, when Colombia rejected two U.S. military aircraft repatriating illegal immigrants last week, Trump responded by threatening to impose immediately a 25% tariff on all Colombian goods (rising to 50% after one week) and restrict travel of Colombian officials. Within hours, Colombia’s president caved. Actual cost to the United States? $0. That the United States had no economic quarrel with Colombia, and that imposing the tariff would have done little to nothing for the American economy, is entirely beside the point.

Which brings us to the latest tariff threats aimed at China, Mexico, and Canada. These are negotiating tariffs. This is clear from the White House fact sheet announcing them, which frames the policy as “addressing an emergency situation” and “using our leverage.” Nothing in the document indicates an economic focus. The ongoing negotiations over whether they will even take effect confirm the strategy.

Unsurprisingly, then, the policy design itself is ill-suited to economic objectives but well-tailored to a negotiating posture. No effort has been made to allow for preparation, create certainty, or support investment in domestic supply. The gentler treatment of China versus Mexico and Canada may also be telling.

China is the proper target for decoupling, so why is the threatened tariff on China lower? True, the United States already imposes tariffs on China. And, further, the threat includes elimination of the de minimis exception for low-value packages, which would hit China especially hard. But as a new status quo, the threatened arrangement across these three countries would make little economic sense. On the other hand, extracting concessions from Canada and Mexico quickly, while going forward with a new 10% tariff and no de minimis exception for China, would be a very good outcome.

Anyone criticizing Trump’s action as a poorly designed economic tariff, or using it as evidence that economic tariffs have high costs and low benefits, is offering talking points rather than useful analysis. So is anyone applauding Trump’s action as a well-designed economic tariff, or claiming it will deliver excellent economic results. Think of a negotiating tariff like an embargo or a loan—an economic tool of statecraft used to advance foreign policy aims. Evaluate it on that basis.

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How should we evaluate the tariffs as tools of negotiating leverage? I don’t pretend to have much expertise on the underlying disputes regarding border enforcement and drug trafficking. At American Compass, we advocate for sharp decoupling tariffs on China and a broad rebalancing tariff worldwide. Those remain good ideas that we will continue to promote, regardless of what’s going on here. But I’d offer the following observations:

The issue is probably best understood as much broader than illegal immigration or fentanyl. I spoke to the Canadian Broadcasting Corporation’s The Current about this for a while on Thursday; you can listen to the whole thing here. President Trump has made very clear that he wants to move the United States away from our post–Cold War operating model of benevolent hegemon and shift instead to a model where the American focus is on American interests, and where relationships with other countries must serve those interests first and foremost. Key members of his economic team, including Scott Bessent and Stephen Miran, have emphasized the point.

“We are going to have to have some kind of a grand global economic reordering,” said Bessent, now Secretary of the Treasury, last June. “I’d like to be a part of it.” In a paper published in November, Miran, now chair of the president’s Council of Economic Advisers, wrote, “tariffs are ultimately financed by the tariffed nation, whose real purchasing power and wealth decline, and that the revenue raised improves burden sharing for reserve asset provision. Tariffs will likely be implemented in a manner deeply intertwined with national security concerns.”

This requires a significant change in mindset for all involved. For several decades everyone has assumed that the United States will operate on the world stage with both arms tied behind its back, in this magnanimous way— premised on a belief that promoting the liberal world order will ultimately work out best for everybody, the United States included. Unfortunately, that has not worked out well for the United States.

We are not going to take it upon ourselves to bear burdens for everybody else anymore. Other countries are going to have to start working from different assumptions and anticipating different challenges and tradeoffs. You can still be very good friends and allies with a country that’s pursuing its own interests first, but you have to recognize and respect what those interests are, and think about a relationship that proceeds accordingly.

So while the headlines are about a “trade war,” the real question is how the reset of these relationships is going to proceed. There are many different theories regarding the best way to start down the path toward dramatic change. Do you try to turn the ship very gradually by small steps or—to mix metaphors—do you start by flipping over the gameboard and scattering the pieces? In a lot of areas, Trump has shown a very strong inclination to take that latter course. The idea seems to be that we have an ossified status quo that has been allowed to settle into place regardless of whether its effects are good or bad, and no one was ever allowed to question or touch it. The president’s inclination has always been that the right way to break from that status quo is with a quite sharp break. Obviously, there is short-term disruption and cost associated with that approach, but that doesn’t necessarily make it wrong.

Stipulating a flip-the-gameboard strategy, these tariffs could be better designed to meet that goal. Credit where due: a real strength of the action is that it’s not shot-through with exceptions. One of the most common political-economy objections to any tariff regime is that it will become a Christmas tree hung with special favors for whichever industries are friendliest with the politicians. Other than the lower rate for energy imports from Canada, these tariffs truly are across the board (for the countries targeted), which hopefully indicates that our policymakers have stiffer backbones than is commonly assumed.

That said, if the goal is to change behavior, the policymaker has an obligation to communicate demands clearly and maximize leverage in service to those demands. Here, the actual demands remain unclear at best. Is this just about border security, or is the goal a broader resetting of the global order? What are other countries—Canada in particular—supposed to do differently? The sudden, sharp imposition certainly maximizes pain, on both sides, but not in a way that encourages capitulation.

For both Canada and Mexico, a clear schedule of gradually increasing tariffs, paired with a clear set of objectives and milestones that must be reached to postpone them, would be preferable. The United States does not benefit from crippled allies. Shooting first and asking questions later is bad economic policy and bad diplomacy.

This is not only a substantive, but also a political issue—especially for someone like Trump who intends to use tariffs as an economic tool too. Tariffs do have the potential to cause economic pain domestically, and it’s important that political leaders level with their constituents about that reality. In one sense, it has been encouraging to see Trump speak directly about this tradeoff. As he wrote on Truth Social on Sunday morning:

THIS WILL BE THE GOLDEN AGE OF AMERICA! WILL THERE BE SOME PAIN? YES, MAYBE (AND MAYBE NOT!). BUT WE WILL MAKE AMERICA GREAT AGAIN, AND IT WILL ALL BE WORTH THE PRICE THAT MUST BE PAID.

That message is exactly the right one to deliver, but this particular set of tariffs is a poor one to accompany that delivery. Tariffs that impose large costs immediately, without the likelihood of delivering economic upside, are more likely to leave free-traders saying “told you so” and Americans souring on the entire project. A less politically sustainable threat, in turn, has the substantive problem of appearing less credible, encouraging the threatened party to believe it can exercise leverage of its own by “calling the bluff” and heading down the path of rising pain on both sides.

The vision that we should be pursuing is one in which the United States anchors a free-trade bloc centered in our own hemisphere and including allies around the world similarly committed to the principles and legal framework of democratic capitalism. Participation in the bloc would require adhering to U.S.-defined requirements that ensured balanced trade, the revitalization of American industry, and the exclusion of China and its producers from supply chains and markets. Thus, all nations in the bloc would need to maintain parallel financial and trade barriers to entry for any nation outside the bloc. China would presumably have a bloc of its own, and those countries would likewise maintain barriers to entry for the American bloc.

While the end goal might be low tariffs amongst allies, we can likely get from the current system to the future one only through an intermediate step that threatens and even imposes tariffs worldwide, and then offers relief from them for nations that agree to our terms. The liberal internationalist hears this and scoffs, “why would they agree to our terms if we treat them badly?” The answer is that doing so will be in their interest, as compared to the alternatives of falling into the Chinese sphere or being excluded from both ours and theirs. Only while the United States offers the alternative of “take advantage of us and gain all the benefits of our alliance anyway” does the option of complying with U.S. demands seem strange.

In his November paper, Miran cites Bessent’s proposal for “putting countries into different groups based on their currency policies, the terms of bilateral trade agreements and security agreements, their values and more. … These buckets can bear different tariff rates, and the government can lay out what actions a trade partner would need to undertake to move between the buckets.” According to Bessent, “more clearly segmenting the international economy into zones based on common security and economic systems would help … highlight the persistence of imbalances and introduce more friction points to deal with them.” Miran adds, “countries that want to be inside the defense umbrella must also be inside the fair trade umbrella.”

The idea of imposing tariffs on Canada and Mexico—and, indeed, on all nations—is not nearly as strange as it seems at first to analysts steeped in the post–Cold War mindset that calls for free trade even with China. Sometimes the board must be flipped. But we should do so in a way that avoids losing any pieces, and with a clear idea of how we intend to set them back up.

- Oren