Slowdown of world economic growth would likely reduce demand for Canadian resource exports

In March, President Trump increased tariffs on US$200 billion worth of Chinese goods, escalating the trade dispute between the United States and China. He also initiated steps to put 25 per cent tariffs on an additional $340 billion of imports from China, due ostensibly to frustration on the part of U.S. trade negotiators with the slow pace of negotiation between the two countries and the reported unwillingness of the Chinese government to codify changes in policies that Chinese negotiators had agreed to informally.

The Chinese government did not retaliate immediately to the U.S. actions, providing some temporary hope that trade talks would resume shortly and, perhaps, even be successful. However, Trump’s top economic advisor, Larry Kudlow, said he expected Chinese retaliation and Beijing indeed announced retaliatory tariffs four days later. Since President Trump seems convinced that U.S. tariffs on Chinese products are beneficial for the U.S. economy, recent developments do not signal a quick resolution of the trade conflict.

Given that the U.S. is Canada’s largest trading partner and that China is the world’s largest trading country, it seems relevant to consider how this ongoing and escalating trade conflict might affect the Canadian economy.

One obvious adverse impact relates to the resulting potential slowdown of world economic growth and international trade. This would likely reduce demand for Canadian resource exports, particularly to the extent China reduces its worldwide demand for primary inputs as production is cut back in that country.

All else constant, this will reduce production and employment in affected Canadian sectors. How severe this effect will be is a matter of conjecture. The tariff wars of the 1920s contributed importantly to the Great Depression of the 1930s. While it’s premature to anticipate such a dire outcome from the current U.S.-China trade war, a substantial slowdown in world economic growth from an already relatively slow rate bodes ill for Canada’s resource-dependent economy.

Conversely, a possible offsetting benefit of the trade war is the potential for Canada to benefit from trade diversion, which would occur to the extent Chinese tariffs on U.S. imports into China led Chinese importers to buy more from Canadian exporters who would offer relatively lower prices (after higher tariffs on U.S. goods are implemented). In 2018, the U.S. exported around US$120 billion of goods to China. Around 15 per cent of those exports consisted of aircraft and parts. Another 11 per cent consisted of semi-conductors, medical equipment and laboratory instruments. Canadian companies do not sell these products competitively in world markets, and Canada exports virtually none of these products to China.

However, the U.S. exports a significant quantity of wood products to China—logs, lumber and pulp accounted for almost 5 per cent of U.S. goods exports to China in 2018. Certainly, increased exports of wood products to China and/or higher realized prices for Canadian wood products exported to China are plausible to the extent that Chinese retaliation against the U.S. increases the landed price of U.S. wood products in China.

Similarly, the U.S. is a significant exporter of passenger cars, vehicle parts and accessories to China. These products comprised around 8.5 per cent of U.S. exports to China in 2018. Motor vehicles are among the top 10 Canadian product exports to China. Therefore, it’s possible Canadian manufacturers of vehicles and parts might also benefit from trade diversion.

While China is a substantial exporter of vehicle parts and accessories to the U.S., it’s unlikely Canada would benefit in the near term from higher prices for Chinese-made vehicle parts and accessories exported to the U.S. as a result of U.S. tariffs. It’s more likely Mexico, with its lower cost structure, would be a beneficiary, although the uncertain fate of the USMCA and the U.S.-Mexico trade relationship, might lead to some substitution of Canadian-made parts rather than Mexican-made parts in place of parts from China.

In 2018, China imported almost US$5.4 billion of crude oil from the U.S. If China turned to Canada to replace some or all of its oil imports from the U.S., it would be a welcome development for Alberta oil producers. However, the lack pipeline capacity to Canadian West Coast ports makes this potentially beneficial manifestation of trade diversion unlikely.

In sum, the U.S.-China trade war is bad news for world economic growth and therefore bad news for Canada’s economy. However, the potential for Canada to benefit from trade diversion is a mitigating benefit of the conflict. So is the potential for Canadians to enjoy lower prices on goods such as apparel, furniture and electrical equipment imported from China as Chinese exporters supply more to other countries in reaction to U.S. trade barriers.