Two Truths and a Lie About the U.S.–Canada Trade Breakdown

U.S.-Canada relations are at their lowest point in generations, but the United States has far more important economic and strategic challenges than fighting a trade war with its closest neighbor. China—not Canada—is the most significant threat to the U.S. economy, and the United States cannot effectively compete with China while weakening the production base it shares with Canada and other close allies. The escalating dispute between the two countries is therefore profoundly self-defeating.

The latest episode in August—when the Canadian government’s decision to suspend trade negotiations with the United States—has further escalated tensions. What happened in the final hours remains disputed. Canadian officials say Washington introduced last-minute terms that were “unfair, uneconomic, and called into question the reliability of any deal.” The White House, in contrast, announced that “Canada chose unreasonable demands, walk-backs, and flat-out rejection.” Canada subsequently imposed tariffs on roughly $20 billion worth of U.S. imports, and the United States announced a ban on Canadian motorcycle, dairy, and alcohol imports.

Both sides need to de-escalate tensions. The White House should move first by ending its needless threats and provocations and returning to negotiations with a focus on strengthening, rather than weakening, North American economic integration.

The United States-Mexico-Canada Agreement (USMCA) sought to reinforce joint production among the three partners. The idea behind a joint trade agreement is to anchor a “factory North America,” taking advantage of scale and complementarities. Canada brings energy, critical minerals, advanced manufacturing, and defense-industrial depth. Mexico provides a platform for nearshoring production away from China, with a strong, low-cost talent base. All in all, risking preferential access to the Canadian market makes the U.S. economy costlier and smaller.

So, what to do next? Repairing the relationship starts with both sides confronting uncomfortable facts:

Truth 1: Canada’s retaliation raises the risk of further U.S. escalation

Canada is the only country, besides China, to have significantly retaliated against U.S. tariffs. Prime Minister Carney might be responding to his constituents; he was elected in part to be a “tough” negotiator with the U.S. government, and after Canada pulled back from the negotiating table, he likely would have been pressed to retaliate anyway. But good politics does not mean sound policy—especially when U.S. trade negotiators now need to show other countries the cost of retaliating against the United States. Thus, the current situation might lead to a downward spiral.

U.S. tariffs have not had the extreme negative economic effect on the American economy predicted in the early days after the “Liberation Day” tariffs, in part because many of the tariffs were walked back and there was largely no retaliation against them. (Canada was not targeted by these tariffs but still received sector-specific Section 232 tariffs, an instrument that allows the U.S. government to tariff goods such as steel, aluminum, and certain auto parts, based on national security concerns.) A general retaliation would be immensely costly for the United States. In 2025, ITIF estimated that if countries retaliated against Liberation Day tariffs only on information and communication technology (ICT) goods covered by the World Trade Organization’s Information Technology Agreement (ITA) customs duty reductions, U.S. exports of these goods could have fallen by at least $56 billion in the first year.

All this suggests that the U.S. government could be considering further escalation. Of course, political economy factors matter—the upcoming midterm elections being the most obvious. Given the United States's political calendar, Canada is retaliating most strongly against goods that affect “swing states.” Yet targeting electoral pressure points may only strengthen Washington’s incentive to escalate and to make Canada an example for other countries.

Lie: The restrictions to Canada involving non-market economies would be unprecedented

Prime Minister Carney argued that U.S. negotiators were pushing for language restricting Canada from making trade deals with other countries—he assessed that as "unacceptable" and "a question of sovereignty." Canadian policymakers deemed it a “poison pill” intended to prevent Canada from expanding its trade relations with China. If that’s true, it is not relevant—it is not much different from what is already in place.

The USMCA, in Article 32.10, imposes conditions on any party seeking to enter into free trade deals with non-market economies. It requires that party to notify the others at least three months before beginning negotiations and share the agreement’s full text at least 30 days before signing. If a party ultimately enters such an agreement, the other two may terminate the USMCA on six months’ notice and replace it with a bilateral accord.

Truth 2: U.S. trade negotiators will keep demanding other countries not sign trade agreements with non-market countries in many deals—and they are right to do so

A non-market clause (or similar) is a pragmatic tool tailored to address trade fragmentation, and, in particular, the fact that Chinese innovation mercantilism is threatening the stability of the world’s manufacturing sector. Countries with the market size of the United States and with remanufacturing as a top economic priority need to act and push back against that reality. As of the publication of this piece, the Trump administration has signed trade deals or frameworks with similar clauses with Bangladesh, Cambodia, Ecuador, Guatemala, Jordan, Malaysia, and Taiwan.

Further steps are necessary: U.S. core allies should retroactively revise existing agreements with China. Such a clause would not exclude U.S. trade partners from maintaining trade and economic relations with China, but it would provide a means to deter the People’s Republic of China (PRC) from indirectly rerouting goods to enter the U.S. economy.

Certainly, trade negotiators also need to address other uncomfortable truths. Canada’s trade irritants, particularly on discriminatory digital regulations, have long worried U.S. trade negotiators. Its Online Streaming Act, for example, a piece of legislation that taxes foreign streaming companies and directly funds its competitors, does not comply with the USMCA’s provision for non-discriminatory treatment of digital products. On the other hand, Trump does little for the U.S.-Canada relationship with his sustained comments about making Canada the “51st State.”

As with many U.S. trade partners, trust and long-term relationships would take time to repair. But economics is the kingmaker. In the case of U.S.-Canada trade, both countries would face the reality of the trade war’s costs—jobs, competitiveness, and growth. When negotiations resume, the stylized facts presented here would be on the table again—better to address them with evidence.