Trade rules between Canada and the United States are about to change, big-league. Minimizing damage to Canada will be the Canadian government's biggest challenge. Under normal circumstances, you'd expect some give-and-take negotiations, with net positives for both the United States and Canada. But we are not dealing with a traditional Washington.

There are two sources of upheaval; both come from the GOP. The first is congressional Republicans' "A Better Way" plan, which includes a 20 percent border tax on imports and tax exemption of U.S. exports. The second is President Donald J. Trump's interest in "tweaking" Canada-U.S. trade.



Something will give.



President Donald Trump meets with Canadian Prime Minister Justin Trudeau at the White House on Feb. 13, 2017. Mandel Ngan | AFP | Getty Images

Today, Canada-U.S. trade is essentially balanced (unlike U.S. trade with Mexico), but its impact is different in each country. Roughly 25 percent of Canada's GDP stems from trade with the United States, but American trade with Canada accounts for merely 2 percent of U.S. GDP. Canada has little economic leverage to negotiate at a federal level, and changes to the trade rules hit Canada harder than the United States. The biggest change in the congressional Better Way blueprint is the addition of a consumption tax. All well and good, except it excludes taxation of exports, which is great for an inward-looking "America First" supporters but poor for trade partners like Canada.

The border tax idea would effectively end NAFTA and its predecessor, the underlying Free Trade Agreement. Economists predict the Canadian economy could lose at least 1.5 percent of GDP because of such new trade barriers. Canada would be forced to retaliate. A weaker Canada will have less productivity to share with the United States. Right now there's more juice to be squeezed from Canada, but the United States can expect diminishing returns as the Canadian economy retracts from American protectionism. A smaller apple produces less juice, even if you squeeze it harder.



Canadian politicians have pointed out the disproportionate impact Canadian trade has on 35 U.S. states. ... Finding a way to get the states and provinces to the table could be Canada's best strategy.

Canada's government under Prime Minister Justin Trudeau has adopted a smart approach — get ahead of change, and show great eagerness to engage with the United States. Negotiate bilaterally — and quickly — without Mexico at the table. This strategy might mitigate damage, but it's unlikely negotiations will result in concessions to Canada, such as a change in dispute mechanisms. For example, Canada's longstanding desire to change the softwood lumber rules to allow subsidies will not be solved. It may get worse.

Canadian politicians have pointed out the disproportionate impact Canadian trade has on 35 U.S. states. It is conceivable the GOP may carve out the deeply integrated supply chains for manufacturing and commodities exchange that occur under NAFTA in these 35 states. Effectively, this would create a 'mini NAFTA.' Actually, more like a renegotiation of the FTA and Auto Pact.

Politicians in the 35 states may pressure the federal government to maintain elements of the status quo. Their supply chain is so well integrated, the job upheaval would be punishing for all involved. Those states would neither want a trade war nor the decrease in economic activity resulting from new trade rules.

Finding a way to get the states and provinces to the table could be Canada's best strategy.



Trump's idea of 'tweaking' — don't trust it