Back to the Future? Canada’s Auto Strategy

Introduction: The Gloves Are Off

A week is a long time in the world of President Donald Trump and of the United States’ trade partners. We went from a sweeping 25 percent tariff on all Canadian and Mexican goods under the International Emergency Economic Powers Act (IEEPA), to a 30-day reprieve, then another reprieve – but only for goods that met the Canada-United States-Mexico Agreement’s (CUSMA) rules of origin – before landing on a 25 percent tariff on steel and aluminum, along with a declaration of intent that the US would slap reciprocal tariffs on all its trade partners. On March 26, 2025, in potentially the most portentous blow of all the ones he has landed, Trump announced a 25 percent tariff on all passenger vehicles and light trucks, as well as key automobile parts (engines, transmissions, powertrain parts, and electrical components), effective April 3, with a 25 percent tariff on all parts to be levied no later than May 3.

Then, just before that latter date, the White House issued new orders exempting US automakers from paying “stacked” tariffs “stacked” on top of one another – for example, a 25 percent tariff on imported steel or aluminum, plus a separate tariff on autos parts. Instead, they would pay a single rate of duty of up to 25 percent on all imported vehicles and materials. In addition, although the White House announced a 25% tariff on parts, importers got a two-year reprieve from paying those, up to a certain portion of the manufacturer’s suggested retail price of the vehicle assembled in the United States (3.75 percent of the price through March 2026 and 2.5 percent through March 2027, then no reprieve). Finally, just as the May 3 deadline approached, the White House stated that CUSMA/USMCA-compliant auto parts would remain exempted from these duties.

The White House’s steel, aluminum, and auto tariffs were imposed under Section 232 of the Trade Expansion Act of 1962 – these tariffs are meant to protect industries whose decline, of which higher import penetration is an indicator, is deemed a threat to US national security. The recent adjustments can be interpreted as an acknowledgement that too rigorous tariffs or rules of origin on intermediate inputs cause final assembly to become either prohibitively expensive or, in the absence of local sources of supply of critical inputs, impossible – in effect causing the industry to actually shrink rather than expand.

Other than that, the only silver lining is that the tariff on vehicles will apply to the value of the vehicle net of their US content, which is typically considerable when it comes to intra-North American trade.

While the administration has signalled that it intends to remain in CUSMA/USMCA, which indeed benefits sectors not affected by s. 232 tariffs and for which most trade can remain duty-free, this is small comfort for the other sectors, including steel, aluminum, and others that may be designated later, and of course autos.

That said, the administration has been clear that it is willing to negotiate new trade and security deals with its partners. Canada does not have many shots at such renegotiations, and the Canadian government needs to build as much leverage as it can during that window. Although the auto industry – conscious that tariffs could sharply diminish North American competitiveness, drive up consumer prices, and even halt production due to unsustainable losses – has secured a partial and temporary reprieve from tariffs on parts, Canada cannot leave the future of its otherwise competitive auto sector, and the skills and capital investments that support it on both sides of the border, to the fate of these ill-conceived tariffs.

The Canadian government’s response has been measured so far, as it should be. Canada has imposed reciprocal tariffs on cars imported from the United States but not on those imported by companies that assemble cars in Canada. For example, BMW vehicles imported from the United States will face tariffs, but BMW can still import cars tariff-free from Europe (albeit at higher transportation costs), given the EU-Canada Comprehensive Economic and Trade Agreement (CETA). But Ford, GM, Stellantis, Toyota, and Honda, which manufacture cars in Canada, can still import them duty-free from the United States. Conscious of the costs to its own producers, dealers, and consumers, Canada has not imposed reciprocal duties on auto parts.

Recent Developments and Consequences for Canada’s Industry

One impact of even the threat of tariffs is the added incentive for manufacturers to locate new investments in the United States – the larger market – even though the production pattern created by this incentive would disregard the benefits of comparative advantages and, therefore, would be costly to the United States. Canada, in contrast, should seek to maintain the more efficient trade and investment patterns that would be obtained if the law of comparative advantages was allowed to play itself out, and if it can do so at a reasonable cost.

In this respect, “plan A” for Canada is to reach a new deal with the US administration that preserves mostly tariff-free trade, as was the case under CUSMA/USMCA. But Canada also needs a “plan B” to counterbalance the incentive for companies to abandon otherwise economically sensible investments in the country due to the threat of US tariffs.

Overall, the tariffs announced will cause a lot of pain for most US manufacturers and consumers. Therein lies a pathway out of these repeated tariff threats, one which is within Canada’s purview to take.

The first Trump presidency threatened to apply tariffs to Mexican imports using the IEEPA. He has made good on those threats (although with a current partial stay of execution) in his second term. Steel tariffs were applied against the world, including Canada, during Trump 1.0, and they have returned with his second term, encompassing even more semi-finished steel products. In fact, the narrative that the world has taken advantage of America’s goodwill – and must be forced into compliance through tariffs – has been a consistent thread in the Make America Great Again (MAGA) movement.

The theory that tariffs can be used to encourage industry back to America in the medium term while boosting government revenue to fund tax cuts in the short term is controversial and not without a legion of detractors. But, for many Americans, a policy that proposes to restore manufacturing jobs, get government spending in line and regain respect for America seems like it deserves a chance. At least until this became a competition between the US and Canada, many Canadians believed in a similar approach for this country. But then the rubber hit the road.

After a home, a car is the second largest purchase anyone will make in their lifetime. Unlike homes, which are built locally, Canadians have a world of choice in cars. Canadians select cars based on issues of personal utility, available budget, or even self-image. Where the vehicle is built is a secondary consideration. As a result, according to Ontario’s Trillium Network for Advanced Manufacturing, Canada is only the third-largest source of vehicles purchased by Canadians, with roughly half of all vehicles coming from the US, followed by Mexico at 15 percent.¹See: Trillium Network for Advanced Manufacturing. 2024. “Canadian Automotive Trade, Production, and Sales, 2014–2023.” Data Bulletin No. 15. December. https://trilliummfg.ca/data-bulletin/canadian-automotive-trade-production-and-sales-2014-2023/.

Canada’s vehicle assembly footprint has shrunk in recent years. Although COVID-19 disrupted supply chains, there has been a broader erosion of Canadian industry. Mexico has actually grown its share of North American production, while US manufacturing has proven remarkably stable. Because Canada doesn’t offer the biggest market or the cheapest labour in North America, free trade has caused automotive assembly investment to leak out of the country.

For Canadian vehicle production and sales to fall – even as Statistics Canada estimates that Canada’s population grew by more than 9 percent between 2020 and the end of 2024 – is troubling. For non-professional workers, well-paid, full-time manufacturing jobs are giving way to more precarious employment in the gig economy. Uber alone had over 140,000 drivers and delivery people using its platform in 2023. It is not surprising that Canadians worry about the drift of the economy.

The Canadian auto industry has limited export opportunities beyond North America. To maintain our manufacturing base, Canada must either exponentially expand its share of the domestic market or achieve healthy sales across the larger North American market. That leads to the inevitable conclusion that Canada must cut a new deal with Washington. Because the Trump plan is a throwback to a time when tariffs were applied to most trade, Canada may also have to look to its past for a plan. But we must do so in a way that has the least possible impact on our other trading partners and on Canadians’ wallets.

Tariffs are like castle walls. Build them high enough, and trade can only come through the front door and only on your terms and conditions. However, the biggest and richest market in North America is guarded by the lowest “most-favoured nation” (MFN) tariff wall applying to all World Trade Organization (WTO) members – 2.5 percent on cars and SUVs (trucks are subject to a 25 percent tariff). To be clear, this is the rate importers pay without regard to the origin of the vehicle. Since CUSMA/USMCA was implemented, even Mexican exporters have increasingly shipped goods to the US under MFN tariff rates – choosing not to claim zero tariffs, even when their products meet the agreement’s rules of origin.

AMIA, the Mexican auto industry association, estimates that more than 8 percent of vehicles and over 20 percent of auto parts exported to the US attract MFN rates of duty. In his second term, President Trump has pledged to address that problem, and now we see he has done so by building a much higher wall.

In the simplest terms, Canada needs to aim to be on the inside of that tariff wall. But for this, the MFN tariff needs to be higher than the current rate on cars and SUVs in order to ensure that all North American products comply with CUSMA/USMCA rules of origin. In other words, for automakers, the benefits achieved from meeting free trade agreement requirements must exceed the cost of compliance. How can Canada foster such an incentive system, given the new US tariffs?

Canada’s Response: Back to the Future?

Before the original 1965 Canada-US Auto Pact, Canada offered auto producers a system of duty remission orders which had a similar aim. Those orders raised import tariffs but waived the duty for Canadian importers who met minimum local production requirements. The remission programs caused the US auto parts sector to demand a response from the US government, and out of that, the Canada-US Auto Pact was born with similar market access provisions on both sides of the border.

In linking import rights to domestic manufacturing, the Auto Pact prevented the type of production losses that Canada has experienced post-CUSMA while still allowing the North American industry to rationalize production in ways that created longer production runs (with only some models produced in Canada) and kept vehicle prices low.

The US tariff position is clear. The more stringent rules of origin negotiated under CUSMA/USMCA have failed to produce the results desired by the US. They are now applying tariffs on top of the agreement’s rates to direct further outcomes. So, rather than continuing to advocate for simply retaining the CUSMA/USMCA formula that allowed Mexico to carve off a larger share of North American production – while also permitting Chinese imports to claim a 20 percent share of the Mexican market – Canada should be ready to go into the next round of negotiations offering a compelling alternative.

Here’s the idea: in response to any US tariffs that are ultimately applied, Canada should impose a surtax on imports of US light-duty vehicles (i.e., passenger cars, minivans, SUVs, and light trucks). At the same time, auto manufacturers currently assembling vehicles or manufacturing major powertrain components in Canada should be provided with duty remission proportionate to their Canadian production. This initiative would be aimed at driving negotiators back to the CUSMA/USMCA table to review the automotive provisions of the pact.

In that review, Canada should propose permanently reinstating tariffs on automobile trade between the three countries and establishing a common external duty rate – set high enough (10 to 25 percent) – to discourage anyone from end-running CUSMA/USMCA rules. In turn, the countries should each agree to waive their duties on a defined volume of vehicles imported from the other two by any company that maintains a manufacturing base in the importing country.

In this model, a manufacturer who, for example, produced 100 vehicles in Canada, the US, or Mexico might be entitled to import up to 100 vehicles in combination from the two other countries (or whatever ratio the countries agree to set). The formula could be based on production value rather than volume, but the mechanism remains the same. The existing CUSMA/USMCA rules of origin would continue to determine whether a vehicle had sufficient regional content to qualify for duty-free entry under the policy.

Let’s think this through. The new-car market accounts for almost 2 million annual sales in Canada. According to the Trillium Network’s calculations, about half of those are imported from the US. For those vehicles to qualify for duty-free import to Canada, manufacturers (not just Ford and GM, but Toyota, Volkswagen, or any other company importing to Canada from the US) would have to assemble a total of 1 million vehicles in Canada. The Canadian vehicles could be sold domestically or exported. If exported to the United States (or Mexico if it buys into the system), the duty-free volume of exports could not exceed the automaker’s value or volume (as appropriate) of domestic production in the importing market.

Advantages of a New Auto Pact

The US administration has called for fairness and the elimination of trade imbalances. It has sought to restore and anchor production in North America and it wants to reinforce domestic supply chains. A reinvigorated North American auto industry, spread across the three countries, would attract foreign investment while creating a home-court advantage for companies that either grew up here or North Americanized their businesses. Nothing could be more in the spirit of tariff reciprocity than a policy that is inherently self-balancing.

As a nod to both the past and the future, let’s call this new deal the Auto Pact. The original Auto Pact included major powertrain components in the calculation of domestic production. Carried forward in the same spirit, that should extend to vehicle electrification and the manufacturing of major components such as batteries. Other parts, however, would be exempt from tariffs.

Since any duties paid on the cars they import (up to the limit calculated under the duty remission formula) would be directly returned to the manufacturers, the effect would be to provide continued duty-free trade for companies operating on both sides of the border. Note that this means that carmakers could continue to produce only a few models at an optimal scale here in Canada, as they do now, while benefiting from the ability to sell any of their models here tariff-free, as they also do now.

This model also assumes that Canada, the US, and Mexico would be able to retain their free-trade agreements with other countries. Even with those agreements, North America is experiencing inward migration of vehicle assembly investment today, and this proposal would do nothing to dampen that trend. So, with continued access to global production and most vehicles produced in North America trading duty-free, consumers would be protected against any significant trade-induced price inflation.

The transshipment of Chinese or other goods deemed to be contrary to North America’s strategic interests continues to be a concern. Today, both Canada and the United States are relying on special tariffs to shut down trade in those goods. Tariffs can be a blunt instrument, impacting products that do not pose a strategic risk. Hiding behind a tariff wall tends to slow industry progress toward full competitiveness, and if history is any guide, companies will tend to price to the tariff if those provisions become too severe.

Instead, a coordinated regulatory approach among CUSMA/USMCA partners – particularly on security risks posed by advanced digital technologies in vehicles, such as grid connectivity, autonomous operation, or data transmission – would be more surgical but also have a more certain impact than tariffs, which can be overcome through tactics like trade diversion or subsidies.

There is a further benefit here. If Canada can clearly define in these regulations the protections needed against Chinese imports – and take into account other protections like anti-slavery and anti-dumping laws – the current temporary tariffs could go away. With the elimination of those tariffs, a strong case can also be made to eliminate the Chinese retaliatory tariffs on Canadian agricultural products.

This proposed approach would offer the following benefits to the United States:

1. Manufacturers would continue to be able to rely on suppliers across the region, including a growing critical mineral and battery supply chain base in Canada.
2. CUSMA/USMCA preferences for local sourcing would be retained and strengthened by increasing the cost of trade taking place under MFN tariffs between North American markets.
3. Running the program as a remission program rather than as a tariff preference level or some other volume limit would minimize the need for heavy government oversight. Production value or volume is easily recorded and audited and would open access to duty-free imports. Failure to comply with program requirements could be addressed under existing monetary penalties or by a reduction in benefits in a subsequent cycle.
4. Because it offers by far the largest market opportunity, the US would continue to be the first location where any company seeking to expand into North America would invest, leaving the US with a sustained competitive advantage.
5. The advantages delivered under the program would be reciprocal and self-limiting. Combined duty-free imports from the other CUSMA/USMCA partners could not exceed the importing country’s domestic production-to-import ratio.
6. Since a growing percentage of the value of a vehicle now comes from software and connected services, it would be possible to calculate other value-added content and services into the remission formula. The CUSMA/USMCA auto chapter already has some recognition of research and development. This would allow the pact to advance to the next logical stage.

Conclusion: A Winning Plan

The Trump administration already plans to use tariffs to manage its trade and foreign policy agenda. Knowing this, Canada needs to seize the initiative and bring forward a win-win plan so the Trump administration can demonstrate results to US voters. That plan must preserve and enhance benefits for a sector of the Canadian economy that is inextricably linked to suppliers and consumers south of the 49th parallel. Before the details of the US plan harden, Canada must show how we can partner to take advantage of an updated and improved North American free-trade agreement.

Canada has already announced, in response to the Trump tariffs, that it would develop a framework allowing auto producers to access federal relief from US tariffs as long as they continue to maintain production and investment in Canada.²See: Robert Fife, Bill Curry, and Steven Chase. 2025. “Carney Hits Back at U.S. with Canadian Tariffs on Autos.” The Globe and Mail. April 3. https://www.theglobeandmail.com/canada/article-carney-announces-25-tariffs-on-us-made-vehicles-not-compliant-with/. The more detailed proposal in this paper elaborates on this first step. Canada has a competitive auto industry, and it is legitimate for Canada to seek to alleviate the distortions – costly for everyone – that US tariffs would impose on the allocation of production between the two countries.