Diversification Comes With a Cost
Almost four decades ago, the Mulroney government concluded the Canada-United States Free Trade Agreement with the aim to gain access to the much larger U.S. market. The Chrétien government followed in 1994 with the North American Free Trade Agreement that included Mexico, creating one of the largest trading blocs in the world. Despite trade frictions from time to time, all three countries benefited from higher economic growth and more jobs by removing many trade barriers. Undoubtedly, NAFTA meant Canada would become even more dependent on the U.S. for trade than it was in the past.
Following the successful export-led strategies pursued by Asian countries after the Second World War, China quickly grew into a superpower in just 40 years, grabbing global market shares in many key industries with its excess capacity. Unlike past economic liberalization, nationalism has given rise to protectionist policies including trade barriers and business subsidies in the name of “industrial policy.” It was therefore no accident that Donald Trump won two elections in 2016 and 2024 with the promise to impose tariffs to counter trade deficits and deindustrialization as well as pay for his competitive tax cuts.
Canadians did not expect the U.S. president’s insults and the aggressive behaviour toward his northern neighbour that started in 2025. With his “elbows up,” Prime Minister Mark Carney contends that the Canada-U.S. relationship is ruptured forever (whether that will be the case, time will tell). Hence, he argued that Canada should diversify its trade to lessen our dependence on America. Yet, trade diversification is not so simple. It works if free trade principles guide more exports to other countries, which has not happened in the past despite the trade agreements with Asia and Europe concluded in recent years. Instead, diversification pushed by government policy will come as a major cost to the Canadian economy with lost GDP and jobs.
In 2025, 73 per cent of Canada’s exports were destined for the U.S. Key sectors remain heavily dependent on American trade: energy (84 per cent), motor vehicles and parts (92 per cent), chemicals, plastics and rubber (85 per cent), forest products (81 per cent) and consumer products (79 per cent). In total, over half of Canada’s merchandise exports are at least four-fifths dependent on the America market.
Can Canada compete profitably in other markets to substitute for exports to the U.S. market? Canada is just one of many global competitors. When it comes to other major countries, Canada’s share of their imports is minuscule, even less than our share of world GDP (two per cent), except for the U.K. and the U.S.
For certain key industries, Canada will be challenged severely to compete in other markets. The auto industry, already reeling from falling production (as Terence Corcoran pointed out this week), is unable to compete with Mexico and China in European, Latin American and Asian markets due to high costs. Even tech-savvy German automakers with falling domestic sales are diversifying product lines to include robotics and defence. Let’s not kid ourselves. Canada’s auto exports to the U.S. won’t easily be replaced by sales to other countries where competition is ferocious.
Energy exports, accounting for a quarter of our exports, have become more diversified with the completion of the TMX pipeline expansion and LNG plants in British Columbia. However, even with Alberta’s proposed new oil pipeline to the West Coast and some additional LNG plants on the coast, at least two-thirds of Canadian energy exports will remain focused on the integrated North American oil and gas markets. This week, a Desjardins report suggests that the most profitable oil exports may remain with the U.S., in part because the West Coast pipeline will be expensive to build, resulting in higher tolls, and Asian pricing won’t be sufficiently better. If the report is correct, any subsidized diversification comes at an economic cost to Canada.
Given the U.S. provides a quarter of global GDP, it is unlikely that chemical, plastic and rubber producers will easily shift to foreign markets without facing stiff competition. Even manufactured industrial machinery (77 per cent exported to the U.S.) and electronic and electrical equipment (69 per cent to the U.S.) will be difficult to shift away from the American market with its fast-growing tech industry, especially compared to Europe.
The luxury of our North American free trade arrangement is that it made it easier for Canada to be lethargic about its competitiveness. If we think we can give up our most profitable market next door to us, think again. It will come at an economic cost unless we make the Canadian economy a lot more competitive than it is today.
In some areas, Canada has more diversified trade, best illustrated by mining and processed products (42 per cent exported to the U.S.) and agriculture and fish (47 per cent). But trying to shift to Europe or Asia is challenging given the high non-trade tariffs often used to protect some of these industries. Norway, for example, imposes such high tariffs on chicken broiler imports that restaurant groups buy only domestically grown chickens.
A version of this article also appears in the Financial Post.
