Tax policy may quickly reverberate through the equities markets, but there is no expectation that it can prompt a manufacturing renaissance in the United States any time soon. The U.S. government’s new tariff regime comes with a vision for a mass influx of on-shore production that would take many years to realize even if the tricky conditions to achieve it were all to fall into place.
Several factors would have to align, beginning with assurance for prospective investors that there would be long-term economic benefits they could not attain from outside the U.S.. From there, they would need investment capital and the time and resources to work through the myriad steps involved in finding a suitable site, getting a facility built and supply chain logistics organized. Those familiar with the process are incredulous at the U.S. administration’s claims that it has motivated this kind of decision-making since taking office.
“If that’s happening right now, it was already in the companies’ planning,” maintains Ted Betts, a partner and head of the infrastructure and construction group with Gowling WLG in Toronto. “Government policy of the day can nudge big major capital decisions, but companies don’t make that determination based just on this year’s tax policy.”
The U.S. government’s April 2 announcement of tariffs on imported goods and commodities from an extensive list of trading nations follows after a 25 per cent tariff on steel and aluminum, invoked March 12, and in tandem with a 25 per cent tariff on imported automobiles. (Or, in Canada’s case, on auto component parts manufactured outside the U.S..) As well, sweeping tariffs on all Canadian and Mexican imports have been threatened, briefly applied and then withdrawn for items that are compliant with the Canada-U.S. Mexico Agreement (CUSMA) on trade. However, that threat remains, with undefined specifications for resolving it.
Economists hypothesize this broad collection of new surcharges for American procurers and consumers would have to stay in place for the long term to spur the kind of investment in manufacturing that the administration is seeking. In turn, though, prolonged tariffs would create other investment disincentives, including higher construction costs due to tax on key building materials and higher borrowing costs if, as is now widely projected, tariff-related inflation pushes up interest rates.
“Assuming that a firm decides that the new tariffs are permanent and never going to go away, which is a big assumption, then perhaps a firm will decide to undertake the investment to build new capacity — eventually,” reflects Jim Costello, chief economist, real assets, with MSCI Inc., based in New York. “That’s not a small decision to be made on a whim.”
Broad range of investment considerations
U.S. development is highly reliant on imported wood, steel and aluminum (much of which comes from Canada), while U.S. inflation and interest rates were higher than Canada’s even before the imposition of tariffs.
“Those are financial model calculations that every developer, every manufacturer, is going to have to make. That starts to build some dark clouds on the horizon about whether this is the best time to take the next step forward,” Betts submits.
He points to Volkswagen’s planned battery cell manufacturing facility in southwest Ontario to illustrate the complexity of such undertakings and argue why project proponents are unlikely to switch course once they’ve committed to a location. To begin, Canada and Ontario offer some baseline fundamentals: negligible corruption; a workable regulatory environment relative to other nations; access to markets and key resources; and an educated labour pool.
Next comes the lucrative sweetener of funding contributions from the Canadian and Ontario governments; then there is the company’s considerable legwork to acquire a massive 1,000-acre site and forge deals with suppliers. None of this is likely to be blithely abandoned.
“It’s years in the planning and making before you even hire an architect and engineer to design your plant. If you’re starting out from scratch, you shouldn’t underestimate how much time it takes just to find and close a deal for the real estate acquisition,” Betts advises. “Big projects valued in the hundreds of millions of dollars take years to design and secure permits for, and then years to procure and build. They do not fluctuate based on some policy of the day. It’s so complicated that unravelling it would set the whole company business plan back by 10 years.”
Although smaller enterprises may have more flexibility to pivot, Costello suggests development proponents of any size will face many similar challenges. “The constraints on building factories are the availability of things like water, power, materials, zoning and other local regulations, transportation links, investment capital and, especially, labour,” he tallies.
Robotics could be necessary to the U.S. government’s aspirations given the aging population and current perilous climate for workers who do not have legal resident status.
“The ratio of workers ready to retire relative to the working age population has never been so high,” Costello observes. “Can firms entice them to step out of retirement and work in any new factories they build? Some perhaps, but enough to cover all the activity where the U.S. depended on imports? That would be a tall order.”
Commercial real estate fallout
Analysts on both sides of the Canada-U.S. border reiterate that the commercial real estate sector’s response to the tariffs won’t be apparent until later this year when transaction data begins to flow through. Still, trends are emerging in Canada.
“From our data, we see that velocity has slowed and transaction lines have really slowed,” reports Mitch Strohminger, director of market analytics with the commercial real estate data provider, CoStar Group, in Montreal.
The firm is forecasting a recession for this year, and Strohminger describes Canada’s economy as “weak” right now. There has been a slip in per capita purchasing power relative to the U.S. over the past decade, which he attributes partly to Canada’s accelerated population growth, but also to a productivity lag. The U.S. has been generating growth and employment across a range of industries, while Canada’s job growth has been more weighted to the public sector.
Heading into a possible tariff-triggered recession, the industrial warehouse/logistics sector is tapped for a hard hit, albeit with some optimism for select landlords depending on how industrial operators adjust their materials inventories and/or the emergence of more supply chain sourcing within Canada..
“That could mean a bit of space demand to offset potential losses if U.S. firms were to scale back operations,” Strohminger says. “But that’s more long-term. In the short term, the next year or so, the clients I’ve talked to tend to be quite cautious in their outlook.”
With much of the world arguably facing the same kinds of uncertainty, Canada’s other relative strengths could be pertinent.
“We have that short-term weakness, but we do have the longer term safe haven story, which is still valid. That makes it attractive for foreign capital to eventually start looking to Canada for a longer-term play,” Strohminger says. “Right now, though, I think the initial reaction of the capital markets is going to be to just sit on their hands and wait to see what happens.”
Wielding promises and threats
In the U.S., tariffs have been framed as part of a comprehensive package of investment-inducing measures, which also notably promises that tariff-related tax revenue will enable corporate and personal income tax cuts. Strohminger acknowledges those envisioned measures could collectively serve as a “carrot” if they can be delivered.
“That (income tax cuts) sounds like a little bit of wishful thinking, if you think of everything else that they need to spend money on,” he muses. “In isolation, it’s hard to see tariffs leading to massive re-shoring and investment all on their own. But when you think about the costs involved with tariffs plus the benefits from these potential changes to the tax structure, that could lead some firms to expand operations or start building out new operations in the U.S.. That’s certainly a possibility, but it’s too early to bank on it yet.”
The U.S. executive order setting out the premise for reciprocal tariffs to be applied against imports from most of the world’s trading nations (minus Canada and Mexico) presents the administration’s perception of the economic and national security threat connected to a “large and persistent” deficit in trade goods. In addition to disparate tariff rates with the U.S., targeted trading partners are accused of policies that “suppress domestic wages and consumption, and thereby demand for U.S. exports, while artificially increasing the competitiveness of their goods in global markets”.
The resulting U.S. trade goods deficit is said to have hollowed out the country’s manufacturing base. “Over time, the persistent decline in U.S. manufacturing output has reduced U.S. manufacturing capacity,” the executive order states.
However, the U.S. National Income and Product Account (NIPA), which tracks the value and composition of national output and the incomes arising from the production of that output, presents a different picture. As other trading nations have gained market share in some production segments, U.S. manufacturers have also evolved.
“The U.S. does not have the same number of manufacturing jobs as at the peak in the 1970s, but the NIPA accounts show that manufacturing output has never been higher,” Costello affirms. “That’s the real story on manufacturing.”
