Canada’s long-term role in the auto supply chain is increasingly tied to trade diversification and the pace of the EV transition, economists say — a structural shift that goes beyond the industry’s expected slowdown in 2026.

TD Economics expects new vehicle sales to fall 4.3 per cent this year and production to drop around four per cent as automakers shift output south of the border. BMO sees a deep break with the past. Together, their outlooks suggest the country’s auto sector is entering what TD economist Andrew Foran termed “a new normal” in an industry outlook report published last week — smaller, more fragmented, and more dependent on policy choices at home and abroad.

“Canada can no longer rely on the traditional model of deeply integrated, tariff-free North American auto production,” BMO economist Erik Johnson wrote in a recent note. “The re-emergence of a tariff barrier — especially one as steep as 25 per cent — undermines Canada’s long-standing role as an export-oriented production hub.”

Since the early days of U.S. President Donald Trump’s second term, the North American automotive industry has been disrupted by tariffs, both real and threatened. Various U.S. policy changes have also altered the trajectory of the EV market. An end to federal EV incentives in both Canada and the U.S. last year triggered a sharp reversal in sales, a result that highlights “how dependent EV sales are on upfront financial support,” Johnson writes.

The challenge Canada’s industry faces is structural, the economists say. Canada’s production base was built around largely frictionless continental trade, with around 90 per cent of domestically produced vehicles exported to the U.S. in a typical year, Foran notes. To move the needle, Canada is trying to broaden its trade base beyond the U.S. — but each potential opening carries constraints.

“Currently, only about seven per cent of exported vehicles from Canada are shipped outside the CUSMA region,” Foran wrote, “so there is room to grow and diversify…”

But retooling the industry with global partners is likely to be challenging. The federal government has hinted at potential production interest from South Korean and German companies, though Foran notes these discussions are currently tied to Canada’s procurement of submarines — and “not currently substantiated.”

Ottawa’s strategy also seeks to use “tax credits and direct support to attract new EV manufacturers,” Johnson notes, but he says Canada’s market is simply too small to support a dedicated EV assembly plant without exports. The U.S. market — which buys about 1.5 million EVs annually versus Canada’s under-200,000 tally — is “indispensable,” Johnson says, but tariffs “have sharply undermined the viability of exporting from Canada.”

That vulnerability is compounded by the economics of the EV transition. Exporting elsewhere would force Canadian manufacturers to compete on “intense and increasingly price-driven” terms — and doing so against established EV makers — “poses immense challenges,” Johnson says.

This friction extends even to potential lifelines. While the federal government hopes joint-venture investments with Chinese firms will follow its deal to allow a limited quota of imports, Foran warns that U.S. “animosity” towards Chinese-linked technology creates a ceiling. If Chinese production does happen on Canadian soil, “any quantity that isn’t consumed domestically would need to be exported overseas.”

In this environment, Johnson argues that growth will depend less on traditional assembly and more on “adjacent segments”— battery materials, advanced components, and leveraging Canada’s “low-carbon electricity advantage.”

Foran expects production to slide another four per cent in 2026, though he notes the sheer complexity of the integrated supply chain makes a full U.S. retreat “suboptimal on a cost and logistics basis.” Canadian counter-tariffs, which penalize production reductions, also raise the cost of shifting output entirely south of the border.

Still, the broader direction is clear. “Nevertheless, the need to diversify automotive trade away from its current outsized U.S. concentration will likely be necessary to ensure the long-run viability of the industry amid growing U.S. protectionism,” Foran wrote.

John MacFarlane is a senior reporter at Yahoo Finance Canada. Follow him on X @jmacf.

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