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March 23, 2017

23 March 2017

Trading Supply Management for Softwood Lumber?

Economic Note explaining the benefits of exempting Canadian softwood lumber from tariffs and opening up the agricultural sectors under supply management to American producers

This Economic Note was prepared by Alexandre Moreau, Public Policy Analyst at the MEI. The MEI’s Regulation Series seeks to examine the often unintended consequences for individuals and businesses of various laws and rules, in contrast with their stated goals.

During the American election campaign, Donald Trump criticized the North American Free Trade Agreement on several occasions, going so far as to call it “a disaster,” and he clearly stated his intention to renegotiate it.(1) Although the new president is wrong to target it as the source of the economic ills afflicting his country, it is true that NAFTA could be improved. Exempting Canadian softwood lumber from tariffs and opening up the agricultural sectors under supply management (dairy, eggs, and poultry) to American producers are two examples of measures that would be beneficial to consumers and producers on both sides of the border.

Two Pioneers of Trade Liberalization

Canada and the United States have been at the forefront of trade liberalization, notably by signing the GATT treaties, the Auto Pact, a free trade agreement, and finally, in 1994, NAFTA.(2)

These deals had a significant effect on trade. Adjusting for inflation, the value of Canadian exports to the United States have increased by more than 176% since 1981 to total $451 billion (US$341 billion) in 2016.(3) Imports followed a similar trend, which brings the total value of trade to nearly $882 billion (US$666 billion) (see Figure 1). This makes Canada the second largest trading partner of the United States, just behind China,(4) which caught up last year. For Canada, the American market represents 68% of its total trade value.(5) As for Canada’s share of total American trade, it stands at 13%.(6)

Yet trade between the two countries has stagnated since the turn of the millennium. They therefore have an interest in tackling their remaining trade barriers in order to breathe new life into their economic partnership.

Supply Management Hurts All Canadians

Supply management will in all likelihood be at the heart of the next trade negotiations between Canada and the United States. A document from the American Government points out among other things the grievances of American producers with regard to this system, which governs the marketing of dairy, eggs, and poultry by establishing production quotas and import tariffs, and by fixing prices. Tariffs in particular are a source of friction, as they triple or quadruple the price of certain commodities, thereby closing the Canadian market to American producers for all practical purposes.(7)

Canadian farmers also lose under supply management, since it deprives them of access to billions of consumers around the world, which means that they have not been able to benefit from increased global food consumption over the past decade. When it comes to milk, Canada’s current production level is comparable to what it was in the 1960s.(8) The OECD furthermore expects the demand for dairy products in developing countries to grow over the coming years. Supply management will prevent Canadian producers from benefiting from this.(9)

Moreover, the funds required to purchase quotas limits the ability of farmers to invest in their facilities and equipment to increase the productivity of their farms. For example, a British Columbian dairy farmer has to pay $43,000 (US$32,470) just to acquire the right to produce and sell what corresponds to the production of approximately one cow, even before owning a single animal. In Quebec, where the price of quotas is fixed at $24,000 (US$18,123) per cow, these production permits represent 42% of the value of the average dairy farm.(10)

Supply management, by contributing to underinvestment in farms, thus traps producers in a vicious cycle. Paradoxically, the low productivity of certain farms is used to justify the maintenance of this system, whereas it is itself responsible for the situation. Yet larger farms would allow Canadian producers to be more productive and more competitive on local and global markets.(11)

The prices of products under supply management being determined by the costs of production, the low productivity of small farms also increases the retail price of these foods. Although direct subsidies for Canadian producers were abolished in the early 2000s, keeping prices artificially high represents an indirect subsidy for producers.

It is therefore Canadian consumers who “subsidize” these farmers. According to OECD estimates, this support represented an annual average of $258 (US$244) per household from 2011 to 2015 for all supply-managed products, for a total of $3.6 billion a year (US$3.3 billion).(12) Other estimates find costs of from $359 to $444 (US$271 to US$335) per household, for a total of up to $6.1 billion (US$4.6 billion).(13)

The abolition of Canadian dairy quotas should be conditional on the elimination of American subsidies. An American producer receives the equivalent of 7.46 cents (5.83 US cents) for each litre of milk produced, which represented 15% of total gross revenue in 2015. For Canadian producers, support in the form of higher prices represented 35.92 cents (28.08 US cents) per litre and 47% of gross revenue for the same year.(14)

Softwood Lumber: Costs for Americans

The U.S. Department of Commerce is currently evaluating the possibility of imposing tariffs on Canadian softwood lumber imports that could go as high as 25%.(15) If this happens, the costs would be much more significant than those incurred under the last softwood lumber deal, which was in effect from 2006 to 2015. Under that agreement, a tax was applied to Canadian softwood lumber when its price fell below a certain level.

The costs were not restricted to the Canadian side of the border. Canadian producers’ losses were substantial, totalling $2.03 billion (US$1.9 billion) over the period, but American consumers had to pay $6.36 billion (US$5.92 billion) more because of these tariffs. As for American producers, they saw their profits increase by $4.6 billion (US$4.31 billion) during this time.(16)

The American market is essential to the survival of thousands of forest communities in Canada. The provinces affected by the softwood lumber dispute actually supply around 30% of American demand,(17) which represents three quarters of Canada’s total exports in this sector. Over 24,300 direct and indirect jobs could thus be preserved by keeping the market exempt from tariffs.(18)

The American real estate market would also benefit from the maintenance of free access to Canadian softwood lumber. The imposition of a 25% tariff would cause the average price of a new home to rise by nearly $1,300 (US$975). This would have led to additional costs on the order of $1 billion (US$750 million) just for single-family homes built in the United States in 2016.(19)

Supply Management as a Bargaining Chip

American farmers’ access to Canadian sectors under supply management would open up for them a market with revenues for production and processing that total over $36 billion (US$27 billion), two thirds of which (67%) comes from the dairy sector.(20)

One study estimates that the complete, immediate abolition, with no financial compensation, of supply management would put 40% of Canadian dairy production at risk, which could cause the disappearance of from 4,500 to 5,000 farms. This is due to the much smaller size of Canadian farms, which entails relatively higher operating costs than in the United States.(21) Such a scenario is excessively pessimistic since a period of transition, including financial compensation for the value of quotas, would allow dairy producers to increase the size of their farms and thus reduce their operating costs.

Certain farmers could indeed decide to cease their activities after having received compensation. The prospect for growth, however, will be more favourable for those who remain. The liberalisation of the dairy industry would thus lead to an increase in Canadian production of from 75% to 150% over a period of 10 years. This change would also benefit the processing sector, by providing it with less expensive inputs and making Canadian products more competitive on the global market.

In all, liberalisation could create over 8,500 jobs in the dairy production and processing sectors.(22) The example of New Zealand speaks volumes: That country nearly tripled its production after having liberalised its dairy industry, becoming the biggest exporter of dairy products in the world.(23)

It is therefore entirely plausible that, following the opening up of the Canadian dairy market, American producers could meet a portion of Canadian demand without leading to a reduction in total Canadian production.

The abolition of supply management in Canada and of dairy sector subsidies in the United States makes sense not only from a strictly economic point of view, but also from the kind of give-and-take logic that often prevails in international negotiations. Canada should therefore seize the opportunity created by American pressure to open up its agricultural markets, and in return, demand full access to American markets for its softwood lumber.(24)

Conclusion

Trade barriers have never made more than a small minority of people richer, at the expense of the vast majority. Eliminating those that persist in the agricultural sectors under supply management and in the softwood lumber sector, and making sure not to erect new ones, would be good both for consumers and for producers. This is even clearer when taking into account the benefits on both sides of the border, which amount to billions of dollars and thousands of jobs. Ultimately, the renegotiation of NAFTA is an opportunity for Canada and the United States to broaden their economic partnership and contribute to its durability. That opportunity should be seized without hesitation. (See Table 1)

References

1. “NAFTA ‘a disaster’ and I’ll renegotiate, says Donald Trump,” CBC News, September 25, 2015.
2. Government of Canada, Canada-U.S. Free Trade Agreement, February 10, 2017.
3. American dollar amounts were calculated using the exchange rate for 2016 of 1.3243 (except where otherwise indicated) from the Federal Reserve Bank of St. Louis, Canada / U.S. Foreign Exchange Rate.
4. The U.S. Department of Commerce’s preliminary figures for 2016 indicate that China has surpassed Canada for the first time. U.S. Department of Commerce, Bureau of Economic Analysis, U.S. Trade in Goods and Services by Selected Countries and Areas, 1999-present, January 2017.
5. Statistics Canada, CANSIM Table 376-0103: Balance of international payments, current account and capital account, 2016.
6. U.S. Department of Commerce, op. cit., endnote 4.
7. Import tariffs of 245% for cheese and 298% for butter are mentioned. See Michael B.G. Froman, 2016 National Trade Estimate Report on Foreign Trade Barriers, Office of the United States Trade Representative, pp. 70-71; Alexander Panetta, “What will Trump want from Canada on NAFTA? A U.S. document may offer clues,” The Canadian Press, February 3, 2017.
8. Statistics Canada, CANSIM Table 003-0011: Milk Production and Utilization, 1945-2016.
9. OECD and FAO, OECD-FAO Agricultural Outlook 2016-2025, Database, July 4, 2016.
10. These are the current prices for the month of January 2017. Les producteurs de lait du Québec, The Milk Economy, Some Figures, Quota prices in Canadian provinces; Statistics Canada, CANSIM Table 002-0072: Farm financial survey, financial structure by farm type, average per farm (gross farm revenue equal to or greater than $25,000), 2015; Groupe AGÉCO, Faits saillants laitiers québécois, Répartition du quota total détenu par les producteurs de lait par région agricole (PLQ), 2015-2016.
11. Michael Grant et al., Reforming Dairy Supply Management: The Case for Growth, Conference Board of Canada, March 2014, p. 43.
12. Using exchange rates for individual reference years from 2011 to 2015, expressed in 2015 dollars, based on the number of households in 2013 and the price index of each product. Statistics Canada, Survey of Household Spending in 2013, February 2016; Statistics Canada, CANSIM Table 326-0020: Consumer Price Index, 2011-2015; Federal Reserve Bank of St. Louis, Canada / U.S. Foreign Exchange Rate, 2011-2015; OECD and FAO, Producer and Consumer Support Estimates database, June 2016.
13. The total cost was calculated based on the number of households in 2013. Survey of Household Spending in 2013, February 2016; Ryan Cardwell, Chad Lawley, and Di Xiang, “Milked and Feathered: The Regressive Welfare Effects of Canada’s Supply Management Regime,” Canadian Public Policy, Vol. 41, No. 1, March 2015, p. 8; Vincent Geloso and Alexandre Moreau, “Supply Management Makes the Poor Even Poorer,” Viewpoint, MEI, August 31, 2016.
14. USDA, U.S. milk production and related data (quarterly), February 2017; Farm & Agricultural Resources & Management, Converting Liters to Pounds of Milk; Federal Reserve Bank of St. Louis, op. cit., endnote 12; Canadian Dairy Information Centre, Historical Milk Production, February 22, 2017.
15. Lumber from New Brunswick and certain softwood lumber by-products, historically excluded from agreements, could be subject to these new tariffs. Mélanie Marquis, “Pas d’entente sur le bois d’œuvre en vue, laisse entendre Trudeau,” Le Soleil, June 22, 2016; Andrew W. Kentz et al. (Picard, Kentz & Rowe LLP), Petitions for the Imposition Of Antidumping Duties and Countervailing Duties on Imports of Certain Softwood Lumber Products from Canada—Volume III: Countervailing Duty Allegations, Document submitted to the International Trade Administration, November 2016, pp. 96-114; International Trade Administration, “Commerce Initiates Antidumping Duty and Countervailing Duty Investigations of Imports of Certain Softwood Lumber Products from Canada,” U.S. Department of Commerce, December 16, 2016.
16. Using exchange rates for individual reference years from 2006 to 2015, expressed in 2015 dollars. See Alexandre Moreau, “The Economic Costs of Protectionism: The Case of Softwood Lumber,” Viewpoint, MEI, September 15, 2016.
17. Katie Hoover and Ian F. Fergusson, Softwood Lumber Imports from Canada: Current Issues, Congressional Research Service, May 11, 2016, p. 4.
18. This figure includes New Brunswick, possibly targeted by the 25% tariff, and excludes Newfoundland and Labrador, Prince Edward Island, and Nova Scotia. Innovation, Science and Economic Development Canada, Trade Data Online, National Exports of Canada by Product (HS Codes 440710 and 440910), 2016; Statistics Canada, CANSIM Table 281-0023: Survey of Employment, Payrolls and Hours (SEPH), employment by type of employee and detailed North American Industry Classification System (NAICS), unadjusted for seasonality, Sawmills and wood preservation [3211], Forestry, logging and support [11N], 2016; Statistics Canada, CANSIM Table 304-0015: Manufacturing sales, by North American Industry Classification System (NAICS) and province, Sawmills and wood preservation [3211], 2016; National Forestry Database, 5.1 Net Merchantable Volume of Roundwood Harvested by Category, Ownership, and Province/Territory, 2010-2014; Natural Resources Canada, Forest Resources, Statistical Data, Forest Management, 2010-2014; BC Stats, Exports and Imports – Database, Softwood Lumber Exports, 2010-2014.
19. Single-family homes represented 67% of residential construction in 2016. The costs do not include those related to multi-unit private residences or those related to renovation work. Our evaluation is modelled after a study by the National Association of Home Builders. Paul Emrath, “15% Tariff on Canadian Lumber Would Cost 4,666 U.S. Jobs,” National Association of Home Builders, May 19, 2016; Jungho Baek, “Dynamics of the U.S.-Canada Softwood Lumber Trade: Market and Welfare Effects of the 2006 Softwood Lumber Agreement,” Estey Centre Journal of International Law and Trade Policy, Vol. 12, No. 2, Summer 2011, pp. 69-81; Federal Reserve Bank of St. Louis, Average Square Feet of Floor Area for One-Family Units, New Privately Owned Housing Starts in the United States, Total One-Family Units and Housing Starts: Total: New Privately Owned Housing Units Started, Thousands of Units, 2014-2016; Federal Reserve Bank of St. Louis, op. cit., endnote 12; Random Lengths, Random Lengths Framing Lumber Composite Price − by Month, February 24, 2017.
20. Statistics Canada, CANSIM Table 304-0014: Manufacturers’ sales, inventories, orders and inventory to sales ratios, by North American Industry Classification System (NAICS), 2016; Statistics Canada, CANSIM Table 002-0002: Farm cash receipts, 2016.
21. Boston Consulting Group, Analysis of the potential impacts of the end of supply management in the Canadian dairy industry, Study mandated by Agropur Dairy Cooperative, December 2015, pp. 50 and 54.
22. The growth hypotheses are inspired by the New Zealand market in the ten years following deregulation (low estimate) and the Canadian canola market over the same period (high estimate). Michael Grant et al., op. cit., endnote 11, pp. 55, 56, and 70.
23. Agriculture & Horticulture Development Board, Dairy, World Milk Production; OECD and FAO, op. cit., endnote 12.
24. Lydia Mulvany and Jen Skerritt, “Spoiling for Canada Fight, U.S. Dairies Push for Trump Deal,” Bloomberg, February 20, 2017.​

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