Ottawa should rethink how it approaches increasing market access in trade negotiations, writes Larry Martin.

By Larry Martin, June 8, 2018

Public commentary regarding the NAFTA negotiations is mainly on the auto industry, as is appropriate. But another of Trump’s whipping boys is US market access to Canada’s supply-managed dairy and poultry industries.  In the fourth round of the NAFTA discussions, the US negotiators tabled a proposal to eliminate Canada’s supply management system for dairy, poultry, and eggs, which Canada’s Agriculture Minister Lawrence MacAulay responded by calling it a “non-starter.”

Yet, in recent days, Trudeau has also indicated a willingness to show “flexibility” on this issue. More uncertain is what this “flexibility” would actually entail. Canada’s recent track record in trade negotiations has been to offer increased access to dairy and poultry through a mechanism called Tariff Rate Quotas (TRQ’s), which denotes a minimum market access for imports before tariffs become applied. Changes in TRQs can affect imports without having an impact on tariff levels. However, questions can be raised about the wisdom of this approach.

Under supply management, dairy and poultry boards manage prices to levels informed by cost-of-production formulas and by allocating production quotas to domestic farmers. Managed prices are frequently above US and world levels. To prevent imports from undermining them, Canada imposes tariffs of between 150-300 percent, which are allowed by the World Trade Organization (WTO).  WTO also mandates a minimum market access using the TRQ mechanism. In Canada’s case, TRQ’s are essentially from 5-8 percent of domestic consumption.

Tariffs work in conjunction with TRQ’s: once the TRQ for a product is full, i.e., when the amount allowed in duty free is imported, the tariff applies against any further imports. For example, Canada’s tariff on butter is just under 300 percent; so assuming the TRQ is 8 percent of domestic consumption, as soon as that quantity is imported, any remaining imports are subject to the 300 percent tariff.  Imports are tariff free within the quota, but highly protected thereafter.

The Strategic Policy Issue

In trade negotiations, the importing country can offer market access by reducing tariffs, increasing TRQ, or a combination of the two.

To date, Canada has been willing to increase TRQ’s for dairy and poultry in trade negotiations. In CETA, Europe got 16,000 tonnes of TRQ for high quality cheeses and 1,700 for industrial cheese.  In CPTPP, Canada gave 3.25 percent more TRQ for dairy and 2.0 percent each for chicken, turkey and eggs. With other access already given up, this means Canada has given just under 10 percent of Canadian consumption to other countries.

The NAFTA negotiations appear to be on hold because of the US-imposed (and WTO-illegal) tariffs on steel and aluminum. But anything that Trump is involved in can turn on a dime, so they could be back on tomorrow. So, what is the best strategy?

Current data suggest major reductions in Canadian tariffs would not give up much protection. Butter will illustrate.  Canada’s milk prices are based on support prices for butter and skim milk powder. Canada’s current support price for butter is $8.00/kg.  The intent of the tariff is to keep imports out by making their landed cost (their price plus transportation and tariff) higher than $8.00.

The US Department of Agriculture’s average wholesale price of butter in late March 2018 was US $4.85 per kg.  Given the weaker Canadian loonie (US $0.78), this gives a US price in Canadian funds of $6.22.  So, ignoring transportation costs, US butter within its TRQ can be sold in Canada for a very healthy profit of $1.78 ($8.00 - $6.22).

But the 300 percent tariff (again ignoring transportation costs) at $6.22 is $18.66.  Adding the tariff to the cost of $6.22 gives a landed price of $24.88.  In other words, in the current situation of relatively low dairy prices in the US, Canada’s tariff is far higher than needed to protect the Canadian market. This is rather like using an artillery barrage to kill a fly when a flyswatter would suffice: in this example, the fly swatter would be a minimum $1.78 tariff.

Implications

Because the tariffs for supply managed products are so high, giving up a lot of tariff gives up only a little protection, whereas giving up a little TRG gives up a lot of protection. Canadian tariffs are far higher than needed to protect the domestic market.

We should expect two arguments against negotiating tariffs rather than TRQ’s. The first is that exporting countries can do the same arithmetic and conclude that TRQ’s are much better for them because the drop in Canadian tariffs required to have real impact on market access is so large. But there’s nothing in the history of trade negotiation that says the exporting countries get to choose how importers provide more market access.  Canada has no obligation to give up TRQ’s.

The second argument is one that members of the supply management industry have made for 30 years.  It’s the “slippery slope” argument: i.e., if we give up any tariff at all, there will be no end to demands to give up even more in trade negotiations. While that’s clearly true, giving up more and more TRQ is not a slope.  It’s falling off a cliff: we simply give increasing parts of the domestic market to foreign suppliers and take it away from domestic farmers. At least with lower tariffs the domestic industry would still have substantial protection, would be able to adjust to meet foreign imports, thereby having a chance to compete in its own country’s market.

There is clearly a choice.

Larry Martin is Principal at Agri-Food Management Excellence.

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