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DAIRY
World Markets and Trade
January 1998
The U.S. Challenges Canada's Dairy Export Subsidies and Import Protection
The United States has initiated a Section 301 investigation of Canada's new dairy price pooling arrangements. The investigation was initiated in response to a petition from the U.S. dairy industry. The petitioners alleged that Canada's dairy system reforms are not consistent with World Trade Organization (WTO) commitments. First of all, the petition maintained that the new special class pooling system subsidizes dairy product exports and circumvents export subsidy commitments. Secondly, the petitioners asserted that Canada's failure to allow commercial shipments under its tariff rate quota (TRQ) for fluid milk imports violated Canada's Uruguay Round obligations.
After an evaluation of the petition, the United States Trade Representative (USTR) initiated consultations with Canada in accordance with WTO procedures. The first round of the consultations were held under the guidance of Article XXII of the General Agreement on Tariffs and Trade (GATT) in Geneva on November 19, 1997. It is the view of the United States that Canada's special class pooling system and Canada's failure to establish a TRQ for fluid milk appears to be inconsistent with its WTO commitments.
The progress of the Section 301 action is being closely observed by dairy product exporters and dairy producers. If it is unsuccessful, it is widely believed that other countries could adopt similar dairy production and export programs to circumvent WTO disciplines on export subsidies and market access. New Zealand has also recently challenged Canada's export policy and have requested consultations with Canada under Article XXII of the General Agreement on Tariffs and Trade.
Canada's Export Performance and Negotiating Position
Canadian representatives asserted that Canada is not in violation its Uruguay Round commitments because its dairy export programs do not meet the Uruguay Round definition of a export subsidy. During the 1996/97 dairy year (August/July), however, Canadian exports of butter, cheese, and other milk products outstripped the quantity ceiling on subsidized exports indicated in Canada's WTO country schedule. Despite domestic dairy prices significantly above world levels, Canada exported over 11,600 tons of butter in the 1996/97 marketing year (August-July), more than 40 percent above its WTO commitments. For cheese, the disparity was even greater: the WTO ceiling was 11,773 tons, while 20,335 tons were exported.
In its 1995/96 export subsidy notification to the WTO, Canada reported only a portion of total exported volumes as subsidized. When questioned, Canada maintained that its pooled price system does not meet the WTO definition of an export subsidy and therefore Canada is not required to report the exported volumes to the WTO.
According to the WTO's dispute settlement procedures, the United States can request a panel after 60 days have elapsed if the dispute has not been resolved through consultations. Such a panel would determine whether the Canadian system is inconsistent with its WTO obligations.
International Pressures Led Canada to Change its Dairy System
Prior to 1995, Canada operated a strict supply management system that included severe penalties for over-quota production. Exports were subsidized (including exports to the United States) in the old system by directly levying producer returns. That system was changed in August 1995.
Participation in international trade agreements led Canada to alter its dairy program to meet its international obligations. Canada's membership in the North American Free Trade Agreement (NAFTA) required Canada to eliminate its subsidized exports to the United States. With its approval of the Uruguay Round Agreements and participation in the WTO, Canada was required to report the exports that resulted from all export subsidy programs, and agree to limits on the quantity of subsidized dairy products. Canada also agreed to limit budgetary expenditures on export subsidies. Furthermore, Canada committed to eliminate its quantitative restrictions on dairy product imports and to establish tariff rate quotas for dairy products.
Canada's response to its international obligations was to develop a new supply management system that maintained the quotas and pooling elements of the old system, but changed the form of its support for dairy exports. The new system pools revenues from milk that is destined for the export market and for certain domestic products that must compete with imported dairy products. For above quota production, the system provides only world market prices. The new national export pool is administered by the National Milk Supply Management Committee. While the new system is highly complex, a basic understanding of how it works, and why the United States is at odds with some of its features can be grasped by understanding its three important elements: classification, pooling, and import protection.
Classification and Pooling Balance Lower Export with Higher Domestic Returns
Nearly all milk produced in Canada is classified according to its end use, whether as a beverage, or for further processing into cheese, yogurt or other dairy products. The concept of product classification is not unique to the Canadian system. The dairy programs of several other countries, including the United States, also feature classification. Canada's system is, however, different because it includes milk classes defined by export destinations, as well as for further processing into products for export.
Another important aspect of the Canadian system is the pooling and sharing of revenues from milk production. An individual producer's returns are not based on the final use of his milk for a specific processor, rather they are based on the final use of the milk from the members of a pool. The payments are "pooled" (averaged) by provincial marketing boards. It is the provincial marketing boards that pool the revenues from producer's raw milk and assign the milk a value based on the prices paid by processors. The highest per unit payments are for milk used as a beverage. Progressively lower prices are paid for manufactured dairy products. The lowest prices are paid for products that are to be exported or to compete against imported dairy products.
Pooling allows delivery of low priced milk to processors for exported products, and balances these lower milk producer returns with higher returns earned on the domestic market. The system is thus two-tiered: one set of milk prices for domestically produced products and another set of milk prices for exported products. This allows the processors to compete effectively with lower cost exporters, like the United States and New Zealand, and allows Canadian milk to be removed from the domestic market at internationally competitive prices.
There are currently three milk pools in Canada: East, West, and National. While each pool has some independence in determining the classifications for the different pools, Class 1 is generally for fluid milk as a beverage in all the pools. Classes 2 to 4 are for dairy products for use on the domestic market, while Class 5 is generally for exports. There are also various subclasses for each class. An elaborate accounting system is used to determine the milk value of the processors' final products, which determines the payments to the producers.
Class 5 is the principal focus of the Section 301 petition. This pool is unique because it is pooled nationally and is mainly for exports. Thus, Canada's producers share the low priced export pool with the higher priced domestic pool.
Import Controls Protect Canada's Market
Canada imports virtually no fluid milk, either for use as a beverage or for processing into dairy products. (Canadian import data show that total milk imports for 1996 totaled only 426 metric tons.) Despite its WTO obligation to establish an import quota, Canada continues to deny access to U.S. commercial shipments of fluid milk. The Uruguay Round agreement required Canada to open a TRQ of 64,500 tons of milk. Canada has claimed that retail purchases by Canadian citizens in the United States are enough to fill the TRQ.
The 301 investigation and the WTO consultations focus on whether Canada is denying the market access it is required to provide under its tariff schedule. Such denial of access may be contrary to Canada's WTO commitments.
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