Canada braced for hard bargaining on dairy when NAFTA talks resume

The United States has unfinished business with Canada's supply-managed dairy, egg and poultry sectors ifbargaining to modernize the North American Free Trade Agreement gets down to the short strokes this fall.

U.S. farmers could have sold more of their products into Canadaunder the Trans-Pacific Partnership, a trade agreement between 12 Pacific Rim countries negotiated during the Obama administration.But President Donald Trump pulled the U.S. out of the deal in his first week in office.

Now he's outto redeem himselfat the NAFTAtable or forceeven more out ofCanada, after imposingpreviously-unthinkable tariffs on steel and aluminum and threateningto do the same to cars.

"Canada knew going into TPP that the price of entry was going to be doing something on dairy," said Bob Wolfe, a professor emeritus at Queen's University who has studied agriculture trade policy since the 80s.

"Everybody in [the United States Trade Representative's office] knows that Canada blinked on [supply management] before, and will blink again and given CPTPP, has a pretty good idea what the Canadian blink will look like."

Under the CPTPP the Comprehensive and Progressive Agreement for Trans-Pacific Partnership,the modified version of theTPPbeing ratified by the remaining 11 countries Canadacreates 20 new tariff rate quotas (TRQs) allowing limited quantities of dairy, poultry and egg imports, to be phased inover 11 to 19 years.

The dairy concessionsrepresentabout 3.25 per cent of Canada's market.

In CPTPPconsultations now underway, farms and other businessescandescribe how they'll be affected by the quota changesand state whatgovernment help they'll need to adapt through the allocation of import permits, for example(recall last summer'sdebate over who getsto import Europeancheese)or financial assistance.

Dairy farmers are known for insisting"the sky will fall because of this and we're going to need a lot of compensation," Wolfe said.

America's share unused?

It's easy to imagineFonterra, New Zealand's dairy monopoly, alreadypacking its first shipping containers of butter.

But not all products covered by Canada's supply-management system are ideal for shipping across the Pacific. Fresh milk doesn't travel well. Acarton of eggs is alow-margincommodity unlikely to absorb huge shipping costs.

"Negotiators are highly conscious of who can supply in any given tariff line," Wolfe said. When theTPPwas negotiated, in other words, Canada knew that the increased quota space for the most perishable supply-managed products was going to be filled solely by American farmersa short drive away from key Canadian markets, like southwestern Ontario.

When the remaining TPP countries decided to proceed without the U.S., noTRQ wasrevised or suspended. Without American suppliers, it's hard to imagine all of that quota being used.

Instead, American expectations are "simply (being) transferred to NAFTA," Wolfe said.

Al Mussell, research lead for Agri-Food Economic Systems in Guelph, Ont., said it's in the United States'interest to "completely disassociate themselves with what they obtained in the TPP ... just pretend that it never happened."

That's what seemed to be happeninglast fall, when CBC News reported a source sayingthat an early U.S. negotiating position askedCanada to give up 10times what it conceded on milk in the TPPtalks, and to phase out supply management entirely within a decade. The pitch was dismissed by Canadian negotiators.

The U.S. needs to export milk to deal with its chronic oversupply problem one thatCanada avoids with its strictproduction quotas. Mexico recently added a new tariff on American milk in retaliation for U.S. steel and aluminum tariffs, making Washington's push for more exports even harder.

One possibleCanadian response to another American request for market spacecould be "we gave at the office," Mussell said.

"We gave you access and you walked away, so no if you want to come back, it's there [in the TPP]."

In the meantime, other countries will supplymost of the CPTPPimports, he said raising the possibility that Canada won't have room to concede much throughNAFTA, at least basedon its TPP-eracalculations of whatCanadacould afford.

Cows in the street

A big American ask, followed by a smaller Canadian give, would mirrorwhatplayed out in the TPP's endgamein 2015.

Canada was in the middle of a federal election campaign at the time. Areport that the U.S. wanted10 per cent of Canada's dairy market brought farmers, and their cattle, into the streets in Ottawa. That provided Canadian negotiators with a helpfulvisual to drive home the messagethey had to deliver to the Americans:largeconcessions arepolitically impossible.

Quebec voters head to the polls this fall, and the next federal campaignis justa year away. Up to now, it's beenMexicans and Americans eyeingelectoral consequences. Soon, it will be Canada's turn.

Quebec nationalists have always been staunch defenders of Canada's supply management system. A Bloc Qubcoismedia release this week warned about the views of former prime minister Brian Mulroney, who has advised the Trudeau cabinet on the NAFTA talks.In a February speech in Winnipeg, Mulroney said ending supply management would be goodforprocessorsand make food more affordable, but farmers would have to be offered enough compensation to make them"very happy."

"Getting rid of it means getting rid of $25-30 billion in quota values," Wolfe said. "From the standpoint of the federal budget, you wouldn't want to absorb that ... I've yet to see a realistic policy as to how you could unwind the quota in a way that wouldn't blow the fiscal framework."

A joint statement from Quebec Premier Philippe Couillard and Ontario Premier Doug Ford at last month's summer premiers' meeting "emphasized the importance of supply management to the Canadian economy."

'We are the weaker partner'

Since Quebec dairy farmers helped a Conservative win ariding away from the federal Liberals in a June byelection, Prime Minister Justin Trudeau appears to have been paying more attention to the supply management file. He recently recorded a message for the Dairy Farmers of Canadasaying his government would "protect and defend" supply management,"and that includes at the NAFTA table."

"I think Canada will have to concede plenty in order to have an agreement with the U.S. because we are the weaker partner,"said Sophia Murphy, a B.C.-based senior adviser with the Institute for Agriculture and Trade Policy.

"Understanding that the politics are complicated ... my impression is that the trade negotiators find [supply management]slightly embarrassing. You know, it's not very 21st century [to have a protectionist system.]

"In the end, this is a losing gameif, every time there's a negotiation, they give up another two, another three and another four per cent," she said. "There's a larger question eventually about whether this works for us."

And yet, Canada's marketing boards doprevent overproduction something that plagues countries that liberalize their agriculture trade and depresses world prices. U.S.farmers get huge subsidies from the taxpayerto stay afloat.

"The United States is not about trying to get Canada to ditch its supply management system," U.S. Agriculture Secretary SonnyPerduetoldCBCNews in June.

Other alternatives?

Two aspects of Canada's dairy system do frustratethe Trump administration, and congressional leaderslike New York's Chuck Schumer and Wisconsin's Paul Ryan.

The first is what's referred to as "class 7," a recentpricing change based onan agreementbetween farmers and dairy processors to lower the price ofingredients.

It made Canadian products price-competitive, squeezingout U.S.diafiltered milk that had been coming intariff-free by exploitinga loophole in the tariff schedule.

Earlier this year, Couillardmet with Americans and, in a later interview with Bloomberg News, floated the idea of doing something aboutclass 7while makingsure farmers were "adequately compensated."

But the ingredient pricing changeis key to stabilizingCanada'smarket. Without it, high processor demand for butterfatcreatesunsustainable surplusesof skim milk products.

Because of that, ending class 7 would be "really costly," Mussellsaid. "More costly than an access play."

Tariff cut?

Instead, Mussellpointed to another possible source of trade concessions. It's Trump's other obsession: the "270 per cent tariff" Canada imposes on U.S. dairy products.

That tariff applies to imports above the TRQvolumes. Itspurpose isn't taxation;no one really pays it because it basically blocks imports.

Mussellpointedto research by Larry Martin at theMacdonald-Laurier Institute suggesting thetariff rates that protect supply-managed sectors are so large they could withstand a cut without substantially harming Canada's industry.

In a NAFTAcontext, global traderules mayallow Canada to have a special tariff rate for the U.S. alone, Mussell said.

Rather than being guaranteed a designated slice of the market (the liberalizing argument goes), Americans would have to compete for it at new rates, offering the domestic industry incentives to innovate. And Trump could brag about winning a bigtariff cut.

But supply management'sdefenderssay that's the top of a slippery slope, one that could undermineCanada'sproduction and price controls.

Currently, NAFTA consists of three separate bilateral agreements on agriculture one Canada-U.S. deal(dating back to their first free trade deal), one U.S.-Mexico deal and one between Canada and Mexico reflecting the fact that, when it comes to farm goods, each trading relationship is unique.

This week, the U.S. and Mexico continued to meetover serious differences ontheautomotive chapter. An Americanconcession on something Mexico wants for its horticulture sectormaygrease those wheels.

As what trade negotiators call the "sequencing" of acomplicated trilateral trade negotiation unfolds, a conversation betweenthe U.S. and Canada may follow.

That's when Canadian negotiatorsmay find themselves weighing potentialgainsagainst continuing to playdefence on dairy.