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CUSMA Dairy Challenge: “Déjà Vu All Over Again …”

On December 9, 2020, the United States took the initial step in the first formal trade dispute under the newly minted (July 1, 2020) Canada-United States Mexico Agreement (CUSMA). The U.S. Trade Representative (USTR) made a formal request for consultations with respect to Canada’s import limits on a variety of dairy products, claiming that these measures unfairly restrict U.S. dairy farmers’ access to the Canadian market contrary to CUSMA Article 3.A.2 of CUSMA.[1] Pursuant to CUSMA Chapter 31, the United States may request the establishment of a dispute settlement panel if the matter is not resolved by consultations.

While Canada has faced great pressure from the United States, the European Union and other trade partners to dismantle supply management for decades, it has operated under the cover of a well-established trade law exception for almost 75 years. The original 1947 GATT included an important exception to the Article XI prohibition of non-tariff restrictions (import bans) with a consensus-driven provision for agricultural products. Article XI:2(c)(i) provided that the general prohibition:

…. shall not extend to the following:

(c) Import restrictions on any agricultural or fisheries product, imported in any form, * necessary to the enforcement of governmental measures which operate:

(i) to restrict the quantities of the like domestic product permitted to be marketed or produced, or, if there is no substantial domestic production of the like product, of a domestic product for which the imported product can be directly substituted.

Article XI:2(c) sets out the conditions[2] that provide the cover for Canada’s supply management system–one that evolved from co-operative efforts in the 1930s by Canadian dairy farmers to establish stability in a domestic market afflicted by unpredictable production cycles. It is based on three pillars 

  • Domestic production control, based on demand and administered through a program of government-administrated quotas;
  • Set prices based on cost of production and negotiated between the government and producers;
  • Import controls designed to plan domestic production and avoid pressure on pricing.

For the system to work, there must be strict limits on imports of supply-managed products and Article XI:2(c)(i) permits restrictions on the import of any of the supply-managed commodities over a set volume or quota. Prior to 1995, imports above the annual set quota were restricted through a complex process based on total demand and total Canadian domestic supply, with an allowance or quota for low, pre-determined global volume of imports. These import quotas were allocated to individual importers through an import permit system.

During the NAFTA re-negotiations, the Trump Administration pressed for the elimination import restrictions but in talks that went into the into the final hours, Canada was able to preserve its vital pillar for the supply management system. However, the United States to obtain increased access for U.S. dairy producers via tariff-rate quotas (TRQs).[3] The concessions, amounting to an estimated 3.59% [4] of the Canadian dairy market, were viewed as a heavy blow by Canadian dairy farmers and significant progress by their U.S. counterparts, who estimate it could mean more than USD 300 million a year in U.S. exports to Canada.[5]

When Canada decided to assign much of the new quota to Canadian dairy processors, U.S. dairy producers protested that Canadian processors will simply import lower-value milk products and turn them into higher-value, retail-ready products rather than import the competing high-value products. The USTR complaint sets out four arguments against Canada’s (TRQ) allocation measures[6] :

  1. Canada is setting aside and reserving a portion of the quota to processors.
  2. Canada is not providing “fair” and “equitable” procedures and methods for administering its TRQs.
  3. As a consequence of reserving large shares of the quota for processors and so-called “further processors”, Canada fails to ensure that, “to the maximum extent possible”, the allocation is made “in the quantities that the TRQ applicant requests.”
  4. Canada’s allocation measures “introduce a new or additional condition, limit, or eligibility requirement on the utilization of a TRQ” that goes “beyond those set out in [Canada’s] Schedule to Annex 2- B.”

If bi-lateral consultations fail to resolve the matter, the future of Canada’s supply management system may well be in the hands of a dispute statement panel. This represents a bit of déjà vu as, just six months after NAFTA’s ratification in July 1995, the United States launched the first trade dispute under the agreement. As with the current matter, U.S. officials aimed at an essential pillar of Canada’s supply management system.[7] And the 1995 challenge was seen as “the most serious threat Canada has experienced since free trade with the United States began … [8] There were predictions a U.S. win would result in unlimited American imports and “… rural Canada could be devastated …” with a loss of 138,000 jobs and $16 billion in government revenues by the year 2000.”[9]

The U.S. argument was simple.[10] NAFTA Article 302 (“Tariff Elimination”) prohibited any new customs duties on trade between the parties and promoted the progressive elimination of existing tariffs. This included supply-managed products. According to the U.S. position, the new tariffs Canada introduced as part of the Uruguay Round GATT negotiations were incompatible with NAFTA ‘s rule against any new tariffs. Canada had lost its cover for import bans.

Until 1995, Canada’s system operated through quantitative restrictions (or import bans). At the conclusion of the Uruguay Round in 1994, the new World Trade Organization (WTO) Agreement on Agriculture, eliminated quantitative import restrictions. They were replaced with tariffs and tariff rate quotas (TRQs).[11] The tariff equivalents were set at levels intended to provide protection that would be equivalent in effect to the restrictions that were replaced. For Canada’s supply-managed products, this meant prohibitive tariffs, which remain in place today, ranging from prohibitive 168% to 300% rates for different products. The import quotas were replaced by tariff-rate quotas set at zero or low-rate duties.

In its reply, Canada set out a more complex defence based on the rules of treaty interpretation and Article 710 of the 1988 Canada – U.S. Free Trade Agreement (FTA) that provided for the incorporation of the supply management exception into the NAFTA:

Unless otherwise specifically provided in this Chapter, the Parties retain their rights and obligations with respect to agricultural, food, beverage and certain related goods under the General Agreement on Tariffs and Trade (GATT) and agreements negotiated under the GATT, including their rights and obligations under GATT Article XI

Canada argued that that the WTO Agreement on Agriculture was an “agreement under the GATT” within the meaning of Article 710 of the Canada-U.S. FTA, and that the “WTO tariff equivalent” for supply-managed products had been incorporated by reference into the NAFTA by the FTA provisions found in Article 710:

The U.S. countered that “retain” in Article 710 only grandfathered existing rights in 1994, not to future actions and that Article 710 did not apply to tariffs. Moreover, Article 710 referred to GATT “rights and obligations” but that “tariffication” was only an element of a trade round negotiation. If Canada had wanted the WTO deal to apply to the NAFTA it should have negotiated for it in the NAFTA negotiations.

Canada countered that, pursuant to international law on the interpretation of treaties as codified in the Vienna Convention on the Law of Treaties, the language of the treaties at play and the intention of the parties when the agreements were negotiated supported an expansive interpretation that brought Article 710 into full effect. The Panel followed Canada’s approach and cited NAFTA Article 102(2) that the agreement was to be applied “in accordance with the applicable rules of international law.” To the U.S. objection that the retention of GATT rights under Article 710 was simply a grandfathering provision, the Panel accepted Canada’s contention that the GATT body of law was an evolving system:

The GATT is more than a static set of rights and obligations. Based on a set of principles embodied in the General Agreement, the GATT has been developed, clarified and supplemented by subsequent legal instruments through successive negotiating rounds into a complex of substantive and procedural rules.[12]

As to the U.S. argument that the process of tariffication was neither a GATT right nor obligation, the Panel found that as part of the WTO Agreement, the Members had the “right to establish tariff equivalents” and;

To bring into the NAFTA only the obligation to eliminate non-tariff barriers without the quid pro quo for their elimination would ignore the agreement that made the elimination of the non-tariff barriers acceptable.[13]

Ultimately, the Panel concluded that the object and purpose of the original Canada-U.S. FTA Article 710 “… was to preserve for both Parties the agricultural protection permitted by the GATT … “[14] The Panel interpreted the interplay of the FTA, NAFTA, GATT and the WTO Agreement on Agriculture in a way that searched for both the underlying intent of the trade negotiators and examined the nature of the “bargain” between the parties.

At the end of the day, Canada had successfully defended a direct attack on its supply management system under the NAFTA’s first state-to-state dispute.[15]

How a CUSMA Panel will deal with the current matter remains to be seen. We will examine the specific issues in play in this first CUSMA challenge–the “Dairy Re-Match”–and review similarities and differences with the 1995 NAFTA case as well as potential arguments in the CUSMA in a future article.

______________________

[1]https://ustr.gov/sites/default/files/files/Press/Releases/CdaDairyTRQConsultationsReq.pdf

[2] GATT Article XI:2(c) concludes with a series of conditions for the application of the above restriction:

Any contracting party applying restrictions on the importation of any product pursuant to subparagraph (c) of this paragraph shall give public notice of the total quantity or value of the product permitted to be imported during a specified future period and of any change in such quantity or value. Moreover, any restrictions applied under (i) above shall not be such as will reduce the total of imports relative to the total of domestic production, as compared with the proportion which might reasonably be expected to rule between the two in the absence of restrictions. In determining this proportion, the contracting party shall pay due regard to the proportion prevailing during a previous representative period and to any special factors* which may have affected or may be affecting the trade in the product concerned.

[3] A TRQ sets out the amount of products that that can be imported without the applicable tariff. For example, the agreement will allow an extra 50,000 metric tons of fluid milk, and 12,500 metric tons of cheese, to enter Canada from the U.S. by the sixth year of the agreement.

[4] https://www.cbc.ca/news/canada/prince-edward-island/pei-macaulay-usmca-dairy-supply-management-1.4850537

[5] U.S. Expected to Make Dairy-Trade Complaint Against Canada – Bloomberg

[6] The CUSMA allows Canada to maintain the right to apply certain TRQs on dairy products, including for the following kinds of goods: milk, cream, skim milk powder, butter and cream powder, industrial cheeses, cheeses of all types, milk powders, concentrated or condensed milk, yogurt and buttermilk, powdered buttermilk, whey powder, products consisting of natural milk constituents, ice cream and ice cream mixes, and “other” dairy.

[7] In the Matter of Tariffs Applied by Canada to Certain U.S. – Origin Agricultural Products [NAFTA Secretariat No. CDA-USA-1995-2008-01 http://publications.gc.ca/collections/Collection/E100-2-1-95-2008-01E.pdf

[8] Francis Russell, “Canada’s Lame Defence” Winnipeg Free Press, February 5, 1995, A6

[9] Ibid.

[10] In the Matter of Tariffs Applied by Canada to Certain U.S. – Origin Agricultural Products [NAFTA Secretariat No. CDA-USA-1995-2008-01 http://publications.gc.ca/collections/Collection/E100-2-1-95-2008-01E.pdf

[11] Based on the U.S. proposal known as “tariffication,” this provided the protection of prohibitive tariffs while setting in motion a process of gradual liberalization as WTO Members were expected to negotiate the very visible tariff to much lower rates over time. With the collapse of the Doha Round the anticipated liberalization has yet to be realized.

[12] Panel Report para. 139

[13] Panel Report para. 183

[14] Panel Report para. 197

[15] For a more detailed review of the Panel’s findings, please see a joint article by Alan Willis QC and Michael Woods  The NAFTA Panel Decision on Supply Management: Gamble or Bargain? The Canadian Yearbook of International Law Vol 35, 1997: pp.81-112. https://www.cambridge.org/core/journals/canadian-yearbook-of-international-law-annuaire-canadien-de-droit-international/article/abs/nafta-panel-decision-on-supply-management-gamble-or-bargain/718EA44C2FB31B83A85B093AC6EC9370

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