April 29, 2006

The Canada-U. S. Compromise on Softwood Trade

by Rodrigue Tremblay



Unless they are in the construction industry, most Americans don't know that the main trade dispute between Canada and the U. S. has been a 25-year old conflict over softwood lumber. This is a conflict that has done much damage to Canada-U. S. relations. Canada exports annually about $10 billion worth of softwood lumber (mainly spruce, fir and easy-to-saw pine) to the U.S. home-construction and renovation sectors, taking about a one-third share of the American lumber market.


Under the Free Trade Agreement between Canada and the U. S., signed in 1987 and implemented at the beginning of 1988, trade in most goods between the two countries is tariff-free and quota-free. The North American Free Trade Agreement (NAFTA) that has brought Mexico into the agreement, reinforced the largest free trade area in the world. With most private investment also being liberalized in North America, some large American companies, such as Weyerhaeuser Co. and International Paper Co., are directly involved in producing wood in Canada for export to American buyers.


Presently, the demand for and prices of construction-grade softwood lumber products have increased due to the boom in construction and also due to the devastation brought on by severe hurricanes in 2005, as witnessed by Katrina in New Orleans and Wilma in Florida. There is also an 18-20 year cycle in real estate that seems to have peaked with the bubble in home prices in early 2005. All this is to say that softwood prices are currently very high and contribute to raising the cost of building new houses.


Another factor that has contributed to raising the price of softwood lumber in the United States has been the punitive tax (countervailing and dumping duties), which has varied between an average of 29.1 and 10.8 percent, that the U. S. government has been levying on Canadian softwood lumber for many years. Indeed, over the last quarter of century, softwood has rarely been traded freely between Canada and the U. S., because American producers and the U. S. government have argued that Canadian producers harvest trees at below-market prices on government-owned land.


Canada has taken the position that trees are more plentiful in Canada than in the U. S., and that is the main reason why lumber is cheaper in Canada than in the USA. Indeed, such is the foundation for international trade based on the law of comparative advantage.


Canada has always considered that the U. S. discriminatory border taxes were unwarranted and contrary to free trade, and asked trade panels established under the North American Free Trade Agreement and the World Trade Organization to declare them illegal. Indeed, in numerous rulings, the NAFTA and WTO panels have ruled many times in favor of Canada and declared the U. S. duties on Canadian lumber imported into the U. S., illegal. While recognizing that the Canadian lumber industry was somewhat subsidized (less than one percent), the rulings established that this posed no material injury to U. S. producers.


Nevertheless, prompted by the American forest products industry lobby, the U. S. government has repeatedly refused to abide completely by the rulings and has continued to impose duties on softwood lumber imports from Canada, under the pretext that it had to protect American workers and lumber companies from unfair trade, irrespective of its trade agreements. As a consequence, many small Canadian softwood producers have been loosing clients in the United States and the financial drain caused by the punitive U. S. tax has pushed some of them toward bankruptcy.


This is the conflict that was tentatively settled last Thursday April 27 (2006), with a compromise agreement between Canada and the United States. It will take two or three months to work out the details.


In summary, the so-called softwood compromise agreement provides for duty-free Canadian exports of softwood lumber to the U. S. under two conditions: it is free trade as long as Canada's share of the U. S. lumber market remains below the recent historical average of 34 percent and as long as the North American market price for softwood lumber remains above $355 US per thousand board feet. When and if these thresholds are violated, Canada will have to levy export taxes on its lumber en route to the U. S. and/or impose export quotas to limit voluntarily its exports of softwood lumber, on a increasing sliding scale. For example, if softwood lumber prices were to fall under $315, exporters from Canadian provinces would be hit with a 5 to 15 percent tax and the total Canadian export quota would be reduced to 30 percent of the U. S. lumber market. As we see, the compromise is for "managed" trade for the next seven years, possibly renewable for two more years, and not an agreement about "free" trade.


In addition, the U. S. government will reimburse Canadian exporters only 80 percent of the $5 billion it has (illegally) levied in punitive duties since May 2002, with about $1 billion staying in the U. S. — half going to the American Coalition for Fair Lumber Imports, mainly to pay for their legal fees, and the rest being divided between joint North American lumber marketing initiatives and "meritorious initiatives" in the U. S., such as the rebuilding of the city of New Orleans.


There you have it.


In the past, Canada and the USA signed similar deals, notably in 1986 and 1996, but none was renewed at expiration. Is the present agreement a fair compromise or is it a deal that has been obtained under duress, after the Bush administration pushed Canadian producers against the wall and the Harper government was hoodwinked and caved in to American demands? Moreover, could a clearly politically driven trade deal undermine the entire legal framework of NAFTA and the WTO? Indeed, is there not a dangerous message being sent that WTO's and NAFTA's dispute resolution systems are worthless? In the long run, this could have detrimental consequences for the entire international trading system.


The principal short-term benefit derived from the agreement is the removal of uncertainty hanging over both Canadian producers and American builders. At least for seven years, production planning can be done without the fear of legal and fiscal disturbances. Also, for financially strapped Canadian producers, the reimbursement of some $ 4 billion of border taxes will be most welcome, and this explains why many decided to accept the deal, with a feeling of resignation, even if some consider it most unfair.


Indeed, the group most responsible for the dispute, the American lobby of lumber producers, will be rewarded with a half billion dollar subsidy, even though their complaints have be rejected by the NAFTA and WTO rulings. Their lawyers are laughing all the way to the bank. It is a precedent that other U. S. industries may be tempted to adopt in future trade disputes.


American trade officials also have reason to rejoice. Given the fact that the price of lumber is relatively high in the current building cycle, they can reasonably assume that they have boxed in the Canadian negotiators by committing them to impose export taxes as soon as the current building boom in the U. S. subsides, or when Canadian producers take a larger share of the U. S. market. Since the building-products market is expected to weaken over the next few years, as construction declines, Canadian exporters may be facing punitive taxes or export restrictions sooner than many expect.


For these reasons, I believe the $355 price per thousand board feet is too high a floor to establish softwood free trade between the two countries. The choice of an average price over many years would have been more logical and less detrimental to Canadian producers. Considering also that the Canadian dollar is posed to appreciate vis-a-vis the US dollar in the coming decade (after an expected short term correction because of the current overvaluation), mainly under the influence of high energy prices and high interest rates, the compromise agreement may look less and less attractive to Canada in the coming years. There could then be a political backlash against a trade deal that would be seen as a sell-out in Canada. —We shall watch how all this unfolds.



Posted by Rodrigue Tremblay, April 29, 2006, at 12:30 p.m.


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