Thursday, September 08, 2005

Economic Brief: U.S.-Canada Softwood Lumber Dispute

Drafted By:Dr. Michael A. Weinstein

The persistence of protectionism in a period of a supposed drive for global free trade is nowhere better illustrated than by the chronic and increasingly bitter dispute between Ottawa and Washington over U.S. restrictions on imports of Canadian softwood lumber. While the conflict has had little visibility in the U.S. outside directly concerned interest groups, it has become a major issue for the broad Canadian public, awakening anti-U.S. attitudes and spurring sentiments of economic nationalism.

As, respectively, the largest producer and consumer of softwood lumber in the world, Canada and the U.S. have a natural symbiotic trading relationship in the product. Over the last ten years, Canada has claimed one-third of the U.S. softwood lumber market, with the exception of the period in 1995 and 1996, when there were no U.S. import restrictions and the share rose to 36 percent. Due to the boom in housing construction in the U.S., exports of Canadian softwood lumber to the U.S. rose from 18,698 million feet in 2000 to 20,950 million feet in 2004, and are on the way to setting a new record in 2005. Canada receives US$7.5 billion from the trade, accounting for 2.4 percent of its total exports of US$316 billion, of which energy and auto parts have the greatest share.

In Canada, there is a predictable unanimous judgment that there should be no restrictions on trade in lumber since there are no countervailing interests to contest that view. The picture is different in the U.S., where lumber importers, retailers and home builders form a coalition in favor of unrestricted trade, and higher cost U.S. lumber companies fight for continued protection.

The core of the dispute is the U.S. lumber companies' argument -- rejected by the Canadians -- that Canada unfairly subsidizes its lumber industry. In the U.S., most harvesting of timber is done on privately owned land, whereas, in Canada, 90 percent of the cutting takes place on public land. U.S. companies contend that the Canadian provinces subsidize their producers by charging artificially low cutting fees. With the support of members of the U.S. Congress from lumber producing states, particularly in the southeast and northwest, the Bush administration responded to industry pressure in 2002 by imposing tariffs averaging 20 percent on Canadian lumber. Ottawa retaliated by filing two dozen suits in trade arbitration bodies seeking judgments that the tariffs should be repealed and their accumulated proceeds be returned to Canadian companies.

Canada's Institutional Strategy Ends in Stalemate

Ottawa's shotgun strategy of pressing its case for relief through the maze of regional and international trade bodies that has proliferated since the fall of the Soviet Union took it into the dispute resolution mechanisms of the North American Free Trade Agreement (N.A.F.T.A.), the World Trade Organization (W.T.O.), the U.S. International Trade Commission (U.S.I.T.C.) and now the U.S. Court of International Trade (U.S.C.I.T.). For the most part, Ottawa won its legal battles, as Washington appealed rulings adverse to it along the line and refused to budge.

Ottawa suffered a blow in 2004 when the U.S.I.T.C., ruling in favor of Washington, accepted the U.S. lumber producers' argument that Canadian subsidies to its softwood lumber industry threatened to damage the U.S. industry. Continuing its fight, Ottawa won a major victory on August 10, 2005 when a N.A.F.T.A. panel -- the final court of appeal -- ruled that Canadian practices did not threaten U.S. lumber producers. To the consternation of Ottawa, Washington simply ignored the N.A.F.T.A. judgment and continued to fight its case in the W.T.O. Ottawa then broke off ongoing negotiations with Washington on the dispute.

The W.T.O. had previously ruled against Washington on the softwood lumber tariffs, saying that the U.S.I.T.C. decision "could not have been reached by an objective and unbiased investigating authority." On August 29, after receiving new evidence from Washington, the W.T.O. issued a preliminary ruling reversing its earlier judgment. Surprised and stalemated by the new W.T.O. ruling, Ottawa expressed its determination to appeal and to take its case to the U.S.C.I.T., which functions to settle discrepancies between N.A.F.T.A. and W.T.O. rulings. Meanwhile, Washington called for Ottawa to return to bilateral negotiations, which Washington hopes would lead to a stable agreement on managed trade such as the kind of quota system that had been tried in the past.

Canada Assesses its Options

The wrangling between Ottawa and Washington over softwood lumber would just be a normal localized trade dispute were it not for the imbalance between the great salience that it has in Canadian politics and its negligible importance in U.S. politics.

Traditionally dependent on the export of primary products for their prosperity, Canadians place trade issues high on their political agenda and their politicians respond to that priority. Washington's refusal to honor the N.A.F.T.A. panel's decision fueled growing anti-U.S. sentiment in the Canadian public and its political class, with parties across the ideological spectrum backing a hard line from Ottawa. The W.T.O. ruling provoked shock, opened up divisions among interests and precipitated a rethinking of the institutional strategy and a consideration of a wide range of other options.

Despairing of a victory for Ottawa, lumber interests in the Canadian west, which represent efficient producers, began to move toward the fallback position of managed trade, whereas less efficient eastern producers continued to call for a hard line. Ottawa promised to pursue its institutional strategy to the bitter end, as nationalist sentiment rose and calls came for retaliatory tariffs on California wine and Florida orange juice, the imposition of a tax on energy exports to the U.S. that would recoup the US$5 billion paid on the softwood tariffs, and outright Canadian withdrawal from N.A.F.T.A.

The Bottom Line

With 86 percent of Canada's total exports going to the U.S., the reconsideration of managed trade by the country's western lumber interests and the expected spike in demand for softwood lumber from rebuilding projects on the U.S. Gulf Coast in the wake of hurricane Katrina, it is unlikely at present that Ottawa will pursue its more drastic options and risk a trade war.

Yet Washington, which would like to contain and isolate the dispute, is now faced with the possibility that nationalist sentiment in Canada will provide an environment for escalating the dispute beyond its directly interested parties. Although they are currently superficial, the softwood lumber dispute has revealed cracks in Washington's primary trading bloc that will deepen unless they are patched.
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URL:http://www.pinr.com/report.php?ac=view_report&report_id=361

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