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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Economic Brief: Economic Nationalism

Drafted By:Dr. Michael A. Weinstein

Since the emergence of globalized capitalist markets in the nineteenth century, the trade policies of states have cycled between support of liberalization and adherence to economic nationalism, depending on whether significant domestic interests are winning or losing in international competition.

The majority of economists who argue that free trade increases wealth in the long run and on the whole through the operation of comparative advantage also admit that in the short run some industries and regions are disadvantaged -- often severely -- by shifts in production to more efficient and innovative enterprises. The inevitability of winners and losers in trade competition opens the way for the latter to seek state protection and subsidies, either to allow them to mature into effective competitors or simply to survive.

Attempts to use the state to protect economic interests are normal, and success or failure is mainly dependent on the domestic balance of power, which in large advanced economies is determined by continual face-offs between winning and losing industries and sectors. More general shifts between liberalization and protectionism call into play public opinion, which can deepen and increase the scope of incipient tendencies.

Long the major supporter of trade liberalization in world forums, the United States has recently had to adjust to growing economic nationalism in the U.S. that is likely to result in a slowing and perhaps a reversal of the thrust toward liberalized global markets.

During the week of August 1, Washington found itself on the nationalist side of the trade spectrum when China National Offshore Oil Corporation (C.N.O.O.C.) withdrew its bid for U.S. oil company Unocal, citing "unprecedented political opposition," and Tokyo, acting within the guidelines of a World Trade Organization (W.T.O.) decision against Washington on steel tariffs, moved to impose punitive tariffs on some goods produced in the U.S. Although the Bush administration did not come down on the side of U.S. Congressional opponents of the C.N.O.O.C. bid and proponents of protecting the U.S. steel industry, it did nothing to resist the drift toward nationalism. [See: "Intelligence Brief: Unocal"]

C.N.O.O.C. Withdraws

C.N.O.O.C.'s bid to take over Unocal collapsed after both houses of the Republican-controlled Congress agreed to propose a bill that would require the departments of defense, energy and homeland security to investigate the bid before it was vetted through normal administrative procedures. The Congressional pressure, which promised to delay a successful C.N.O.O.C. takeover, was the result of a full-scale lobbying campaign by Unocal's other suitor -- Chevron -- that gained the support of security hawks as well as legislators in Chevron's constituencies, and spread to lawmakers playing to sentiments of economic nationalism.

The success of Chevron's strategy of throwing the viability of C.N.O.O.C.'s bid into question prompted Institutional Shareholder Services, a proxy advisory service, to announce on August 1 that Chevron's lower bid was "not unreasonable" in light of Congressional pressure which "opens the door for adverse developments that could place a C.N.O.O.C. bid in jeopardy." C.N.O.O.C. withdrew its offer the next day, clearing the way for Chevron's takeover.

The two most significant factors in C.N.O.O.C.'s failure were the intensity of Congressional opposition to its bid and the silence of the Bush administration throughout the fray. With powerful U.S. business interests on both sides of the issue, it is likely that the Congressional tilt to economic nationalism and the administration's acquiescence in it were fueled by the mobilization of popular sentiment against China over U.S. job losses, which made Congressional opposition to C.N.O.O.C.'s bid politically expedient and the administration's acquiescence in it politically prudent.

Tokyo Strikes Back

On August 3, Tokyo announced its imposition of punitive tariffs on a range of U.S. goods, including ball bearings and aircraft components, in retaliation for the failure of Congress to repeal the Byrd Amendment, which diverts the proceeds of U.S. tariffs placed on foreign steel that has been determined to have been dumped on the U.S. market directly to domestic U.S. steel producers.

Tokyo had argued successfully before the W.T.O. that the Byrd Amendment violated international trade agreements because it not only penalized Japanese producers, but also rewarded their U.S. competitors. Since the W.T.O. decision, the Bush administration has sought to have the Byrd Amendment repealed, but Congress has dragged its feet. As in the C.N.O.O.C. affair, powerful U.S. business interests are on both sides of the steel tariffs issue, with U.S. steel producers predictably in favor of keeping the Byrd Amendment in force and steel consuming industries in favor of its repeal.

In the case of the Byrd Amendment, the purely economic balance of power would seem to favor the forces for repeal, since steel consumers are more financially powerful and greater in number and political influence than steel producers. Organized as the Consuming Industries Trade Coalition, the consumer interests have made inroads in Congress, but have not achieved success. Their failure is another indication that sentiments of economic nationalism are providing added energy to protectionist interests, giving them victories on issues in which they would have lost or at least have had to compromise in climates of opinion more favorable to trade liberalization.

The Bottom Line

Signs of growing economic nationalism in the U.S. -- where mounting, though still inchoate, popular resistance to liberalization of global markets finds resonance in Congress -- do not portend a radical shift to protectionism, but a normalization of trade policy, in which internationalist and nationalist interests compete for influence in the state.

As rising economic powers throughout the world become more competitive, the U.S. is bound to lose comparative advantage in many industries, setting off moves for protection that will be opposed by industries that gain or maintain advantage.

Look for Washington to lose its role as leader in the drive for open markets and to become a player in a complex international system of markets that remain global but are hedged by restrictions and do not move in the direction of neo-liberal models of "free trade."

The greatest threat to normal bargaining that would set off a decisive tendency toward protectionism would be the mobilization of popular nationalist sentiment that political classes are unable to contain.
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Economic Brief: Textile Quotas

Drafted By: Erich Marquardt,Dr. Michael A. Weinstein

On January 1, 2005, international quotas on the exports of developing countries ended. The termination of the quotas, which had been in place for 40 years and was long-awaited by retailers, gave China the opportunity to greatly increase its exports of textiles to the United States, the European Union, and other countries. Indeed, in the first six months of 2005, U.S. imports on Chinese-made clothing increased 97 percent from the previous year, totaling US$7.4 billion. The E.U., too, witnessed a sharp increase in Chinese textile imports. For instance, the E.U.'s trade deficit with China in 2004 was €78.9 billion; in the first six months of 2005, that number already stood at €46.3 billion.

The imports, which are in response to a strong demand for Chinese-made apparel by U.S. and European retailers, have triggered protectionist measures in the United States and the European Union, as the two developed powers react to complaints by their domestic textile producers and labor unions who are unable to handle the increased competition from China.

The Effects of China's Textile Imports

The increase in Chinese textile imports has a negative effect on U.S. and European textile producers. These producers cannot compete with the production capability of China due to that country's low employee wages and weak labor laws. The termination of the quotas has hurt their businesses since retailers increasingly turn to China for cheaper products, thus increasing their potential for profit.

U.S. and European labor unions are also against the termination of the quotas since textile workers in these developed countries are losing their jobs to the Chinese. The lack of labor regulations and the low wages in China make it impossible for U.S. and European textile workers to produce the same quantity at such reduced rates. For instance, U.S. textile companies and clothing manufacturers have argued that due to the termination of the quotas, 19 U.S. textile factories have closed down, and some 26,000 American workers have already lost their jobs.

On the other hand, American and European retailers argue that the quotas were responsible for higher consumer prices. The retail industry looked forward to the end of the quotas at the beginning of 2005 since it would give them the opportunity to purchase cheaper goods. However, the implementation of new quotas, or "safeguards," has put them in the same boat as before. Indeed, in Europe, the situation has become desperate since millions of dollars of Chinese apparel is being held up on the E.U.'s borders.

Washington Places Safeguards on China's Textile Imports

In May, the United States responded to the increase in imports by placing "safeguards" on imports where domestic industries were threatened. It announced that it was investigating some 20 Chinese products to decide whether import restrictions should be instituted.

Then, on September 1, after the initial failure of three-day bilateral trade talks with China in Beijing, the Bush administration announced that it would reinstitute quotas on two categories of Chinese clothing and textile imports: fabric made with synthetic filament threads (such as spandex), in addition to bras and other body-supporting undergarments.

The meeting ended in disagreement, as the U.S. and China could not agree on new import rules. U.S. Commerce Deputy Assistant Secretary Jim Leonard responded to the implementation of the new quotas, saying, "Today's announcement demonstrates this administration's commitment to leveling the playing field for U.S. industries by enforcing our trade agreements." The U.S. then threatened that while it would delay further safeguards until October 1, at that date it would also place safeguards on four other textile products: sweaters, dressing gowns, knit fabric, and wool pants unless agreement is reached with the Chinese.

These actions are also premised on U.S. concern over the 2004 gigantic US$162 billion trade deficit with China. This year the deficit with China is 32 percent above the 2004 level.

While the U.S. has historically been the prime promoter of free trade and the ending of international trade quotas, the magnitude of Chinese textile imports brought such domestic pressure on the administration that it responded with protectionist measures.

Brussels Blocks China's Textile Imports

The E.U. had placed its own quota limits on Chinese textile imports in June 2005. The E.U. instituted the limits for the same protectionist reasons that the U.S. did. The quotas limited Chinese textile imports to an 8-12.5 percent growth rate per year. France, Italy and Spain were especially forthright about the quotas since they all have large domestic textile industries. In addition, France has been steadily instituting more and more protectionist measures, also seen through its shielding of strategic industries from outside buyers. And Italy wants to protect its domestic manufacturers, such as Marzotto SpA.

Once the limits were announced, European retailers excessively ordered Chinese-made apparel in an effort to fill their shelves before the quota limit was met. However, the limit was reached so quickly that it resulted in much of the retail orders getting stopped on Europe's borders by E.U. trade officials.

Now, tens of millions of Chinese-made garments are sitting on Europe's borders. Retailers, concerned that the hold-up will leave their shelves empty and cause them to lose business, reacted strongly, putting pressure on the E.U. to rethink the quota restrictions.

It created such a controversy that E.U. Trade Commissioner Peter Mandelson announced that the E.U. was preparing to unblock some 75 million garments from the borders. Beijing's official state newspaper, the China Daily, commented on the decision on August 31, saying, "This trade fiasco demonstrates that protective measures, at best, are zero-sum games for those who resort to them."

In the first few days in September, the E.U. struggled to find a compromise solution where producers and retailers could be placated. Mandelson argued, "Every day [that the products] are held costs money for European businesses and member states. It is unfair to penalize importers in this way." Mandelson also said, "I urge member states to move with utmost rapidity to approve the Commission regulation and get the goods released."

On September 5, Brussels and Beijing found a solution to the dispute. The E.U. announced that it will overlook half of the blocked imports, while the other half will go toward the 2006 quotas. If the 25-member E.U. body approves the agreement, then the some 75 million Chinese-made garments will pass through the E.U.'s borders and make their way to retailers and consumers.

The Bottom Line

The imposition of import restrictions on Chinese textiles by Washington and Brussels is one of many recent instances of a growing tendency toward protectionism in wealthier countries that find their domestic industries threatened by lower cost producers in rising economic powers. Interest groups in the countries with advanced economies that are disadvantaged by competition can be expected to continue to mobilize as they suffer further losses. As they defend their sectoral interests, they will attempt to fan sentiments of economic nationalism within the general public.

As wealthier countries move to protect their industries from outside competition, it can damage the economic growth rates of developing states. For instance, the U.S. and E.U. textile restraints placed on Chinese imports has had ramifications for the Chinese workforce since demand for Chinese-made products has gone down, thus putting people out of work and potentially putting factories out of business, hampering the country's growth toward becoming a strong economic power.

The drive for global free trade, once championed by states with advanced economies, appears to be encountering an obstacle, if not a limit. Look for increasing difficulty in promoting relaxed trade restrictions -- particularly in the W.T.O. -- as governments are pressured to protect domestic interests. If trade disputes begin to spill over into broader relations among states, globalized trade itself could suffer declines and trade disputes could exacerbate and cause political and even military conflicts.
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Intelligence Brief: Moldova

Drafted By:Federico Bordonaro

The Moldovan separatist state of Trans-Dniester is increasingly at the center of a major geopolitical battle between Russia and the E.U.-U.S. combine in Eastern Europe. Situated between Ukraine and Moldova, Trans-Dniester proclaimed its independence in 1992. Although formally dependent upon Chisinau, the region is actually controlled by Moscow, which maintains its 14th Division (over 1,400 troops) in the Trans-Dniestrian territory. Washington would like an "orange revolution" -- of the kind that recently occurred in Georgia and Ukraine -- to take place in the separatist state to expunge Russian influence there.

A Russia-Moldova quarrel is, therefore, inevitable. Behind the dispute, the battle for Eastern Europe is once again emerging.

Moldovan Geopolitical Issues

Moldova, an independent state since the collapse of the U.S.S.R., is actually the old czarist region of Bessarabia without its southern part -- Budjak, which is now part of Ukraine -- which once gave it access to the Black Sea. Trans-Dniester (the region east of the Dniester River) has a population of over 700,000, the majority of whom are of Ukrainian and Russian descent (whereas ethnic Moldovans speak a Romanian dialect). This separatist state raises permanent concerns among European diplomats both because of its destabilizing effects on Moldova and because it functions as a smuggling hub in Southeastern Europe.

After the fall of the Soviet Union, Chisinau and Kiev signed a treaty to regulate their disputes. Ukraine would renounce its claims to Trans-Dniester and Chisinau to Budjak. After the recent pro-Western turn in Ukraine, however, the Trans-Dniestrian state increased in geopolitical importance and in its potential destabilizing effect for Russian influence in Southeastern Europe.

Since its independence, Moldova has tried to follow the example of Romania by progressively matching the requested criteria for admission into the European Union. The European Union is perceived by Chisinau as the best guarantee against both Moscow's and Bucharest's hegemonic drives on its soil. Moreover, E.U. membership for the former Warsaw Pact states mean entry into N.A.T.O. Almost all the new elites in Eastern Europe consider that a double security guarantee (N.A.T.O. plus the E.U.) is the best solution for coping with regional threats.

As a consequence, a pro-E.U. Ukraine immediately formed a Western-oriented axis with Moldova to the detriment of Russian interests. Therefore, maintaining a solid grip on Trans-Dniester is Russia's strategy to avoid being expelled from the region.

Moscow's strategy has been to back Trans-Dniestrian President Igor Smirnov's request for national independence, rejecting the regional autonomy solution proposed by Chisinau. Russian decision-makers believe that an independent Trans-Dniester would be a solid Russian rampart against Western penetration.

As Ukraine borders Trans-Dniester, Kiev's new president Viktor Yushchenko and Moldovan President Vladimir Voronin formally asked the E.U. in June 2005 to help the two states collectively monitor the Ukrainian-Trans-Dniestrian frontier. This move infuriated Russian Foreign Minister Sergei Lavrov, who sees it as a maneuver to progressively wipe out Moscow's influence from Trans-Dniester.

On July 22, however, the Moldovan parliament voted a law intended to give Trans-Dniester a higher degree of autonomy. Chisinau hopes to pave the way for reconciliation with the separatist state without losing its sovereignty over it. By pursuing this strategy, it hopes to receive support from the European Union. In fact, although the current majority in Moldova is neo-communist, its policy is overtly pro-Western and aimed at joining the E.U.

Once again, as in the case of Ukraine in December 2004, the E.U. and the U.S. appear to be working together in Eastern Europe against fundamental Russian interests, whereas such cooperation is far more difficult on other issues such as Iraq. Brussels needs to secure the entire corridor from the Baltic Sea to the Black Sea, and cannot afford to inherit a potentially explosive conflict such as the Trans-Dniestrian issue (with Russian implication).

Henceforth, the Russo-Moldovan dispute is to be read also in light of the recent confrontation between a Russo-Belarusian combine against a Polish-inspired enhanced cooperation group formed by Lithuania, Poland, Ukraine and Georgia. These latter states, backed by the U.S., are working together to form a liberal "vertical axis" from the Baltic to the Black Sea in order to facilitate oil and gas transport from Kazakhstan and Caspian sources to Eastern and Northern Europe without passing through Belarus. [See: "The Poland-Belarus Controversy and the Battle for Eastern Europe"]

A pro-Western Moldova, integrated into the E.U. and with a settled Trans-Dniestrian conflict, would be of great help for such a regional project. Moreover, Moldovan stability is also in the interests of other European states such as Italy, whose small and medium-sized business enterprises have established important production and commercial ties with the former Soviet country.

The Bottom Line

After the battle for Ukraine, and the quarrels over Belarus, look for Moldova to be the next epicenter of the U.S.-Russia geopolitical conflict in Eastern Europe. Security and energy issues go hand in hand in the region, and a new setback in a traditionally pro-Moscow region would be disastrous for Russian President Vladimir Putin.

As parliamentary elections in Trans-Dniester approach -- scheduled for December 2005 -- the social split between pro-Moldovan and pro-independence citizens in the region is likely to worsen.

Independent of the election's outcome, expect the European Union to back Moldovan efforts to resolve the Trans-Dniestrian question, and the U.S. to seek to ensure that this process marks the end of Russian predominance in the region.
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