The Canadian government made an all out effort to be asked to join the Trans-Pacific Partnership (TPP) free trade agreement negotiations.  The U.S., Australia and New Zealand believe the Canadian government’s supply management programs for dairy and poultry that limit imports to maintain high domestic market prices should be part of the negotiations.

Canada’s national supply management program for milk was started in 1972, eggs in 1973, turkey in 1974 and young chicken meat in 1978.  The supply management programs have three common factors: 1) government set market prices determined by a cost of production formula including imputed costs for farmer supplied labor and a return to equity and management; 2) production limited to what the domestic market will consume at the cost-determined market prices; and 3) border tariffs to keep out less expensive foreign products.  It is the third factor that makes the programs an issue to be addressed in the TPP talks.

These programs were specifically excluded from the Canada-U.S. Free Trade Agreement in 1987 that was the basis for NAFTA that came into force at the beginning of 1994.  Canada used GATT-legal import volume quotas to limit access to markets.  With the creation of the WTO, those quotas were turned into tariff rate quotas (TRQs) with over quota tariffs of 150-300 percent.  The supply management commodities account for about 20 percent of the value of agricultural production in Canada, and the government promotes free trade for the 80 percent of agricultural production while maintaining import restrictions for the supply management commodities.  If the WTO Doha Round talks had moved to conclusion, Canada would have been pressured to lower over quota tariffs rates or have the products identified as ‘sensitive’ with limited tariff reductions.

Producers of the supply managed commodities are opposed to change because the high government set prices have resulted in the quota (the right to produce and sell the products) taking on a value of its own as quota is free to be bought and sold.  That has happened throughout the world, including the U.S., when governments restrict domestic production and limit imports to achieve politically determined market prices.  Consumers pay higher prices and that income is attached to the quota as the most limiting factor for production.  If the Canadian government changed the supply management programs to accommodate its trading partners, the quota holders could demand payments for the lost value of the quota.  Similar actions were taken for sugar in the EU, milk in Australia, and peanuts and tobacco in the U.S.

According to the U.S. agricultural attaché in Canada, milk is the third largest product in Canadian agriculture after grains and red meats, with fluid milk consumption accounting for 40 percent of production.  Since 1999 the number of dairy cows has decline 17 percent, while milk production has increased 2.4 percent.  Over the last 10 years, the number of dairy farms has declined by 36 percent.

Canadian dairy product imports in 2010 were C$610 million and exports were C$227 million.  Much of the exports were for products that were imported at world market prices under a re-export program begun in 2003.  This allows processors to achieve economies of scale and be competitive in export markets.

In the young chicken meat industry, production volume decisions are made before every 8-week cycle, with prices received for each cycle based on the government calculated costs of production.  The national volume is allocated to each of ten producing provinces where allocations are made to individual producers.  The industry is not integrated and independent chicken farmers supply birds to processors.  The price guarantee applies only at the farm level; prices for all other segments of the supply chain reflect normal supply and demand factors.

Production grew 5.8 percent per year in the 1990s and slowed to 1.6 percent per year for the last ten years.  Production was up less than 1 percent in 2011.  Young chicken meat is consistently higher priced for consumers than beef and pork which are not part of supply management programs.  The TRQ under NAFTA is 7.5 percent of last year’s production, about 77,000 MT for 2012.  Over-quota tariffs are 240-250 percent.  Imports are about 135,000 metric tons (MT) per year, with 85 percent coming from the U.S. and another 12 percent from Brazil.  Exports are about 155,000 MT with 40 percent going to the U.S. under the same re-export program used in dairy.

The two market tests for assessing the distortions caused by the supply management programs are the value of the quotas and the re-export program introduced in 2003 to make Canadian processors competitive with U.S., Brazilian and EU food exporters.  The re-export program is a political work-around of the outcomes from politically determined market prices.  According to Statistics Canada’s balance sheet for agriculture on December 31, 2010, the quotas for the supply management programs have a market value of C$30 billion.  The value has been rising in recent years, it was C$24.8 billion in 2004, indicating that farmers think the programs will continue and increase in value.  The provinces with the biggest quota values are Ontario at C$10.4 billion and Quebec at C$9.3 billion.

Governments have the right to run income transfer programs anyway they wish.  When governments enter into talks with other governments about free trade agreements, they give up some of those prerogatives to gain the benefits of increased economic efficiencies through trade.  That normally means giving increased market access, the hard currency of trade talks.  Running a supply management program for a commodity without import restraints has not been possible.  Canada will need to change its programs or make some huge market access changes in other areas to offset the market access not given for the supply management commodities.

Canada must reach an agreement on the overall TPP free trade agreement to protect its place in U.S. supply chains that will be driven in part by the national content rules for the current TPP participants and possible new ones.  The only question is what will be the politically acceptable trade-offs on agricultural commodities.

Ross Korves is an economic policy analyst with Truth About Trade and Technology