U.S. blat de moro, tomato, orange and wine producers have discovered that they may be caught in a 25 year-old dispute over exports of softwood lumber from Canada to the U.S. Canada is considering retaliation because the U.S. has failed to respond to the latest NAFTA ruling against U.S. duties that were set in 2002. The issue was further complicated this week when the WTO ruled in favor of the U.S. in a case brought to uphold revised duties set in December of 20004. After 12 years of NAFTA the three countries have failed to develop an effective dispute resolution system.

The U.S./Canadian softwood lumber dispute is a good case study for thinking about how to reform the dispute resolution process. In softwood lumber the two countries have different resource ownership systems. The Canadian provinces own 90 percent of the timberlands. The provinces set stumpage fees (the right to harvest trees), and U.S. companies argue these fees are set artificially low and constitute a subsidy. Canada also restricts exports of logs that could be used to keep U.S. mills open. In the U.S. només 42 percent of the timberlands are government owned, and much of that timber is sold on competitive bids. Log exports from federal and state government lands are prohibited, but there are no restrictions on logs from private lands.

Logs and lumber would naturally flow from Canada to the U.S. under any approximation of a market system. Canada has a population of 32 million compared to 298 million in the U.S. It has extensive timberlands in both the eastern and western portions of the country. Canadas share of the U.S. lumber market has grown from about 7 percent in the early 1950s to 33-35 percent since 1995. U.S. producers argue that the growth has been too large; Canadian producers say increased market share is a logical outcome.

The first complaints were received by the U.S. Department of Commerce and the U.S. International Trade Commission in 1981. la 1983 investigation ended with no policy change. la 1986 investigation resulted in a finding of harm and resulted in the U.S. and Canada agreeing on a 15 percent tax on lumber exports to be replaced with higher stumpage fees within five years. a 1991 Canada ended the agreement because stumpage fees had been increased. That resulted in another investigation and finding of harm in 1992. Els EUA. lost a series of rulings on that investigation under the U.S.-Canada Free Trade Agreement. a 1996 the two countries agreed to a five-year deal with a quota and an over-quota fee. That agreement expired in March of 2001. The present dispute is based on determinations of harm made in 2002 and in 2004. Since 2002 Canada has initiated about two dozen cases under NAFTA, the WTO and in U.S. courts.

Twenty-five years of policy conflicts has allowed government and industry positions on both sides to become hardened. Sobre $5 billion in duties ride on the outcome of the dispute. Some policy watchers believe that the money involved is now so large that lawyers and lobbyists on both sides will drive the process unless top-level political intervention occurs.

In thinking about how to prevent reoccurrences of this type of situation, two points are critical. First, trade agreements like NAFTA are designed to lead to increased market integration in the short run and one large market in the long-run. Homes built in all three countries should use building supplies from all three countries based on supply and demand factors.

Second, while NAFTA encourages this type of integration, each country has maintained its existing domestic policies that attempt to protect against unfair competition from the other two countries. From cement to corn to pork to sugar to wheat there are a host of trade disputes in which each country is trying to use its traditional domestic policies to resolve issues.

Any changing in those domestic policies must address legitimate concerns about the sovereignty of each country to pursue domestic policies. The issue is not about giving up sovereignty, but about recognizing that achieving the economic benefits of market integration requires a new framework for settling what trade disputes are no longer in their traditional sense.

Cross border disputes between Canada, Mexico and the U.S. are no longer the same as a dispute between any of the three countries and a fourth country such as Brazil and should not be handled in the same way. Some Canadian leaders have argued that the NAFTA relationship should be the final authority. If that is to be true, then an appropriate dispute resolution system that meets the needs of the three countries must be established.

As a place to start, some type of timeout mechanism needs to be developed to halt the escalation in the intensity of disputes. If a disagreement cannot be resolved in two to three years, a mandated cooling off period of perhaps five years would be imposed. In the soft wood lumber case there has been, by mutual agreements, two periods of calm.

Public policies that artificially keep economic activity in one of the three countries need to be reconsidered. Market integration by definition means that resources will move across borders seeking the best economic match to achieve economies of scale, specialization and the use of fixed investments that have little or no value in alternative uses.

The political leaders of each of the three countries have to see the economic benefits of market integration as more important than the short-term political gains that can be made by another set of dispute filings. In the end, political will by political leaders is the only thing that can make dispute resolution work. Understanding the economic benefits of market integration has to occur upfront, not after a dispute has lingered for years.