CLASS MARCH 19, 2013 TRADE

SOFTWOOD IN THREE MINUTES

TRADE THEORY (1) Absolute Advantage Canada can produce lumber more cheaply while the US can produce tomatoes more cheaply (costs are lower) Benefits from trade are obvious-each country will specialize Example of Absolute Advantage CommoditiesUnit Costs of Production in terms of labour CanadaUS Lumber46 Tomatoes83

TRADE THEORY (2) Comparative Advantage Canada can produce both lumber and tomatoes more cheaply than the us But here trade will still be beneficial (Ricardo) Example of Comparative Advantage CommoditiesUnit Costs of Production in terms of labour CanadaUS Lumber46 Tomatoes810

BENEFITS OF SPECIALIZATION How Comparative Advantage Works CommoditiesProduction (outputs) per unit of labour Total Output CanadaUS Lumber (railcars) Tomatoes (bushels) Ratio (opportunity cost) No trade1.25 bushels and 2.5 railcars 1.7 bushels and 1 railcar 2.95 bushels and 3.5 railcars Specialization5 railcars3.4 bushels3.4 bushels and 5 railcars

BILATERAL TRADE BETWEEN COUNTRIES Canada domestic lumber market US domestic lumber market Q d-c Q s-c Q es Q s-us Q d-us P Q Can QUSQUS Q exports P in Canada Price in US Canadian exports (“derived excess demand and supply”) ES ED

FREE TRADE IN PRACTICE Free trade is well understood to offer these benefits from trade… There are also legitimate concerns that influence trade These include safety regulations Environmental regulations Controls over illegal activities

STRATEGIC TRADE But it also turns out that it can be in a country’s interest to renegotiate the terms of trade By imposing tariffs it can improve its welfare More broadly there may be other reasons for protectionism Protecting a domestic industry And there may also be non-economic motives National defense Foreign policy National pride

TRADE AGREEMENTS AND INSTITUTIONS FTA and NAFTA WTO TPP (under negotiation)

THE SOFTWOOD LUMBER DISPUTE “We can compete against any lumber industry in the world, but we can’t compete against their government, too.” Steve Swanson, President, Swanson Group, Inc. and Past Chairman of the Coalition for Fair Lumber Imports

IT IS AN OLD ONE…. 19th Century : American tariff introduced of % Free trade briefly ( ; ) In 1866 Canada introduces export duty on sawlogs in response to US duties on lumber Century ends with US duty and Canadian restrictions on log exports 20th Century Duties remain in place In 1932 revenue tax imposed (triple existing tariffs) and Canadian exports drop to 1890 levels 1950’s tariffs and taxes approximately 1% In 1962 group of US lumber producers propose market sharing agreement with 10%tariff in both countries when imports exceed 10%

RECENT HISTORY Lumber I ( ) Lumber II ( ) Lumber III ( ) SLA I ( ) Lumber IV ( ) SLA II (2006 to current) Recently extended to 2015

LUMBER I In 1982 complaint filed-stumpage conveys a subsidy In 1983 Determination-Department of Commerce investigates and finds it does not

LUMBER II Complaint: stumpage conveyed a subsidy Initial findings: subsidy of 15% against lumber exported from BC, AB, ON and PQ Resolved through MOU BC increases stumpage and no export tax PQ introduces phased increases in stumpage and corresponding phased decreases in tax AB & ON make no changes and pay tax In 1991 Canada withdraws from MOU Free Trade Agreement signed in 1986 and enters into force in 1989

LUMBER III Department of Commerce initiates complaint on October 31, 1991 (Canada had withdrawn as of September 3, 1991) DoC finds stumpage and log export control convey subsidies In July 1992 DoC imposes final countervailing duties of 6.51% on all provinces except Maritimes series of decisions in Canada’s favour that end up in duties being refunded December 15, 1994

SOFTWOOD LUMBER AGREEMENT (SLA I) May 1996 to March 2001 Tariff Rate Quota system Can ship up to 14.3 billion board feet feet duty free; above that amount, incur costs of either $50; above 14.7 billion bf; $100/mbf (adjusted for inflation over period) Four provinces assigned quota Companies within provinces receive quota

LUMBER IV Canada can’t agree on what is next and we are back in a world of litigation April 2, 2001 to September, 2006 Initial allegations allege subsidies of 39.9% and anti-dumping margins of 22.5% to 73.9% August 2001 DoC makes a determination of a 19.31% subsidy, retroactively payable back to May October 2001 DoC determines dumping margins for six companies, ranging from 5.9% to 19.2%, with average margins applied to all others of 12.6% Companies are Abitibi, Canfor, Slocan, Tembec, West Fraser, Weyerhaeuser

LUMBER IV (2) February 2002 Canada starts NAFTA challenges (WTO consultations initiated earlier) March 2002 CVD set at 19.34%; dumping reduced to 9.7% April 2002 CVD reduced to 18.8% and 8.4% June 2004 first administrative review: CVD now 9.2%; dumping 4% December 2005 second administrative review: CVD now 8.7%; antidumping 2.1% Cost US industry astronomical sums of cash- $hundreds of millions

SOFTWOOD LUMBER AGREEMENT II April 27, 2006 Canada and US agree in principle to negotiated deal July 1, 2006 Canada and US conclude negotiations September 26, 2006 deal signed

SLA II (2) Seven year deal recently extended to nine years Covers all provinces except Maritimes Two options Option A has three-tiered tax, based on lumber prices, but no volume restriction (but surge tax) BC and AB selected this option Option B has three-tiered tax but at lower levels for given prices and volumes capped All the other provinces selected this option

SLA II (3)

FREE TRADE AGAIN! Random Lengths

BILATERAL TRADE BETWEEN COUNTRIES (REDUX) Canada domestic lumber market US domestic lumber market Q d-c Q s-c Q es Q s-us Q d-us P Q Can QUSQUS Q exports P in Canada Price in US Canadian exports (“derived excess demand and supply”) ES ED

THE EFFECT OF A TARIFF Canada domestic US domestic Canadian exports (“derived excess demand and supply”) Q d-c Q es Q s-us Q d-us Q d-c Q es-new P in Canada Price in US

THE EXPORT MARKET tax Q ft Q tax Deadweight loss The export tax (or tariff, or duty) opens up a wedge between Canadian and US prices US prices are now higher than in Canada The wedge is equivalent to the tax (since firms will choose to sell into either market where it can get the best price) Exports fall And someone collects a lot of tax revenue

THE US DOMESTIC MARKET The US domestic price goes up and US supply goes up US consumer surplus goes down But US producer surplus goes up

THE CANADIAN MARKET In Canada the domestic price drops Quantity supplied drops Canadian consumer surplus goes up And Canadian producer surplus drops

The Effect of a Quota Canada domestic US domestic Q d-c Q es Q s-us Q d-us Q d-c P in Canada Price in US Canadian exports (“derived excess demand and supply”)

EFFECT OF A QUOTA In the export market quantities drop and a wedge is created between US and Canadian price A deadweight loss is created again In this case however it is payments that accrue to quota holders (this is now economic rent!)

DIFFERENCES BETWEEN THE QUOTA AND TAX Besides who might appropriate tax revenues or quota rent A hard quota fixes how much can be exported so increases in US demand will not translate into increases in Canadian prices beyond a certain point But at low enough US demand, prices may equilibrate Under a tax however, wedge is maintained regardless of whether US demand is high or low

WHY? Political economy One estimate (van Kooten) pegs the gains from quota (relative to free trade)as follows: Canadian producers+ $190 million US producers +$1.2 billion Canadian consumers +$250 million US consumers - $1.8 billion Deadweight loss - $160 million

RECENT DEVELOPMENTS $5 billion-$1 billion to US interest ($500 million to Coalition, $500 million to US Endowment) No appeal - final 3 arbitrations-under LCIA Adjustment factor; Canada lost $68.5 million –export charge On and PQ programs tariff ($4 billion); Canada lost.65% and 2% duty BC & MPB; Canada won Fourth looming-BC Coast stumpage reduction Arbitration is a crapshoot After agreement no litigation for a year If no agreement, how do you agree?

DYNAMICS OF THE DISPUTE Market share Historically 30-35% Now at 26% Agreement designed to manage market share

CHRONOLOGY 1980 TO 2013

WILL IT GO AWAY? The financial returns are considerable Political and legal machinery in place to continue Different perspectives by Canadian and American public contribute to persistence of dispute 25 cent stumpage-wouldn’t happen under private system