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Dairy cows at a farm in Sainte-Marie-Madelaine, Que., on Aug. 31, 2018. This disagreement over dairy between Canada and the U.S. is a first test of how the USMCA will function as a replacement for the North American free-trade agreement.Ryan Remiorz/The Canadian Press

The first dispute settlement panel struck under North America’s revised free-trade deal has ruled that Canada is violating the treaty and must change the way it grants preferential access to its heavily sheltered dairy market.

In a decision made public Tuesday, the USMCA panel said Canada can no longer reserve preferential access, or tariff-rate quotas, exclusively for the use of Canadian processors – a practice the Americans say denies U.S. farmers the full benefit of selling into Canada’s market. The panel was made up of lawyers, one selected by Canada, one by the United States and a chair, Elbio Rosselli, a Uruguayan diplomat who has served as his country’s ambassador to Canada and the United Nations.

This disagreement over dairy between Canada and the U.S. is a first test of how the United States-Mexico-Canada Agreement, or USMCA, will function as a replacement for the North American free-trade agreement.

Under Canada’s supply-management system for dairy, the country protects domestic farmers from foreign competition with a wall of high tariffs but grants some access, up to a quota limit, for non-Canadian products such as milk, cheese, ice cream and yogurt that are then imported under a lower duty rate. This special access is called tariff-rate quotas, or TRQs.

Panel members ruled that Canada is breaching its commitment under the new USMCA by reserving nearly all of its dairy tariff-rate quota for the exclusive use of Canadian processors. “Canada’s practice of reserving TRQ pools exclusively for the use of processors is inconsistent with Canada’s commitment” under the USMCA, it said.

“The current Canadian system, which sets aside significant TRQ volumes only for processors, does not pass muster under the treaty.”

A processor refers to a company that turns dairy goods into products such as processed cheese or ice cream.

International trade lawyer Lawrence Herman said the ruling could be of considerable value to U.S. farmers but he declined to speculate on a dollar amount. He said it also “represents another blow to Canada’s supply-management system which I think is coming under increasing attention from our trading partners.”

He said Canada’s practice of reserving a significant portion of TRQs for processors is an effort to reduce the price impact of U.S. dairy on this country’s carefully controlled supply-management system. “By forcing U.S. suppliers to export to a limited number of Canadian processors that are part of the supply-management system, American suppliers lose the ability to export to a wider market at higher prices.”

The U.S. requested the dispute settlement panel last May to adjudicate its complaint.

On Tuesday, U.S. Trade Representative Katherine Tai lauded the ruling as a win for the United States. “This historic win will help eliminate unjustified trade restrictions on American dairy products, and will ensure that the U.S. dairy industry and its workers get the full benefit of the USMCA to market and sell U.S. products to Canadian consumers,” she said in a statement.

She said Canada’s conduct put U.S. farmers at a disadvantage.

“As a result of this restriction, Canada has been undermining the value of its dairy TRQs for U.S. farmers and exporters since entry into force of the USMCA by limiting access to in-quota quantities negotiated under the agreement.”

Canada had argued before the panel that reserving market access for processors is central to its effort to maintain the overall stability of its supply-management system, which has long been a target of American trade actions. Canada’s protectionist rules for milk, eggs and poultry slap hefty tariffs on imports of these goods and tightly regulate domestic production and pricing.

Prime Minister Justin Trudeau’s government on Tuesday argued Canada had won a partial victory because the panel declined to rule on additional elements of the U.S. complaint.

International Trade Minister Mary Ng said Ottawa has “taken note of the panel’s findings” on reserving market access for dairy processers. “Our government, as it proceeds with the next steps in the process, will continue to work closely with the Canadian dairy industry. Canada takes its commitments and obligations under international agreements seriously.”

Ms. Ng said Canada was happy the panel did not dispute supply management itself.

“We are pleased with the dispute settlement panel’s report, which ruled overwhelmingly in favour of Canada and its dairy industry. In particular, it is important to note that the panel expressly recognizes the legitimacy of Canada’s supply-management system. The panel also confirms that Canada has the discretion to manage its TRQ allocation policies … in a manner that supports Canada’s supply-management system.”

The Canadian dairy industry, which includes more than 10,000 farms and more than 500 processors, contributes more than $16-billion to Canada’s annual economic output and supports more than 178,000 full-time-equivalent jobs, according a 2021 estimate from the Dairy Farmers of Canada.

The Canadian government has 45 days to comply with the panel findings. While it was only made public Tuesday, the panel report was issued on Dec. 20 and Canada has until Feb. 3 to alter its conduct.

Trade consultant Peter Clark, who formerly worked for the dairy industry, said the decision is not a significant blow in his opinion. “It’s not dismantling tariff-rate quotas. It’s not dismantling supply management. It merely means Canada has to be more liberal in how it allocates access to our dairy market.”

Mr. Clark noted there is a long history of both countries trying to claim victory in trade dispute panel decisions.

The USMCA, which took effect in July, 2020, granted some additional limited access for U.S. dairy farmers and processors to Canada’s largely closed domestic dairy market, through tariff-rate quotas on 14 products from milk powder to ice cream and cheese.

With a report from Reuters

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