A Strategic Partnership at Risk: Softwood Lumber, North American Competitiveness and Respect for the Rule of Law

September 30, 2005

Published in the National Post, September 30, 2005.

By Thomas d’Aquino
Chief Executive and President
Canadian Council of Chief Executives

Canada and the United States share daunting challenges in an increasingly dangerous and competitive world. Our people face the relentless threat of international terrorism and of rogue states with no respect for human rights or the rule of law. Our enterprises in every industry face intense competitive pressures from new economic powers such as China and India.

In this global context, bilateral trade in lumber is a sideshow, representing a small fraction of the half a trillion dollars in goods that cross the Canada-U.S. border each year. Yet this sector is the source of the longest-running and most bitter trade dispute between our countries. And the latest development in the softwood lumber saga threatens serious damage to the broad strategic interests of both countries. At issue is whether Canada can rely on the United States to respect the rule of law and live up to its treaty obligations, or whether the United States is prepared to sacrifice these principles in order to satisfy narrowly-based protectionist interests.

The facts of the lumber case are clear. So are the strategic interests of the United States and of its North American neighbours. If the current impasse is left unresolved, the lumber dispute threatens at the very least to provoke retaliation that could have a major impact on consumers and exporters in the United States as well as in Canada. More seriously, it could derail a huge strategic opportunity to strengthen the competitiveness of North American industry. Finally, it could badly damage the credibility of the United States as a champion of free trade and the rule of law globally.

THE NAFTA FRAMEWORK

The framework for the Canada-U.S. economic relationship is established by the free trade agreements negotiated in 1988 (the Free Trade Agreement, or FTA) and expanded to include Mexico in 1993 (the North American Free Trade Agreement, or NAFTA). At the heart of this arrangement is a process that provides for final and binding settlement of disputes over the application of so-called unfair trade laws. These laws, in all three countries, provide for countervailing and anti-dumping duties to protect domestic producers from injury caused or threatened by imported products that are subsidized by the exporting country or that are dumped — in other words, sold abroad for less than in their country of origin.

Canadian business leaders strongly supported the negotiation of a free trade arrangement with the United States. We recognized that while such an arrangement would require a substantial restructuring of Canadian industry to meet increased competition from highly efficient American competitors, this process would lead to more competitive and healthy businesses and open the door to a much larger North American marketplace.

In order to make the substantial investments required to take advantage of the opportunities of free trade, however, Canadian businesses needed a solid assurance that barriers could not be reintroduced unilaterally by the United States at some later date. It was therefore a fundamental requirement that the agreement should eliminate the risk of barriers being raised through the arbitrary imposition of countervailing or anti-dumping duties.

This was not a marginal issue. It was incontestably the critical requirement for Canadian agreement to a free trade arrangement.

From the American perspective, the proposed agreement offered a different set of tradeoffs. Free trade would eliminate Canadian tariffs, which stood at roughly twice the level of U.S. tariffs, as well as many other barriers to trade. It would ease restrictions on American investment in Canada. It would give the United States much more secure access to Canada’s plentiful supplies of oil, natural gas and electricity.

Nevertheless, the U.S. Congress was strongly opposed to any restriction on the use of trade measures that it considered necessary to protect its domestic constituents. The result was an impasse that resulted in the breakdown of the free trade negotiations.

The negotiators finally hammered out a compromise based on the final and binding arbitration of these disputes through a system of binational panels composed of trade experts from both countries, which replaced review of agency determinations by domestic courts. These panels would definitively determine whether the national authorities had correctly applied the rules spelled out in their own legislation to the facts of the case. If the laws had been fairly applied, the duties would stand; if they had not been fairly applied, they would be struck down and any duties improperly collected would be returned. There would be no appeal of these final binational panel decisions.

At the request of the United States, and during the final hours of the negotiations, a provision was included to permit either country to initiate an "extraordinary challenge" of a panel determination where it believed the panel had acted so improperly as to bring the whole system into disrepute.

These binational panels, including the Extraordinary Challenge Committee, were not new international tribunals. They apply the same domestic law and use the same standard of review as domestic courts, and their rulings and orders are enforceable as if they had been made by the these courts. (This is in marked contrast to the dispute-settlement process under the World Trade Organization, which produces international rulings that do not have direct effect in the courts or in U.S. law.).

With these provisions in place, Congress (and U.S. business leaders) overwhelmingly supported the free trade agreement. At the same time, it was clearly recognized that these protections were the absolute minimum that the Canadian government could accept. In the end, the deal survived in Canada by the narrowest of margins. Free trade became the defining issue of the 1988 federal election, and while the governing party won re-election and was able to implement the agreement, a majority of Canadians voted for parties opposed to the deal.

THE PANEL EXPERIENCE

By and large, these dispute-settlement provisions have proved adequate both under the Canada-U.S. and the North American free trade agreements. Decisions by administrative authorities in all three countries have been challenged successfully, and all three countries have been willing to respect the outcomes of the dispute-resolution process.

The most common type of case brought by Canada involves determinations by the U.S. International Trade Commission (ITC) that American producers were being injured by imports that the U.S. Department of Commerce (DoC) had determined were subsidized or dumped. In case after case, impartial binational panels have found, usually unanimously, that these determinations failed to apply properly U.S. laws to the facts of the cases. The DoC had imposed duties in cases where no duties or only much lower duties could be justified, and the ITC had found injury where none could be demonstrated. As a result, the panels were compelled to reduce or strike down the illegally imposed duties, which were then refunded with interest.

In short, with all its flaws, the system ultimately has worked to produce a final and binding resolution of these disputes in almost all cases.

THE CASE OF LUMBER

Softwood lumber has been a special case for a number of reasons:

• First, there is a major difference between Canada and the United States in the underlying ownership of the standing timber. The bulk of this timber in the United States is privately owned. In Canada, most of the timber is owned by provincial governments, which then lease the right to cut the timber to private firms.
  
• Second, these industries are politically highly sensitive in both countries, involving, as they often do, the principal employer in regions with limited alternative opportunities.
  
• Third, the trade is exceptionally one-sided: the United States imports far more lumber from Canada than flows in the other direction.
  
• Fourth, imports of softwood lumber from Canada account for about one-third of the total U.S. market. This is a large share, but one that has remained quite stable for more than a decade. This is because Canadian exports are filling a supply deficit in the U.S. market that U.S. companies cannot and will not be able to fill. Binational panels have found no evidence that the Canadian share of the U.S. market would increase if no duties were imposed.

LUMBER I AND LUMBER II

The first dispute over softwood lumber started in the early 1980s, even before Canada and the United States had begun negotiating the Free Trade Agreement. In this first round, the U.S. Department of Commerce found that no subsidies were provided by Canadian government practices, and the case failed.

The dispute process then became politicized. In 1986, the Secretary of Commerce advised Canadian authorities that he believed he had no choice but to determine that lumber imports were subsidized, regardless of the facts, rather than run the risk of Congressional irritation.

Rather than face protracted litigation, the Canadian government agreed to a "Memorandum of Understanding" (MOU) that called for a 15% tax on lumber exports unless and until provinces introduced "replacement measures" of equivalent effect.

A number of provinces did introduce measures that were certified by the DoC to be in full replacement of the border tax, and thus eliminated any alleged subsidy. Nonetheless, the aggressiveness of Commerce officials in policing this understanding was finally judged by the various Canadian governments to be intolerable. In 1991, therefore, Canada exercised its right to terminate the MOU.

LUMBER III

The reaction of the U.S. administration was swift. Under intense domestic political pressure, the DoC launched an investigation that found that lumber imports — even from those provinces that had introduced replacement measures — were subsidized. The ITC then ruled that U.S. producers were being injured.

Both of these determinations were challenged before binational dispute settlement panels, which ruled in Canada’s favour and struck down the 6.5% countervailing duties that had been imposed by the United States. The United States Trade Representative (USTR) then brought an extraordinary challenge, but this challenge was rejected by the Extraordinary Challenge Committee (ECC), composed of senior judges from both countries. The United States threatened not to respect this decision, but ultimately did return the duties that had been collected.

In 1996, after another round of negotiations, Canada and the United States signed a new Softwood Lumber Agreement (SLA). This agreement allowed lumber from Canada to enter the United States free of duty up to a threshold of 14.7 million board feet — close to recent levels of shipments to the United States. Canada agreed to collect a substantial border tax on shipments above that level.

LUMBER IV

The SLA remained in effect for its full term of five years, but was then not renewed. As soon as it expired, in 2001, the U.S. lumber industry coalition petitioned to have the ITC determine that it was "threatened with injury" resulting from imports from Canada. The DoC then imposed duties, of up to 27% in some cases, on imports of Canadian softwood lumber. Canada immediately challenged these determinations before NAFTA panels.

For the past several years, the NAFTA dispute-settlement panel system has been seized with this dispute. One panel has ruled against the DoC determinations that Canadian lumber is subsidized. Another panel found that the DoC had not properly calculated the margins of dumping. A third panel found that the ITC had no proper basis under U.S. law for finding that these imports threatened the domestic industry.

Instead of simply complying with the final panel decision on injury, however, the USTR again resorted to the "extraordinary challenge" process. On Aug. 10, 2005, the Extraordinary Challenge Committee ruled unanimously against the United States.

Under the NAFTA provisions, this should have resulted in the closing of the action, the cancellation of the duties and the return of all deposits. In this case, however, the Secretary of Commerce responded to the ruling of the Extraordinary Challenge Committee by announcing that he had no intention of returning the duties. The U.S. Trade Representative, for his part, announced that the Extraordinary Challenge Committee’s decision changed nothing and he proposed to continue to collect the anti-dumping and countervailing duties that had been struck down by the NAFTA panels.

It is important to recognize that Canadians are not seeking to deny anyone, least of all American lumber producers, their legitimate legal rights. Lawyers are paid to marshal creative legal arguments in defence of their clients. At some point, however, a binding and final determination must bring closure to the case. The key point is that this process is the one established specifically under the free trade agreements to resolve disputes over whether the importing partner had correctly applied its own laws. It was created to take these issues out of the political arena and subject them to judicial review by an expert tribunal. Once this process had run its course — as it now has in the softwood lumber case — both governments were obliged to abide by the decision.

To force the Canadian parties now to undertake yet another round of litigation to compel the U.S. authorities to comply with this definitive verdict is an indefensible abuse of process and a clear transgression of the NAFTA.

Meanwhile, the United States is pointing to developments at the WTO, where an implementation panel in late August, 2005, issued an interim ruling that the United States had taken action to bring itself into technical compliance with its WTO obligations on the issue of the ITC’s determination of injury. Even within the WTO process, this decision affects only one element of the dispute, is not final and is subject to appeal. Most important, though, whatever happens at the end of the day within the WTO does not change the obligation of the United States under the NAFTA and under U.S. law to implement the decision of the NAFTA panel upheld by the Extraordinary Challenge Committee.

THE GRAVITY OF THE CRISIS

In the United States, the softwood lumber case has been treated as a simple commercial dispute of little interest except to the American producers and landowners (and, to a lesser extent, consumers) directly affected. Apart from a critical editorial in The Wall Street Journal, there has been little discussion in the mainstream media. American business and political leaders have failed to appreciate the deep and serious nature of the crisis.

The economic costs of the U.S. duties have been substantial. Over the past five years, the cost of lumber to American consumers and home builders has been inflated by as much as $15-billion. Some $10-billion of this amount has been pocketed by U.S. lumber producers through higher prices. Of the remaining $5-billion, a relatively small amount has already been distributed to the U.S. lumber coalition under the so-called "Byrd amendment," which states that anti-dumping and countervailing duties are to be given to the U.S. producers who launch trade remedy actions. (In 2001, 11 countries, including Canada, challenged the Byrd amendment at the WTO. A WTO panel subsequently ruled that the Byrd amendment is not consistent with U.S. obligations under the WTO. The United States, however, has yet to implement this ruling.)

For their part, Canadian producers have been obliged to tie up some $5-billion in duty deposits and this amount is increasing by roughly $1-billion a year. However, these costs only scratch the surface of the damage that could flow from a continued failure to resolve this sectoral dispute. Consequences are likely to unfold on several levels:

The impact on American companies and consumers. At the very least, a failure to resolve the softwood lumber issue risks a broad bilateral trade war. A resort to retaliation would hurt consumers and producers in both countries. On the other hand, a failure by Canada to take vigourous action in defence of its lumber producers would increase the risk of arbitrary harassment of its exports in other sectors.

The damage to American commercial interests could prove far more extensive over time. Canada is only one of many countries that have challenged the Byrd amendment and other U.S. trade remedy actions. Continuing failure by the United States to implement these cases generally will undermine the already difficult negotiations in the current WTO Doha Round by reducing the willingness of other countries to make concessions of interest to U.S. consumers and producers.

The impact on North American competitiveness. The emergence of China and India as major economic powers is transforming patterns of trade and investment around the world. Companies in every industry in North America face an unprecedented degree of competitive pressure.

President George W. Bush and Prime Minister Paul Martin, together with President Vicente Fox of Mexico, recognized this strategic imperative at their Texas summit in March of this year, when they signed the Security and Prosperity Partnership of North America (SPP). The SPP is based on the principle that all three economies will be stronger if we focus on working together to make the most of our assets, instead of wasting precious time and money over disputes among ourselves. A North America divided is a continent that is both poorer and less secure.

For Canadians, however, the softwood lumber dispute cuts to the heart of the bilateral relationship. There is overwhelming support for the government’s decision to suspend negotiations on lumber because most Canadians see no point in trying to work out a new deal with a government that refuses to comply with the existing arrangement under NAFTA. There also are a growing number of calls for Canada to diversify its customer base, in energy and natural resources as well as manufacturing. This is a fundamental issue of trust, and without that trust, the prospects for moving toward a broader and deeper North American partnership will be significantly diminished.

The impact on the rule of law globally. The United States has been a staunch defender of the rule of law as the basic foundation of human rights and freedom. It also has been steadfast in defending the rule of law as an essential protection for its economic interests. In an era where prosperity flows increasingly from brains rather than brawn, respect for the rule of law in areas such as intellectual property rights is a critical interest of the United States.

In this respect, the impact of the decision by the United States not to comply with the Extraordinary Challenge Panel on softwood lumber goes well beyond its bilateral relationship with Canada. Faced with demonstrated disrespect for the rule of law in the lumber case in response to repeated NAFTA and WTO rulings, how can any trading partner trust that the United States will not do the same with any other agreement?

In short, what is at stake for the United States in the softwood lumber dispute is nothing less than its global credibility as a champion of free trade and the rule of law.

RESOLVING THE DISPUTE AND BUILDING A BETTER FUTURE

In order to avoid these consequences and move forward in building a more competitive and secure North America, I believe that the following actions are necessary:

First, the senior business leadership of all three NAFTA countries must become engaged on this issue. Because the dangers go far beyond the softwood lumber sector and threaten the very heart of the NAFTA and of future efforts to encourage deeper North American co-operation on economic and security issues, we need to bring a broader, economy-wide perspective to bear on these matters.

Second, the U.S. administration should recognize the determination of the Extraordinary Challenge Committee in the softwood lumber dispute and honour its decision, including the return of all duties with interest. The legal arguments advanced in justification for continuing to collect anti-dumping and countervailing duties and refusing to return the deposits already collected simply do not stand careful scrutiny.

Third, the Canadian government should return to the table and seek a durable solution to the issues that provoked the softwood lumber case. Agreements that restrict Canadian exports or impose export taxes on lumber shipments simply prolong the problem rather than resolving it. What we need is a deal that addresses the root issues.

The United States wants Canada to change its system for charging stumpage fees, and Canada should agree to do so. However, Canada should not agree to change its stumpage practices to accommodate the United States without receiving an equally fundamental commitment in return, such as an agreement to abolish the future application of anti-dumping and countervailing duties between the two countries, whether across the board or specifically in the lumber sector.

The bottom line is that the high degree of economic integration that has been achieved in North America over the past decade and a half does not just make the use of such trade remedies between Canada and the United States unnecessary; it has become highly counterproductive in a world in which our countries face an urgent need to increase our productivity and competitiveness globally.

Fourth, the NAFTA partners should design a new dispute-settlement system that fits the new realities of North American economic integration. At the very least, the existing NAFTA dispute-settlement mechanism should be reformed to provide for more effective implementation of NAFTA panel rulings. Longer-term reform should include the establishment of a permanent standing tribunal to deal with all disputes under the NAFTA. The tribunal would be composed of permanent judges appointed from each of the three countries and would be served by a common secretariat with legal clerks to assist the judges.

Finally, as an immediate gesture of goodwill, Canada and the United States should work together to help the victims of Hurricanes Katrina and Rita to rebuild their lives. The awesome forces of nature never lose their capacity to put our commercial disputes into perspective. An immense rebuilding project lies ahead, one that is likely to draw on a wide range of Canadian resources, products and expertise. As so many Americans struggle to rebuild their homes and businesses, it is important to ensure that their needs can be met fully, promptly and without an unnecessary run-up in prices.

To this end, and in the spirit of our North American partnership, I would suggest that the U.S. administration immediately stop collecting the duties on softwood lumber that are subject to the ruling by the Extraordinary Challenge Committee. This would directly reduce the reconstruction costs faced by American families and enterprises. Canada, for its part, while recognizing that its enterprises are entitled to a full refund of the illegally collected duties, should offer, on their behalf and with their agreement, to donate a portion of the money being held on deposit to a trust fund that would be used to build affordable housing in North America, starting with New Orleans and other hurricane-ravaged communities.

In conclusion, whether the issues affecting softwood lumber are addressed bilaterally or trilaterally, the essential point is that this dispute has become far more than a commercial disagreement in a particular sector. Even the strongest friends and allies of the United States within Canada — those of us who have championed the cause of free trade and deepening economic integration for the past quarter century — can neither comprehend nor accept such a blatant assault on the integrity of the NAFTA and the security of the rule of law.

The softwood lumber issue must be addressed quickly and decisively. Canada and the United States both have much to lose if we fail to act, and the greatest cost would be a lost opportunity to build on our long-standing economic partnership. We must not let this single dispute distract us from the main challenge, that of building a safer and more competitive North America within a transforming global economy.