INTERNATIONAL AGRICULTURE AND TRADE--NAFTA September 25, 1996 Approved by the World Agricultural Outlook Board ----------------------------------------------------------------------------- INTERNATIONAL AGRICULTURE AND TRADE Situation and Outlook is published four times a year by the Economic Research Service, U.S. Department of Agriculture, Washington, DC 20005-4788. WRS-96-3. Please note that this release contains only the text of INTERNATIONAL AGRICULTURE AND TRADE--tables and graphics are not included. Subscriptions to the printed version of this report are available from the ERS-NASS order desk. Call, toll-free, 1-800-999-6779 and ask for stock #WRS, $20/year. ERS-NASS accepts MasterCard and Visa. ----------------------------------------------------------------------------- Contents Summary Agriculture at a Glance for NAFTA Plus One United States Canada Mexico Chile Current Trends in NAFTA Trade Long-Term Prospects for NAFTA Agricultural Trade NAFTA Policy Briefs NAFTA Maintains National Antidumping/Countervailing Duty Laws International Trade Commission and Commerce Department Rulings on Tomatoes and Peppers First NAFTA Phytosanitary Panel Decision Clears the Way for U.S. Sweet Cherries Proposed Phytosanitary Rule Change for Mexican Avocados Karnal Bunt Crisis Challenges North American Grain Handling System Hot Competition in North America North American Meat Markets Integrating Rapidly Grain Trade Between the United States and Canada An Emerging North American Barley Market Selling Wheat to Mexico Selling Oilseeds and Products to Mexico The U.S. Vegetable Market Canada's Fruit and Vegetable Markets Chile Moves Ahead with Regional Trade Agreements A Reader's Guide to Trade Liberalization Report Coordinators Daniel Plunkett Terri Raney Authors Stephen Haley Suchada Langley John Link John Love Gary Lucier Daniel Plunkett Teresita Ramos Terri Raney Mark Simone David Skully James Stout Julieta Ugaz-Pereda Other Contributors Audrae Ericksen Mildred Haley Charles Handy Maurice Landes Fred Ruppel Gerald Schluter Acknowledgments The authors wish to thank Francis Tuan, Gary Vocke, Stephen Haley, David Skully, Lon Cesal, Suchada Langley, Shayle Shagam, Fred Surls, Gene Hasha, Carolyn Whitton, Peter Riley, Terry Crawford, and David Harvey of the Economic Research Service; Frank Tarrant, Carol Goodloe, Michael Fay, Leanne Hogie, and others of the Foreign Agricultural Service; Felix Spinelli of the Animal Plant Health Inspection Service; Gerald Bange, Jim Matthews, Ed Missiaen, James Nix, Jerry Rector, Russell Barlowe, Andrew Aronson, and others at the World Agricultural Outlook Board for their reviews; and Diane Decker, Martha Evans, Wynnice Napper, and Vic Phillips for editorial, production, and design assistance. Summary NAFTA Spurs North American Trade Trade in agricultural products is expected to grow rapidly over the next decade both within the North American market and between North America and the rest of the world. Trade liberalization under the North American Free Trade Agreement (NAFTA) will continue to bolster the economic forces that are promoting trade growth, including favorable socioeconomic conditions, complementary resource endowments, and changing consumer preferences. By 2005, intra-NAFTA trade in agricultural products is projected to reach $30 billion, up from about $19 billion in 1995. North American exports to the rest of the world will also grow rapidly as strong economic growth and trade liberalization under the WTO expand markets. Now in its third year, NAFTA has produced a mixed agricultural trade picture for the United States. The reduction in tariffs and non-tariff barriers contributed to the 13-percent increase in U.S. agricultural exports to its NAFTA partners (Mexico and Canada) in 1994. In 1995, U.S. trade (exports plus imports) with NAFTA partners fell 8 percent, affected mainly by the deep recession in Mexico following the peso crisis. The 32-percent increase in U.S. agricultural imports from Mexico in 1995 was concentrated in a few key products (coffee, live cattle, tomatoes) where trade barriers were non-existent or already low before NAFTA. The 22-percent drop in U.S. exports to Mexico could have been steeper without NAFTA, because NAFTA limited the import-reducing policy responses Mexico could implement during a recession. NAFTA gave the United States and Canada an advantage over other traders in the Mexican market during the difficult period. According to Mexican import data, the United States gained Mexican market share in 1995. Based on trade data for the first 6 months of 1996, the United States will likely once again enjoy a large agricultural trade surplus with Mexico, which is suffering from a bad drought and still recovering from its financial crisis. Trade liberalization with Canada, which dates back to 1989, has also contributed to increased two-way trade. There have been several prominent trade disputes with Canada as well. The United States has enjoyed a small agricultural trade surplus with Canada in recent years, which may disappear in 1996. Agricultural trade issues within NAFTA during the past year range from allegations of unfair trade practices to phytosanitary concerns. As tariffs are reduced and eliminated under NAFTA, attention is increasingly focused on other potential barriers to trade, such as laws governing antidumping or countervailing duties. Beyond the World Trade Organization commitments, NAFTA does not provide for harmonized procedures or criteria for determining whether dumping has occurred or when and how countervailing duties should be set. However, NAFTA does lay out some rules for the process to be followed, such as publishing of notices and time limits. Some agricultural trade disputes may be settled under NAFTA provisions (sweet cherries, for example) and others under national laws (tomatoes). It appears that phytosanitary issues are becoming increasingly prominent (avocados, Karnal bunt). Competition is intensifying in specific commodity markets in North America due to trade liberalization and regional specialization. Regional markets are emerging in fruits and vegetables, animals and livestock products, and grains and feeds as producers take advantage of production complementarities and seasonal variations that reach beyond national boundaries. Examples of hot competition and regionalization include the North American meat markets, grain trade between the United States and Canada, vegetable markets in the United States and Canada, and in selling wheat and oilseeds to Mexico. One year ago, NAFTA was poised to expand its membership to include Chile as the next step toward hemispheric free trade. While the lack of fast-track negotiating authority in the United States has stalled NAFTA expansion, Chile has aggressively pursued bilateral ties that may set the agenda for regional integration for the next decade. Chile recently agreed to become an associate member of MERCOSUR (a trading group composed of Argentina, Brazil, Paraguay, and Uruguay), and is also negotiating economic cooperation agreements with Canada, the European Union, and other groups further afield. Over the last 5 years, Chile's free trade agreement with Mexico has led to increased trade between the two countries. Chile's deepening regional ties may be more important to the United States than any direct trade impact that would arise from Chilean accession to NAFTA. NAFTA (with some help from the Uruguay Round) eliminated quotas on trade among the North American countries and replaced the quotas with a tariff-based system. For many sensitive products, tariff-rate quotas (TRQs) are in effect, permitting a specific volume of imports at a reduced or zero tariff, and imposing a higher tariff for greater quantities of imports. From an economics standpoint, the tariff-based system (including TRQs) is preferable to quotas due to improved economic efficiency and transparency. The operation and liberalization of tariffs, quotas, and tariff-rate quotas form the basis for many of the trade issues currently being disputed among the three NAFTA signatories. Because tariffs and quotas were also used to reinforce the operation of domestic supply control programs for many commodities, the liberalization of these trade instruments can also affect the operation of supply control programs. [Figure 1: U.S. Food and Agriculture at a Glance] [Figure 2: Canadian Food and Agriculture at a Glance] [Figure 3: Mexican Food and Agriculture at a Glance] [Figure 4: Chilean Food and Agriculture at a Glance] Current Trends in NAFTA Trade: The First 2 Years Trade occurs when complementary economic relationships between trading partners make commerce mutually beneficial. NAFTA trade is no exception. The pattern of agricultural trade reflects production advantages in the three NAFTA countries (United States, Canada, and Mexico) arising, for example, from differences in cost or resources, demand factors in the countries, and policies that affect farm production and trade. The composition of trade is also a product of complementary growing seasons, cultural preferences, and even differences arising from weather in a given year. Trade among the United States, Canada, and Mexico is also enhanced by the proximity of the countries. NAFTA has locked in the benefits of the growing and changing trade pattern between its members, and has set the stage for expanded trades in the future. [John Link (202) 219-0667] What Has Been Happening with Trade? Trade and integration among the NAFTA countries has grown and become more important to all three countries. The growth in trade among the United States, Canada, and Mexico during 1994 and 1995 continued the strong trend of the past decade. NAFTA liberalization has locked in the recent trade gains and provided the framework for continued acceleration of trade. But while the NAFTA is important, it is only one of many factors contributing to the growth in North American trade. The NAFTA agreement on agriculture is really three bilateral agreements: U.S.-Mexico, U.S.-Canada, and Mexico-Canada. While the agreements are similar, there are also differences. U.S. tariffs and other barriers were already low relative to those for Canada and especially Mexico before NAFTA. The largest gains in trade would be expected to occur in those countries and commodities with the largest reduction in barriers. The phase-out for tariffs under NAFTA is long-term--15 years, from 1994 to 2008, for U.S.-Mexico and Canada-Mexico; and 10 years for U.S.-Canada, from 1989 to 1998. While some of the benefits may occur in the first years, the lowering and eventual elimination of tariffs will cause structural changes in the agricultural sectors that will take a longer time to develop. The Big Picture for Trade Total trade expansion among NAFTA partners during 1994 and 1995 was consistent with recent trade patterns and continued an already intense integration of the three economies 1/. ----------- 1/ Material on total trade based on: NAFTA Implementation in the United States: The First Two Years, United Nations: Economic Commission for Latin America and the Caribbean, June 27, 1996. ----------- In NAFTA's first year, total U.S. trade with Canada and Mexico was record large. In the agreement's second year, trade flows were disrupted by Mexico's financial crisis. Following the peso devaluation in late 1994, Mexico entered a severe recession. As a result, U.S. total exports to Mexico fell almost 9 percent in 1995, after increasing over 22 percent in 1994. Despite this sharp drop, U.S. exports to Mexico remained 10 percent higher than in 1993, before NAFTA. Total three-way trade reached almost $350 billion in 1994, up 17 percent from the previous year. Total three-way trade increased overall about 8 percent in 1995, to $380 billion. In 1995, U.S. exports to NAFTA grew 16 percent, over twice as fast as U.S. exports to the rest of the world. Agricultural Trade--Has NAFTA Raised U.S. Exports to NAFTA Partners? Thus far under NAFTA, agricultural trade has been mixed. In 1993, before NAFTA, the United States maintained a strong positive agricultural trade balance with its NAFTA partners. In 1994, while U.S. farm exports to the rest of the world increased about 8 percent, exports to NAFTA partners grew 13 percent (Mexico up 25 percent, Canada up 4 percent), reaching $10 billion and accounting for about 22 percent of total U.S. farm exports. Trade data for the first half of 1996 indicate that U.S. agricultural exports to Mexico have rebounded sharply from last year and should end the year with a positive trade balance. Current indicators put U.S. farm exports to Mexico in the range of $5-5.5 billion, with imports at $3-3.5 billion. Current information and data indicate that U.S. - Canadian farm trade should give the United States a small trade surplus this year with both exports and imports near $6.0 billion. The United States is still expected to realize long-term benefits from NAFTA, but economic conditions, weather, and other factors could push the realization of those benefits several additional years into the future. U.S. farm exports to Mexico showing the greatest increases in 1994 included corn, beef, pork, poultry, fresh and processed fruits, vegetables and preparations, oilseed products, and nuts. Exports of these commodities to Mexico as a share of total U.S. exports also increased. Most of these commodities are also ones that had tariffs reduced or eliminated by NAFTA (see 1995 NAFTA International Agriculture and Trade Report, WRS-95-2). There is clear evidence that the reduction in tariffs and non-tariff barriers increased U.S. agricultural exports in 1994. In 1995, the picture changed as Mexico's financial crisis and the worst drought in 50 years engulfed the country. U.S. exports to the NAFTA partners fell about 8 percent, with a 4-percent gain to Canada offset by a 22-percent drop to Mexico, resulting in exports of $9.3 billion (17 percent of U.S. farm exports to the world). In light of the Mexican situation, did NAFTA help or hinder U.S. exports in 1995? At first glance, one would believe NAFTA did not help, given the 22-percent drop in exports to Mexico. However, the drop in U.S. exports was due to the financial crisis in Mexico, not the NAFTA agreement. Mexico underwent a major devaluation in December of 1994 that triggered the financial crisis and economic recession, sharply reducing demand for most imports in 1995. In fact, the drop could have been even more extreme if it were not for NAFTA, because NAFTA limited the import-reducing policy responses Mexico could implement. When Mexico went through a major devaluation in the early 1980s, import restrictions hit all countries equally. In 1995, NAFTA gave the United States and Canada an advantage over other traders in the Mexican market. In fact, according to Mexican agricultural import data, the United States actually gained Mexican market share in 1995. During 1993-95, U.S. farm imports from NAFTA partners continued their long steady trend upward, with a very strong seasonal pattern (figure 5). U.S. farm imports from Canada and Mexico grew 10 and 16 percent respectively to $8.1 billion in 1994 and $9.3 billion in 1995, representing about 30 percent and 31 percent of all U.S. farm imports. Imports from Mexico were up 5 percent to $2.9 billion in 1994, while imports from Canada were up 13 percent to $5.2 billion. In 1995, the numbers were up 32 percent to $3.8 billion for Mexico and up 6 percent to $5.6 billion for Canada. The fact that imports from the NAFTA partners account for nearly a third of U.S. agricultural imports -- compared with about a fifth of U.S. exports -- helps explain why trade disputes involving imports often get greater attention than successes achieved in exporting. Leading Import Gainers Little Affected by NAFTA Looking at overall import numbers may imply that trade liberalization under NAFTA led to greatly increased imports from Mexico, in particular. But the increased imports were concentrated in a few key products (coffee, live cattle, tomatoes) where trade barriers were non-existent or already low before NAFTA. U.S. farm imports from Mexico increased 5 percent in 1994 to $2.9 billion, with the value of coffee imports alone increasing $82 million. Imports of vegetables and vegetable preparations, our largest category of imports from Mexico, grew 6 percent. Tomato imports fell 6 percent in volume, but higher prices raised their value about 4 percent, to $315 million. Cattle imports from Mexico were down to 1.1 million head valued at $352 million in 1994. U.S. farm imports from Canada were up about 13 percent to $5.2 billion with grains increasing the most due to economic and weather conditions in the two countries. In 1994, imports from NAFTA were pretty much on trend, with little indication that the increase was due to the NAFTA agreement. In 1995, the picture changed sharply, with imports from Mexico jumping nearly a third. U.S. tomato imports were up nearly 58 percent in volume and 30 percent in value to $423 million. Much of the increase was due to the sharp decline in demand in the Mexican domestic market, due to the financial crisis, making more production available for export. Some improvement in Mexico's competitive position in tomatoes, such as successful adoption of extended shelf-life varieties, may also have contributed to the trade growth. Mexican ranchers sold off their cattle herds in response to the drought and favorable U.S. prices relative to the devalued peso, raising U.S. imports a third to 2.8 million head valued at $1.4 billion. High coffee prices, due to world production shortfalls, pushed the value of coffee imports up nearly 73 percent to $660 million. As a result, U.S. imports from Mexico were up 32 percent to $3.8 billion. With zero U.S. tariffs on coffee and live cattle, those important growth categories cannot be attributed to NAFTA. In 1995, the U.S. tariffs on fresh tomatoes from Mexico ranged from 2.0 to 4.6 cents per kilogram (approximately 3 to 7 percent weighted average ad valorem equivalent), compared with 3.3 to 4.6 cents per kilogram in 1993, before the agreement. As the financial crisis and the drought worked their way through the Mexican farm sector, most of the advantages of the December 1994 devaluation appear to have been wrung out of the Mexican farm export sector with a few important exceptions, mainly tomatoes and live cattle, by the end of 1995. [Begin Box] Drought Affects Both United States and Mexico The drought in the southwestern United States and northern Mexico has reduced agricultural production throughout a contiguous cross-border region, with the main U.S. states affected being Arizona, New Mexico, Texas, and Oklahoma, along with at least 12 northern states in Mexico. With about 70 percent of Mexico's territory affected this year, the Mexican government has called it the worst drought in the last 43 years. In the United States, President Clinton announced a $70-million relief package for drought-stricken domestic producers, through the non-insured crop disaster assistance program for grazing and forage losses and federal crop insurance programs. There have also been various actions to provide feed grains, including a request to release 45 million bushels of corn, barley, and sorghum from CCC reserves in order to address the high prices for feed grains in part exacerbated by the drought. Grazing was authorized on cropland idled under the Conservation Reserve Program. The drought has affected northern Mexico for the last 3 years (5 years in parts of Chihuahua). For the summer of 1996, about 600,000 hectares or 5 percent of total crops area were left uncultivated or unharvested--meaning some farmers will not receive the PROCAMPO direct payments (440 pesos, or about $59 per hectare), which require planting. Livestock producers have been hurt because drought has devastated pasture conditions, reducing forage output. In April, the Mexican government announced a $150-million Drought Action Plan that was up 55 percent from the 1995 assistance level, mainly to assist livestock producers with feed costs. In the key state of Sinaloa, irrigation water is being diverted to human consumption. Summer crops on irrigated land--mainly soybeans, rice, and corn--will not be planted. The PROCAMPO direct payments will not be distributed to Sinaloa producers, but instead the $4.4 million allocated to that state will be used to modernize Sinaloa's irrigation system by lining the water canals with cement, re-equipping wells, and drilling new wells for livestock producers. [End Box] Differences Shape Trade Patterns While the economic relationships between countries make trade mutually beneficial, a whole host of factors determine those economic relationships, including the role of agriculture in each country's economy, the importance of trade for domestic producers, and the allocation of factors such as land and labor. In the building of regional markets within North America, those local differences lead to incentive for trade. The contribution of production agriculture to the economy of all three countries has been declining for a long time. Agriculture's share of gross domestic product (GDP) is less than 2 percent in the United States and Canada and less than 10 percent in Mexico. At the same time, the farming sectors of the United States, Canada, and Mexico have been increasingly depending on foreign markets as an outlet for domestic production. Trade in general is an increasingly important part of each country's national economy, ranging from less than 10 percent of GDP for the United States, 15 percent of GDP for Mexico, to nearly 28 percent of GDP for Canada. This helps explain why there are differences in opinions about the importance of trade, trade agreements, etc., among the NAFTA partners. Agriculture's share of total trade also varies across countries, but in a less pronounced manner, with farm exports and imports accounting for about 11 and 13 percent of Mexico's total trade, 11 and 5 percent of U.S. trade, and 8 and 6 percent of Canadian trade (table 1). For some commodities, trade is critical for the economic survival of the industry. The United States exports about a third of its production of corn and soybeans, about 40 percent of its cotton production, over 40 percent of its rice production, and often over 50 percent of its wheat production. While bulk commodities will continue to be an important component of U.S. trade with Mexico, dietary changes in response to income and taste changes are altering the composition of agricultural trade. The composition of trade among the NAFTA partners has been shifting since the early 1980s, with increasing emphasis on higher-value products. Between the mid-1980s and the early 1990s, U.S. exports to Canada and Mexico in the category called consumer processed products gained, while Canadian exports of processed intermediate products to the United States and Mexico gained, and Mexican exports of consumer unprocessed products to the United States and Canada gained (figures 6-8). Trade between the United States, Canada, and Mexico was taking place before the arrival of Columbus. With their populations and economies expanding over the past three decades, Canada and Mexico have become important trading partners of the United States. The United States ships about 10 percent of its farm exports to Canada and 6 percent to Mexico, while importing about 19 percent from Canada and 13 percent from Mexico. The United States is also a very important market and supplier of the Canadian and Mexican markets (table 2). Canada purchases almost 60 percent of its imports from the United States, while Mexico gets about 75 percent of its imports from the United States. About 66 percent of Canada's farm exports and more than 80 percent of Mexico's farm exports go to the United States. The amount of land available for agricultural production varies greatly between the three countries (table 3). Only about 5 percent of Canada's land is arable, compared to 13 percent for Mexico and 20 percent for the United States. However, on a per capita basis, Canada has over twice as much land as the United States and nearly six times as much as Mexico. All three countries' farm sectors have both traditional and large-scale agriculture, with a larger concentration of more commercial farms in the United States and Canada and more traditional subsistence farms in Mexico. Just as the United States has a Corn Belt, key commodities in both Mexico and Canada tend to be concentrated in specific regions of Canada and Mexico. In Mexico, large irrigated farms in the north and northwest produce grains, oilseeds, cotton, and vegetables. Cattle operations are also concentrated in the northern and Gulf states. Over half of Mexico's cropland is located in the rain-fed central highlands, where small farms produce two of Mexico's most important staples--corn and beans. In the southern, tropical regions of Mexico, coffee, rice, sugarcane, and traditional plantation crops are produced. In Canada, most of the grains and oilseeds are produced on the western prairies. In addition, cattle are raised in the western region of Canada. Smaller farms and dairy operations are located in the eastern part of the country. These regional aspects of production greatly affect trade flows and help explain why the United States can both import and export large volumes of beef with Canada. While all three countries are highly urbanized, the income levels are much higher in the United States and Canada. However, the strongest growth will be in Mexico's economy over the next decade. Mexico's population is young (37 percent of the population under 14 years old) and growing (nearly 2 percent annually), which means Mexico will remain a good market for U.S. agricultural products for many years. Long-Term Prospects for NAFTA Agricultural Trade Trade in food and agricultural products will grow rapidly over the next decade both within the North American market and between North America and the rest of the world. NAFTA trade liberalization will continue to bolster the economic forces that are promoting North American trade growth, including favorable socioeconomic conditions, complementary resource endowments, and consumer preferences. By 2005, intra-NAFTA trade in food and agricultural products could reach over $30 billion. North American exports to the rest of the world will be spurred by strong economic growth and trade liberalization under the WTO. [Daniel Plunkett, Teresita Ramos, and Terri Raney (202) 219-0610] A Plausible Scenario for Agriculture and Trade The projections presented in this article were developed by ERS based on specific assumptions about world market developments, domestic and international macroeconomic conditions, and government policies. The projections form a plausible long-term scenario for agricultural production and trade for North America and the rest of the world under "normal" conditions. They provide a starting place for assessing the impact of policy proposals and other potential events on agricultural markets. The projections for grains, oilseeds, and meats for the three NAFTA countries and the rest of the world were developed as part of the most recent USDA baseline process and are based on information available in mid-1996 2/. ------- 2/ The USDA baseline projections were published in Long-Term Agricultural Projections to 2005, Interagency Agricultural Projections Committee, USDA World Agricultural Outlook Board, Staff Report WAOB-96-1. USDA international baseline projections were published in Long Term Projections for International Agriculture to 2005, Commercial Agriculture Division, Economic Research Service, USDA, Staff Report No. AGES 9612. ------- The other projections, such as those for snack foods, were developed by ERS for the purposes of this article; they were NOT approved by the Interagency Commodity Estimates Committees and are not part of the USDA baseline. [Begin Box] More About the Projections The projections form a consensus scenario derived from formal model results and analysts' judgments, based on a shared set of assumptions about U.S. and international macroeconomic conditions and policy developments. Because action on new U.S. farm legislation was incomplete when the baseline projections were being prepared, U.S. policies authorized under the 1990 farm bill, as amended, were assumed to continue throughout the projections period. However, the 1996 U.S. farm bill will likely have little impact on the analysis presented herein. Canada's decision to eliminate transportation subsidies formerly provided for wheat exports under the Western Grains Transportation Act (WGTA) is incorporated in the projections, as is Mexico's PROCAMPO program. All countries were assumed to adhere to existing international agreements that affect agricultural trade, but not necessarily to enforce the most restrictive policies permissible under those agreements. For example, because Mexico has not enforced the tariff-rate quotas (TRQs) on corn and poultry meat imports from the United States that were established under NAFTA, the projections assume that Mexico will not enforce them in the future. The projections assume that no new international agreement affecting agricultural trade will go into effect, beyond those already signed. Thus the projections make no attempt to assess the impact of potential NAFTA expansion. The projections are based on normal weather patterns, and the impacts of short-term market disturbances are intentionally ignored. The long-term baseline projections for the macroeconomy are based on the belief that business cycles and external shocks to the general economy cannot be predicted accurately. Unforeseen macroeconomic crises, such as the recession caused by the peso devaluation or a war affecting petroleum prices, can of course greatly affect short-term trade performance. By intentionally smoothing out the business cycle and ignoring external shocks, we avoid distorting the long-term commodity projections through the introduction of unpredictable swings in the macroeconomy. In these projections, the macroeconomic assumptions do not attempt to predict periodic crises, but instead offer a reasonable scenario based on the prevailing conditions for long-term growth. [End Box] NAFTA Fosters Market Integration in North American Agriculture NAFTA is a long-term agreement, with the gradual reduction and elimination of tariffs for most items completed during the projection period, which goes through 2005, and finishing in 2008 for the remaining few. The economies of NAFTA will become increasingly integrated through investment, cross- border sourcing, and trade as regional markets stretching across national boundaries continue to flourish. NAFTA is an agreement to achieve a free trade area, rather than a customs union or a common market. Barriers to trade will remain, although they will not be tariff barriers (with perhaps a few exceptions). Administrative barriers to trade, such as customs posts, paperwork, and other red tape, will remain. Substantial improvements are possible, particularly at crossing points from Mexico into the United States, where long waits in obtaining product clearance raise the costs of doing business. Fiscal barriers, such as varying rates of sales and excise taxes on items such as liquor or cigarettes, will encourage movement of products from low-tax areas to high-tax areas, but block movement in the opposite direction. Financial barriers in the form of exchange rate risk will continue to influence trade and investment patterns. Technical barriers, such as phytosanitary standards, labeling requirements or product approval procedures, will continue to hinder trade, particularly for selling to Mexico, where many of these norms and standards are being developed. Strong Economic Growth Will Stimulate Trade Growth The macroeconomic outlook over the next decade is for relatively strong growth in the United States and Canada, with more rapid growth in Mexico's emerging economy (table 4). The U.S. share of total NAFTA area GDP will shrink slightly from 88 percent in 1995 to 86 percent by 2005, so developments in the U.S. economy will continue to affect Canada and Mexico more so than vice versa. The U.S. economy will still be about 10 times the size of Canada's, but Mexico's rapid growth will allow it to close the gap somewhat between itself and its Northern neighbors. Economic growth is projected to be even faster in the rest of the world than in North America, creating higher demand elsewhere for products from NAFTA countries and slightly dampening increases in intra-NAFTA trade. Important Assumptions Underlying the Macroeconomic Projections: United States o Labor productivity growth is expected to range from 1.5 to 1.6 percent through 2005. o The labor force will grow about 1.2 percent a year. o Government spending will average only about 0.5 percent real growth from 1999 to 2005, in order to stay on a 7-year path to deficit reduction. o Money supply growth will average 3.9 percent, reflecting a continuing commitment by the Federal Reserve to contain inflation. o Real international crude oil prices will rise 2.2 percent a year. o The real trade-weighted exchange value of the dollar will appreciate slightly by the end of the decade and then remain essentially constant through 2005. Canada o Fiscal policy will be very restrained through the next several years, in the wake of the large debt accumulated during the 1990-92 recession, and will ease only slightly after the end of the decade. o Monetary policy will ease slightly as the failure of the Quebec independence vote indicates less need to defend the currency and allows more room for lower interest rates. o The Canadian dollar will gradually appreciate to purchasing power parity by the end of the projection period. o Employment and wage growth will improve as productive capacity and capacity utilization rise. Mexico o With the recovery in full swing, GDP will resume its previous path toward annual growth of about 5.8 percent by the end of the decade. o The manufacturing base will expand as Mexico continues to move away from an oil-based economy. o Population growth will slow, but remain near 2 percent. Mexico's population will be near 110 million in 2005. o Because of cheap labor and land, new jobs will emerge in labor-intensive industries and provide economic opportunity to poorer segments of the population. o The peso will be fairly stable in real terms under free exchange rate policy. Capital inflows will lead to slightly stronger real exchange rate. o Mexican consumers will be eager to upgrade their diet with more meats, horticultural products, and processed foods. Concern will grow about product safety and adulterated goods. Agricultural Policies in NAFTA Members Becoming More Similar, Less Trade-Distorting NAFTA does not provide for a "common" agricultural policy in the three member countries, such as in the European Union's common market. However, the reduction of trade barriers under NAFTA is in keeping with the major agricultural policy changes in the United States, Canada, and Mexico. The emphasis has been on reducing economic distortions in the production, distribution, and consumption of food and agricultural products. With all three NAFTA countries now focusing on supporting producer income and letting markets operate with only limited government intervention, there is more similarity in the policy approach than ever before. These projections are based on greater market orientation in agriculture and the increasingly reduced government influence in the sector through traditional commodity programs. The policy assumptions for these projections were set before the 1996 U.S. farm bill was enacted, so they are based on policy decisions as of January 1996. Critical Agricultural Policy Assumptions: United States o Most commodity markets operate without government price supports. o Programs for dairy, sugar, and cotton continue relatively unchanged. o The Conservation Reserve Program continues to keep millions of acres of environmentally fragile land out of production. o No land is set aside for purposes of supply control. Canada o The Western Grains Transportation Act subsidy is eliminated, meaning grains prices will better reflect the costs of transport. With less grain moving east, some livestock operations will move west. Also, more grain will move through western outlets. o Supply control programs and barriers to trade remain in place for poultry, eggs, and dairy, forcing Canadian consumers to pay higher prices and limiting potential U.S. markets. o Producer support for grains and oilseeds continues to be mainly through whole farm income program. o The Canadian Wheat Board (CWB) continues to operate as an export monopoly. Mexico o Producers receive PROCAMPO per-hectare payments. No price supports. o Minimal government role in production and marketing of products leads to development of new commercial relations between producers, processors, and importers. o Despite prohibitively high over-quota tariffs for corn and poultry meat, Mexico continues to import as much as its domestic buyers need, duty-free. Long-Term Outlook for North American Agricultural Trade Wheat Trade Grows Within NAFTA and in Offshore Markets The United States and Canada are among the most competitive producers and exporters of grains and oilseeds in the world (figure 9). World wheat trade is projected to grow 2.2 percent annually during 1995-2005, well above the rate of growth during the 1980s. With strong world prices as incentive for producers, the United States is projected to capture a slightly higher share of the world wheat market, 36 percent by 2005 compared with 34 percent during 1993-95. Canada's share of total exports is projected to fall to 17 percent by 2005 from 20 percent during 1993-95. Although Canadian wheat area is projected to increase compared with recent levels, future supplies are likely to be constrained by area competition from higher-value crops such as canola and specialty crops. The elimination of transportation subsidies under the Western Grains Transportation Act in 1995/96 will raise the cost of shipping grain to Canadian ports. As Canadian grain farmers face rising transportation costs from the Prairie Provinces to export ports, they are likely to increase wheat shipments to the United States. By 2005, the United States could import about 15 percent of Canada's wheat exports (figure 10). Mexico currently imports about 1.4 million tons of milling wheat for blending with its lower quality domestic product. Mexican wheat imports are projected to peak in 1999 at about 1.65 million tons before dropping back to roughly their current level. The United States and Canada receive preferential access to the Mexican wheat market under the NAFTA agreement and will continue to be the dominant suppliers to that market. North American Feed-Livestock Markets Becoming More Integrated With growing meat production around the world, U.S. coarse grain exports are projected to reach about 79 million tons by 2005, from about 54 million tons in 1992-95. Corn will account for about 70 million tons of U.S. coarse grain exports in 2005 and about 20 million tons of the growth. The United States is projected to maintain about 68 percent of the world coarse grain market, but the U.S. share of the world corn market will reach 80 percent, compared with 69 percent in 1993-95. As the United States focuses on its competitive advantage in corn, other countries, particularly in Central and Eastern Europe, will boost exports of barley and other coarse grains. Almost one-quarter of the increase in U.S. coarse grain exports is projected to go to our NAFTA partners. Mexican coarse grain imports are projected to increase very rapidly, to 10 million tons in 2005, to fill Mexico's growing demand for animal feeds. As the preferred feed, corn will likely supply over half of the Mexican import demand for coarse grains, with sorghum supplying most of the remainder. Under PROCAMPO, some Mexican corn area has been switched to sorghum production, but demand is expected to outstrip production gains. Total and per capita corn food use are also projected to rise, reflecting both population and income gains among the poorest consumers. Canadian coarse grain exports, predominantly barley, are projected to increase slightly to about 5 million tons. U.S. coarse grain imports, again predominantly barley from Canada, are projected to remain at about 3 million tons. Canadian corn imports, primarily from the United States, are projected to increase modestly to a little more than 1 million tons as feed demand rises in Canada. Besides being the leading corn exporter, the United States is the dominant world supplier of soybeans, another key feed ingredient. From 1993-95, the United States accounted for 67 percent of world soybean exports and 15 percent of soybean meal exports. Those shares are projected to fall to 64 percent and 16 percent respectively in 2005, as countries such as Brazil, Argentina, India, and the Andean Pact countries expand production. U.S. soybean meal and soybean oil are also important to animal feeding and human needs around the world (figure 11). Canada's main oilseed grown for export is canola. Over the next few years, Canada will export less canola seed, focusing on crushing domestically and exporting canola meal and canola oil (figure 12). One of the most important stories for intra-NAFTA trade is Mexico's rising animal feed needs (figure 13). Due to sharply lower incomes, Mexican per-capita consumption of meat is only about half that in the United States and Canada (figure 14). Only about one-fourth of Mexico's population is considered to have sufficient income to eat meat. Over the next decade, an improving standard of living will allow meat consumption to rise 16 percent. As in the United States and Canada, poultry will outpace beef and pork. Most of the meat consumed in Mexico will be produced in Mexico, using both domestic and imported feed grains. Given Mexico's limited arable land and significant water scarcity, import demand for feed grains and protein-rich feeds will grow proportionately (figures 15 and 16). Not all of Mexico's increased meat demand will be produced in Mexico. Mexican poultry and beef imports will both rise to over 200,000 tons by 2005, while pork will be about 150,000 tons (figure 17). As at present, Mexico will import primarily lower-value cuts of meat as well as organ meats such as livers or kidneys. Most of the poultry meat imports will be mechanically deboned chicken and turkey meat intended for sausages and other processed foods. The United States will supply nearly all of Mexico's meat imports, given competitiveness in terms of price and quality, reinforced by proximity and a tariff preference over other suppliers. The United States will emerge as a major meat exporter in the world, particularly in poultry and beef (figure 18). By 2005, the United States is expected to be competing with Australia as the largest beef exporter in the world, to have surpassed the EU as the largest pork exporter, and be exporting nearly four times more poultry than any other country. The increasing industrialization of the U.S. meat industry will contribute to U.S. export competitiveness, combined with a reduction in subsidized exports from the European Union due to the Uruguay Round. There will likely be relatively little change in Canada's meat trade, except for some substitution of beef for live cattle exports to the United States (figure 19). Horticultural Products and Processed Foods--The New Horizon Prospects for increased U.S. trade with Canada and Mexico are perhaps brightest in horticultural and processed food products, particularly after economic growth resumes in Mexico. U.S. exports of fresh vegetables to the two NAFTA partners will likely reach $1.5 billion, with fresh fruit close behind (figure 20). Canada accounts for about three-quarters of U.S. exports of fresh fruit and vegetables, so continued market development there is key. U.S. snack food exports to the two NAFTA partners should resume the strong growth of the early 1990s and are likely to be worth well over $1 billion by 2005. Pet food exports will probably more than double over the next decade to be worth nearly $500 million. U.S. consumers will continue to demand new and different types of foods, and year-round availability, raising high-value product imports from Canada and Mexico (figure 21). Fresh vegetable imports, primarily from Mexico, will likely continue to grow, as Mexican produce will complement U.S. supplies at certain times and compete at other times. As on the export side, snack food imports will probably double over the next decade, although the broadening of the snack food trade deficit has raised little attention to date. Beer from Canada and Mexico are increasingly appreciated by U.S. consumers, with much of the Mexican beer produced using U.S. and Canadian barley and hops. NAFTA Policy Briefs Changes in agricultural trade flows have generated a number of trade issues within NAFTA during the past year. Some of the latest policy issues range from allegations of unfair trade practices to phytosanitary concerns. [Suchada Langley, Daniel Plunkett, Terri Raney, Mark Simone, and Jim Stout (202) 219-0610] NAFTA Maintains National Antidumping/Countervailing Duty Laws As tariffs are reduced and eliminated under NAFTA, one of the remaining potential barriers to trade is the use of laws governing unfair trade practices, such as antidumping or countervailing duties. While additional tariff protection can occur from either antidumping or countervailing duty cases, there is also the possibility that simply initiating an investigation could inhibit trade. NAFTA retains domestic laws on antidumping and countervailing duties that differ among its members. In some cases, these differences in national laws can create or contribute to trade disputes. Chapter 19 of the NAFTA lays out the common areas of agreement, including provisions for a binational panel review of final antidumping and countervailing duties determinations to ensure that the final determinations are in accordance with the applicable law of the importing party. Binational panel decisions may not be appealed to the domestic courts of either party. Beyond the World Trade Organization commitments, NAFTA does not provide for harmonized procedures or criteria for determining whether dumping has occurred or when and how countervailing duties should be set. Areas of agreement on the process for antidumping and countervailing duty investigations include: publishing notice of initiation of investigation; time limits for submissions of information and for decisions; reasonable access to information during the course of the investigation; an opportunity for interested parties to present facts and arguments; disclosure of relevant information, including an explanation of the methodology used to determine the margin of dumping or the amount of the subsidy; and a statement of reasons for final determinations (dumping, subsidization, material injury, threat of material injury, or material retardation of the establishment of such an industry). Annex 1911 of NAFTA sets out the standards of review and general legal principles that would apply to a review of a determination. Since the implementation of NAFTA, there have been a number of unfair trade practice allegations, among them: sales of U.S. and Canadian wheat to Mexico; sales of U.S. beef and pork to Mexico; U.S. sugar exports to Canada; Canadian wheat exports to the United States; and Mexican exports of tomatoes and peppers to the United States. In some of these cases, the differing national definitions and criteria for dumping have played an important role. For example, beef producers in Mexico have argued that it is unfair for U.S. exporters to sell low-value cuts to Mexico at a price below the per pound price of producing the carcass as a whole. In the United States, the cost calculation is made on the cost of producing the individual cut rather than the entire carcass. A range of solutions has been found to some of these cases, with others still pending (see following sections). For example, the U.S. and Canadian governments have discontinued subsidies for wheat exports to Mexico. Producer groups for beef in the United States and Mexico have agreed to cooperate in joint marketing activities. Antidumping duties have been applied on U.S. sugar exports to Canada. For Canadian wheat exports to the United States, the two governments agreed on temporary measures governing trade for 1 year. An antidumping investigation of Mexican winter vegetable exports to the United States has not yet been resolved. ITC and Commerce Department Rulings on Mexican Tomatoes and Peppers Increased U.S. imports of winter vegetables from Mexico since NAFTA have sparked a contentious trade dispute between the two NAFTA partners. In 1996, growers of tomatoes and bell peppers from Florida and several other states and the Florida Department of Agriculture filed two petitions seeking relief from Mexican imports. The first, with the U.S. International Trade Commission (ITC), sought economic relief against import surges under Section 201 of U.S. trade law. The ITC ruled 4-1 on July 2 that imports of tomatoes and peppers do not pose a serious threat of injury to U.S. producers. The second, an antidumping petition, charged Mexican exporters with selling tomatoes in the U.S. market at less than fair market value. On May 16, the ITC made a unanimous preliminary determination that there were sufficient grounds for the Commerce Department to undertake an investigation. The Commerce Department's preliminary determination on provisional "anti-dumping margins" to be applied to imports, has been delayed until October, and the final determination on antidumping margins will be made later. The ITC will make a final determination of injury early in 1997. Additional duties resulting from the case can be applied retroactively. The two petitions in 1996 follow an April 1995 case in which Florida tomato growers petitioned the ITC for relief under Section 201 of U.S. trade law. The ITC ruled 5-0 against the Florida petitioners, saying that the Florida winter tomato crop could not be recognized as a separate industry on the basis of seasonality. U.S. tomato imports from Mexico grew 58 percent by volume in 1995 compared with a year earlier. In 1994, Mexico's strong economy and overvalued peso bolstered domestic demand for tomatoes and constrained Mexican exports to the United States. Following the peso crisis in late 1994, Mexican incomes plummeted, lowering Mexican demand. Liquidity problems hindered domestic commercial transactions, further raising the incentive to sell to the United States. U.S. 1995 tomato imports from Mexico totaled 593,000 tons, worth $406 million (figure 22). A smaller U.S. crop in 1996 has raised domestic U.S. prices and stimulated imports. In the first 5 months of 1996, tomato imports have grown another 21 percent by volume compared with the same period a year before, and the per unit value of imports has increased 26 percent. Bell pepper imports, the second largest U.S. winter vegetable import, have also risen rapidly, up 40 percent in volume in 1995. Import value was $175 million. In the first 5 months of 1996, bell pepper imports were up a further 28 percent, with the per unit value down 41 percent. First NAFTA Phytosanitary Panel Decision Clears the Way for U.S. Sweet Cherry Exports The first dispute handled by a NAFTA phytosanitary technical review panel involved U.S. sweet cherry exports to Mexico. Mexico closed its market to U.S. cherries in 1991, ostensibly because of concerns about two pests--the apple maggot and plum curculio. The NAFTA phytosanitary dispute resolution panel, tasked with issues related to pests, diseases, and chemicals in animals and plants, ruled in June that Mexico's concerns about the two pests entering its country were not scientifically justified. Mexico continues to insist that fumigation is necessary to adequately protect against the pests. The phytosanitary panel endorsed the opening of Mexico's market for U.S. cherries without fumigation. To date, the United States is waiting for Mexico to implement the phytosanitary decision. Prior to Mexico's ban, U.S. cherry exports were small, but had been growing, reaching 222 tons worth $350,000 in 1991. Fumigation would raise the cost of marketing the product to Mexico and reduce its shelf life. Mexico had a 20-percent tariff prior to NAFTA, but eliminated it immediately. Proposed Phytosanitary Rule Change for Mexican Avocados Mexican avocados have been prohibited from the U.S. market since 1914 because they contained seed weevils and other pests. The debate over partially lifting the ban on imports has not reached a final resolution. USDA published a proposed rule in the Federal Register on July 3, 1995, that would allow imports of fresh Hass avocados grown in approved orchards in Michoacn, Mexico, into 19 northeastern States and the District of Columbia (where avocados are not produced) from November through February--Mexico's peak harvest season. After five public hearings throughout the United States in August 1995, the public comment period on the proposed rule ended on October 6, 1995, with over 1,000 comments. USDA's Animal and Plant Health Inspection Service (APHIS) has been reviewing the comments prior to publishing a determination. APHIS may proceed with the proposed rule unchanged, proceed with modifications, or drop the proposal entirely. In the first two options, a final rule would be the final legal step. A series of full-page ads run by the California Avocado Commission in the Washington Post and the Wall Street Journal during 1996 have heightened public awareness of the issue. Despite the ongoing ban on fresh avocados, Mexican exporters have found a way to market their avocado products in the United States. Imports of processed avocados from Mexico have grown strongly in the last few years (figure 23). The phytosanitary ban does not apply to processed avocados, as the husk and large seed have been removed. Processed avocados--including avocado pulp, avocado paste, and guacamole in consumer-ready packaging--face a 1996 tariff of 9.2 cents/kilogram, which will be eliminated by 2003 (NAFTA provides for similar treatment for fresh avocados). Mexico is by far the world's largest avocado producer, accounting for 45 percent of global production. Karnal Bunt Crisis Challenges North American Grain Handling System On March 8, 1996, the USDA Agricultural Research Service announced the presence of Karnal bunt fungus discovered in durum wheat seed in Arizona, the first occurrence of this disease in the United States. Karnal bunt was subsequently found in parts of New Mexico, Texas, and California. Karnal bunt is a fungal disease of wheat, durum wheat, and triticale that reduces grain yield and quality, if the presence exceeds 3 percent. The disease was first reported in 1931 in India and has since been found in Pakistan, Iraq, Afghanistan, and Mexico. Karnal bunt is harmless to humans but can cause an unpleasant odor and taste in flour made from wheat highly affected by the disease. Karnal bunt is caused by a smut fungus and is spread by airborne spores that can also be carried on plants, soil, farm equipment, and vehicles. Because of the risk to U.S. wheat's reputation in both the domestic and international markets, USDA imposed a federal quarantine on the areas where Karnal bunt was detected. An eradication program was established to contain the disease by destroying infected wheat. Farmers are being compensated for certain financial losses resulting from the disease. At the time of the discovery in the United States, 37 countries had existing quarantines on wheat imports from countries where Karnal bunt is present. Canada and Mexico did not have quarantines, but instead regulated imports of wheat from countries where Karnal bunt is known to occur. In addition, NAFTA Article 712 allows member countries to "adopt, maintain, or apply any sanitary or phytosanitary measure necessary for the protection of human, animal, or plant life or health in its territory, including a measure more stringent than an international standard, guideline, or regulation." Most of the 37 countries agreed to accept U.S. wheat shipments, provided the USDA APHIS certified that the wheat originates from an area where Karnal bunt is not known to occur. After the initial Karnal bunt discovery in Arizona, Canada banned all imports and transshipments of U.S. durum wheat and all grain imports from the four quarantine States. Although Canada only imports a small amount of U.S. wheat, approximately 1 million tons of U.S. wheat annually pass through the Canadian ports of the St. Lawrence Seaway system on the way to third country markets. In early April, Canada agreed to permit in-transit shipments of U.S. wheat through the Seaway to resume. In-transit shipments include those that do not stop at Canadian ports or that are topped-up with Canadian grain. Canada also allowed non-durum U.S. wheat to be transshipped through Canadian grain elevators and agreed to reassess its prohibition on durum wheat based on additional survey and sampling data provided by the United States. Currently, no such shipments have tested positive for the Karnal bunt disease. Although Canada imposed the ban to insure the "integrity of the Canadian grain system," a NAFTA phytosanitary technical review panel was not used to resolve the case. Rather, it was resolved through bilateral negotiations with the United States. Karnal bunt was detected in some areas of northwestern Mexico in the late 1970s--long before the implementation of NAFTA--and the United States banned Mexican wheat imports in 1983 to prevent the introduction of the fungus. Article 722 of the NAFTA established a Committee on Sanitary and Phytosanitary Measures. In the committee's most recent meeting, in June 1996, Mexico sought recognition from the United States that the Mexicali Valley region is free of Karnal bunt. The United States recognized that the Mexicali Valley is free of Karnal bunt but has not established a protocol for allowing wheat imports from the region. After regulations related to Karnal bunt were issued in the four U.S. States, Mexico announced it would restrict wheat produced or stored in Arizona, New Mexico, California, and certain parts of Texas from entering Mexico. Mexico will import U.S. wheat from non-quarantined areas if the grain is tested and certified free of Karnal bunt, or fumigated with methyl bromide if it is produced within the quarantine area. Hot Competition in North America Competition is intensifying in specific commodity markets in North America due to trade liberalization and regional specialization. Regional markets are emerging in fruits and vegetables, animals and livestock products, and grains and feeds as producers take advantage of production complementarities and seasonal variations that reach beyond national boundaries. [Steve Haley, John Love, Gary Lucier, Daniel Plunkett, Teresita Ramos, Terri Raney, and James Stout (202) 219-0610] North American Meat Markets Evolving Rapidly Meat and livestock trade within North America is rapidly integrating due to new investment and changing international trade rules. Trade liberalization under NAFTA has facilitated this rapidly-growing sector, by lowering the cost of imported products. As a result, livestock producers and processors compete based on regional factor allocation that often has little to do with the national origin of the animals involved. The United States usually has a substantial trade surplus with Mexico but an even larger trade deficit with Canada in animal products. As of 1994, all tariffs on North American cattle and beef trade were eliminated. Canada and Mexico typically account for up to 95 percent of U.S. cattle exports (figure 24). Mexican cattle imports can be quite variable, but can reach a quarter of a million head in years when Mexico is rebuilding its herd. Canada mainly buys beef to serve its eastern population centers. Both Canada and Mexico sell over a million head of cattle per year to the United States, although Mexico exports feeder cattle to be finished by U.S. fatteners, while Canada exports slaughter animals to western U.S. slaughterhouses, primarily in the Great Plains. Canadian beef exports to the United States have more than doubled in the last 5 years to over 175,000 tons and may increase further. Two U.S.-owned meat packers have built very large plants in Southern Alberta. It is likely that when these plants are fully operational, U.S. imports of Canadian slaughter animals will decline, as demand by the new packers may outbid U.S.-based plants for the throughput. More Canadian beef could thus come south in boxes as meat, rather than "on the hoof." Another change in trade flows will likely be increased demand for U.S. beef exports to Eastern Canada. Elimination of Canada's grain transport subsidy makes beef production in Ontario and Quebec relatively more costly than competing beef production in feed grain producing U.S. states. U.S. beef exports to Canada have been growing since the beginning of trade liberalization with Canada in 1989, reaching 100,000 tons in 1995. U.S. beef exports to Mexico will likely grow to more than 100,000 tons in the next few years, though because of lower incomes and taste preferences the per unit value has been one-fourth lower than on sales to Canada. Trade is predominantly in lower-value cuts for sale to Mexican consumers, although high-value cuts move to the hotel, restaurant, and institution buyers, who serve upper income groups and the tourist trade. North American hog and pork trade is limited by health restrictions. Canadian hogs are shipped to the United States for finishing, but pseudorabies restrictions limit U.S. hog exports north. At close to 200,000 tons exported, Canada is the number one supplier of pork to the United States. There are significant volumes produced in western Canada that move south to the U.S. West Coast market, but U.S. pork moves into eastern Canada. U.S. pork exports to Mexico peaked in 1994 at 50,000 tons, but could be three times that size within the next 10 years. U.S. imports of pork from Mexico, currently nil, could grow if the northwestern Mexican state of Sonora is declared free of hog cholera. Before the Uruguay Round, entire countries were required to attain disease-free status to gain access to other disease-free markets. Under the "regionalization rules" in the WTO Sanitary/Phytosanitary annex, geographical regions able to meet disease eradication and control standards can be declared "disease-free" and attain access to other "clean" markets. Three large modern slaughter facilities have been built in Sonora in recent years. Sonora offers a dry climate favoring manure disposal, low labor costs, and excellent proximity to western U.S. markets. Sonora exported about 10,000 tons of high-value loins to Japan in 1995, shipped through the California port of Long Beach. In April 1996, USDA published the proposed rule under which regions in foreign countries could apply for disease-free status. The United States usually sells over $100 million in variety meats (such as bovine or porcine livers, kidneys, and stomach linings) to Mexico. U.S. variety meats are highly competitive in Mexico's market both on price and quality. U.S. variety meats are considered to be of higher quality than Mexican variety meats due to better animal nutrition, slaughter, and post-kill handling conditions in the United States. The 20-percent tariff prior to NAFTA has been reduced to 14 percent for 1996 and will be eliminated by 2003. In the 1990s, Mexico and Canada have accounted for over one-fourth of U.S. poultry meat exports by value, with Mexico usually a larger--and growing--market. In 1995, this one-fourth share was lower due to reduced Mexican imports and much higher U.S. exports, particularly to Russia. Two of the main export categories to Mexico are mechanically deboned chicken and turkey meat, which compete with Mexican pork for sales to Mexico's sausage and "ham" industry. U.S. mechanically deboned meat is very price-competitive, but the Mexican government has yet to enforce the prohibitive over-quota tariff under NAFTA (for 1996, the greater of 229 percent or $1,478 per ton), which has led to complaints by the Mexican pork industry. For Canada, U.S. poultrymeat is very competitive, but imports continue to be limited by tariff rate quotas. However, prepared foods containing poultry, such as microwave meals, are not subject to the production quota, and that category was up 12 percent by value during the first 5 months of 1996 compared with the year before. The United States does provide an important input into Canada's poultry industry through exports of nearly $30 million in baby chicks and other live poultry. Grain Trade Between the United States and Canada The United States and Canada are two of the world's largest grain exporters and they share a common interest in reducing government interference in world agricultural markets and encouraging world trade. The U.S. grain and oilseed sector is almost 10 times larger than that of Canada, and U.S. exports are much larger. In relative terms, however, Canada is much more dependent on export markets. On average, about 75 percent of Canadian wheat production is exported. The climate of the Canadian Prairie Provinces (Alberta, Saskatchewan, and Manitoba), where upwards of 80 percent of Canadian grain and oilseed production occurs, is similar to that of the U.S. Northern Plains. The region is characterized by a short growing season, little precipitation, and long harsh winters. The number of frost-free days per year varies from 90 to 120, and annual precipitation ranges from 8 to 14 inches. Consequently, small grains such as wheat, barley (see next section for more information on barley), and oats, and oilseeds such as canola and flaxseed dominate production in this region. U.S. and Canadian agricultural policies and grain marketing systems are fundamentally different, and these differences contribute to U.S./Canada grain price differentials. Canada's production system remains carefully linked to the grain marketing system, which is much more heavily regulated--by both federal and provincial governments--than in the United States. The Canadian Free Trade Agreement (CFTA) and NAFTA have served to accelerate a continuing process of integration of U.S. Plains States and Canadian Prairie Provinces grain/grain processing and feed/livestock sectors. The integration proceeds with little consideration for national boundaries. Oats provide an example of a commodity for which U.S. mills have come to rely heavily on imports from Canada, particularly in the last year as oat exports from Scandinavia have declined (after Sweden and Finland joined the European Union). U.S. oats acreage has declined from about 7.5 million acres in the early 1980s to about 2.5 million in the current 1996/97 marketing year, in part due to changes in policy. Subsequently, imports from Canada have risen from less than 100,000 tons per year in the mid-1980s to 1.4 million tons in calendar 1995. Similarly, the Canadian livestock feeding sector has relied on the United States to supply an increasing share of its corn and soybean meal requirements in recent years, although, for the most part, the Canadian market was not protected by tariffs even before the CFTA (Canada did impose a countervailing duty on corn in the mid-1980s). Soymeal imports from the United States have increased from about 400,000 tons in the early 1980s to an average of 765,000 tons in 1993-95. Inevitably, occasional grain trade conflicts have occurred. The U.S./Canada wheat dispute of 1994 was triggered by policy and marketing differences and 2 consecutive years of poor weather in the United States and Canada. In both 1992 and 1993, Canada's Prairie Provinces suffered from poor weather that led to above-normal levels of lower quality wheat. Historically, only about 10 percent of Canadian Western Red Spring (CWRS) wheat has graded as feed wheat, but in 1992 and 1993, 39 and 22 percent, respectively, graded as feed wheat. Meanwhile, the 1993 flood in the U.S. Midwest sharply cut U.S. feed grain production and created a feed deficit in the United States. The U.S. livestock industry benefited from the surplus supply available in Canada. Compared with 1990, U.S. wheat and wheat product imports from Canada increased 42 percent by 1994. The import surge led to the negotiation of a temporary agreement to limit Canadian wheat exports to the United States during September 12, 1994 to September 11, 1995. The agreement also established a 1-year U.S.-Canada Joint Commission on Grains to examine all aspects of the two countries' respective marketing and support systems, their effects on the U.S. and Canadian markets, and their effects on competition between the two countries in third-country markets. The Joint Commission released its findings in January 1996. Its major recommendations were that the United States and Canada remove export subsidies on grains and products, reduce or remove direct market interventions resulting from government programs that distort trade, and reduce and/or remove all domestic support programs that distort trade. The Joint Commission also recommended that Canada and the United States continue to undertake "regular and structured" consultations concerning grain policy issues, including examination of the impacts of the U.S. Export Enhancement Program (EEP) and the operations of the Canadian Wheat Board (CWB). An Emerging North American Barley Market The United States and Canada are important producers, consumers, and exporters of barley. In the past, competition between the United States and Canada has been centered in third-country, offshore markets. Recently, however, U.S. producers have seen increased competition in home markets. U.S. barley imports from Canada grew rapidly from 215,000 tons in calendar 1990 to nearly 2 million tons in 1994, following the U.S. flooding the previous year. Imports fell to 1.0 million tons in 1995 and are slightly below that pace thus far in 1996. Looking to the future, the possibility that Canada may loosen restrictions on its export marketing system could mean even more competition from Canada in the U.S. barley market. Barley is differentiated into two classes, malting quality (for beer) and feed quality. Barley for malting is the higher valued activity in the United States. Malting barley prices recently have ranged 10 to 36 percent higher than those for feed barley. In Minnesota, North Dakota, and South Dakota, malting barley varieties compete for area with Hard Red Spring wheat, durum, and sunflowers. However, much of the barley planted in these States is eventually marketed for feed use because it does not necessarily meet malting standards. About 55 percent of the total U.S. barley crop goes for feed. Feed barley varieties are more prevalent in the western growing States of Colorado, Idaho, Montana, Wyoming, California, Oregon, and Washington. Higher yields for feed barley varieties make the crop competitive relative to alternative crops such as potatoes, alfalfa, edible beans, sugarbeets, and irrigated vegetables. Most of the malting barley planted is in Montana, Idaho, Wyoming, and Colorado. Barley production in Canada is centered in Alberta and Saskatchewan. Competing crops include spring wheat, durum, and canola. Feed use of barley is more important in Canada because it is the lowest-cost feed in Western Canada, where it is in plentiful supply. In Canada, barley exports are currently marketed by the CWB. The CWB pays producers an initial price when the barley is delivered, and after it markets the barley and deducts operating costs, the CWB returns any revenue surpluses back to the producers as final payments. The CWB's objective is to maximize the returns of barley producers. In the United States, barley is marketed by individual grain trading firms, so firms bid among themselves for export or domestic outlets. In the past, export bonuses from the EEP helped promote U.S. barley in world markets, often in direct competition with CWB barley. Except for a brief 6-week period in 1993, Canadian barley exports have been controlled by the CWB through export licenses (the CWB must grant permission for each shipment). Many Canadian grain producers, including barley producers in Alberta, would like to see more flexibility in the western grain marketing system. Their concerns led Agriculture Minister Goodale to set up a Western Grain Marketing Panel (WGMP) last year to conduct a comprehensive examination of western grain marketing in Canada. The WGMP suggested that changes in the Canadian grain marketing system should take place in the next year, permitting Canadian farmers to market barley freely on the open market. However, recent press reports indicate that the government is not likely to make significant changes. Researchers at North Dakota State University issued a preliminary study in 1994 of the economic consequences of a more liberal Canadian barley marketing system 3/ ---------- 3/ Johnson, D. Demcey, and William W. Wilson. (1994) North American Barley Trade and Competition. Agricultural Economics Report No. 314, Dept. Agr. Econ., North Dakota State Univ., Fargo, ND. ----------- Given certain conditions, some of which are not currently in force, U.S. imports from Canada could increase up to 3.5 million metric tons, supplying 43 percent of the U.S. feed market and 24 percent of the U.S. malting market. The California feed market is particularly attractive to Canadian exporters because it is large and relatively distant from U.S. feed grain sources. However, U.S. exports have declined below the levels assumed in the North Dakota study, and imports from Canada have been ratcheted down as well. If Canada were to relax its regulations on varieties of barley grown, there could be added adjustments in the U.S. market. U.S. brewing companies have encouraged additional planting of malting barley varieties in Canada, at the expense of feed barley varieties. Therefore, malting barley could gain a greater share of total U.S. barley imports from Canada, as was seen during the 1995/96 marketing season. Selling Wheat to Mexico One of the most hotly contested markets in North America is the Mexican wheat market, where imported wheat is blended with domestic varieties to upgrade the quality and performance characteristics of domestic flour. Export subsidies are not currently being used, but both the United States and Canada use export credit guarantees to facilitate trade, particularly important because of the severe liquidity problems within the Mexican economy since the peso crisis. Mexico imports about a third of its wheat needs, generally seeking bread- making wheat with 14 percent protein content at the best price. The primary reason for importing is to serve the population centers in Central Mexico such as Guadalajara, Puebla, and above all, the 23 million people in Mexico City. Since 1992, Mexico has imported between 1.3 and 1.8 million tons per year, with the United States and Canada sharing fairly evenly (figure 25). Mexico's tariff for 1996 under NAFTA is 10.5 percent (zero by 2003), compared with the 15-percent tariff for non-NAFTA members. U.S. wheat exports to Mexico primarily go by maritime shipping through Houston to Mexico's Gulf Coast ports such as Veracruz (occasionally wheat will move by rail through Laredo). Canada's wheat exports go by ship to Mexico's Pacific ports. Thus, relative freight rates in different bodies of water play an important role in the choice of supplier, but likely not as important as the offer price of the wheat itself. Selling Oilseeds and Products to Mexico The United States and Canada also compete in the Mexican market for oilseeds and products. Mexico's import decisions for oilseeds and products are based on price and the availability of credit, rather than quality or strong consumer preference. A complex set of substitution ratios determines the combination of oilseeds, oils, and oilseed meals that Mexico will import (figure 26). Mexico's demand for both protein meal and vegetable oil can be satisfied through any combination of a number of products, including soybeans, soymeal, soyoil, and sunflower oil from the United States, and canola and canola oil from Canada. Other products in the mix include coconut oil, palm oil, cottonseed oil, fish oil, and animal fats. With the increasing industrialization of Mexico's poultry, egg, and pork industries--and therefore a heightened interest in meeting optimal nutrition requirements--there are few substitutes for the protein provided by soybean meal. Rapeseed meal is limited to the dairy industry. About 75 to 85 percent of both the edible oil and protein meal used in Mexico comes from imports, whether imported as meal or oil or imported as oilseeds to be crushed in Mexico. Because of NAFTA, the tradeoff between products and suppliers to meet the import demand of 1.2 million tons of edible oil and 2.6 million tons of protein meal is more than ever before a function of relative prices. Since 1990, a stable 80 percent of total meal demand has been met by meal derived from imported oilseeds. From 1987 to 1993, imported oils were making inroads into the Mexican market at the expense of oil from imported oilseeds. But in the first 2 years of NAFTA, Mexico increased its share of edible oil that came from crushing imported oilseeds, a trend boosted by slightly greater tariff reductions for soybeans than for competing oils and meals. Import demand for oil is now evenly split between imported oils and oil from imported oilseeds. The United States is doing well in the competition because Mexico's oilseed market is dominated by imports of U.S. soybeans (over 2 million tons in both 1994 and 1995) and soybean meal (about 350,000 tons). NAFTA will reduce Mexico's soybean tariff (at 7 percent for the Oct. 31-Dec. 31 dutiable season in 1996) to zero by 2003, giving soybeans the same access as canola seed, which already had a zero tariff prior to NAFTA. Canada started exporting canola oil to Mexico in the late 1980s, but is now mainly shipping canola seed (over 400,000 tons according to Canadian data). Over the last decade, Mexico has switched its sunflower imports from seed to oil, with market share evenly split between the United States and Argentina. The U.S. Vegetable Market Mexico and Canada are increasingly important sources of horticultural products in the U.S. market. The United States imported $3.12 billion of horticultural products from its NAFTA partners in 1995. Their 31-percent share of U.S. horticultural imports was up from 25 percent in 1990. In turn, Canada and Mexico imported $2.74 billion in U.S. horticultural products in 1995, but their share of U.S. horticultural exports fell from 38 percent in 1990 to 31 percent. Fresh produce accounted for about 80 percent of Mexico's horticultural exports to the United States in 1995. Mexico's fresh vegetable exports compete principally with Florida vegetables during the fall, winter, and spring months (figure 27). Half of Canadian horticultural exports to the United States in 1995 was fresh produce, with the other half processed and greenhouse/nursery products. Canada's potato exports--largest in the fall and winter months--compete especially with potatoes from Maine and New York. Fresh and frozen potatoes from Canada more than doubled during fiscal 1996, compared with a year earlier, partly because of tight U.S. supplies and higher prices. Canadian exporters have a cost advantage from the weak Canadian dollar. They also face lower transportation costs to markets in the eastern half of the United States than do U.S. producers in western States. Two french fry plants undergoing expansion in Manitoba are expected to ship more product to the United States over the next several years. Recent contributions to Mexico's export advantage in U.S. markets are the weakened peso and occasional poor growing weather in Florida. The weakened peso gave Mexican producers a labor-cost advantage during fiscal 1996, at a time when freezes reduced Florida's supply of winter fresh vegetables. A shift to extended-shelf life tomato varieties by Mexican growers is likely to increase Mexico's competitive advantage for the remainder of the 1990s. Canada's Fruit and Vegetable Markets Under NAFTA, the Canadian market for fruits and vegetables from the United States and Mexico is becoming increasingly open and competitive. Mexico and the United States face similar competitive conditions in exporting most fruits and vegetables to Canada, because NAFTA granted Mexico many of the same tariff rate and phase-out concessions given to the United States under the CFTA (table 5). Tariffs on most fruit and vegetable products from Mexico and the United States will be phased out by 1998. Mexico receives different treatment from the United States for some fruit and vegetable categories (table 6). For many of these products, Mexico faces higher tariffs and a longer phase-out period, but for others Mexico receives more favorable treatment. The largest differentials between U.S. and Mexican treatment apply to certain frozen vegetables and fruits, including asparagus, broccoli and cauliflower, small baby carrots, mixed vegetables, and strawberries. For these categories, the tariffs on Mexican products are about three- to four-times those on U.S. products. All Canadian tariffs will phase out to zero for U.S. products in 1998 and for Mexican products by 2008. In addition to the tariffs described above, Canada has at its disposal additional "snapback" provisions of the CFTA and NAFTA under which tariffs on fruits and vegetables may revert back to Most Favored Nation (MFN) rates under certain conditions. In the case of the United States, this provision covers all fruits and vegetables except turnips, truffles, cranberries, and blueberries, but requires a cumbersome investigation process--Canadian import prices and U.S. acreage must be monitored and compared with a 5-year historical period before a determination to apply MFN tariff rates can be made. Canada has used CFTA "snap-back" provisions to impose additional duties on U.S. asparagus in 1990, on peaches and tomatoes in 1991, and on lettuce, cabbages and peaches in 1992. CFTA snap-back provisions between the United States and Canada expire in 2008. In NAFTA, the snap-back provisions that apply to Mexican horticultural products entering Canada are simpler to apply because they are triggered on a quantity basis, but they are also more targeted--they are available only for fresh and processed tomatoes, onions, cucumbers, broccoli, strawberries, and cut flowers. NAFTA snap-back provisions expire in 2003. Canada has also imposed a number of anti-dumping duties against U.S. horticultural products, some of which originated before the CFTA. At the present time, Canada has antidumping duties in place for U.S. potatoes, yellow onions, Red Delicious apples, iceberg lettuce, and refined sugar. Two of these duties are targeted to particular jurisdictions and characteristics, specifically, the duty on iceberg lettuce, which applies only to fresh iceberg lettuce from the United States for use or consumption in British Columbia, and the duty on potatoes, which applies only to potatoes of certain sizes imported into British Columbia. Mexico's most important fruit and vegetable exports to Canada are tomatoes, peppers, melons, grapes, avocados, onions and shallots, cucumbers and gherkins, and mangoes. In 1995, Mexico and the United States were the top two exporting countries to Canada in each of these commodity groups, with the sole exception of grapes, in which Mexico ranked third behind the United States and Chile. As in the U.S. market, two of Mexico's biggest export gains since 1993 have been in tomatoes and grapes. Mexico's presence in these Canadian markets is still a minor one relative to that of the United States, however. According to Canadian data, Canada imported $1.4 billion of fruits, vegetables, and nuts from the United States in 1995, compared with only $126 million from Mexico. Chile Moves Ahead with Regional Trade Agreements One year ago, NAFTA was poised to expand its membership to include Chile as the next step toward hemispheric free trade. While the lack of fast-track negotiating authority in the United States has stalled NAFTA expansion, other work toward regional trade integration in the hemisphere is progressing rapidly. Chile is aggressively pursuing bilateral ties that may set the agenda for regional integration for the next decade. [Terri Raney and Julieta Ugaz] Chile enjoys an international reputation as Latin America's star economic performer, with agricultural exports a key sector. One of Chile's main economic objectives over the past several decades has been to further liberalize trade with its commercial partners. Despite the delay in NAFTA accession, Chile has wasted little time in looking elsewhere in the hemisphere for trade agreements (figure 28). Chile recently agreed to become an associate member of MERCOSUR 4/, --------- 4/ MERCOSUR, the Common Market of the South, is the largest regional trading group in the hemisphere after NAFTA. Beginning in 1991, MERCOSUR members agreed to phase out tariff and non-tariff barriers among themselves and to establish a common external tariff by the end of 1994. --------------- which is comprised of Argentina, Brazil, Paraguay, and Uruguay. Chile has bilateral agreements with a host of other Western Hemisphere countries, notably Mexico, within the framework established under ALADI 5/, the Latin American ----------- 5/ ALADI was established under the Montevideo Treaty in 1980. Members include Argentina, Bolivia, Brazil, Chile, Colombia, Ecuador, Mexico, Paraguay, Peru, Uruguay, and Venezuela. ----------- Integration Association. Chile is also negotiating economic cooperation agreements with Canada, the European Union, and other groups further afield. Chile has announced its intention of using its accord with MERCOSUR as a model for renegotiating its other existing agreements and for any new agreements in the region. Chile's deepening regional ties may be more important to the United States than any direct trade impact that would arise from Chilean accession to NAFTA. Chile has or is negotiating preferential bilateral trade agreements with all of its major trade partners in the hemisphere except the United States, which is Chile's largest single export market for agricultural products (figure 29). Chile receives preferential access to the U.S. market as a developing country under the Generalized System of Preferences. Most U.S. tariffs on Chilean agricultural products, with the exception of some processed fruits and vegetables, are already quite low and further reductions would probably have limited impacts on U.S. imports (ERS, Fruit and Tree Nuts Situation and Outlook Report, August 1995). Chile achieved and sustained macroeconomic stability and high rates of economic growth in the 1980s and 1990s through the development of a strong private sector and a liberal export-oriented trading environment. Chile transformed itself in the 1970s from an economy dominated by government intervention and control to one based on private property and market forces. By the mid-1980s Chile had the most liberal trade policies in Latin America with an average tariff of 26 percent. In 1988, Chile unilaterally reduced its average tariff to 15 percent, and when democratic government resumed in 1990, tariffs were slashed further to 11 percent. Chile maintains a price band system for a few agricultural commodities (wheat, wheat flour, sugar, and vegetable oils) that can raise the effective tariff on these products well above the 11-percent average. U.S. exports to Chile receive no preferential access. Chile and MERCOSUR Sign Free Trade Agreement Chile's most important bilateral agreement is the June 25, 1996 Economic Complementary Agreement (ECA) establishing Chile's associate membership with MERCOSUR. The countries of MERCOSUR are already Chile's largest supplier of and second largest market for agricultural products. Tariff elimination among them may further erode U.S. exports to the region. Because Chile has more liberal trade policies than its neighbors, it has traditionally sought bilateral market-opening agreements rather than full membership in any of the multitude of free trade areas in the region (Western Hemisphere International Agriculture and Trade Report, 1994). The agreement between Chile and MERCOSUR provides for the gradual elimination of internal trade barriers, but it does not require Chile to adopt MERCOSUR's higher Common External Tariff. The tariff elimination program under the ECA will eventually phase out all tariffs on trade between Chile and the MERCOSUR countries, with products falling into four categories: general, sensitive, especially sensitive, and major sensitivity. Except for products in the sensitive categories, tariffs will be reduced 40 percent when the agreement takes effect on October 1, 1996 and will be gradually reduced to zero by 2004. Tariffs on "sensitive" products will be cut 30 percent initially and held constant for 3 years before being phased down to zero tariff by 2006. Some "sensitive" import products for Chile are tomato paste, methanol, pastas, beans, grape must, and wooden boards. For MERCOSUR, most "sensitive" import products are non-agricultural items such as propane, butane, gas, oil, other petroleum derivatives and aluminum drums. Tariffs on "especially sensitive" products will not be cut during the first 3 years, but will be reduced to zero by the 10th year. The sectors in this category for Chile and MERCOSUR include textiles, clothing and footwear. Many agricultural products fall in the category of "major sensitivity" for which tariff reduction will not begin until 2006. Tariffs on these products will be phased down to zero over 5 years, beginning in 2006. For Chile, import products of "major sensitivity" include wines, raisins, apples, fresh grapes, ice cream, and some paper manufactures, and for MERCOSUR, soybean oil, sunflower oil, boneless meat, soybean cake, and rice. Longer phase-out periods will be provided for sugar, wheat, and wheat flour. Tariffs for these products will begin declining in 2006 and will reach zero after 16 years for sugar and 18 years for wheat and wheat flour. In terms of market access, Chile and the MERCOSUR countries agreed not to change import tariffs, non-tariff barriers, or export taxes in any way that would undermine the conditions for market access among the group. Chile's price band system will remain in place, so while imports of vegetable oils, sugar, wheat, and wheat flour from MERCOSUR members will eventually receive preferential tariff treatment, they will continue to face price band levies. Chile will not include new products in the system of price bands, nor change the mechanisms it uses or apply them in a way that would threaten market access for MERCOSUR. Chile agreed to approximate the sanitary and phytosanitary norms set by the MERCOSUR countries. Rules of origin require 60 percent regional content, compared with the 50-percent regional content negotiated under ALADI. Chile and MERCOSUR agreed to establish a safeguard mechanism specific to the agreement before January 1, 1997. Transport and transit of goods and people will be conducted freely among the members of MERCOSUR and Chile. Measures will be taken so that preferences negotiated under the agreement will not be affected when one of the parties decides to negotiate some kind of trade accord with a country or trade block outside the region. Chile Has ALADI Agreements with Mexico and More In addition to the agreement with MERCOSUR, Chile has signed several other bilateral Economic Complementary Agreements within the ALADI framework. The agreements with Mexico (1991), Bolivia (1993), Venezuela (1993), Colombia (1994), Ecuador (1994) all seek to establish free trade areas with the objective of achieving full trade liberalization for most products by the year 2000. Chile's ALADI agreements are very similar in terms of structure and objectives, which are to lower tariffs on trade among the parties and eliminate many non-tariff barriers. Products negotiated and tariff preferences vary from one agreement to another. Chile has expressed its intention to renegotiate these agreements along the lines of its agreement with MERCOSUR. The ALADI general rules of origin govern Chile's current bilateral agreements. As noted above, ALADI rules of origin require 50 percent regional content. Safeguard measures lasting up to 1 year may be applied where products imported under the agreements' concessions cause or threaten to cause "serious prejudice" to the domestic production of similar or directly competitive products. The signatory countries of these agreements condemn "dumping" and all unfair trade practices, as well as the granting of supports for export and other domestic subsidies with similar effects. If situations involving "dumping" or distortions of competition arise in bilateral trade as a result of support for exports and other subsidies with similar effects, the affected signatory country may apply the corrective measures provided under its domestic legislation. In this regard, the signatory countries agree to follow the criteria and procedures stipulated in the framework of the General Agreement on Tariffs and Trade (GATT, now the WTO) as of the date of the signing of these agreements. Chile and Canada Are Negotiating Negotiations are underway between Chile and Canada, but little information is available about the scope of the discussions. Early reports suggest Chile intends to use its agreement with MERCOSUR as a model for further negotiations with Canada. However, it is not clear what will emerge in the final agreement. Chile already receives preferential access to the Canadian market under Canada's General Preferential Tariff. Preferences granted to Canada could have the potential to displace U.S. suppliers of products that compete with Canadian exports. Wheat, beef, and pork are a few products in which the United States could face stiffer Canadian competition in the Chilean market. Chile and NAFTA Trade liberalization in the Western Hemisphere is proceeding despite the delay in NAFTA expansion. The United States may soon find itself as the only major player in the Western Hemisphere that does not have preferential access to the Chilean market. Chile's bilateral agreements may be establishing precedents for integration that are not consistent with U.S. goals for trade liberalization in the hemisphere. [Begin Box 1] Lack of "Fast-Track" Authority Delays Expansion of NAFTA At the Summit of the Americas held in Miami in December 1994, the United States, Canada and Mexico agreed to negotiate Chile's accession to NAFTA. The expansion of NAFTA to include Chile was seen as the next step toward a hemispheric Free Trade Area of the Americas (FTAA). The FTAA is intended to progressively eliminate barriers to trade and investment throughout the hemisphere by 2005. The NAFTA partners remain committed to Chile's inclusion in NAFTA, but concrete progress has been limited by the lack of "fast-track" negotiating authority in the United States. The Executive Branch of the U.S. Government has the sole legal authority to negotiate trade agreements with foreign governments, but they must be approved by the Legislative Branch before becoming law. In the normal legislative process, bills can be amended if necessary to achieve the required number of votes for passage. Under fast-track authority, Congress often generally specifies the bounds within which the Administration can negotiate an international trade agreement, and in return agrees to approve or reject the final agreement without amendments. The Administration does not legally require fast-track authority to negotiate international agreements, but as a practical matter it is deemed essential. Without fast-track authority, the Administration cannot make firm commitments during negotiations, because Congress would retain the right to amend those commitments in the legislative process. Chile has declined to negotiate NAFTA accession unless fast-track authority is assured in the United States. The Administration and Congress have not been able to agree on a mutually acceptable fast track bill for NAFTA expansion despite bipartisan support for trade agreements in recent years. Fast track authority was used in the negotiations and approval of the CFTA, NAFTA, and the WTO. The disagreement between the Administration and Congress on fast track authority reflects an ongoing debate about the scope of the trade liberalization agenda. One key area of disagreement has been that the Administration wants to include environmental and labor standards within the scope of the negotiations with Chile, but the Congress wants to limit the negotiations to the more traditional aspects of trade and investment. The Administration and many in Congress remain strongly committed to bringing Chile into NAFTA, and both sides continue to express confidence that negotiations will resume in due course. [End Box 1] A Reader's Guide to Trade Liberalization The operation and liberalization of tariffs, quotas, and tariff-rate quotas form the basis for many of the trade issues currently being disputed among the three NAFTA members. Liberalization of these trade instruments can increase the benefits flowing to the overall economy while reducing the benefits to previously favored groups. Trade barriers have been used to reinforce the operation of domestic agricultural supply control programs. This article provides an introduction to the economics of trade liberalization with particular emphasis on the interactions between trade liberalization and domestic supply controls. [David Skully] Prior to NAFTA, tariffs, quotas and other non-tariff barriers were used extensively to restrict agricultural trade among the United States, Canada, and Mexico. Tariffs and quotas were also used to reinforce the operation of domestic supply control programs for many commodities. Policies restricting imports or limiting domestic supply create an artificial scarcity of the restricted product in the domestic market. This scarcity results in a higher price for the product than it would otherwise obtain. Domestic producers benefit from the artificially high prices, while domestic consumers of the product must pay more than necessary. NAFTA converted nearly all quotas in North American agricultural trade to a tariff-based form of protection, and the Uruguay Round of GATT finished the job of "tariffication." NAFTA calls for the gradual elimination of virtually all tariff barriers within North America, but does not require the elimination of domestic supply control programs. Supply control programs remain in place in the United States and Canada for several commodities, but the elimination of import barriers may disrupt the operation of these programs. Quotas An import quota sets a quantitative limit on imports that can change from year to year. Prior to NAFTA, Mexico used discretionary import licensing to regulate the effective size of its imports of a number of commodities. In 1991, for example, Mexico imported 38,000 tons of dry beans under import licenses. No imports were permitted beyond that quantity. It should be noted that the economic effect of an import license is identical to that of a quota. Prior to NAFTA, quotas and import licenses were in use in all three NAFTA countries, with Mexico by far the most dependent. In Mexico, quantitative restrictions were in place for imports of corn, barley, wheat, tobacco, dry beans, grapes, dairy products, poultry, and eggs, among others. Canada had quotas on imports of chicken, turkey, and eggs, and import licensing requirements for wheat, barley, and oats. The United States operated quota systems for dairy products, sugar, cotton, and peanuts. Because quotas are created and enforced by the government of the importing country, quotas are initially government (or public) property. The government of the importing country can capture the rental value of the quota by selling it, usually by means of an auction, to domestic importers and/or foreign exporters. Like tariffs, which are simply a tax levied on imports, quotas can be a source of government revenue. By restricting imports below what would prevail under free trade, a quota raises the domestic price of the product, effectively taxing consumers and rewarding those who have the right to import the product. The mechanics of a quota are discussed in detail in Box 1. In general terms, if imports are restricted by a quota, the price to consumers is higher than it would be under free trade, which results in a misallocation of resources. The difference between the quota price and the free trade price represents a riskless profit opportunity for importers called "rent." Owners of the quota rights receive this on each unit imported under the quota. An important consideration in the evaluation of quotas and their tariffication and liberalization is the ownership of the quota rights. Whoever owns the right to import under the quota will capture the rent from this profit opportunity, but the windfall profits will diminish with trade liberalization. Quota rights are a form of wealth. When a quota is liberalized, the owner of the quota rights loses wealth while the country in general gains because of lower prices and more efficient resource allocation. Rather than retaining ownership of the quota and raising public revenue from leasing it to importers and exporters, the government may choose to give the quota away by transferring ownership rights. There are two principal kinds of beneficiaries of such public gifts: 1) The quota can be given to private agents in the importing country. Mexico's duty-free quota for corn under NAFTA is distributed in part to feed manufacturers, the starch industry, the breakfast cereal industry, and traders. 2) The quota can be given to the government or private agents of an exporting country . The U.S. sugar program operates in this manner. For example, in the 1995/96 marketing year, the United States granted Mexico the right to export 8,001 short tons (raw value) of sugar to the United States. Mexican exporters (and other countries granted quota by the U.S. Government), who would otherwise face a relatively low international price in other markets, gain the higher U.S. domestic price for exports under the quota. The foreign government can distribute the quota rights as it wishes: it may lease them, sell them, or give them away. [Begin Box One] Import Quotas Distort Markets and Block Price Signals Figure 30 is a standard two-panel diagram representing the domestic and international market for a specific product. The right panel shows the domestic supply and domestic demand curves for the product. Point "a" represents domestic equilibrium in the absence of trade, the point where domestic demand and supply are in balance. Consumers pay price Pa, to consume Ca, which is equal to the quantity produced domestically, Qa. [Figure 30] At prices below Pa, consumers demand more of the product than can be supplied domestically. The difference between the domestic supply and domestic demand curves, represented in the left panel by the import demand line, shows the quantity that would be imported at alternative prices if trade were permitted. The import supply curve, which runs horizontally through the right and left panels, represents the quantity of the product that is available for import at the world price, Pw. The import supply curve is drawn here as a horizontal line under the assumption that the importing country is "small" and therefore can import as much as it wants without affecting the world price. The small country assumption simplifies the discussion but is not necessary for the analysis. If the importing country were assumed to be "large," the import supply curve would be drawn with an upward slope, indicating that the world price would rise as the quantity imported increases. Under completely free trade, imports would occur at point f, where the import demand and import supply curves intersect. At point f, consumers would pay the world price, Pw, and consume quantity Cf. Domestic suppliers would produce Qf, and the difference between domestic production and consumption would be imported (Cf-Qf=Mf). By imposing an import quota, the importing country can limit imports to a specific quantity, Mq, which is less than the quantity that would be imported under free trade conditions. Restricting imports with a quota raises the domestic price to Pq. The difference between domestic and world prices, Pq-Pw, represents a risk-free profit opportunity on every unit of product imported under the quota because the importer can buy the product at world prices and sell it in the domestic market at the higher price. This amount, Mq*(Pq-Pw), is labeled RENT in the figure, and accrues to whoever has the right to import under the quota. The right to import an item for price Pw and resell it for the higher price, Pq, is worth an amount up to the difference, Pq-Pw. The government auctioneer should be able to get Mq*(Pq-Pc), less administrative and transactions costs. [End Box One] Tariffication The tariffication of all quotas within North America was one of the achievements of NAFTA and the Uruguay Round. This raises the question: Why are tariffs viewed as better than quotas? There are two primary reasons: 1) efficiency and 2) transparency. Tariffs, acting through the price system, are more efficient than quotas because they allow producers and consumers to receive and respond to information (prices) about changes in the relative scarcity of products and resources. Quotas, in contrast, completely block price signals. Box 2 compares the mechanics of tariffs and quotas in detail, but in general terms a quota does not permit the market to respond to price signals. If demand increases for a product that is imported under a tariff, foreign and domestic producers can respond by increasing production. Under a quota, however, only domestic producers can respond to the higher demand while potentially more efficient foreign producers are barred from entering the market. Domestic producers may be able to produce enough to meet the increased demand, but at a much higher resource cost (and consumer price) than under a tariff. Converting a quota to a tariff equivalent is known as "tariffication." For any quota we can design a tariff that will yield an identical outcome in terms of production and trade, but the equivalence only holds if supply and demand conditions in the market do not change. The tariff equivalent of a quota changes according to market conditions. The greater the gap between domestic prices and international prices generated by a quota, the greater the value of the quota-equivalent tariff. This leads us to the second reason tariffs are preferred to quotas: transparency. Because the amount of economic distortion generated by a quota varies with market conditions (the quota rent is a good measure of the distortion) quotas are awkward units for negotiation. Tariffs, on the other hand, (when expressed as a percentage of the international price) do not vary in their magnitude or degree of distortion with changes in market conditions. NAFTA (with help from the Uruguay Round) led to the elimination of all quotas in intra-NAFTA trade, in favor of tariffs and tariff-rate quotas, which are more efficient and more transparent. [Begin Box 2] Tariffication Lets Price Signals Influence Markets Figure 31 shows the contrast between quotas and tariffs with changing market conditions. Figure 31 builds on the example in figure 30, with an equilibrium at point q which corresponds to the import quota Mq, domestic market price Pq, domestic production Qq, and domestic consumption Cq. An increase in domestic demand (caused, for example, by income growth) is represented by shifting the domestic and import demand curves to the right, to the lines labelled Domestic Demand' and Import Demand'. The domestic supply and import supply curves do not change. If the import quota remains fixed at Mb, the consumer price must adjust upward to Pq' because imports cannot increase to help fill the expanded market. Domestic production increases to Qq' and consumption increases to Cq'. The rent generated by the quota increases from Mq*Pq to Mq*Pq'. [Figure 31] Tariffication involves converting the quota to a tariff. For the original case, at point q, a tariff equal to the difference between Pq and Pw results in the same level of production and trade as under the quota. The distribution of income, however, differs because the quota rent goes to the importing government in the form of tariff revenue. Consider again the increase in demand shown in figure 31. With the tariff of (Pq-Pw), the increase in demand causes imports to increase to Mt, and domestic output remains at Qq. Exchange takes place at the price of Pq, so consumers fulfill their increased demand without an increase in price as under the quota, Pq'. The increased demand is met by more efficient foreign production, rather than an expansion of relatively inefficient domestic production. [End Box 2] Tariffication Disputes and Problems Some disputes have emerged over tariffication, the process of calculating the tariff protection equivalent to the protection offered by the quota (or other non-tariff barrier). Most of the disputes involve what has come to be called "dirty tariffication." Although figure 31 makes the calculation of the tariff equivalent appear to be a simple mechanical operation, there are many opportunities to bias the calculation. In both NAFTA and the Uruguay Round, the tariff equivalents agreed upon as part of the tariffication process were as much a result of political negotiation as economic measurement. Under NAFTA, Mexico's political sensitivities resulted in tariff equivalents of 215 percent for corn and 139 percent for dry beans. Canada's concerns about the competitiveness of its poultry, egg, and dairy sectors resulted in establishing such high Uruguay Round base tariff equivalents as 280 percent (whole chickens), 192 percent (table eggs), and 289 percent (cheese). Whether Canada will eventually eliminate those tariffs for U.S. products is the subject of a current trade dispute (see Policy Briefs). Tariff-Rate Quotas Tariff-rate quotas (TRQs) are a means of preserving the import volume control of a quota, by means of tariffs rather than quotas. Because TRQs use tariffs rather than direct quotas they are allowed under GATT/WTO rules. An example will clarify how TRQs operate: The United States, allows imports of 5,887 tons of cheese from Mexico (for 1996) with zero tariff. Any additional cheese imported from Mexico faces a 49-percent tariff. There is no quantitative restriction on cheese trade. U.S. firms are free to import all the cheese they wish from Mexico, but after the first 5,887 tons, a 49-percent tariff is charged. The quota is on the volume of imports at the zero tariff rate, not on the volume of imports per se. Intra-NAFTA agricultural trade is rich with TRQs. Mexico, for example, allows the import of 15,914 tons of fresh potatoes from the United States (for 1996) with a zero tariff rate. Imports beyond this volume are charged a 239-percent tariff. In both examples, the higher or "over-quota" tariff is prohibitive. In other words, the tariff is so high that it is not economically rational to import over-quota goods. Tariff-rate quotas are liberalized in two ways: through gradual reduction of the over-quota tariff and expansion of the in-quota volume. If the over-quota tariff starts at a prohibitive level, reducing the tariff may not lead to increased trade opportunities for several years. However, expanding the in-quota volume can immediately lead to increased imports, since most of the NAFTA TRQs feature zero duty on the in-quota volume. Because the over-quota tariffs for U.S.-Mexican trade all go to zero by 2008 under NAFTA, the TRQ eventually is completely dismantled. The right to use the quota (normal or tariff-rate) can be sold or leased. The sale value of the quota is determined like any other income-generating asset, such as a bond or a rental property: The sale value will tend to equal the discounted value of the flow of income generated by the asset for the expected life of the asset. Future or even anticipated reductions in the price gap maintained by the quota result in an immediate reduction in the value of the quota. That is, the net worth of quota owners falls immediately, even if reductions commence several years in the future. The further in the future that reductions occur, the lesser their current impact. If negotiating governments are concerned about minimizing the loss of wealth to quota holders (or minimizing the opposition of quota holders to liberalization), it is in their interest to delay the abolition of quotas or other liberalization paths that reduce quota rents. [Begin Box 3] Tariff-Rate Quotas Are Liberalized Through Tariff Reduction and Quota Expansion Figure 32 illustrates the mechanics of tariff-rate quotas and their liberalization under GATT/WTO and NAFTA. Suppose the initial import quota were set at an import volume of Mtrq (coincidentally drawn to coincide with the original quota in figure 31). This would result in an equilibrium at point q: Imports of Mtrq at the world price Pw, domestic production of Qtrq, and domestic consumption of Ctrq at the price Ptrq. Consumers pay Ptrq, the world price plus the unit quota rent, and the owners of the right to import under the tariff-rate quota capture the quota rent. A tariff-rate quota is shown in the international market panel by the bold line, which is equal to the world price for the first Mtrq of imports and then jumps to the bold line segment at T, equal to the world price plus the "over quota tariff" for imports in excess of Mtrq. [Figure 32] Tariff-rate quotas may be liberalized in two ways. First, the over-quota tariff may be reduced. This is shown by the downward arrow in the international panel and the heavy dotted line at T'. In the example shown, tariff reduction (from T-Pw to T'-Pw) results in an equilibrium of q'. Imports expand to M', domestic production declines to Q' and consumption increases to C' (equal to Q'+M') at the price T'. Imports are composed of Mtrq of quota imports and M'-Mtrq of over-quota imports. The lower market price results in tariff revenue of (T'-Pw)*(M'-Mtrq) and a unit quota rent of T'-Pw which is less than the initial tariff equivalent of Ptrq-Pw. Consequently the unit value of the quota rent falls by (Ptrq-T')*Mtrq. The second way to liberalize tariff-rate quotas is to expand the volume of the tariff-rate quota. This is shown in Figure 32 by the horizontal arrow marked TRQ Expansion. Basically, the government of the importing country increases the volume of imports allowed at the zero (low) tariff rate from Mtrq to M'. We have drawn this example to result in the same combination of production, imports, and consumption as the tariff reduction of the previous paragraph. The only difference between the two modes of liberalization is the distribution of income and wealth. An expansion of the quota reduces the unit quota rent to T'-Pw (from Ptrq-Pw) and results in a loss of income and wealth to the owners of the original Mtrq of tariff-rate quota. However, an additional quantity of zero-tariff quota rights, M'-Mtrq, with a unit value of T'-Pw is created and distributed. [End Box 3] Domestic Supply Controls, Liberalization, and Quota Wealth There are several supply control programs in operation for agricultural commodities in the NAFTA countries. The United States has supply controls for peanuts and tobacco. Basically, one must own the right (quota or license) to produce and market these commodities at preferential prices in the United States. These rights were created by the government but are now privately owned and traded. Canada also has supply controls for dairy products, chicken, turkey, eggs, and broiler hatching eggs. In general, a national quota is determined and distributed among the provinces. As in the United States, the quota (the right to produce and market the product) was created by the government but is now owned privately. In Canada, these rights can be sold and transferred within the province of origin. The value of these rights can be calculated in a manner analogous to import quota values. Like import quota, their value can be substantial. A 1984 study of U.S. tobacco quotas calculated that the value of the annual quota rent for flue-cured tobacco amounted to $800 million. Quota was reported to sell for about four times the annual rental rate, yielding a market value of $3.2 billion for the flue-cured tobacco rights alone (Sumner and Alston). In British Columbia, it costs approximately $10,000 to buy the quota to cover the milk yield of a single cow. For a dairy herd of 200, it requires $2 million to enter the business, above and beyond the cost of a dairy farm and herd (Freudmann). The Royal Bank of Canada, in a recent examination of Ontario agriculture, estimates that quota ownership accounts for one-third of the investment needed to enter the dairy industry and accounts for two-thirds of the investment needed to enter the egg production business. Trade liberalization under NAFTA (and to a lesser extent, the Uruguay Round) is likely to erode the value of these production rights as imports expand supply and reduce consumer prices. In order for supply control programs to be effective, there are usually severe restrictions on imports. As market access is increased under NAFTA, lower-priced imports can enter the supply-controlled market. Consumers benefit from lower prices, but producers see less benefit from the supply control program. [Begin Box 4] Supply Controls Depend on Import Restrictions Figure 33 shows the effect of domestic production quotas and the impact of trade liberalization on the value of production quota rents. First, notice that the domestic supply curve follows the normal upward sloping supply curve until the supply control becomes binding. At the supply control point, the domestic supply curve becomes vertical. Most supply control programs require severe restrictions on imports. Otherwise the programs would fail in their objective to keep domestic prices above their free market equilibrium levels. When imports are barred, a consumer price of P results and consumption equals domestic production, Q. The value of the domestic production right, the "production quota rent," is equal to the difference in the world price and the domestic price (P-Pw) times the domestic quantity produced. [Figure 33--Supply Controls, Liberalization, and Quota Rents] When market access is allowed, say by means of allowing imports of Mq (under a quota or a tariff-rate quota), the consumer price falls to P' and consumption increases to Q+Mq. This reduces domestic production quota rental values from P to P'. It also creates rents for whomever has the right to import Mq of imports. The right can be distributed to domestic importers, like U.S. dairy import quotas, or distributed to exporters, like the U.S. sugar import quotas. [End box 4] Sources: Feudmann, Aviva, "Milk Controversy Shakes Canada," Journal of Commerce, 18 August 1996. Sumner, D.A., and J.M. Alston, "Effects of the Tobacco Program," AEI Occasional Paper, American Enterprise Institute: Washington, DC, 1984. END-OF-FILE