THE CASE FOR RESTORING TRADE WITH CANADA

UNCLAS SECTION 01 OF 04 OTTAWA 003159 SIPDIS SENSITIVE STATE FOR EB/TPP/BTA AND WHA/CAN - HOLST DEPT PASS USTR FOR MELLE AND CHANDLER USDA FAS/OA/ETERPSTRA, LDAY, FAS/ITP/PSHEIKH, PSIMMONS AND FAS/DLP/WETZEL USDOC FOR 4322/ITA/MAC/WH USDOC PASS ITC - JENNINGS TREASURY FOR IMI E.O. 12958: N/A TAGS: ECON ETRD EAGR CA SUBJECT: THE CASE FOR RESTORING TRADE WITH CANADA IN BEEF AND LIVESTOCK ¶1. (U) This cable is sensitive, but unclassified. This cable was prepared jointly by Ottawa's Economic and Foreign Agricultural Service staff. SUMMARY -------------- ¶2. (U) This message describes the economic costs which are estimated to stem from continued trade restrictions put in place to control BSE on the U.S.-Canada border. These costs are so manifold that we do not attempt to quantify them, though the order of magnitude must certainly be multiple billions of dollars per year. They include: -- Direct subsidy costs. -- Efficiency costs, not just in beef and livestock industries but throughout the economy. -- Possible eventual trade remedy cases. -- Distortion of consumers' buying habits. -- Environmental costs. -- Harm to third-country exporters. -- Delayed or derailed trade negotiations. -- Increased competition between U.S. and Canadian exporters in third country markets. ¶3. (U) In addition to these economic costs, continued trade disruption is exacting political costs for U.S. interests in Canada. END SUMMARY. INTRODUCTION -------------- ¶4. (U) In May 2003, the U.S. Department of Agriculture stopped imports of Canadian cattle and beef products after an animal in Canada tested positive for bovine spongiform encephalopathy (BSE). Although resumed trade in some products such as boxed beef in the fall of 2003 alleviated some of the worst economic losses, this trade - which is valued in billions of dollars - remains severely disrupted, not just across the U.S.- Canada border but also with third markets (Japan, Korea, Mexico). ¶5. (U) Cattle is a big industry which had evolved into a highly integrated cross-border sector before the BSE event stopped trade literally overnight. We know much about the gains from trade; BSE gives us a salient case study of the losses from stopping trade. The integration of the U.S. and Canadian economies since 1940 generated vast benefits, even if the analysis is limited to specific sectors. When markets are suddenly disintegrated, even in a single sector, we can expect correspondingly large damage. Because Canada's economy is smaller, the damage may be somewhat more obvious on this side of the border, but this does not mean that the U.S. is not being hurt on a comparable scale. "REPOSITIONING" THE CANADIAN LIVESTOCK INDUSTRY -------------- -- ¶6. (U) In general, prior to 2003 Canada exported live cattle to the U.S. where the cattle were slaughtered and processed. An immediate result of the border's closing was that livestock inventories built up rapidly in Canada. After more than a year went by without full reopening of the border, Canadian attention turned toward expanding slaughtering and processing capacity within Canada - in order to help cull this inventory but, more importantly, to reduce dependence on cross- border trade and thus insure against possible future restrictions. ¶7. (U) On September 10, 2004, Canada's federal government announced a multi-faceted strategy to "reposition" the industry, including up to C$488 million (about US$400 million) in federal funding. The goal of this repositioning project is to develop independent slaughterhouse and processing capacity for Canadian live cattle indefinitely excluded from their traditional export market. Provincial governments have announced related measures (e.g. Manitoba committed C$11.5 million to a new slaughter plant). Further measures are being considered. ¶8. (U) These are painful decisions for Canadian governments, who generally are committed to market mechanisms and would far prefer to see the border reopened. The longer BSE-induced trade restrictions remain in place, the more deeply Canadian players will commit themselves to the "repositioning" strategy. And to the extent that it is implemented, this will distort the structure of the whole North American industry and raise its costs. ¶9. (U) Economists foresee several obvious kinds of harm flowing from this strategy: -- Direct costs to governments (who pay the subsidies). Canadian governments have spent the past two decades reining in their deficits and reducing economic intervention of just this kind. Indeed, we might encourage other countries to emulate their performance. Now, suddenly, they are held responsible for bailing out an industry that was globally competitive just eighteen months ago. -- Efficiency costs to the beef industry, whose "repositioned" continental pattern is sure to be less efficient than the one that existed pre-BSE. -- Efficiency costs to the rest of Canada's economy, which will be taxed to pay for the strategy and/or will pay higher prices for beef and related products. ¶10. (SBU) In the long term, these subsidies may well have long-term disruptive effects on the bilateral relationship if competing U.S. producers file countervailing duty petitions. GOC policymakers, who are veterans of repeated bilateral disputes over live swine and pork, are acutely aware of such risks and would prefer not to run them. Nevertheless, the dramatic impact of the BSE event on their cattle and beef industries and the communities depending on them make some kind of support program both economically and politically necessary. LOSS OF SUPPLY TO U.S. MEAT AND DAIRY INDUSTRIES -------------- --- ¶11. (U) The BSE restrictions of May 2003 removed Canadian animals from the supply stream available to U.S. slaughter and processing plants. In 2002 Canadian animals provided 32 percent of U.S. beef imports and nearly four percent of U.S. beef consumption. The U.S. meat industry's supply options are narrower and presumably, its costs higher than they would be if trade had remained unrestricted. Similarly, Canada was a major source of replacement heifers to U.S. dairy herds, so the stoppage of trade reduces their competitiveness as well. SURGE IN U.S. VEAL IMPORTS -------------- ¶12. (U) BSE restrictions stopped Canada's access to U.S. markets for live veal calves, but not for veal meat. As a result, Canadian processing plants increased their veal output and Canada's exports of veal meat to the United States approximately doubled. U.S. veal calf slaughter appears to have decreased as a result. We are not surprised to hear that U.S. producers are now contemplating trade remedy action against Canadian veal. RESTAURANTS AND CONSUMERS -------------- ¶13. (U) Upscale Canadian restaurants and consumers normally buy U.S. prime beef in preference to Canadian product. These imports were interrupted for several months after December 2003, during which a "Buy Canadian Beef" campaign took root. While imports of these cuts of meat have resumed, elements of the "Buy Canadian" campaign have continued in order to support the hard-hit domestic industry, reduce its dependence on U.S. markets, and bring pressure on U.S. players to reopen trade completely. LOSS OF CANADIAN MARKET FOR U.S. PUREBREDS -------------- ¶14. (U) Under normal commercial conditions, U.S. purebred beef breeders are important vendors at Canadian livestock shows. BSE control measures prevented these breeders from bringing their animals to Canadian trade events, to the detriment of their business. RENDERING INDUSTRY RECYCLING SERVICES -------------- ¶15. (U) The rendering industry, which turns animal by- products and used cooking oils into saleable goods, also normally provides services to farmers and other businesses in the form of free disposal of animal carcasses and oils. We understand that the oversupply of animals due to the trade stoppage has interrupted or terminated these services, imposing new costs on farmers, landfills and the environment. SECONDARY TRADE EFFECTS -------------- ¶16. (U) Prior to May 2003, the healthy beef trade situation in North America led Canada to allow significant supplementary imports from third countries, above its "tariff rate quota" (TRQ). The stoppage of trade due to BSE forced Canada to stop allowing these imports, harming exporters in non-NAFTA countries such as Australia. ¶17. (U) Prior to 2003 Canada had restricted imports of U.S. live cattle due to veterinary concern over an infection called "bluetongue," but a successful pilot project was operating which exempted imports of U.S. feeder cattle under certain conditions. In 2003-2004, U.S. and Canadian negotiators significantly increased year-round access for U.S. feeder cattle by eliminating the testing and treatment requirements for cattle imported from the United States. This would have significantly benefited U.S. cattle exporters. Unfortunately, this progress was derailed by the imposition of control measures for BSE - even though BSE is, in objective scientific terms, a less likely risk to animals or humans than bluetongue. ¶17. (U) Finally, the restriction of cross-border trade has forced Canadian beef exporters and GOC trade officials to scour third countries for new markets for Canadian beef and livestock. Any success in this effort is likely to be found in markets where U.S. meat is already sold -- to the detriment of U.S. beef and livestock exporters. ¶18. (SBU) COMMENT: Continued delays in reopening the border are exacting large economic costs. In the long run, however, the political costs may be even higher. The BSE crisis has hit hard in some of the regions of Canada that are most traditionally pro-U.S., and where there has been broad support for U.S. political and security agendas. Pro-U.S. individuals and politicians in these areas are clearly feeling a sense of betrayal, as a number of MPs have pointed out to us. CELLUCCI