Canadian Foreign Minister Chrystia Freeland and United States Trade Representative Robert Lighthizer are engaged in intensive ongoing talks to have Canada join the renegotiated NAFTA deal the United States agreed to with Mexico earlier this month. As is common during trade negotiations, the most politically sensitive issues are left until last. Trump’s National Economic Council Director, Larry Kudlow, stated in a recent interview that, “the word that continues to block the deal is M-I-L-K.” Any person might ask, why in the world is milk holding up one of America’s most consequential trade deals? The answer lies with Canada’s system of dairy supply management.

What is Supply Management?

Every year, the Canadian Milk Supply Management Committee determines the national demand for dairy products and sets a national target for production. This target is then split up among Canada’s provinces. Farmers within each province are able to purchase parts of the quota that allows them to sell their milk to processors. The price for milk sold under the quota is set by provincial committees, guaranteeing that Canadian dairy farmers receive steady and high paychecks.

Many argue that, between production limits that create supply constraints, and price-setting by provincial boards, Canadian milk drinkers pay significantly more than they would in a free market. In one estimate, the average price for four liters of milk in U.S. cities was $3.85 (in Canadian dollars), while prices in Canada ranged from $4.50 to $6.79.

Conversely, for certain lucrative and in-demand dairy product ingredients, such as milk protein concentrate and caseins, Canadian dairy boards have set prices at or below international market prices. U.S. and other global dairy farmers have argued this offers Canadian exports an advantage in third markets, while driving global prices and farm receipts down.

Why U.S. Dairy Farmers are Whipped into a Froth

To preserve a portion of the market for higher-priced domestic milk products, the Canadian government must limit imports of more competitively priced products. They do this through quotas and tariffs. Within quota limits, the tariff on imported milk products is relatively low at 0 to 7.5 percent. Any imported quantity beyond the quota is subject to tariffs ranging from 241 to over 300 percent – prohibitively expensive for Canadian consumers, leaving domestically-produced $7 per carton milk their only option at the grocery store.

U.S. farmers, particularly those in Wisconsin, Minnesota, and New York, are upset that they are unable to sell more product to their neighbors just a few miles away. When Canada’s ingredient pricing strategy was introduced to encourage more Canadian exports, U.S. farmers further complained the intervention amounted to a subsidy in violation of Canada’s commitments under existing trade agreements, including NAFTA and the WTO. The new pricing immediately undercut their sales in Canada. Worse, they argue the policy has also suppressed global prices, displacing their sales in third markets, causing further economic hardship for U.S. farmers.

U.S. farmers aren’t alone – dairy farmers in Mexico, the European Union, and New Zealand have complained about Canada’s ingredient pricing policy to their governments as well. They want their governments to sue Canada in the WTO. Canada lost a case in the WTO in 1997 that dealt with elements of Canada’s dairy management system. Other governments would prefer to keep chipping at Canada’s system as it affects global markets, rather than allow Canada to simply satisfy the United States in NAFTA by offering more access specifically to U.S. producers under the overall quota.

Udder Nonsense?

Canada’s rebuttal is three-fold. Officials have recently argued that U.S. producers import significant amounts of dairy products to Canada – nearly $800 million worth in 2017, compared with Canadian exports to the United States that totaled $149 million in 2017. The deficit is Canada’s, so what are we complaining about? Second, they contend that U.S. oversupply is a significant factor in depressed prices, not subsidized (according to U.S. producers) Canadian milk products. And third, the U.S. government is casting stones from a glass house since we use import quotas and tariffs on dairy products as well.

“Don’t Have a Cow, Man”: Supply Management Could be Dealt with in NAFTA

In the NAFTA negotiations, the Trump administration has repeatedly called for the phasing out of supply management in Canada. This is a politically untenable position for Prime Minister Justin Trudeau, given the political pull and presence of Canadian dairy producers throughout the provinces. As a result, some compromise between the two sides is needed. But what compromise can be found?

Canada’s recent free trade deal with the European Union, the Comprehensive Economic and Trade Agreement (CETA), could provide a model. Under Canada’s supply management system, Canada uses a “tariff rate quota” that allows foreigners to import a limited quantity of dairy products with no or limited tariffs. When that small allowance is exhausted, the normal high tariffs apply. Under CETA, Canada expanded the tariff rate quota for the European Union, allowing them to nearly double the amount of cheese imported from the European Union without tariffs to Canada. A NAFTA deal could do the same, expanding the amount of milk that is able to enter into Canada without tariffs.

Another possibility is for Canada to repeal the artificially low pricing scheme for certain milk-based ingredients. Such a move would be politically unpopular in Canada, but if the Canadian government feels the program is vulnerable to legal challenge, it might take the opportunity of NAFTA to change its approach.

The Question for NAFTA 2.0: Got Milk?

Canada’s dairy supply management system went largely unscathed in the first NAFTA negotiation. But as Chrystia Freeland and Robert Lighthizer enter into the final stretch of negotiations for Canada to join the new NAFTA, Canadian dairy is featuring prominently. The Trump administration has been clear that supply management reforms must be included in any final deal. A path to compromise likely does exist on this issue. It’s up to the negotiators now to ensure that a new NAFTA has got milk.