The accidental case that brought us to the edge

Class 7 milk provisions have created a loophole in the North American Free Trade Agreement that America intends to exploit

There’s no way to provide a brief history of the evolution of Class 7 milk.

But it is possible to untangle the factors that led to the creation of possibly the single biggest American complaint about Canada’s trade behaviour, one that has threatened to cause the unravelling of the North American Free Trade Agreement.

Nothing about dairy rules is simple, but the Class 7 imbroglio comes from a simple dynamic:

Trade agreements, supply management laws, and a key legal finding led to a mid-2000s regulatory vacuum, which was quickly filled, first by American processors and then by Canadians, like a quick-growing weed sprouting inside a hole in a crop’s canopy.

“Instantly, this became a loophole, if you want to call it that, or a means for the United States to export proteins to Canada outside of the tariff system,” said Al Mussell, an economist with Agri-Food Economic Systems, about the legal decision that exempted some dairy protein from supply management rules.

But first, here’s how it evolved:

  • Canadian dairy supply management is created by the 1966 creation of the Canadian Dairy Commission and 1972 enabling legislation for national supply management systems, intended to break the boom-and-bust cycles of open markets. Import barriers and domestic production restrictions strangle imports and provide consistent profitability for farmers.
  • 1988-1994: Supply management is exempted from the Canada-U.S. Free Trade Agreement and then NAFTA, allowing it to continue free of the general ban on import barriers.
  • Mid-1990s: supply management rules are overhauled to comply with creation of the World Trade Organization, which replaced the previous international agreement with which the original supply management system had been designed to comply.
  • 2002: Canada loses a WTO challenge from the U.S. against subsidized Canadian dairy exports. Canada agrees to cap dairy exports at very low levels to resolve complaint.
  • Mid-2000s: a legal battle between a Canadian pharmaceutical company and Canadian tax authorities results in some dairy protein isolates being classed as “industrial” rather than “dairy” products, allowing them to be imported free of supply management rules.
  • Late 2000s to 2017: Expansion of ultrafiltered milk production in U.S. and access to the Canadian market sees increasingly more U.S. milk protein isolates enter Canada. That undermines the price of milk proteins and increases the strain of a Canadian skim milk glut.
  • 2016: Ontario farmers develop a provincial milk Class 6, designed to create milk proteins that can be sold to processors at world prices, which allows Ontario surplus protein to compete head-to-head with imports from the U.S. It also allows processors to expand production with more confidence of affordable supplies.
  • 2017: The Ontario model is expanded, creating a national Class 7, which eliminates the price advantage U.S. milk proteins had held.
  • 2017: U.S. President Donald Trump denounces the Canadian developments during a highly publicized visit to Wisconsin dairy country.
  • 2017-18: Canadian domestic supply management import restrictions and exports become a key U.S. complaint in NAFTA renegotiations. The U.S. demands Canada stop exporting milk products and reverse developments that have reduced U.S. sales to Canada.

Essentially, supply management prevents substantial imports. The WTO resolution prevents substantial exports. The legal exemption for some protein products exempts them from both WTO and supply management restrictions, creating a new market outside supply management.

Both U.S. and Canadian dairy industries find innovative ways to move into the space created by that exemption.

Without the legal ruling, which was not focused on food production, this situation would not have evolved.

That ruling, said Mussell, became the loophole, or the first crack in the system that enabled the U.S. to export proteins to Canada outside of the tariff structure.

“It was created by this system.”

That in turn created the need for Canadian producers to close the loophole and also provide processors with a reason to expand.

“They realized a lot of imports were flying underneath the radar,” said Sylvain Charlebois, a Dalhousie university business professor, food industry expert and a long-time observer of the dairy issue.

“All of a sudden they had stopped buying.”

U.S. dairy imports have declined as Canadian products filled the space.

For such a major international trade dispute it is interesting to note that it arose accidentally.

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