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WT/DS103/R WT/DS113/R
17 May 1999
(99-1924)
Original: English

Canada - Measures Affecting the Importation of Milk and the Exportation of Dairy Products

Report of the Panel

(Continued)


(e) In- and Over-quota Milk and the Producers' Choice

4.93 New Zealand noted that Canada placed considerable emphasis on the distinction between in-quota and over-quota milk that was destined for export. New Zealand maintained that the objective of the Canadian distinction between in-quota and over-quota milk was to distance over-quota milk even further from government agencies such as the CDC and the provincial milk marketing agencies. However, the distinction between in-quota and over-quota milk was an irrelevant distraction. It was an artificial distinction created for Canadian regulatory purposes that had no reflection in reality. Milk was milk in the tank or in Special Class 5(d) or (e). What Canada had done through the Special Milk Classes Scheme was to determine that the revenue that producers received for their milk would be based on one price for a certain quantity of milk and on a different price for another quantity of milk. Canada had decided that exporters were to pay a different price for milk for products destined for export than that for products destined for domestic consumption; it had thus provided an export subsidy regardless of whether the milk sold to processors for export was classified as in-quota or over-quota milk.

4.94 New Zealand noted that the distinction between in-quota and over-quota milk was not as clear-cut as Canada described it. Whether or not an increase in producers' supply would constitute over-quota production was a determination made by others, not by the producers. Each province managed a complex system according to its own rules. As the Chairman of the CDC had said in April 1998, "there are almost as many ways to manage provincial quota, over-quota production and payment mechanisms as there are provinces". 120 Most provinces had a complex monthly credit and debit system according to which producers who did not fill their quota one month could carry over "quota credits" for future months, or indeed, in the case of Manitoba, for future years.

4.95 New Zealand noted that Canada claimed that over-quota production arose when producers in a province produced milk in excess of their quotas and as a result the province as a whole exceeded its share of the national MSQ in a month. Thus, whether a producer produced what ultimately would be determined to be over-quota milk might depend on the level of production in the province as a whole. Furthermore, it was ultimately the CMSMC which decided what would be sold as in-quota and what would be sold as over-quota milk. Hence, a producer could not know whether milk produced on any particular day, week or month would be treated as in-quota or over-quota, or whether it would be used for domestic or for export purposes. A producer could simply decide to produce more milk. The consequences of producing more milk were in the hands of the milk marketing boards and the CMSMC. Thus, the concept of producers systematically deciding to produce over-quota milk for export purposes after considering current world market prices was far-fetched.

4.96 Nevertheless, New Zealand emphasized that focusing attention on whether a producer produced in-quota or over-quota milk ignored what was really at issue in this case. That was, whether providing exporters with access to lower-priced milk for products destined for export - as occurred with Special Class 5(e) in- and over-quota, as well as with Special Class 5(d) - constituted a subsidy within the meaning of the Agreement on Agriculture.

4.97 New Zealand argued that Canada's claim that individual producers decided, on market considerations, whether to produce over-quota milk misrepresented the facts. Over-quota milk production was not always a result of a deliberate decision by a producer to produce for export. 121 It made sense for producers to slightly overshoot their quotas to allow for fluctuations in milk production caused by weather or biological factors. This was not a deliberate decision to produce for the export market; it was a rational decision to maximise revenue by ensuring they do not underfill their more lucrative in-quota entitlement.

4.98 The United States argued that milk was milk; it was not labelled in-quota or over-quota when it was sold - the distinction was not of concern to processors or exporters. What was of concern to exporters was the ability to access their major input at a low cost, which was precisely what classes 5(d) and (e) set out to achieve. Like New Zealand, the United States emphasized that there were a variety of factors, mostly beyond the control of Canadian dairy farmers, that determined whether there was over-quota production in the first place. Many factors, including weather, quality of feed, and the biological condition of the dairy herd, would affect the amount of milk produced in any given time period. Thus, despite a farmer's best efforts to confine production to the amount of his/her quota, doing so was more an art than a science. Production could not be regulated with precision. Moreover, a farmer had an incentive to try to produce the full amount of his/her quota. This was because producing the full amount of quota provided the best opportunity to recover as much of the applicable fixed costs of production as possible since within-quota production was entitled to receive the higher domestic prices, or, at least, a blended price that included primarily higher domestic prices.

4.99 The United States argued that several authorities had testified regarding the difficulty of precisely producing to the level of the quota. Mr. Rick Phillips, Director of Government Affairs, Dairy Farmers of Canada, made the following statement regarding the uncertainty of over-quota production:

"In 1997, Dairy Farmers of Ontario conducted a survey to determine the extent of producer interest in providing milk for the Optional Export Program. Now, as you probably differentiate this milk supply, which represents a conscious and voluntary exposure to world markets from over-quota milk - and I wouldn't want that to be said in public, as well - producers produced or filled their quota, and that's basically a producer behaviour, and the level of over-quota milk as Mr. Core [President of Dairy Farmers of Ontario] has stated a bit earlier, is sort of dependent on the biological conditions that they find on the farm. In fact, if you happen to be in a state where the feed is good and the cows are calving properly and there is not a whole bunch of diseases, these can add together to create a fairly significant level of over-quota milk. When in fact, under normal chance circumstances, if you didn't have a lot of good things happening at the same time, the level of over-quota milk would be much less." 122

4.100 The United States noted that Mr. Phillips' views were confirmed by the testimony of Mr. Guy Jacob, President, Canadian Dairy Commission, before Canada's Parliamentary Standing Committee on Agriculture and Agri-Food.

"Last year the quota was cut by 3%. A farmer had the choice of reducing his production by 3%. He could sell one cow out of that barn and reduce his net revenue. He had to reduce his production because the quota was cut last year by 3%. That's the choice he has. He may decide to keep his production at the level of the previous year and then produce 3% over quota. Then it may happen that this year the feed was a little better, the climate was a little better, and it just happens that he's producing 6% over his quota. That milk is being removed by the CDC at the international price." 123

4.101 The United States argued that when the level of production by dairy farmers was so greatly influenced by factors largely beyond the producers' control, Canada's assertion that an increase in over-quota production in a single year evidenced the willingness of its farmers to sell at world price levels was simply not credible. Rather, farmers' willingness to sell milk for use in the OEP 124 would be a far better gauge of interest in selling at the Special Class 5(e) price for export. Yet testimony from Mr. Phillips 125 , indicated that dairy farmers in Ontario had shown very little interest in participating in the OEP. There had been virtually no use of the OEP for the first two years of its authorized usage. 126 Any increase in usage during the 1997/98 year was most likely attributable to the unusual level of over-quota production in that year and the fact that farmers had an opportunity to obtain a higher price for their milk under the OEP than from the CDC dictated price under Special Class 5(e). For example, Manitoba was selling milk for OEP contracts in 1997/98 at $32 per hectolitre compared to the Special Class 5(e) price of between $23 and $25. 127

4.102 The United States further noted that Mr. Phillips had predicted in hearings before the Canadian International Trade Tribunal that it was very unlikely that dairy producers would voluntarily participate in a new special class:

"So, again, I would note that a 5-B, which is a typical Class 5 price, most of the variable costs are covered. But when we go down to the world price, the $23.38 in this instance, look across there, you find that the cutoff point is around 18 percent of producers whose variable costs would be covered. That means that a vast majority of producers would definitely not want to produce milk at the world price." 128

4.103 The United States also observed that Mr. Phillips had testified that only one-half of one per cent of producers in Ontario had shown any interest in participating in the OEP that, like the Special Classes, involved the sale of milk for export at approximations of world market prices. 129

4.104 The United States stressed that Canada's argument that an increase in over-quota production since the implementation of the Special Milk Classes was evidence that milk producers were deliberately choosing to export milk at world market prices was flawed. First, over-quota production actually declined in the first full year, 1996/97, after the implementation of the Special Milk Classes Scheme. The annual report of the Dairy Farmers of Canada showed that over-quota production actually declined between 1995/96 and 1996/97, both in actual volume and as a percentage of total production. 130 Furthermore, the purported increase in over-quota production between 1996/97 and 1997/98 appeared to be attributable in large part to a decision to reduce the Market Share Quota (MSQ) for 1997/98. The United States noted that information contained in Canada's Exhibit 16 showed that the MSQ had been reduced by one million hectolitres between 1996/97 and 1997/98. When such a major reduction in MSQ occurred, it all but compelled an increase in over-quota production, as it was difficult, if not impossible, for milk producers to reduce production in such a precipitous manner. A one million hectolitre reduction in the MSQ equalled almost one-half of the total over-quota production in 1996/97, which according to the DFC was 2.21 million hectolitres.

4.105 The United States argued that there was the definitional question of what actually constituted over-quota production. Various "flexibility" provisions authorized by several provinces allowed for a departure from the pre-existing practice of determining whether a particular milk producer was over-quota based on an analysis of a dairy farmer's daily or monthly production levels. Canada had confirmed the United States understanding that both Alberta and Manitoba permitted such adjustments. 131 Alberta and Saskatchewan performed a year-end price adjustment which applied under-delivered quota against over-quota deliveries. Manitoba currently allowed flexibility for up to 25 days of quota production. This was characterized as a credit that the dairy farmer could use on a rolling basis to apply against over-quota production. The United States understood that other provinces had similar provisions. In addition, Manitoba had introduced a so-called "cover-off" that provided yet another hedge against over-production. 132 While this "cover-off" mechanism was originally instituted for only the months of August through November, Manitoba later extended it to additional months. To the extent that other provinces had similar arrangements, their existence undermined Canada's contention that there existed a consistent definition of over-quota production that dairy farmers consider in their daily production plans.

4.106 The United States noted that whether milk was in-quota or over-quota and what Class price it received was in fact so confusing, that many milk producers apparently did not know whether their production was over-quota and, if it was, what price they would receive for the over-quota production. The Manitoba Milk Marketing Board's newsletter Milkline has responded to milk producers confusion with a number of articles attempting to explain the mechanics of these various schemes. 133 In the face of such uncertainty, it was difficult to comprehend Canada's assertion that dairy farmers were producing over-quota milk in response to price signals from the world market. Moreover, the United States stressed that the price earnings information provided to producers was largely, if not entirely, retrospective. 134 While Canada stated that producers knew that Special Class 5(d) and (e) prices were set on the basis of negotiated transactions, Canada omitted to mention that the returns that producers received from Special Class sales were pooled under the Special Class Agreement if they consisted of in-quota production. In the case of over-quota production, the producer also received a weighted average return based instead on all Class 5(e) transactions during the year. Thus, any individual negotiated transaction price was of no direct consequence to an individual producer; his ultimate return from in-quota exports was determined based on the Special Class pooled price and over-quota sales were based on a weighted average Class 5(e) price.

4.107 Canada recalled that milk to be used in exported products under the Special Classes arose from two sources of milk: in-quota production and over-quota production.

(a) In-quota milk: Producers, acting collectively through their milk marketing boards and the CMSMC, controlled the quota level and the amount of milk that was likely to be exported from in-quota production. If prices obtained for milk used to make products for export were not high enough, producers could decide, through their boards, to reduce the quantity of MSQ. 135

(b) Over-quota milk: Individual producers decided whether to supply milk above their individual production quota in the full knowledge 136 that over-quota shipments would receive world market returns. In fact, considerable numbers of producers voluntarily, as a business matter, chose to engage in over-quota production.

4.108 Canada noted that the Complainants suggested that there was no real distinction between over-quota and in-quota milk: "milk was milk", it was all fungible. Canada argued that this was irrelevant: the molecules of milk were not tracked into export or domestic markets. What was relevant was that the producer was perfectly aware when his milk was picked up at the farm gate that his shipment was within his marketing quota or was "over-quota". If it was "over-quota", then the producer knew that his return for this shipment would be in accordance with actual Class 5(e) prices, world market-based prices. This was true regardless of where the molecules in that truckload of milk actually ended up.

4.109 Canada argued that for both in- and over-quota milk, the essence of the Canadian system was that it exposed milk producers to market signals from the export market and allowed them to make business decisions based on those signals. In contrast to the allegations of the Complainants, the government did not direct milk to be used for manufacturing products for export. On the contrary, while milk sold on the domestic market was subject to marketing quotas and price regulation or approval, the quantity or price of milk sold for use in products destined for export markets was determined on a strictly commercial basis. There was no government involvement whatsoever in decisions to participate in the export market. That was a choice left entirely to the producers. Over-quota production for exports did not constitute any sort of pre-condition for a producer's annual allocation of quota for milk sales into domestic markets. In short, the decision to produce for the export market or not was one that was made by producers alone on the basis of true price signals with the objective of profit maximization. The essential feature was that the milk producer was exposed to world market-driven prices for dairy products and responded entirely on a commercial, market-driven basis. Canada emphasized that the individual farmers knew their individual quota level and knew that any production above their individual quota would be paid to them at world market prices. 137

4.110 Canada argued that in the case of in-quota milk, the decision to provide for a certain amount of milk within the annual Market Sharing Quota (the "MSQ") was taken by the producers collectively. These decisions were taken at the producer board-dominated Canadian Milk Supply Management Committee (the "CMSMC"), in consultation with the processors. Producer representatives on the CMSMC were accountable through a system of producer democracy that began at the district level, with elected district or regional milk committees. Generally elected members of these committees were directors at the provincial level, and provincial boards were the main voice in deciding on production targets in the CMSMC. Thus, the producers were free to collectively determine whether and to what extent they wished to provide in-quota milk for export purposes. There was no evidence of government control, direction or coercion in this process.

4.111 In the case of over-quota milk, any qualified dairy producer in Canada was free to produce as much milk as he or she chose. Specifically, the producer was free to produce any amount of milk over his or her domestic marketing quota, i.e., over-quota production with the understanding that their return for over-quota milk would be based on actual world market-based prices, i.e., the prices realised from Special Class 5(e) sales, taking into account their individual cost structures. The individual over-quota producer received a Special Class 5(e) return whether or not the province's producers taken collectively were in an over-quota position. 138 Accordingly, decisions to participate in over-quota production and to supply milk for export use were market-driven choices made by individual producers. As such, the absence of any government control or direction was clear and unequivocal.

4.112 In respect of the assertions of the United States with respect to testimony of officials of the Dairy Farmers of Canada (DFC) before the Canadian International Trade Tribunal (CITT), Canada argued that the testimony had been taken completely out of context and did not support the US proposition (paragraph 4.102). The context of the DFC testimony was an inquiry by the CITT, initiated at the request of the Canadian government, into issues raised by increased imports of blends of dairy products, particularly butteroil/sugar blends, into Canada. Among the various options considered by the CITT was the possibility that producers may wish to create a Special Class price to service the domestic butterfat market at world prices. The DFC testimony to which the United States referred was addressing this option, not the question of individual producers deciding to produce milk at world market prices for the export markets. This distinction had been made abundantly clear in the DFC's Final Agreement before the CITT:

"7.1.6 There is evidence that some dairy producers produce quantities in excess of MSQ. This is done by producers who voluntarily seek to increase production for participation in world markets. Certain low cost producers may also voluntarily decide to actively participate in world markets through the Optional Export programe. These producer decisions, however, must not be confused with a proposal to service the domestic butterfat market using within quota production at world prices. The recent decision to reduce MSQ is clear evidence that dairy producers are not willing to produce irrespective of domestic market requirements." 139

4.113 In the case of both in-quota and over-quota milk production, the claim of the Complainants that the Canadian dairy system was government-controlled and directed had to fail. Particularly with respect to the marketing of over-quota milk for export purposes, this represented a decision, by the governments, not to intervene, to avoid the use of the discretionary authority provided to the boards and rely instead on market-driven results. To suggest that such a restraint from intervention constituted government action resulting in export subsidies was not logical.

4.114 In respect of pooling, Canada argued that contrary to suggestions from the Complainants, pooling was not an obligation that had been forced on the producers by coercive governments. Pooling was a consensus-based arrangement that the producers, through their boards, had agreed to, pursuant to the terms in the Comprehensive Agreement on Special Class Pooling (the P9 Agreement) and the P6 and P4 Agreements (paragraph 2.24). The producer boards were full signatories of those agreements, which were co-operative agreements involving all interested stakeholders. These agreements were not agreements between governments to impose on the dairy industry and the dairy producers, in particular, certain arrangements and requirements, as suggested by the Complainants. Each producer board had joined in pooling freely, and they were equally free to leave the pooling arrangements. The provincial producer boards could agree at any time to cease any sharing of revenues and markets. Indeed, to give a practical example, the Manitoba producer board had temporarily opted out of the P6 pool, pending their evaluation of their participation. Under the enabling legislative framework, such decisions could not be overridden by provincial or federal governments.

4.115 Canada noted that it was also possible for a provincial producer board to partially withdraw from the pooling of revenues if it so chose. For example, as outlined in US Exhibit 39, under an experimental programme introduced in the province of Manitoba, two per cent of each producer's daily quota had become optional and was no longer pooled. Producers could choose to ship this quantity of their quota, at a known, non-pooled return, based on realised returns in Class 5. The volumes associated with this experimental programme approximated the share of in-quota Class 5(d) and (e) production in Manitoba. By filling this portion of the provincial MSQ through voluntary shipments by producers at non-pooled prices, the producer board reduced the exposure of other producers who did not ship the optional quantity to Class 5 returns. In other words, contrary to US assertions, this was an example of a provincial producer board giving its members an option to increase or decrease their participation in Class 5 sales. Significantly, this was a unilateral decision by the Manitoba producers acting through their board. Contrary to the image of government coercion suggested by the Complainants, no permission was required from the Government of Canada or the CDC. No government sanctions followed this decision by producers to reduce their participation in the pooling of returns. Canada emphasized that the Special Milk Classes Scheme was producer-driven and necessarily based on co-operation and consensus.

To continue with In- and Over-quota Milk and the Producers' Choice


120 The Chairman of the CDC's Address to the Federation des Producteurs de Lait du Quebec. New Zealand noted that this text was available on the Canadian Dairy Commission's Website (http://www.cdc.ca).

121 New Zealand noted that Canada had noted that only those producers who produce in excess of 105 per cent of their quota were considered to be deliberately producing for the export market. In fact, Canada had admitted that only one third of producers produced milk in excess of 105 per cent of their quota. (Footnote 37 of Canada's First Submission, para. 47)

122 Testimony before the Canadian International Trade Tribunal. (United States, Exhibit 33)

123 United States, Exhibit 45, pp. 21-22. The United States noted that it was significant that Mr. Jacob's testimony had been given in March 1998, nine months into the 1997/98 marketing year. Thus, his comments had particular force respecting the reasons for over-production in that year, including the reduction in the quota that was made at the outset of the marketing year. Mr. Jacob also made the following additional observation about the unpredictability of production levels: "If we could manage to put in some kind of a system instead of having just over-quota production, which is there this year and might not be there next year ... no one can really count on it. A dairy farmer just happens to be producing over quota.", p. 15.

124 Para. 2.57(b) refers.

125 United States, Exhibit 33.

126 The United States noted that Mr. Phillips' testimony was confirmed by Canada's answer to the additional questions of the United States.

127 United States, Exhibit 46.

128 Hearings before the Canadian International Trade Tribunal in its "Inquiry Into the Importation of Dairy Product Blends", testimony by Mr. Phillips. (United States, Exhibit 33)

129 Ibid. (United States, Exhibit 33)

130 United States, Exhibit 38.

131 The United States referred to Canada's replies to the Panel's Questions 4(b) and 4(d).

132 United States, Exhibit 49.

133 The United States referred to United States, Exhibit 48 as an example. In addition, it was noted that the British Columbia Milk Marketing Board reported in its May 1998 newsletter that the increase in over-quota production in the four western provinces during 1997/98 had been attributable not to over-production of industrial milk, but was the result of decreased fluid milk sales (beverage milk). The United States noted that presumably, fluid milk had been diverted into the industrial milk classes as a result and then had showed up as over-quota production. Again, this occurrence had nothing to do with milk producers deliberately deciding to accept world market prices for their milk.

134 The United States referred to Canada's response to the Panel's Question No. 19(g).

135 Canada noted that most in-quota milk was marketed for domestic use. A limited amount of in-quota milk was marketed for export use. The sources of this milk were the planned fixed amount under Class 5(d) and any additional in-quota milk resulting from the "sleeve" or other milk intended for, but not required by, the domestic market. Canada claimed that the amount of this additional in-quota milk had significantly diminished in recent years. On the other hand, all over-quota milk was intended for the export market, with returns paid to the producer based on Class 5(e) export returns, even if it was required to be re-directed to the domestic market in the event of in-quota shortfall.

136 Canada stressed that each producer knew the amount of his individual quota and his production. This was clearly indicated on producer cheques. While a producer might not know whether his province was over-quota, the individual over-quota producer received a Class 5(e) return whether or not the province's producers taken collectively were in an over-quota position (Alberta, accounting for 4.77 per cent of Canadian producers was an exception).

137 Canada noted that this was with the exception of producers in Alberta and Saskatchewan, where under-shipment by some producers would lead to adjustments of the prices paid for over-quota shipments by others.

138 Canada noted that in Alberta, shipments in excess of an individual farm quota could be offset because of under-production on other farms. In all other provinces and individual that produced milk in excess of the individual farm quota received the world price for that milk, regardless of the production of other individuals.

139 Canada referred to arguments of the DFC, Dairy Farmers of Ontario, Federation des producteurs de lait du Québec, 20 April 1998 (Canada, Exhibit 52, p.21, para. 7.1.6).