By Patricia Adams for the Financial Post

July 6, 2000

The OECD is tired of Canada’s EDC flouting international trade rules, writes Patricia Adams. Now the clock is ticking toward a confrontation.

Canada, as one of the world’s most successful trading nations, depends upon a sound international trading order more than almost any other nation. Yet Ottawa is allowing a federal Crown corporation — the Export Development Corp. — to violate the OECD agreement underpinning trade, a course that could spark an international trade war among the OECD nations.

As Larry Summers, the U.S. Treasury Secretary, recently told leading financial officials from around the world who gathered in Washington for the 65th anniversary of the U.S. Export Import Bank: “Several prominent OECD members — including some where the tradition of using aid for commercial advantage is strong — have managed to elude the restrictions on their national export credit agencies by providing or maintaining the ability to provide export subsidies through other state-owned, or controlled … institutions.”

Mr. Summers warned: “The United States cannot stand by and watch a small number of countries undermine the multilateral discipline that we have all worked so hard to achieve.” If negotiations among the OECD nations fail, and these countries continue to unfairly subsidize their exporters by failing to respect the OECD agreement, he said, “we can and will act.”

Although Mr. Summers was too diplomatic to single out the transgressors at this celebration, everyone in the distinguished audience knew he was referring to the EDC and its German equivalent, Kreditanstalt fur Wiederaufbau (KfW). Senior U.S. government officials confirm that the U.S. government is prepared to retaliate against Canada and Germany as early as this November or December.

The decision to retaliate hinges on the outcome of the OECD’s next meeting, in November. If Germany and Canada don’t rein in KfW and EDC by its close, as the U.S. government demands, the United States plans to utilize its “war chest,” available to the Export Import Bank, to match any illicit subsidies made by the rogue agencies. The war chest, established a decade ago, successfully ended comparable abuses using foreign aid funds. If it doesn’t succeed this time, the United States could take even stronger retaliatory action.

Although the United States is taking the lead in trying to restore order to international trade rules, it has the quiet support of the U.K., Switzerland, France and virtually all other OECD members. They also believe Canada and Germany are surreptitiously contravening the OECD agreement — known as “The Arrangement” — and that the two are hiding behind a wall of secrecy to prevent OECD members from proving it. Once the United States retaliates, the other OECD nations will likely join in.

“Cutthroat competition funded by taxpayers” will then break out in every OECD country, says Allan Mendelowitz, executive director of the U.S. Trade Deficit Review Commission, which reports directly to the Congress and to President Bill Clinton. No one can predict the extent to which such events could unravel the world trading order. The WTO, which examines trade disputes on a time-consuming, cumbersome case-by-case basis, would be ill-equipped to prevent a trade subsidy war.

Of the two export credit agencies that are violating the rules, EDC is the far larger player. And it is growing rapidly, thanks to a 1993 change in legislation that allows it to use government-granted advantages to take business that would normally belong to Canadian insurance companies, banks and other parts of the financial services sector. Once a bit player, EDC now backs 10% of all Canadian exports and plans to extend its reach dramatically within the next five years. In contrast, the Export-Import Bank, the U.S. equivalent, subsidizes between 1.5% and 2% of U.S. exports, mainly for projects the private sector refuses to fund.

Under the OECD Arrangement, EDC must report its “officially supported export credits” but not its “unsubsidized” activities, which EDC deems to occur through a “market window.” Over the past few years, EDC has claimed that fewer and fewer of its deals are receiving official support and more and more are falling under the “market window,” exempting them — if true — from OECD rules. According to a reporting mechanism under the OECD, EDC confirmed that the overwhelming majority of its activities (as much as 90%) fall under that supposed “market window.” In effect, it claims it has been outcompeting the world’s private- and public-sector lenders for virtually all its business without relying on its many government advantages.

Though a “gentlemen’s agreement” and not a treaty, since 1978 the Arrangement — which operates on the honour system — has restrained expensive subsidy competition and pork-barrel politics in international trade. But “without mutual confidence that all members are following the rules, the rules will disintegrate,” predicts Mr. Mendelowitz, a former Export-Import Bank executive vice-president. “Then we’ll have a trade war. We’ll be back to square one.”

EDC scoffs at suggestions it isn’t honouring the gentlemen’s agreement, claiming it operates according to the competitive constraints of privately owned institutions. As proof, it holds up the fact that it earns a profit, and does not require annual appropriations from Parliament. Thus, it argues, the majority of its trade finance is no longer subject to OECD Arrangement rules.

U.S. officials don’t buy it. These market window institutions, says Mr. Summers, “operate with an unfair competitive advantage because they benefit from special government concessions including guarantees by the state that enable them to raise funds at a lower cost than their private-sector competitors, and because they are exempted from certain taxes and dividend payments.”

Just how EDC is cross-subsidizing its deals is unclear because it keeps details of its pricing under wraps — EDC is exempt from the Access to Information Act and signs its clients to strict confidentiality agreements.

But transparency is essential for the OECD Arrangement to do its job of regulating and minimizing government subsidies in international trade. And, it is well understood, U.S. officials will use Canada’s lack of transparency against it by siding with U.S. exporters, and using its war chest liberally, whenever EDC hides information.

Canadian officials are well aware that trouble is brewing, and have reviewed two options. A recent federal government review of EDC conducted by Ottawa law firm Gowlings, Strathy and Henderson recommended EDC hive off its market window operations into a separate institution. U.S. officials indicate they would reject such an approach, because it would accomplish nothing apart from putting the subsidies — and the problem — into “another box.” Our federal Department of Finance is also expected to draw up a compromise proposal. U.S. officials also hold out little hope here, since in past showdowns with Finance, EDC has typically come out the winner.

EDC’s remarkable growth and political power stems from its emergence as Prime Minister Jean Chrétien’s chief mechanism for funding pork-barrel projects, a disproportionate share of which go to Quebec. EDC uses the profits from the business it took over from the financial services sector to subsidize politically motivated, economically unsound exports, such as sales of nuclear reactors to Romania or turbines to China’s Three Gorges dam.

If the United States can be taken at its word, EDC’s growth is now sure to stop. “While we sincerely hope that these problems can be resolved on a multilateral basis, we stand ready to act unilaterally if they are not,” Mr. Summers states. “The U.S. government has both the responsibility and the tools in hand to protect U.S. exporters from unfair practices that undermine their competitiveness.” To protect its credibility, the U.S. can be counted on either to stop continued violations of the OECD Arrangement, or to match the cheating to neutralize it. What isn’t clear is whether Canada and Germany will respect their international trade commitments without first triggering a trade war.