Supply Management in Dairy and Poultry

April 10, 2023

Mike P. Moffatt

April 10, 2023

About Me:

Assistant Prof. in the Business, Economics and Public Policy Group at Ivey Business School / Western University.

Areas: International Trade, Business Strategy and Political Risk.

1. What problems did Supply Management set out to fix?

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Mike P. Moffatt

April 10, 2023

1965 report by the Canadian Dairy Advisory Committee identified a number of issues in the dairy market.

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PROBLEM 1: The 1960s saw low and fluctuating prices paid to dairy and (poultry) farmers that often fell below their marginal costs.

ISSUE: Farm livelihoods + how do you “shutdown” when this happens?

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Chattanooga Courier – June 27, 1973

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PROBLEM 2: Regulatory costs placed on farmers.

While prices going down, costs going up, making problem 1 worse.

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PROBLEM 3: Difference in negotiating power between processors and farmers.

Roughly 145,000 dairy farmers in Canada in 1971 vs. handful of processors.

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A system was desired to deal with these issues.

The cornerstone of Supply Management, the National Milk Marketing Plan was founded in 1970, with Quebec, Ontario and the Fed Gov as founding members. By 1974 all provinces except Newfoundland members.

2. What is supply management?

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Mike P. Moffatt

April 10, 2023

Supply Management has three pillars, with the final two pillars needed to correct obvious unintended consequences from the first.

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Pillar I: Wholesale price targets set by the Dairy Commission.

The Dairy Commission sets target prices for milk, with those target prices differing depending on the end use of milk (table milk vs. butter, etc.)

Price set to ensure a “reasonable” rate of return for farmers.

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Pillar I: Wholesale price targets set by the Dairy Commission.

OBVIOUS UNINTENDED CONSEQUENCE: Since farmers have practically guaranteed profits, this provides incentives for increased production (from either existing farmers or new entrants).

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Pillar II: Supply regulated through National Milk Marketing Plan.

To ensure an “excess” supply does not drive down prices, production regulated through a quota system. Illegal to produce without quota.

Initial quota issued to farmers in 1970s.

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Pillar II: Supply regulated through National Milk Marketing Plan.

If a farmer wishes to obtain more quota (or enter the market), quota must be purchased either through new issuance (which is quite limited) or through purchasing from an existing farmer.

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Pillar II: Supply regulated through National Milk Marketing Plan.

OBVIOUS UNINTENDED CONSEQUENCE: Limited supply and high prices invite foreign competition through imports.

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Pillar III: Tariffs.

Initially imports almost entirely restricted into Canada, but this difficult to do under WTO rules.

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Pillar III: Tariffs.

This replaced with an “access commitment” rule, where a set amount of foreign dairy products are allowed to enter Canada with a small tariff, for those who hold an import quota (only 95 importers in Canada hold this quota).

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Pillar III: Tariffs.

Anything above this amount (or for non-import quota holders) faces a tariff between 200-300%, depending on the type of dairy product.

Cheese tariff = 245%. Import $1000 of Gouda from the Netherlands, pay $2450 in taxes on top. (Total $3450).

3. State of the Industry and Consumer Prices

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Mike P. Moffatt

April 10, 2023

Consumer Prices

Since the introduction of Supply Management, retail dairy prices have risen faster than the rate of inflation in Canada, while they have risen slower than the rate of inflation in the US.

OECD estimates retail milk prices in Canada as much as double the world price.

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Consumer Prices

The average family pays (an estimated) $200+ more per year for dairy products a year thanks to the higher than world prices.

A regressive tax – disproportionately impacts the poor.

Reduced selection of products.

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Price of Quota

Quota prices have increased substantially, averaging roughly $25,000-$30,000 per cow – a doubling of over 10 years.

An average herd is roughly 60-70 cows, making a farm quota worth nearly $2m. Total quota value in Canada $25-30 BILLION.

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Price of Quota

This presents a significant barrier to entry, as well as a significant windfall to quota holders.

Large consolidation in industry, as smaller farmers found it more profitable to simply sell quota and live off of capital gains. Just over 10,000 dairy farmers left in Canada.

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Dairy Exports

Relatively small, since Canadian exporters “priced out” of world markets due to higher prices.

4. “Logic of Collective Action” and lack of reform

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Mike P. Moffatt

April 10, 2023

If the regulation worked properly…

Given very high retail prices and what should be happening is that quotas be significantly increased to ensure prices stay at “reasonable” levels, ensuring consumers not gouged but farmers earn a decent rate of return.

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REGULATORY CAPTURE

Problem is – who sets dairy prices and supply? An agency primarily made up of the industry itself!

They have little incentive to keep prices low and much incentive to keep quota prices high, as in many cases this is the most valuable asset they own.

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QUOTA VALUES

Farmers sitting on an asset worth, on average, $2M per farmer. Furthermore, many have used this as loan collateral, so institutions such as Farm Credit Canada (FCC) have incentive to keep prices high.

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But don’t consumers have incentive to keep prices low?

Not particularly – only worth $200 to the average family. No financial incentive to lobby government, donate to consumer causes, etc.

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LOGIC OF COLLECTIVE ACTION

Large dispersed groups are at a public policy disadvantage relative to smaller groups with concentrated interests.

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5. Less obvious unintended consequences

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Mike P. Moffatt

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1. Signing Free Trade Deals

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2. Cheese Smuggling

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3. Frozen Pizza

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4. Industry incentives to bypass own rules.

5. A possible way out

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Mike P. Moffatt

April 10, 2023

The Australian Solution

Australia found itself in a similar situation to Canada, with a supply management system in dairy keeping prices high and restricting trade (most notably with New Zealand).

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The Australian Solution

Australia opened up the market but charged a temporary 11 cent a litre tax on fluid milk prices, which was phased out over a decade.

Funds went to a transition package. Worth nearly $2B.

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The Australian Solution

Due to the inefficiency of the existing Australian system, retail prices for milk fell between 18-29% inclusive of the new tax.

Savings to consumers over $100M/yr.

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The Australian Solution

Overall dairy production increased slightly, outside of the 2002-2004 drought.

However, this was a period of significant change, with some producers expanding and modernizing, but others leaving the industry.

6. What about the issues from the 1960s?

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Mike P. Moffatt

April 10, 2023

Issues from the 1960s

If Supply Management were eliminated tomorrow (say through an Australian type system), we still need to consider how to deal with the issues from the 1960s, which (arguably) have not disappeared entirely.

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PROBLEM 1: Low and fluctuating prices paid to dairy and (poultry) farmers that often fell below their marginal costs.

SOLUTION: Financial markets and long-term contracts.

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PROBLEM 2: Regulatory costs placed on farmers.

SOLUTION: Should be reflected in market prices. Problem if those costs not faced by foreign producers.

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POSSIBLE SOLUTION: Tariffs set proportional to regulatory cost differentials. HOWEVER, this runs to the Industry Capture problems of the existing system.

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PROBLEM 3: Difference in negotiating power between processors and farmers.

SOLUTION: Less of a problem now farms are much larger. Competition Bureau needs to ensure processor market stays competitive, stomp out any signs of collusive activity.

7. Lessons for Policy Makers

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Mike P. Moffatt

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LESSON 1: Regulations invite unintended consequences, which become more significant over time, as markets tend to evolve faster than regulation.

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LESSON 2: Any regulation or agency designed to “balance” consumer and industry needs will almost always enrich producers at the expense of consumers thanks to Industry Capture.

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LESSON 3: Problems of Industry Capture and regulatory inertia difficult to reform thanks to the Logic of Collective Action.

Any Questions?

April 10, 2023

Mike P. Moffatt