The reference price for milk is going up again today by 7.8%, forcing milk-using industries to pay more coast-to-coast for an important input. Soon, consumers will feel the price hike when they buy fluid milk or other dairy products at the grocery store.
Given that productivity has been rising for centuries in agriculture, one might wonder why we keep paying more for milk instead of less. The reason: These productivity gains are being wasted away in our inefficient supply management system.
The creation of the Canadian Dairy Commission in 1966 produced Canada's first national agricultural supply management system. This system relies essentially on two major forms of government involvement in agricultural markets. Largely through a quota system that controls the quantity of milk offered, it sets up planning and administrative control over pricing and marketing. And it relies on customs tariffs that are set high enough to keep foreign products out. Through these measures, the government ensures a captive market for Canadian farmers.
The establishment of quotas is equivalent to issuing rights to sell a certain quantity at administratively set prices. Milk quotas were initially distributed free of charge but later changed hands on centralized exchanges, becoming increasingly expensive. An average of more than $22,000 was required to make use of a cow and sell its milk in Canada in 2002. In 2003, according to Statistics Canada, quotas amounted to an average of nearly $1.1-million per dairy farm and a total of almost $17.6-billion for all dairy farming operations in Canada. This represents close to half the entire permanent long-term asset base of milk producers. To set up a dairy farm, almost as much would have to be spent on quotas as on the assets truly required for milk production, such as animals, land, buildings, farm machinery and equipment.
Thus quotas have become a barrier to entry for anyone wishing to start a new dairy operation. The paradox is that farmers already in the market have no interest in ending the quota system. Quotas constitute an "asset" that farmers can sell and that is often used to guarantee loans from financial institutions. Abolishing supply management would result in quotas losing their entire value, posing serious problems for farmers and their creditors.
Supply management also deters adapting production to economic conditions. Efficient farmers who might wish, for instance, to raise their production cannot do so because they are not authorized to exceed their quotas. Instead of trying to win market share to the benefit of consumers through various strategies in areas such as pricing, quality, product differentiation, advertising, service or forms of marketing, Canadian farms under supply management must devote an increasing share of their resources to covering the cost of quotas.
From a geographic standpoint, evolution of the system is blocked. It is very difficult to modify the proportion of quotas that each province receives. This rigidity is a source of conflict between provinces and of added uncertainty for farmers. Because of quotas, it is impossible to take advantage of more favourable production conditions in different parts of Canada if and when they arise.
The costs of the supply management system are, of course, reflected in retail prices. These artificially high prices correspond in reality to an implicit tax that governments have authorized farmers to impose on consumers. The OECD estimates the assistance provided to Canadian dairy producers through supply management at $2.7-billion in 2003, equal to more than 60% of the value of total dairy production that year. It also found that Canadian milk prices have been two to three times higher than world prices since 1986. This has no doubt contributed to a drop of nearly 15% in per capita milk consumption in Canada between 1986 and 2003.
Entire milk-using industries, such as food processing and the restaurant trade, have no choice but to pay for the costs of supply management. To compensate for these penalizing effects and to help affected industries become more competitive against foreign rivals, government authorities have created additional regulations providing for lower preferential prices, depending on the final use of the milk. For example, to maintain their competitiveness in relation to their U. S. rivals and to keep them from moving their production outside the country, Canadian makers of frozen pizzas are entitled to pay lower prices for their cheese, which in turn is made from milk billed at a lower price. On the other hand, Canadian pizza restaurants, which are in direct competition with these firms and go after the same consumers, do not have access to these preferential measures and pay higher prices. Supply management thus creates further distortions in the economy.
This failed system is equivalent to the establishment of a government-supported cartel for the marketing of farm products. Not only is it inefficient and costly, it is also a source of conflict with our trade partners. Following complaints filed by New Zealand and the United States going back to 1998, Canada has been condemned by the WTO for price-fixing practices that amounted to export subsidies. As noted by OECD agriculture director Stefan Tangermann, "In fact, support provided by consumers through artificially high prices for farm produce is just as trade distorting" as a system of direct subsidies. Customs tariffs, applied to all imports beyond a certain authorized limit, reach prohibitive levels of over 200% – for example 245.5% for cheeses and 298.5% for butter – for farm products under supply management. Canada's practices were a focus of discussions at the WTO talks last July and will again come under pressure in trade negotiations.
Our dairy supply management system will have to be reformed sooner or later. A return to a free domestic market would benefit both farmers and consumers.
Valentin Petkantchin is MEI's Research Director and author of the Economic Note entitled Dairy production: the costs of supply management in Canada.