Supply Management in the Ontario Dairy Industry Essays

Supply Management in the Ontario Dairy Industry Essays Supply Management in the Ontario Dairy Industry Essay Supply Management in the Ontario Dairy Industry Essay To counteract this instability and to Increase milk prices, Canadian milk producers, along with the federal government, established a supply management yester to prevent surpluses and provide support prices based on a production cost formula. The formula is updated throughout the year from data collected from producers by the field staff of the marketing boards (Saber, 1988). This supply management program empowered the federal government to use production restrictions, rather than price, to fit the supply of milk with its demand Jacobson, 1988). At present, there are five commodities in Canada under supply management (milk, eggs, chickens, turkey and tobacco) which account for about 1/4 of all farm receipts (Lealer and Statuary, 1985, Schmitt, 1983). At the beginning of supply management, the program seemed like a cure for the problems of the dairy Industry. Now however, the supply management system, with all Its rules and regulations, Is too rolled and Inflexible to consumer Interests and wasteful In resource allocation compared to a free market. In Ontario, the Ontario Milk Marketing Board (MAMBO) Is the sole buyer of milk and which it then sells it to processors (Annexed, 1986). The MAMBO has jurisdiction for the provincial regulation of fluid milk. The Canadian Dairy Commission has primary responsibility for regulation of industrial milk. It sets target prices for industrial milk as well as purchases surplus skim milk powder and butter which it sells on world markets and puts back into the local market as demand requires (Saber, 1988). While the dairy industry in the United States is not perfect, supply management is opposed there. The National Dairy Commission on Dairy Policy (NCSC) endorsed a market oriented policy. The commission believed that profitability should be possible but not guaranteed. The producers that are efficient and Innovative would prosper in a free market (Pedal, 1988). Because the marketing boards in Canada are the ole buyers of milk at a fixed price, there Is unfairness In returns among producers because they cannot make competitive contracts with their local milk processors like Unlike farmers in the United States, who are paid basically on a supply and demand system, dairy farmers in Canada are peptidase on a cost of production formula. The formula base is derived from the following elements: cash input prices (35%), average earnings of industrial workers in Ontario (20%), general wholesale price index (30%), and fluid sales as a percent of total milk sales (15%) (Ham and Not, 1986). The cost of production formula for calculating the price of milk seems to be too generous. As the price of milk increases, the value of quota increases. This occurs because farmers are willing to pay more since they can expect to recover the cost of acquiring quota and still make a profit in the future. Producers acquire a net income that is higher than what they would under an unregulated system (Lealer and Statuary, 1985). Therefore, elevated quota prices are an indication that dairy farmers are being overpaid (Forbes et al. , 1982). The supply management pricing formula gives small and inefficient producers enough income, which would not be adequate for producers under competition. For example, the flock size of Ontario egg producers is less than the minimum efficient size while the average flock size in the United States is greater than this minimum efficient size (Schmitt, 1983). Supply management causes inefficiencies in the dairy industry. Overlaps in the raw milk assembly routes lead to higher transportation costs and small milk processing plants are inefficient because they do not achieve the economies of scale of larger plants (Forbes et al. , 1982). The system also lacks competition. Supply management raises prices to unrealistic levels, which reduces growth and development within the industry (Pedal, 1988). In a free market, there is price competition. This can lead to price wars and, therefore, lower prices for consumers. Some provinces, like Ontario, do not have minimum prices for fluid milk. Grocery stores, especially in border towns, lower the price of milk to that of American stores. By using milk as a loss leader, grocery stores can bring in more customers because milk is a necessity (Saber, 1988). Supply management also causes loss of entrepreneurial freedom, and increased penitence of producers on government (Forbes et al. , 1982). Regulations in the supply management system limit expansion and the size of the operation (Schmitt, 1983). Ontario dairy producers are essentially prevented from significant expansion unless they have significant amounts of capital to cover further purchases of quota (Ham and Not, 1986). Canada is a relatively high-cost milk producing nation (Forbes et al. , 1982). Milk production costs are higher in Canada than they are in the United States (Saber, 1988). The productivity of Canadian dairy farms relative to other countries, such as he United States and New Zealand, is quite low. Milk yield per cow is 15% lower in Canada than in the United States. Ontario has the largest herd size in Canada. However, the average dairy herd in the northeastern U. S. Is 60% larger than in Ontario (Forbes et al. , 1982). While Michigan and Ontario produce almost the same amount of milk (5,568 million pounds and 5,585 million pounds, respectively), Michigan has only 6,500 dairy farmers while Ontario has 10,300. This is because Michigan, on average, has more cows per farm, and each cow has higher production than its counterparts in Ontario (Ham and Not, 1986). Ontario farmers also have the United States are 1/3 to 1/2 of those in Ontario. As well, management productivity is lower in Ontario than in the United States (Forbes et al. , 1982). The dairy industry in Canada is also subsidized more than in the United States (Emilee and Large, 1989). A direct subsidy from the federal government is paid to dairy farmers at a rate of $6. 03 per hectoring (Saber, 1988). The subsidy is fashioned to keep prices for consumers lower than they otherwise would be. This maintains a larger Canadian dairy industry than might be if the subsidy was not here (Ham and Not, 1986). Supply management gives farmers monopoly power. Milk production under the quota system in Canada involves massive transfers of income from consumers and taxpayers to milk producers and, to a lesser degree, to dairy processors and foreign consumers. These income transfers mean significant losses in social welfare and are a misapplication of resources (Schmitt, 1983). The extra consumer burden is a social cost resulting from an inefficient risk allocation, and is composed of three parts. The first is the redistribution of income from consumers to producers. The second is the compensation paid to producers for the risk of their regulatory asset (quota), which is a cost to society. The last is the administration costs and the inefficiencies brought on by the program (Lealer and Statuary, 1985). Dairy producers gain about $700 million from these income transfers. Dairy processors also share in this windfall because the industrial sector is notably larger than it would be in a free market system. Foreign consumers of exported skim milk products also gain because they can purchase these products at prices much lower Han they are in Canada, and even below the Canadian cost of production (Forbes et al. , 1982). The largest factor affecting the social cost of supply management is how much Canadian prices diverge from prices of efficiently produced output in world markets (Lealer and Statuary, 1985). In 1980, it cost taxpayers $300 million to pay dairy producers the direct subsidy and the administrative and marketing costs of the regulatory programs. Because consumers pay higher prices for fluid milk and dairy products and consume less than under a free market, they suffer an income transfer of $700 million (Forbes et al. 1982). This consumer loss of almost $1 billion is by far the largest of any of the supply managed commodities (Schmitt, 1983). The income gains by dairy farmers under supply management soon translate into capital gains, benefiting those who held land and quota in the early sasss and leaving succeeding entrants into dairy farming not much better off than dairy farmers before the system began. This is because the higher milk price is offset by the capital cost of quota to enter the system (Forbes et al. , 1982). When the quota system started, producers obtained free quota, based on historic production. However, the demand for quota soon increased, which put a capital value on it. In 1988, quota prices were $204/keg. At this price, it is estimated that quota alone costs over $5000 per cow (Saber, 1988). This can mean up to 2/3 of the farms initial capital costs (Annexed, 1986). This immense outlay of money makes it very hard for new producers to enter the market (Saber, 1988). Banks are often reluctant to finance loans to purchase quota because it only has a paper value and cannot be used as collateral (Annexed, 1986). Quota is also not production can only secure quota from future growth (Saber, 1988). When quota is not freely transferable, producers absorb most of the risk. This raises social costs and reduces the net transfer benefit to farmers (Lealer and Statuary, 1985). The restrictions of transferring quota increases the marketability costs and the possibility that quota will be held by persons who are underspecified (Lealer and Statuary, 1985). Constraints in transferring quotas between producers increase the costs of diversifying (Lealer and Statuary, 1985). The quota system makes dairy products more expensive for consumers. Prices for dairy products have skyrocketed since the introduction of supply management. Consumer prices could average 50 percent higher than comparable U. S. Dairy product prices. Higher prices of milk also discourage consumption (Pedal, 1988). Milk and dairy products are an important source of calcium, protein and vitamin D and form a crucial part of the Canadian diet (Forbes et al. , 1982). As a result, they are considered a necessity. Canadians spend about 1/6 of their total food budget on milk and dairy products. Therefore, higher milk prices puts a burden on consumers with the lowest incomes, because it is something that everyone buys (Forbes et al. 1982, Saber, 1988). Supply management has increased food prices substantially in the poultry industry as well. In 1970, prices of eggs in the United States exceeded those of Toronto by 5. 2 cents per dozen. However, with the introduction of supply management system in the early sasss, a dramatic reversal occurred. By 1976, a dozen eggs in Toronto cost 18. 1 cents per dozen more than in the United States (Schmitt, 1983). As well as having lower prices, the United States also has lower farm retail price spreads. Farm gate prices accounted for 79% of the retail price of eggs in Toronto, while in New York it is only 58% (Schmitt, 1983). Dairy producers also take a higher proportion of the retail price of dairy products than they do in the United States. This means higher input costs for processors. Dairy processing is the second biggest industry of the food processing sector, accounting for over 16% of total food and drink sales (Moron, 1990). Supply management has caused wide disparities in bargaining power between milk producers and milk processors (Forbes et al. , 1982). As of 1988, processors only held observer status on the Canadian Milk Supply Management Committee and they also old not vote (Saber, 1988). Although wanting to respond to consumers desires for new products, especially ones with low fat, processors feel constrained by the quota system in Canada. In 1988, the supply system was based on butterfat, so the promotion of low fat products was very slow (Saber, 1988). However, there are now negotiations to move toward multiple component pricing and place less emphasis on Processors feel unable to meet consumer demands and wish that more milk was available to develop new products. Canadian dairy groups are not as enterprising in search and development as Americans. One example is low fat processed cheese. It took two years to introduce this product to grocery stores in Canada after it was developed in the United States (Saber, 1988). A supply management program for the dairy industry is bad for international and national trade. As well as a virtual embargo on the importation of butter, only a certain quantity of cheese can be milk, are dumped on world markets at prices under the national price and the cost of production. Imports of fluid milk from the United States are virtually prevented and here is no intervocalic trade of fluid milk (Forbes et al. , 1982). Trade barriers decrease the welfare of the whole world and policies of individual countries inflict unwarranted costs on domestic economies (Emilee and Large, 1989). These practices are contrary to Canadas policy of promoting more liberalized international trade and breaking down intervocalic trade barriers. The world is moving toward greater trade liberalizing. This trend towards trade liberalizing has swung public policy away from farmer protection towards processor survival and sector development (Harley, 1990). The mandate of the General Agreement of Tariffs and Trade (GATE) is to reduce import barriers, increase control of the use of direct and indirect subsidies and minimize the unfavorable effects that sanitary and Photostatting regulations can have on trade (Emilee and Large, 1989). With multilateral trade, the dairy industry would experience domestic deregulation, and the value of quota would become nil. Dairy production would expand 32% and net earnings (gross income minus cash and feed costs) would increase 38% (Emilee and Large, 1989). Under multilateral trade, total producer welfare would decrease $2. Billion but consumers and taxpayer would gain $3. 7 billion (Emilee and Large, 1989). If world dairy products were to increase under liberalized trade, production would expand and net revenues would be greater than under supply management (Emilee and Large, 1989). The dairy industry under the supply management system in Canada is not as effective as a free market system. The costs of administering the program and the loss to society, taxpayers, and consumers are not worth any benefits that the producers gain from this system. As the world moves toward freer trade, growing pressure will mount on he Canadian government to open its border to trade of dairy products. Dairy production under a free market will allow efficient and entrepreneurial farmers to expand.