This article was originally Dairy Farmers Milk Co-operative.
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In the last commentary I discussed the issue of global food security. The view expressed was that this is a legitimate concern of many sovereign nations. In many (but not all) cases, dairy industry regulatory systems have been put in place to address this concern – to ensure that there is a viable agricultural industry with sufficient capacity to meet the population's needs, and to guard against the strategic risks of droughts, floods, pestilence, trade and physical wars.
The Dairy Industry Restructure Package is now a thing of the past and Australia has almost completely dismantled government regulation and support for the dairy industry. Since this happened: milk production has contracted by 20%; private processors have gained control of the industry; factories are closing; family farms are disappearing; regulations are more complex; cost and quality improvement is essential.
Was deregulation a good thing for Australia? To provide a point of comparison I thought it might be interesting to look at Canada where, despite raging debate, pressure to deregulate has been vehemently and successfully resisted by the dairy industry.
The Canadian system of dairy regulation
Canada’s method of dairy regulation is similar to what existed in some states of Australia prior to deregulation. The government sets milk prices and allocates fixed production quotas or licences. The milk price is based on an assessment of cost and the quota is based on domestic demand. Dairy imports to Canada are restricted, preventing a flood of cheaper imports from the USA and elsewhere.
Arguments for and against regulation
It is quite easy to see why Canadian dairy farmers are working hard to head off attempts to deregulate their industry. Across the border, their USA cousins suffer a lower milk price and constant price volatility and uncertainty. Not only that, the value of Canadian farm assets will be dramatically reduced if they were forced to compete on similar terms. In an Australian context, the US / Canada border is the equivalent of the Murray River prior to July 2000.
More interesting are the arguments for deregulation:
“Consumers are paying more than they need to for dairy products”: Yes they are. But they still seem to have a reasonable standard of living and are able to consume a fair quantity of dairy products (about 90% of Australian and 80% of US consumption). Perhaps it just means that they consume what they need rather than an excess – a small latte rather than the quart of coffee they can buy over the border in the US.
“Consumers are funding the profitability and wealth of dairy farmers”: That is only the case if farmers acquired their production quota at little or no cost and then benefited from artificial capital gain on the quota. New entrants to the industry will purchase quotas at the prevailing asset price and need to make a return on this in just the same way as they do from land and cows. Profitability and wealth is about return on assets, not cash flow and apparent surplus income.
“The barrier to entry for new farmers is made too high by the cost of milk production quotas”: A barrier will exist no matter what the system. In Australia and New Zealand entry costs are in excess of $1 million and are probably double that for an average farm. The difference here is that most of the money will be spent on more tangible assets like land, cows and machinery. Irrigation water rights are perhaps our closest parallel to milk production quotas.
“A domestic market milk price that is out of step with the rest of the world puts a constraint on industry growth”: It is no surprise that leading Canadian processor Saputo is looking to Australia and elsewhere to grow their business. They have no chance of building a significant export market from Canada given the cost disadvantage in milk supply. This is a case of “you make your bed and you lie in it”. The only imperative to change will be if Canada has a need or ambition for an export dairy industry.
“There is inadequate economic pressure to drive productivity and cost improvement”: The mantra of the modern age – unless we constantly become more cost efficient at what we do the world will come to an end. The truth is Canada may be progressing at a steadier pace than the rest of the world but they are not sitting still. The statistic that validates this is a reduction in farm numbers from 30,000 in 1990 to about 12,000 currently. Over the same period milk production per cow has increased from about 5000 to 8000 litres per annum. This argument just doesn’t hold water.
“The world needs Canada to produce more milk": We can’t keep loading up the planet with more and more people, who want more quantity, diversity and quality in their food supply, unless we develop more productive cost and energy efficient food production systems. In relation to this, an argument that could be put is: countries with the natural and financial resources, plus technological capability, need to do their part to support the growing population and material expectations of developing nations. Even if you believe that countries like Canada have a responsibility to produce more food for the rest of the world, when applied to dairy products, this is rubbish. The most energy efficient place to produce milk is where it is consumed. Pulling the water out of milk just so you can transport it to the other side of the planet might be a solution for the NZ trade deficit. It is not however, a suitable basis for the production of the 600 billion litres of milk that the world needs, let alone the extra 600 billion litres that developing nations want. The proper solution is to develop the local dairy industry and then deliver grain and other (naturally) dry food products as a feed source.
A personal view on Canadian dairy regulation
On balance, my personal view is that Canada could do a lot worse than keep their current system in place, with perhaps some tinkering. For me the key issue with the Canadian system is the concept of high value tradeable production quotas. This is adding a cost layer and barrier to entry that is completely artificial (we have parallels in water rights and abalone licences). Land value is also a barrier to entry but at least the value there is set by a broader range of agricultural and other uses, not just by the closed shop of the dairy industry.
Without having thought too deeply about this, perhaps the answer to quotas as an artificial asset lies in the government regulator’s ability to set milk price. If they set a price that places a zero or nominal value on production quotas then, on average, the quota will hold that nominal value. A very cost efficient producer may well put a higher price on quota purchase than their average neighbour. They do this however (a) against the background of a more profitable operation than the industry average, and (b) knowing that if the rest of the industry catches up to them the milk price will be squeezed lower and their quota's value will be eroded. This method has the benefit of encouraging continuous improvement in farm systems. It also delivers the rest of the population a milk cost that is based on something closer to a competitive cost of agricultural production.
With regard to Canada needing or wanting an export industry? Well that is entirely up to Canada. The rest of the world doesn’t really need another dairy exporter – unless of course you don’t like New Zealanders, or Australians, or Americans, or any of the 27 EU countries, or ….
Back to the future for Australia?
Gratuitous advice for Canada aside, my guess is that about half of the Australian dairy farmer population can see a lot of merit in the Canadian system of regulation. The other half sees red tape and stagnation of the industry, a constraint on their ability to grow their business and their wealth. Trade and industry restrictions would act as a barrier to that opportunity in both the domestic and export markets.
Just as it was 15 years ago, the Australian dairy farming community will remain divided on the merits of a regulated industry. There is no consensus to take to Canberra and, even if there was, there is the matter of the 70 - 80% of the population that live in the city and want cheap milk. They hold just a little bit more sway with the politicians. Add to that a very important free trade arrangement with New Zealand and you have a recipe for more of the same. Senate enquiries on the dairy industry might make good theatre but they are unlikely to convince either side of politics to turn back the clock.