Werner's Blog — Opinion, Analysis, Commentary
Will TPP liberate Canadian Dairy Markets?
Canadian Dairy Farm

Milk in Canada is more expensive than in the United States. Statistics Canada reports the pice of 1 litre of partly-skimmed milk at $2.33 (CANSIM Table 326-0012) in May 2015. The US Bureau of Labor Statistics reports the price of 1 gallon of fresh milk as US$ 3.387 in May 2015; this is equivalent to $1.13 per litre in Canadian currency. In other words, the average Canadian pays about twice the price for a litre of milk than the average American. This large gap is, by and large, a direct result of Canada's supply management for dairy products. Canadian dairy farms buy quota to produce milk, and the quota guarantees a high price for milk. The quota price for a dairy cow has already reached $25,000, as Andrew Coyne reported in Maclean's magazine in 2011. He points out that supply-management quotas are worth about $28 billion, three-quarters of that in dairy.

The Canada-U.S. price gap for milk may be somewhat exaggerated by fluctuations in prices and exchange rates. And it is true that farmers in the U.S. are subsidized in a way that Canadian farmers are not. The lower milk price in the U.S. reflects some of these subsidies from Washington. Even if the price of milk is suggestively low in the U.S., a closer inspection of production prices reveals that producing milk in Canada is more expensive than in the United States. If trade with the U.S. was liberalized for dairy products, prices in Canada would surely drop. Canadian consumers would benefit significantly. On the other hand, dairy farmers are rather anxious about losing the protection of supply management. Trade liberalization would put most of them out of business unless they manage to innovate and improve productivity drastically.

While North America's Free Trade Agreement (NAFTA) has reduced tariffs to nil for most products, it has kept in place high tariffs for dairy and poultry. Through a tariff-rate quota (TFQ), a certain amount of milk can be imported with a 7.5% tariff, and milk in excess of this amount faces a prohibitive 241%-292.5% tariff. The same goes for butter (298.5%) and cheese (245.5%, but not less than $3.53/kg). Certain types of cheese carry even higher penalties: $5.08/kg for Provolone and $5.25/kg for Gruyère. The "access commitment" amount is relatively small and does not have a significant impact on price. The Comprehensive Economic and Trade Agreement (CETA) with the European Union, currently awaiting ratification, has designated a 18,500 tonne TRQ for cheese. This additional access is still only a fraction of the roughly 400,000 tonne cheese market in Canada.

‘TPP is Canada’s last best hope to retire supply management gracefully.’

The Trans-Pacific Partnership (TPP) negotiations are currently under way and are expected to reach a conclusion this summer. TPP is a far-reaching agreement that will cover trade in goods and services, investment, government procurement, non-tariff barriers, and will also cover labour and environmental issues. If it comes to pass, TPP will provide access to 40% of the global economy and provide improved market access to new free-trade partners (Australia, Brunei, Japan, Malaysia, New Zealand, Singapore, and Vietname) and old free-trade partners (the United States, Mexico, Chile, and Peru). The obstacle to reaching a deal with Canada: supply management. Canada has declared that it will continue to support supply management and shut out foreign competition in certain agricultural markets while at the same time arguing that Canada should have free access to agricultural markets in other TPP markets, especially for beef and grains. The Foreign Affairs web site about TPP does not even list supply management. If Canada wants in on the TPP deal, the federal government in Ottawa should be prepared to cut a deal. Kirsten Hillman, Canada's top TPP negotiator, has been put into an impossible position trying to reach that deal. Instead, Canadian Trade Minister Ed Fast and Prime Minister Stephen Harper are putting the TPP deal at risk. They hope that conceding a little bit of increased "access commitment" for dairy, chicken, and egg producers will be enough to satisfy TPP partners. Perhaps they are stalling to delay a decision until after the election in October. The last round of talks in Hawaii concluded without a deal, but negotiations will probably restart before October. Conservatives are nervous to take too much a leap towards market liberlization. The NDP has come out strongly supporting supply management, with a keen eye to rural ridings in Quebec. If the government is speculating that Canada can get in on the TPP deal without making major concessions, they are taking a gamble. Perhaps they are right, but in the interest of Canadian consumers, I hope that our TPP partners will not give in so easily. TPP is Canada's last best hope to retire supply management gracefully.

So why is supply management, pardon the pun, a "sacred cow" in Canada? Former Liberal minister John Manley was quoted by John Ivison in the National Post with the remark that the defence of supply management is "deeply built into the DNA of our political system—a dog that it is better not to poke or it will jump and bite you." Even though the number of dairy farmers are dwindling (22,055 in the 2011 census, down from 25,780 in the 2006 census), they punch above their weight politically through a well-organized industry lobby. Curiously, no major political party is willing to embrace reform, as party representatives confirmed again in interviews with the Hill Times. All parties fear political backlash; consumers are not well organized compared to farmers.

With the high level of protectionism and high dairy prices, are Canadian dairy farmers among the richest farmers in the Western hemisphere? Surprisingly, far from it. Canadian dairy farmers are extremely hard-working people, and many of them are struggling to survive financially. The problem is that Canadian dairy farming has some of the highest cost structures among developed countries because dairy farms in Canada remain labour-intensive and too small. The International Farm Comparison Network (IFCN) puts Canada in the top range of production cost among OECD countries. In other parts of the world, notably in the US, dairy farms tend to be larger and more capital-intensive. High dairy prices support small-scale family farms and prevent consolidation into larger-scale farms. The average dairy farm in Canada has about 80 dairy cows (Canadian Dairy Information Centre), with larger farms in British Columbia (160 cows/farm) and smaller farms (60 cows/farm) in Quebec. Restrictions on who can buy milk quota, and how much, make it nearly impossible to consolidate dairy farms into more-efficient entities. Existing caps on quotas also reduce liquidity in the quota market, which in turn prevents entry of new efficient producers.

How can the existing supply management system be retired "gracefully"? Farmers have invested heavily into their quotas, even to the extent that they have borrowed funds to do so. Farm indebtedness offsets much of the equity that is represented by the dairy quotas. Where farmers have positive equity, the quota is also their retirement fund. Opening up trade will rapidly erode the value of quotas, which would drive many smaller dairy farms out of business. Perhaps we may moan the loss of family farms like we moaned the loss of mom&pop grocery stores that were replaced by supermarkets and hypermarkets. Perhaps we may moan the loss of rural idyll that goes along with family farms. But even farmers are painfully aware that their own kids often don't want to step into their footsteps; the work is hard, the pay is bad, and vacations are short (someone has to look after the animals 24x7). No wonder that many chidren who grow up on farms look for better economic opportunities elsewhere. Retiring farmers often close down and sell the farm when the kids don't want to take over. Can this process of attrition-by-retirement be accelerated? Governments would not be prepared to retire quotas at current inflated prices. It would cost too much and threaten the bottom lines of provincial and federal budgets.

A number of experts have recommended a variety of alternative remedies. Busby and Schwanen (2011) propose to cap support prices, and gradually reduce the price ceiling. This would ensure continued support during the transition period. They also propose to open up dairy trade within Canada (across provincial borders), which is currently severely limited. Furthermore, dairy farms that produce exclusively for export should be allowed to work outside supply management altogether. This might attract efficient new entrants that can compete in international markets. The key to dismantling supply management is an orderly transition that protects farmers through that period, and creates an incentive structure aimed at increasing productivity.

Opening the door to more trade in dairy products should come with one important caution in mind. We should insist unequivocally on maintaining the high quality standard that currently exists for milk produced in Canada. While dairy prices in Canada are high, this high price has also ensured that Canadian dairy producers keep our milk free of growth hormones and other contaminants. Free trade does not mean unregulated trade. International trade law gives Canada the right to insist on high health standards. The demand for organic milk is rising and. Consumers are also increasingly paying attention to the origin of the products they buy, and this can give Canadian farmers a valuable advantage to defend market share against future US competition. Opening trade does not and must not equate with lowering quality standards.

While I am highly critical of supply management in Canada, I should add that not all is well with dairy production in the United States either. The US has many hidden direct and indirect subsidies for farming that distort competition and put Canadian farmers at a disadvantage. Hidden "ecosystem subsidies" abound, for example through water rights management that favours farmers over other water users. Ted Bilyea and David McInnes argue that Canada needs to push back on these anti-competitive practices. If Canadian dairy farming is to have a (higher-productivity and competitive) future, it needs a level playing field. Industrial policy towards dairy farming needs to realize the need to bring this industry into the 21st century. This modernization policy needs to go along with opening up trade, gradually and with the clear vision to phasing out most elements of supply management over the next two decades.

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Posted on Saturday, August 8, 2015 at 19:30 — #Trade
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