Pasteurizing the Canadian Dairy Industry

The CBC reported recently that residents of Newfoundland and Labrador pay double for dairy products compared with Ontarians. In Windsor, Ontario, for example, one may expect to pay $3.65 per gallon, whereas in some rural Newfoundland communities, one can expect a similar price per litre. On average, in fact, the price of dairy in Canada is almost 43 per cent higher than in the United States.

For Canadians–including even the lactose intolerant among us–this deal is raw.

Since the 1970s, Canada has run a system of “supply management,” through which provincial marketing boards, sanctioned by the federal government, set the price of dairy products, protect the Canadian industry from foreign competition, and control supply in the domestic market. Each board determines a quota governing both entry into the market and production within it, and requires farmers to purchase producer rights. Producers must sell that milk back to the marketing board, which then distributes the product to stores. Furthermore, the government enforces import quotas and imposes high tariffs on foreign products to insulate domestic production from outside competition.

In essence, this process “protects” both consumers and producers from market fluctuations that come with globalized trade and the associated risk of shocks in the agricultural industry. It also promotes local agriculture and ensures product quality.

Despite these objectives, the reality is different. Firstly, Canadian consumers pay more for dairy products than do consumers in other countries. The Conference Board of Canada estimates that Canadian families can expect to spend $276 more per family on dairy than our counterparts in the developed world. Dairy Farmers of Canada (DFC) claims that Canada, unlike our trading partners, does not devote subsidies to agriculture, implying that consumers do not give domestic producers “special treatment.” Consumers do subsidize Canadian dairy, however, through paying artificially inflated prices: setting the price of dairy products, insulating our industry from foreign competition, and controlling its supply is an indirect subsidy to the industry. Moreover, limiting the supply drives prices upward and higher prices means additional income for those with producer rights. Lastly, limiting entry into the market, while simultaneously enforcing prohibitively high tariffs on foreign products, reduces competition, which affords Canadian farmers an advantage. Indeed, the World Trade Organization (WTO) restricts Canadian dairy exports specifically because they view supply management as a subsidy.

This variety of quota and regulatory system is, essentially, geared to make market entry incredibly difficult and concentrate power in the largest firms. First and foremost, one must purchase quota rights to begin producing. In Newfoundland and Labrador, a scarcity of inputs raises the cost of production even further, while the provincial government pushes aggressively for “pro local” policies, such as an initiative to allot land for homegrown feed, which is the chief expense of Newfoundland and Labrador dairy farms. Unfortunately, these developments have consequences for the market structure: Newfoundland has the most concentrated dairy industry in Canada, with just 34 farms and 174 cows per farm. Even Prince Edward Island, with 200 smaller farms, produces more than twice the milk of Newfoundland.

It is difficult to identify how supply management benefits Canadians. The system is not necessary to ensure quality, and although it may protect producers from unanticipated price fluctuations, several industries fare well without government protection. The foregone benefits of a deregulated dairy industry far outweigh the complications of price volatility. It seems the only remaining claim is that “locally grown, locally produced” is better–a dubious and subjective claim at the very least. After all, many consumers may believe milk imported from the Maritimes, or internationally, is “better.” In any case, it ought not to be the producer that decides what each consumer prefers. Supply management is a net loss for Canadians and a particularly grave loss for residents of Newfoundland and Labrador.

Leo Plumer is an AIMS on Campus Student Fellow who is pursuing an undergraduate degree in economics and political science at McGill University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies

Supply management: a gift to farmers at the consumer’s expense

Supply management, the system by which Canada controls dairy, poultry, and egg production, helps farmers weather market fluctuations and shields them from international competition. However, by creating quota assets for farmers that increase production costs (while boosting income levels), it increases consumer prices for a number of agricultural products, disproportionately harming low-income Canadians.

In Canada’s supply management system, the national Dairy Commission stipulates a price range for various dairy products, which provincial boards use to set exact prices. These boards consider production costs and the “fair level of return” for farmers in setting these prices. The poultry and egg industries operate in a similar manner.

Without trade barriers, foreign competitors could undercut these prices. American dairy products, for instance, cost roughly 30 to 50 per cent of Canadian products. Consequently, the federal government has erected trade barriers for managed products in the form of prohibitive import tariffs.

If farmers could sell their products for higher-than-cost prices without further controls, they would overproduce and create a surplus of these products. This unpalatable possibility explains a third element of the Canadian supply management regime: production quotas. Farmers can purchase and sell these quotas on centralized exchanges made available by the government. By creating scarcity in the dairy, poultry, and egg markets, the government creates economic rents payable to farmers (in the form of higher consumer prices).

Economic rents include all payments to factors of production, whether land, labour, or capital, which rise beyond the minimum payment at which someone would supply the factor.

If, for example, Ottawa abandoned supply management, anyone with the proper resources could enter the dairy industry. Competition among different dairy farmers would drive prices down to a level near cost. The economic rent created by supply management per dairy product would be the price differential between this at-cost price and the actual price charged.

Why is this price higher?

In a roundabout way, it is because the costs are also higher. Supply management creates an implicit cost for producers–the rent attributed to their quotas, which they can sell on an exchange. The price consumers pay ultimately represents the cost of producing managed products–the labour, the feed, the physical capital, and the rent of the land–in addition to the market value of the quota for that given product.

Proponents of supply management claim that farmers deserve prices above cost to compensate them for their work. They also claim that subjecting Canada’s agricultural industries to international competition might threaten food security.

Oddly, Alberta Milk claims that supply management makes subsidies unnecessary. This contention concedes that dairy farmers receive enough revenue to produce under supply management. However, this is because consumers pay above-normal prices, instead of the government providing direct subsidies.

Farmers tend to be wealthy, largely because of the assets that government creates for them in the form of production quotas. In fact, the OECD reports that dairy farmers in the group gross more than $250,000 annually. Yet, higher prices for milk, eggs, and chicken hurts low-income Canadians more than any other group, as they spend a higher proportion of their incomes on these goods. Thus, supply management is a regressive arrangement.

Low-income Canadians are also more likely to spend their money on less healthy products. It is likely that many opt for a $1 two-litre bottle of pop, instead of paying $6 for two litres of milk.

New Zealand and Australia both axes their supply management systems and saw increases in domestic production paired with lower prices. Canada should follow these examples and buyout the quota assets the federal government created for farmers. This would lower prices and reduce the price of essentials for low-income Canadians, instead of subsidizing the farming industry.

Michael Sullivan is a 2013-2014 Atlantic Institute for Market Studies’ Student Fellow. The views expressed are the opinion of the author and not necessarily the Institute

Government Assistance and Unintended Consequences: Scotsburn Dairy

Nova Scotia’s Scotsburn Cooperative Services Ltd. announced recently that they are in the process of selling their fluid milk operations to Montreal’s Saputo Inc. for $61 million and purchasing Quebec’s family-owned Ailments Lebel Foods Inc., which produces ice cream and other dairy products.

Narrowing the company’s focus seems like a reasonable strategy for any business that discovers their competitive advantage and seeks to expand upon it. However, considering the amount of provincial funds used this past August to support Scotsburn’s operations in Truro, Nova Scotia, their decision to relocate in another province is troubling.

In March, Saputo and Scotsburn will finalize the $61 million deal, after which Saputo will resume dairy operations as a major distributor of fluid milk to Atlantic Canadian processors. In addition to Saputo’s acquisition of Scotsburn’s distribution network, it will also obtain ownership of some of its capital assets in Nova Scotia and Newfoundland and Labrador.

The details of Scotsburn’s agreement to purchase Quebec’s Ailments Lebel Foods, announced on 22 January, remain confidential, although they will likely finalize them in March. Scotsburn’s acquisition is part of a broader strategy to penetrate Canada’s ice cream market and the deal between Saputo and Scotsburn demonstrate its confidence that it can emerge as an innovator in the dessert industry.

Overall, these developments are business as usual. This includes concerns about employment stability and the subsequent loss to communities dependent on Scotsburn for their livelihood. More important is that Scotsburn received $7.5 million in provincial funds in August 2013 to help support the expansion of its Truro operations. Some of the money came in the form of a forgivable loan, although the province earmarked $2 million for purchasing updated processing equipment.

Consequently, the decision to relocate represents a significant departure, since the province assisted Scotsburn to bolster its operations in Atlantic Canada and secure its presence in the region.

Nova Scotian’s should be questioning the province’s decision to allocate provincial funds to Scotsburn. The province provided nearly $10 million in government assistance to secure Scotsburn’s Truro operations and provided additional employment opportunities and it is hardly conceivable that relocating to Quebec will produce those results. In fact, the company’s current business strategy clearly does not require provincial assistance–it is always good to be in a position to sell. The fact that it received such large sums of assistance already is the cause for concern.

Notwithstanding these developments, Scotsburn is seizing an opportunity to narrow its operations and become more profitable. However, this decision is at odds with Nova Scotia’s government, which provided assistance solely for securing Scotsburn’s presence in the province. Government assistance should help the local economy by generating more economic growth, increasing the standard of living, and producing employment opportunities. Scotsburn’s departure from Nova Scotia shows that government assistance is not always the strongest alternative for retaining industry and bolstering economic activity. Indeed, it is possible for some actors to take advantage of these programs and without proper specifications, the likelihood is much greater.

Rachel Lowe is a 2013-2014 Atlantic Institute for Market Studies’ Student Fellow. The views expressed are the opinion of the author and not necessarily the Institute