Milking Subsidies: Canada’s Regulated Dairy Sector

Background

Canada’s supply management system was created in the 1970s after a period of volatile dairy farm revenues during the 1950s and ‘60s. The current national program grew out of efforts of regional milk producers to create a greater degree of year-to-year income stability—for example by pooling production and creating price floors. However, these small organizations lacked the reach to effect any real change, and as a result government-sanctioned provincial milk marketing boards were established. Still, these boards could only regulate products that stayed within provincial borders.

The Canadian Dairy Commission (CDC) was created in 1966 to address the lack of reach from provincial marketing boards. With much broader powers, the CDC had a mandate of coordinating federal and provincial dairy policies and controlling production to stabilize revenues and avoid surpluses. The supply management system was rolled out for dairy and later adopted by the poultry and egg farming sectors.

The premise of the supply management system is simple: control supply to match demand. This is accomplished by setting strict domestic production quotas, setting prices, and restricting imports.

The domestic production quota, called the Total Quota, is the national milk production target for all of Canada established by the CDC. From the national quota, provincial pools are each allocated a share and distribute allocations to individual producers.

Prices are established after an annual review of production costs for dairy by the CDC, after which it sets support prices for dairy products that it uses for its various programs. Provincial marketing boards take these support prices as a baseline for establishing the prices that they will pay farmers for milk to sell to dairy processors. The prices are determined by which class, or processing use, the milk will be used for, as determined by the official CDC Harmonized Milk Classification System. Milk, for different end uses—e.g. fluid milk, yogurt, cheese, butter—is set at different prices by the CDC.

Finally, supply is restricted by imposing a cap, called a tariff rate quota (TRQ), on imports with low, or no, tariffs. Within the TRQ, tariffs on dairy imports are typically less than 10 percent. Over the TRQ, tariffs on dairy imports reach as high as 200 to 270 percent. Dairy production has remained relatively steady over the decades in Canada as a result of the supply management system.

Meanwhile, producer prices in the country can rise above prices in similar markets, impervious to international market dynamics, according to how the CDC sets national prices.

Despite the protectionist nature of its dairy sector, Canada has a strong record of free trade. It currently has 12 active free trade agreements, with another 15 somewhere in the stage of discussions, negotiations, or implementation. Rather than scrapping its dairy supply management system for a more trade-friendly system, Canada has simply modified it over the years to accommodate new trade deals. The current TRQ system, for instance, came into effect in 1995 after Canada became a signatory of the WTO’s Agreement on Agriculture. Previously, Canada had operated a system of firm quantitative import controls that would not be allowed under the WTO’s terms.

Ultrafiltered milk fight

The current US-Canada dairy conflict that President Trump cited is largely over a small sliver of dairy products called high-protein solids, or ultrafiltered milk. Protein solids are one of three main components of milk (the other two being milk fat and water), and new technology in the past decade has made it easier and cheaper to separate these components and concentrate them by reducing water content. With filtration technology using polymeric or ceramic membranes, milk processors are able to quickly and reliably separate out different components of milk, creating lightweight, non-perishable milk protein products that were easy to ship. These kinds of products have been a major driver of increasing international trade of dairy products, and ultrafiltered milk in particular became a way for the US to take advantage of a loophole in Canada’s strict supply management system.

The loophole exploited a blind spot in Canada’s supply management system. At the time the TRQ system was set up in the 1990s, the technology didn’t exist to separate out milk proteins so easily, which left ultrafiltered milk imports unprotected. Once this technology was available, dairy manufacturers were able to export an unlimited amount of ultrafiltered milk to Canada.

Additionally, there was no CDC classification for high-protein milk products. These products were lumped under the butter category, meaning Canadian manufacturers purchasing Canadian ultrafiltered milk had to pay the above-market CDC butter price. Or, they could buy the same products at the far cheaper market rate from the US, effectively creating a captive market in Canada for US high-protein solids. This imbalance led to a huge boost in ultrafiltered milk imports from the US over the past decade, from 8,000 metric tons in 2009 to 58,000 metric tons in 2016.

Aiming to boost the competitiveness of Canadian ultra-filtered protein, the Canadian dairy industry responded to this influx of US imports by creating a new class of dairy products for high-protein solids. Rather than pricing this new class of products at above-market rates—like with butter, yogurt, milk, and cheese—as of April 1, 2017, they were priced at competitive market rates in a direct challenge to US imports. For much of the US industry, this classification change came out of the blue. Processors in Canada suddenly started to switch from US ultrafiltered milk to Canadian ultrafiltered milk, leaving US dairy farmers without a buyer for their milk when the US market is already facing a huge surplus.

The supply management debate

Over the years, Canada’s supply management system has come under fire from free market proponents. In the 1990s, the US and New Zealand brought a case to the WTO against Canada, claiming that its dairy products set aside for exports were unfairly subsidized, and that its domestic market was too restrictive to allow foreign products to compete. The WTO ruled in favor of the US and New Zealand, and Canada was forced to limit its exports and expand access to its domestic markets to comply with the ruling.

However, supply management’s critics extend beyond competing dairy-producing countries. The Organisation for Economic Co-operation and Development (OECD) has sharply criticized supply management on the grounds that it is inequitable and inefficient. The high support prices, it argues, act as a regressive tax. They cost the poorest 20 percent of Canadians 2.3 percent of their incomes and the highest 20 percent only 0.5 percent of their incomes. Moreover, this money is directly redistributed to dairy farmers who are on average wealthier than the poorest Canadians.

Additionally, total factor productivity in Canada’s dairy sector declined 1.5 percent from 2002 to 2011, while OECD countries averaged 2.0 percent growth, likely the result of weakened incentives to boost efficiency given the high support prices. The OECD also found that, from 2002 to 2011, Canadians paid an extra $2.6 billion per year for milk, or about $276 per family (not adjusted for inflation), but this figure has been criticized for exaggerating the true cost.

Supporters of supply management, on the other hand, have their own set of convincing statistics. A 2016 survey shows that the retail price of dairy is more expensive in Canada than the US, Germany, and the UK, but less expensive than in France, China, Norway, and New Zealand, the posterchild for a free market-driven dairy sector. Additionally, supporters point to the Australian dairy sector, which deregulated in 2000, only to see producer prices fall while retail prices kept rising. A 2013 poll revealed that 81 percent of Canadians want to keep supply management and 58 percent were willing to pay more for dairy at the grocery store to protect Canadian farmers. Finally, an Abacus poll in April 2017 showed that 92 percent of Canadians are satisfied with the quality and variety of dairy products in Canada and two-thirds are satisfied with their prices.

Part of the difficulty of weighing one country’s support system against another’s is that it’s nearly impossible to nail down the true cost. If anything, Canada’s supply management system is at least, in one sense, more transparent. Farmers don’t receive any government payments; consumers directly feel the cost of higher prices at the grocery store rather than paying a second time out of their taxes. In the US, by contrast, retail dairy prices are much lower yet the industry would collapse without government support. In 2015, $290 million in government payments was given to the US’s roughly 50,000 dairy farmers. Further, in the past 17 years, from 2000 to 2016, US dairy farmers only broke even once—in 2007—on milk sales excluding government payments.

Conclusion

Canada’s unique dairy supply management system has been on the receiving end of lots of criticism over the years, most recently from US lawmakers and President Trump after a change in a classification of high-protein milk solids led US imports to be less competitive. Yet even after a closer look, it’s difficult to determine what is fair or unfair for all stakeholders. Critics of supply management claim Canadian consumers are paying far more than their fair share for dairy products just to subsidize the country’s well-off, inefficient dairy farmers. Yet a comparison of retail data shows that dairy is more expensive in some dairy producing countries with similar incomes, such as New Zealand, France, Norway and China. And Canada’s consumers, allegedly getting a raw deal, are among the most fervent supporters of supply management.

Subsidies for agriculture are tricky. Governments are responsible for providing affordable food for their citizens, which leads to various forms of support structures to reduce the risk of agricultural production. Yet an increasingly globalized agricultural sector champions free markets and reprimands protectionism, potentially increasing risk of volatility, such as the current dairy surplus around the world that has put downward pressure on prices. As globalization continues, industry players and governments will have to do a better job decreasing risk while promoting increases in efficiency. Needless to say, it’s a difficult balancing act.