Cartels protect producers, not consumers

Mark Schatzker explains how Canada's agricultural cartels help keep quality produce from Canadian foodies (HT: @acoyne):

But here’s what hasn’t been said about supply management: It is the enemy of deliciousness.

If you have ever wondered why you can buy heritage chickens such as the famed poulet de Bresse in France but not in Canada, or pastured butter the colour of an autumn sunset in Ireland but not in Canada, or why it’s so hard to find pastured eggs here, the reason is supply management.

Great ingredients, as any good cook will tell you, come from small producers who lovingly tend their flocks and the land that sustains them. These artisan producers – the very people attempting to make food local and sustainable – are stifled under supply management because it requires the one thing these starry-eyed pastoralists almost always don’t have: money. A single cow’s worth of dairy quota, for example, costs about $27,000 (up to $40,000 in B.C.). Quota for one egg-laying hen can cost upward of $200.

Now do the math. A tiny egg farm of 500 hens (a typical Canadian farm has 20,0000 or more) can cost more than $100,000. (Exact prices and rules vary across provinces.) Ontario’s minimum allotment of chicken quota – 14,000 units (or about 90,000 birds a year) costs $1.5-million. And a tiny herd of 10 dairy cows costs more than $250,000. How many small farmers have that kind of scratch?

The resulting lack of agricultural diversity is a story told on store shelves across Canada. At my local butcher shop, the choice of chicken is limited to standard factory birds and “natural” factory birds. South of the border, by comparison, delectable breeds such as Plymouth Barred Rocks, New Hampshires and Jersey Giants can be found at farmers’ markets, butcher shops and on the Internet.

And yet the Canadian ag cartels have been able to paint themselves as the stalwart defenders of Canadian product against American imports, which all right-thinking Canadians know have to be less pure and clean than Canadian product.

Meanwhile, the Ottawa Citizen's Kate Heartfield rightly invokes Olson's Logic of Collective Action in explaining the mess:

In fact, the only thing the parties can find to argue about in this complex and vexing area of public policy is which party supports supply-managed farmers most.

The political barriers to reform are built into the system. Almost half the dairy quota goes to Quebec, an electoral battleground. There are only 12,965 dairy farms in this country — plus fewer than 5,000 in all the other supply-managed sectors combined — and every Canadian is a food consumer. But the costs to the consumer are invisible and difficult to quantify, and the complex system that imposes those costs is not widely understood. Dairy, egg and poultry farmers, though, know all about it and they’re heavily invested in the issue — literally, since the value of the quota they hold depends on what happens to prices in the future.

“If a government takes them on, they’re in for a big fight,” says John Manley, former Liberal cabinet minister, now the president and CEO of the Canadian Council of Chief Executives. “Look at what’s happening with the wheat board. It would be 10 times more vicious.”

The whole piece is excellent; it rightly points to New Zealand as example of a thriving free-market agricultural sector.

But Canada's problem is worse than Olson, though; it's Tullock. Even the winners aren't made better off by the system as all the rents are capitalised into the price of quota. But I still think there's a potential solution in buying them out.

Dairy population

Canada has roughly thirty million people and about a million dairy cattle [update: 1.4m including replacement heifers]. Its dairy markets are completely controlled by the government through supply management which works to make poor people pay too much for milk and inflate the capital value of dairy quota owned by relatively wealthy dairy farmers.

New Zealand has roughly four million people and about six million dairy cattle. It has the world's most free dairy markets and relatively rich dairy farmers; rents capitalize not via quota but rather via the relatively small proportion of land suitable for irrigated pastoral systems (most of the country isn't green pastures; rather, it's mostly mountains and dry steppes).

But isn't supply management wonderful?

And let's bat down a few defences I've heard of supply management.

First: without it, Canada wouldn't have a dairy sector any more; they'd just be swamped by American dairy imports because shipping costs are so low from the States. Interesting. Note that it's as cheap to ship milk powder from the US to New Zealand as vice versa. We have 1.5 cows per capita and ship large volumes of milk to the US every year. And NOTHING stops the Americans from selling us milk other than the basic economics of our being better at it. Our free markets have not resulted in our being swamped by foreign milk. Not that I'd particularly complain if that were the result; I don't mind that we export milk and import cars rather than the other way round, but either one's fine by me. Keith Ng's post of a few years back was great fun on this point.

Second: without it, Canada would be swamped by GE-modified, chemical-additive-ridden milk. Free markets would only supply adulterated awful product. This is utterly insane. Complete madness. First, it isn't the case here in NZ. Second, it only would happen to the extent that consumers value a price reduction over a quality reduction. Third, even if most consumers want lower quality product at lower price, the granola folks can still pay extra to get higher quality product. On the grocery shelves here, I can pay a bit more to get certified organic whole milk; I also can get raw milk, but not from the supermarket. I don't attach pejorative weight to granola here: I often get raw milk and buy the organic milk when the supermarket's out of whole (silver-top) milk. Free markets generally mean product diversification and market segmentation, not homogenization. The most reasonable, but still repugnant, form of this argument would be that the current system lets granola people satisfy their preferences at the expense of poor people who'd prefer cheaper product; economies of scale get granola folks product a bit cheaper than they otherwise would if everyone's forced into buying the no-hormones version. Why not ban cheap cars on similar argument?

Third: without it, Canadian farmers would be beaten down by some kind of big multinational to which they'd be forced to sell their milk. Again, this is utterly insane. First, here in NZ, Fonterra is a cooperative owned by its farmer-members and has the vast majority of dairy production. Nothing stops Canadian farmers from setting up their own cooperatives. Co-ops have a long history in Canada; my grandfather was on the board of one for decades. Second, nothing would stop any dairy farmer who has a tiny bit of nous from branding himself and taking his own product to market. Third, dairy companies have to compete with each other for milk.

I really don't get the status quo bias among otherwise sane Canadians about dairy. I've heard these arguments from reasonable people whose rationality flies out the window when thinking about cows.

Do hit the dairy and "transitional gains trap" tabs below for prior posts in the series...

Chris Auld gets shrill

But he's largely right:

Yesterday Federal Agricultural Minister Gerry Ritz uttered insane lies about dairy supply management:

I would make the argument that I don’t see those inflated prices, certainly, depending on where you buy,” Ritz told a joint news conference with Alberta Agriculture Minister Evan Berger and Saskatchewan Agriculture Minister Bob Bjornerud.

I received a flyer in my mailbox last night when I got back to my apartment and I opened it up and it’s from Canadian Tire. They’ve got four litres of milk for $4.19. That’s completely comparable to the American price that we’re always being beat up over.

Canadian Tire Econometrics aside, consumers are of course harmed by high prices driven by quantity restrictions. Click here to see a graph showing how much higher our prices are than the EU, US, or New Zealand (all of which also have some sort of supply management, Canada’s is just more severe).

I'm a bit puzzled though by Auld's claim that New Zealand has supply management. The closest thing we have is that Fonterra is required to sell some of its milk at to its smaller competitors - this is more a form of antitrust action than supply management as Fonterra is a very dominant producer cooperative. I'm not defending the regulation, but it can hardly be counted as a form of supply management. There will eventually be an effective form of supply management via irrigation permits for pastureland - irrigation consents will eventually become the binding constraint, at which point those start accruing the kind of rents that dairy quota gets. But I don't think we're there yet. And, again, a real resource constraint is different from a regulatory one.

Auld excoriates all of the Canadian political parties, from the Conservatives to the Communists, for their siding with producer rents over the public good. The Greens' concerns in particular I worry have some resonance with Canadian voters - that the Canadian market would be overrun quickly with hormone-laden, genetically modified American poultry and milk. It's not been the case with beef despite the lack of supply management for beef. It's not been the case in New Zealand despite our free markets in dairy and poultry - we have lots of product heterogeneity here without supply management. The Greens' worries only come to fruition in the case in which consumers care more about cost than about having yuppie-quality products, in which case it's best that that outcome obtains anyway.

He asks:

Supply management is effectively a hidden tax: Would any the major political parties support this inefficient and regressive policy if it had been implemented as a tax on consumers combined with a subsidy to firms?

I point to the old Tyran and Sausgruber results on tax incidence and voter inability to understand same. I'd expect the problem is worse for regulatory incidence than for tax incidence.

Keep Canadian supply management in play

Conflicting reports emerge on whether Stephen Harper is really prepared to open up the Canadian Dairy cartel. This is understandable: there will be really large political costs if Harper abandons supply management. Why? Every dairy farmer in Canada owns quota: a permit giving the farmer the right to milk a cow. Those quota permits cost real money. The price varies from province to province, as each province is allocated a different amount of quota. In October of this year, that price ranged from $25,000 in Quebec to $40,000 in British Columbia.

That quota value is really important to dairy farmers; it's the nest egg a whole lot of small farmers can pass on to the next in line. Abolishing the quota system means abolishing some farmers' retirement or inheritance plans. That's not the kind of thing folks accept without a fight. Think the Canadian Wheat Board has been contentious? That's just a single desk seller. If there are capitalized rents anywhere, they'll be in land values for farms especially suited to growing quota crops; that many farms opt out by growing non-board crops suggests the value of those rents is pretty limited. At best, the system provides transfers to small farmers who don't want to handle their own marketing arrangements and, perhaps, offsets some market power enjoyed by the ports, rail lines, and grain companies. Abolishing it wouldn't immediately destroy a substantial portion of any farmer's asset portfolio, but there's still a non-trivial subset of western grain farmers who really want to keep the system.

It's exceedingly unlikely that any Canadian politician can simply abolish the quota system. The benefits of the system are highly concentrated in the capitalized rents embodied in the trading prices of dairy quota. The holders of that quota will fight very hard to make sure that the system stays in place. The costs of quota management are dispersed among thirty-odd million Canadians who have to pay more for butter, ice cream, chocolate, cheese, and baby formula than they'd otherwise have to pay. Mancur Olson's Logic of Collective Action takes hold: if you think the CWB's ads trying to save the Board's single desk tug at heartstrings, wait 'till you see the ads featuring small dairy farmers facing the eradication of their retirement nest eggs.

Gordon Tullock suggested there isn't any real way out of a transitional gains trap. Here's how the trap works. The regulatory barrier confer excess profits on those holding the asset in fixed supply, like New York Taxicab medallions (now trading at $1 million) or Canadian dairy quota. The initial set of people who held the asset when asset prices jumped enjoyed a windfall gain, but most of those medallions, or quota permits, trade on the open market and are bought by people who can only earn a normal profit if the system stays in place. At that point, the system really benefits nobody - everyone earns only a normal rate of return on investment. But it's impossible to abolish because the political costs of imposing massive capital losses on permit or medallion holders is too high.

But I think there is a way out.

The cartel arrangement has to be inefficient - it destroys some value in the process of taking money from consumers and giving it to producers. Dairy farms are smaller and less efficient than they could be. Processors have to use less suitable milk substitutes. So long as there is some inefficiency associated with the system rather than there just being a transfer, it's possible in theory to abolish the system and transfer some of the consumers' gain back to producers to compensate them for their loss.

How would you do it in practice? Start by buying out the quota held by dairy farmers: abolish the quota system while paying farmers for the value taken. This will not be cheap. Where does the government come up with the money to pay the farmers? Institute a new and temporary tax on all dairy products. The supply management system, as best I understand it, winds up charging larger excess prices for industrial milk, where price inflation can be more hidden, than for fluid milk. Set the tax proportionate to the excess price that currently obtains in different parts of the system. That tax would pay off a bond issue used to fund the farmers' compensation. When the bonds are retired, the tax is retired.

The benefits of this accrue immediately. CD Howe proposes a great plan for a gradual elimination of the quota management system. But I'm not sure that's enough to get Canada into serious trade negotiations: I don't think New Zealand would look kindly on Canadian promises to abolish quota in a decade - just look at how seriously Canada's taken its promises under Kyoto. The immediate buy-out of quota farmers lets free trade in dairy start very quickly. The dairy tax would be TPP compliant as it would be assessed on all milk, whether domestic or imported. There'd be some technical hassles about appropriate tax treatment of milk embodied in products, but that can be worked out.

If I take off my economist hat and put on my libertarian hat, I'd go a bit further and say that quota compensation could be based on a fraction of quota value rather than on full quota value to save some money and in recognition that Canadian dairy farmers have been ripping off consumers for decades. But that's a trivial detail.

The same logic holds for poultry and eggs.

A tax and compensation regime can get Canada out of supply management very quickly while largely attenuating the political fallout. It would let Harper make some trade progress without slitting his throat in Quebec and Ontario. It can and should be done, and that right soon.

One cost of US dairy protectionism

One tangible cost of American dairy protectionism: baby formula prices.

In New Zealand, 900 grams of Heinz Infant 1 Gold Starter Formula costs $23.60 at Countdown. In $US terms, that's $20.68/kg. I often saw it for around the $18 mark on special when we were in that market.

In the US, the best comparison I can find is a 35 oz can of Enfamil at Safeway: $33. That's about a kilo. And, it's about the cheapest dry formula I can see on the Safeway site on a per ounce basis.

I can think of few other goods where the real New Zealand price is two thirds of the US price. Maybe the US formula has some kind of magic to it where it can make larger quantities of reconstituted drink, but I'd be a bit surprised.

Does American policy really wish to transfer money from poor mothers buying formula to relatively wealthy members of the dairy compacts?

Meanwhile, in Canada, The Real Canadian Superstore will sell you 730 grams of store brand formula for $15: $25.70 NZ per kilo. But I'm not sure that a sale flyer price of a store brand is a fair comparison.

Dairy protectionism and Pacific trade [Updated!!]

Canada's continued support for dairy supply management keeps it out of the Trans-Pacific Trade negotiations:

After months of angst and debate, Japan confirmed it’s ready to embrace a nascent Pacific free trade area.

Friday’s decision is a huge boost for the Trans-Pacific Partnership (TPP), which among other things will tackle lingering protectionism in agriculture.

It’s also bad news for Canada, which has been involved in virtually every major global effort to break down trade barriers in recent decades. Not this round.

Canada isn’t welcome at these talks because the Harper government won’t put Canada’s highly protected dairy and poultry sector on the table. The supply management system shields fewer than 20,000 farmers behind a massive tariff wall and forces millions of Canadian consumers to pay inflated prices for milk, cheese, eggs and chicken.

Japan, on the other hand, made the economic calculation that some pain for its rice and wheat farmers is worth the far greater gains that its export-oriented manufacturers can expect. And with the country’s economy stagnating, Japanese Prime Minister Yoshihiko Noda wisely sees trade as a way out.

...once the TPP deal is done, U.S. and Australian beef producers will have a massive advantage over Canada in the lucrative Japanese market. Ditto for pork, perhaps lumber as well.

It is a lose-lose for Canada. We all pay way too much for vital food items at the grocery store. And exporters who generate wealth for Canada are shut out of key markets.

The next time Prime Minister Stephen Harper vows to protect supply management, maybe a few more Canadians will understand they are the ones paying the price of his politically calculated pledge.

None of this is new; Canada was being shut out of the TPP back in April 2010 precisely because of their intransigence on dairy. Canada's dairy cartel is a perfect illustration of Gordon Tullock's Transitional Gains Trap. All the cartel rents are capitalised into the quota price Canadian dairy farmers have to pay, so they earn only normal returns after counting the cost of quota. But they lobby strenuously against anything that would impose capital losses. Solution? Buy them out. I wrote last year:

Either buy out the quota holders or start eroding quota value. Not only will you start seeming sensible in trade negotiations - damning tariff barriers elsewhere while defending supply management is an asinine bargaining position - but you'll also start getting much better ice cream. The cheapest store-brand ice cream here is on par with premium brands in Canada - seriously. 

Not making efficient moves makes Baby Pareto cry. Stop poking thorns into Baby Pareto's heart, Canada! Follow CD Howe's plan, and you get to remove a thorn from Baby Kaldor-Hicks's heart; follow mine, and you get to remove a thorn both from Baby Kaldor-Hicks's heart AND from Baby Pareto's heart. Happy baby giggles and good ice cream ensue.

I remain worried, as I was earlier this year, that American support for free trade in dairy may be more nominal than real. From this weekend's Press:

In a submission to the US Trade Representative last year, US dairy lobbyist the National Milk Producers Federation explained why these deals would be a problem.

"Our agreements with Chile, Singapore, Australia and Peru were very carefully calibrated to take into account the particular concerns and sensitivities of each of our trading partners in order to maximise US export opportunities," it said. "We strongly urge our negotiators to respect the good work that has already been done on existing US [free trade agreements] by leaving their market access provisions untouched."

In particular, New Zealand's dairy industry should on no account be granted open access to the US, it said. "Gross revenues received by US dairy farmers would plunge by a cumulative US$20b over the first 10 years of the FTA if US dairy restrictions on exports from New Zealand are fully phased out in the TPP."

The strength of US fear can be seen in the high tariffs applied to dairy imports. On skimmed milk powder, for example, the US has a quota on imports of 5261 tonnes from all countries. Imports in excess of that attract tariffs of 86.5c a kilogram. On wholemilk powder, the over-quota rate is $1.092/kg. On cheddar cheese, 8300 tonnes is permitted from New Zealand on tariffs of 10-16 per cent; anything more gets slapped with tariffs of $1.50/kg or more.

For New Zealand, nothing less than complete removal of those tariffs will do. Indeed, a TPP that perpetuated trade tariffs would be a failure.

That Canada is being further sidelined because of their dairy cartel makes me more optimistic that the Americans might be serious about free trade in dairy. Let's hope!

UPDATE:

Prime Minister Stephen Harper announced Sunday Canada will apply to join a new free trade agreement with the United States and the Asia-Pacific region, and suggested that Canada’s farm supply management systems could be on the table for negotiation.