From Government Regulation to the Open Market: a Study on the Effects of Regulation Change

Running head: A Study on the Effects of Regulation Change in the Dairy Industry

From Government Regulation to the Open Market: A Study on the Effects of Regulation Change

in the Dairy Industry in Australia, Ireland, and Canada

A Case Study Analysis

Christine N. Zwart

School of Environmental Design and Rural Planning

University of Guelph Running head: A Study on the Effects of Regulation Change in the Dairy Industry

Abstract

With the rise in globalization international trade agreements introduce new opportunities for trade on an international scale, yet can affect how agriculture operates at the local level. This paper examines how deregulation and trade liberalization has affected the dairy industry in Aus- tralia and discusses how liberalization through the CAP, the CETA, and the TPP may affect the dairy industries in Ireland and Canada. By using Australia as a benchmark to make some predictions about the Irish and Canadian cases it is apparent that under the right conditions the dairy industry has the ability to survive major policy changes. In the Irish case study, it is apparent that their dairy industry has great capacity for growth under recent changes to the CAP, however their goal of increasing their dairy yields by 50% by 2020 may be overly optimistic as Irish producers will be competing for international markets. Ireland is also likely to see a reduction in total number of dairy farms over time. The future for Canadian dairy is less certain should the government abandon supply management. Many economists would like to see the end of supply management in Canada, while those in the dairy sector are set on keeping it. So far it is uncertain if Canada would be competitive in a global market due to challenges such as: high production costs, high value of dairy quotas, and low dairy exports. While there are no certainties regarding the health of an industry after significant changes in regulation, understanding what happened in other countries, such as Australia, provide valuable lessons and can give context to the global market.

Keywords: Dairy, deregulation, quota, supply management, common agricultural policy, trans-pacific partnership, common economic and free trade agreement, free trade agreement, global market.

A Study on the Effects of Regulation Change in the Dairy Industry

From Supply Management to the Free Market: A Study on the Effects of Regulation Change in

the Dairy Industry in Australia, Ireland, and Ontario

A Case Study Analysis

Introduction

The dairy sector is an important contributor to the economies of Canada, Ireland, and

Australia, providing goods both locally and internationally. As globalization opens up increased opportunities for trade, new international agreements change the ways in which agriculture operates at the local level, often resulting in adjustments made to local regulations regarding how dairy industries operate within the country and changing the relationships in import and export markets (Gifford, 2005). Alterations in dairy regulations are especially significant when free trade agreements open traditional local markets to international trade. This paper focuses on how deregulation and trade liberalization has affected the dairy industry in Australia and discusses how liberalization through the CAP, the CETA, and the TPP may affect the dairy industries in

Ireland and Canada.

The paper consists of three case studies, with data collected through examination of the literature found in academic journal articles, government websites, and newspaper articles. The

Australian case study examines the effects of the end to the government regulated dairy industry in 2000. The Irish case study will examine the factors leading to the end to dairy quotas in 2014 and project some potential trends for the near future. The Canadian case study will consider the potential effects of ending the supply management system on the Canadian dairy industry, should the government ever decide to deregulate. In order to determine how changing from a supply

2 | Page A Study on the Effects of Regulation Change in the Dairy Industry managed to a free market system effects the industry, the following research question will be asked:

1. What can we learn from the Australian case to inform how deregulation may change the

dairy industries in Ireland and Ontario?

To answer this main question several subsidiary questions will be considered:

a. How did the opinions of dairy lobbyists affect policy decisions made in Australia and Ire-

land?

b. How does dairy farming change, at the farm level, after switching to a free market sys-

tem?

c. What structural conditions need to be in place for a free market dairy system to flourish?

The paper uses Australia as a benchmark to make some projections about the Irish and

Canadian cases to suggest what Ireland may expect from a free market system in the future, and what might happen to Canadian dairy should the government decide to deregulate supply management in the future.

1.0 Australia: Case Study

The Australian dairy industry is among the top three Australian agricultural sectors. Pro- ducing around 9.7 billion liters of raw milk a year, the industry employs 40,000 in farm jobs and the industry as a whole generates over $9.8 billion USD1 annually (Dairy Australia, 2011). This significant industry is spread across all states in Australia – the most substantial farming taking place in the southeastern states (see figure 1).

1 All dollar amounts converted to USD. Australian dollar to US dollar conversion using a AUD/USD exchange rate of 0.76. 3 | Page A Study on the Effects of Regulation Change in the Dairy Industry

The industry not only provides locally produced milk in every region but serves to add value in many regions by way of local processing of dairy products (Dairy

Australia, 2011). Today, Australia produces around 325,000 tonnes of cheese annually, followed by skim milk powder and whole milk powder as the country’s top manufactured dairy products (see figure 2).

In addition to providing dairy products locally, the Australian dairy industry exports around 40% of their product, ranking 4th in the world for total exports which bring in approximately $2 billion on an annual basis (Dairy Australia, 2011). The top importers of Australian

4 | Page A Study on the Effects of Regulation Change in the Dairy Industry dairy are in South East Asia and the Middle East, with Japan making up 19% of the export market (see table 1).

This industry which was once heavily controlled by the government has been deregulated since 2000, changing the regulated system into a free market system where demand and price points for fluid milk were no longer regulated by the government but rather determined by the free market (Doucouliagos & Hone,

2000a). This shift in management caused significant changes in both production and the number of farms left in the country after deregulation. The following sections describe this history as it unfolded, economic changes within the sector, and what the dairy industry looks like today, 16 years after deregulation.

1.1 The Deregulation of Australian Dairy Industry

Dairy cows first found their way into Australia in the late 1700s with a mere two bulls and seven cows landing in New South Wales in 1788 (Dairy Australia, 2015). Since then the industry has grown to 1,740,000 animals by 2015 (Legendairy, 2016b). For most of its early history, Australian dairy was primarily localized, serving consumers within the country and there were very few exports. With the advance of technology (i.e. refrigeration) towards the end of the

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1800s however, dairying began expanding rapidly and Australia started exporting dairy products abroad.

As exports increased in the 1880s and 1890s the government began to consider the benefit of regulating the dairy sector. The first national dairy regulation was developed in the early

1920s as the Dairy Produce Export Control Act 1924-1938 (PwC Australia, 2011). The control act was developed as a way to examine all legislation regarding international competition as agreed upon by the Commonwealth of Australia. The act stipulated that the board is to make recommendations to the minister regarding international trade regulation, with recommendations then made through a report which examines Australian exports, laws, and regulations regarding the quality of dairy products, and works to ensure that the commonwealth is taking advantage of any new international markets which could be beneficial to the Australian industry (Dairy Pro- duce Export Control Act, 1924-1938).

Under the new regulated system, the Australian dairy sector was separated into two cate- gories: market milk and manufactured milk. Market milk consisted of fluid milk products2, in order to prevent surpluses of fluid milk products sold locally the government regulated the amount of fluid milk produced. Manufactured milk products - such as cheese, butter, powdered milk, etc. – were under fewer regulations and the majority of Australia’s manufactured milk products found their way into the export market (Edwards, 2003, Whetton, 2000). The regulation of the dairy industry saw that producers who sold market, or fluid, milk in the domestic market received a higher price for their product than those selling into the export market, due to domes-

2 For the purposes of this paper “fluid milk” refers to “market milk” as a more reader friendly term. 6 | Page A Study on the Effects of Regulation Change in the Dairy Industry tic price regulation and dairy levies placed on dairy products (Industry Commission, 1991; PwC

Australia, 2011).

The Dairy Produce Export Control Act has been amended over the years – with the present version being the Export Control Act 1982 – and has since been joined by the Food Stand- ards Code, Export Control (Prescribed Goods – General) Order 2005, and Export Control (Milk and Milk Products) Order 2005 as a part of a regulatory set that provides the codes and standards for the Australian dairy sector. The current system has policy and standards for the dairy industry set by federal agencies, while the responsibility for monitoring food standards is regulated by state authorities (Dairy Australia, 2016a).

During the years of dairy regulation, the fluid milk sector was the main area of regulation while manufactured milk products were under less strict regulation practices. While the dairy system has always been managed on a state-by-state level the main government interventions across the country for fluid milk included: regulating the farm gate price; regulating retail prices

(apart from Western Australia); supply quotas; regulating processing and distribution; and the restriction of interstate trade between some states (Industry Commission, 1991). In addition to the aforementioned regulations on fluid milk, the government also placed a levy on all milk production which then went to subsidise export milk products. The government also managed imports and exports by way of import quotas and export controls (Edwards, 2003; Industry Com- mission, 1991; PwC Australia, 2011). One of the main contributors to the decision to deregulate was the concern over high consumer milk prices due to the levy’s which were used to subsidize dairy exports (Edwards, 2003; Whetton, 2000). Over time this system of taxing milk products

7 | Page A Study on the Effects of Regulation Change in the Dairy Industry meant that the Australian consumer paid significantly higher domestic prices than global market prices. So while the regulated system made exporting more profitable to farmers, and ensured that there would be no national surpluses of dairy in Australia, it was steadily increasing the prices that local consumers had to pay for dairy products (Doucouliagos & Hone, 2000a).

In the years leading up to the deregulation of the dairy industry in Australia farmers were being paid approximately 21 cents per liter higher when they sold their product locally than if they exported abroad (Edwards, 2003). The challenge with this system for the Australian government however was that local prices were nearly double the global market prices in the late

1990s. With such a significant disparity between the price of milk in Australia versus the price on the global market the government began entertaining the idea of deregulating the dairy industry and returning it to a market based system.

The first steps towards deregulating the dairy industry were taken in 1995 when the Aus- tralian state and territorial representatives agreed to make changes to the National Competition

Policy (NCP) (Courtney, 2000). This agreement to make changes to the NCP eventually led to the Australian government entering into the Competition Principles Agreement (CPA), which promised to evaluate all laws which restricted international competition within the Common- wealth, to be completed by 2000 (Edwards, 2003). The CPA stipulated that there be strict rules regarding when laws restricting competition were to be permitted. These rules were based on the following two principles:

1. If the benefits to the community as a whole exceeded the costs; and

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2. If it could be proven that the benefits could only be reached by restricting interna-

tional competition (Edwards, 2003).

From the CPA came the decision to deregulate the dairy industry by 2000, this meant that the Commonwealth would open up dairy to the global market. This decision would drop consumer milk prices through encouraging more international competition (PwC Australia, 2011).

Not only did deregulation take away dairy quotas for fluid milk and subsidies for exports, but the Australian government encouraged international trade and increased competition in the dairy market through entering into the trans-Tasman trade agreement. Deregulation made it more appealing for other countries to export dairy products to Australia. As a result, the domestic dairy market in Australia lost over $5 million a year due to the increase in imports from the trans-Tasman trade agreement (Edwards, 2003). At the time Australia also had a free trade agreement with New Zealand, one of the world’s largest dairy exporters - holding approximately

35% of the global export market, with Europe sitting at 32%, followed by Australia at 11%

(NFF, 2016). Competition with New Zealand proved to be a significant hit to Australia’s domestic dairy sector and forced more Australian dairy farmers into the export market due to the competition with New Zealand domestically. In the years leading up to deregulation New Zealand was rapidly increasing its dairy production. From 1992 to 1998 Australia’s neighbour had increased dairy production by 40%. As such a small country with a low population, a large majority of dairy produced in New Zealand was heading into the export market, with the country increasing dairy exports by 50% over the same time period (Lattimore & Amor, 1988). This growth in New Zealand dairy is attributed largely to the abundance of grasslands in the country, with a low input cost margin for dairy production and the added benefit of government subsidies 9 | Page A Study on the Effects of Regulation Change in the Dairy Industry at the time of Australia’s deregulation (Edwards, 2003; Lattimore & Amor, 1988), New Zealand dairy grew at alarming rates. It is not surprising therefore that once Australia removed dairy tariffs, it was New Zealand dairy that came into competition with Australian farmers.

One of the most significant changes to the dairy sector after deregulation was the reduction in the number of farms. Prior deregulation in 2000 the number of dairy farms in Australia was approximately 12,500, this number fell to 8,884 by 2005, and now 15 years later the number of dairy farms in the country has fallen to 6,128 registered farms in 2015 (Dairy Australia,

2016b); the discussion on how production levels were affected by the change in farm numbers will be continued in section 1.3 under the economic impacts of deregulation.

Perhaps foreseeing this drastic change in dairy farming the government took measures to ensure that the transition was as smooth as possible for dairy farmers. First, they made the announcement in 1995 that the industry would be deregulated, giving farmers ample time to pre- pare. Second, the government spent $1.3 billion to compensate farmers for restructuring after deregulation (Edwards, 2003; PwC Australia, 2011).

The adjustment packages provided to farmers during the phasing out period were the

Dairy Structural Adjustment Program (DSAP) and the Dairy Regional Assistance Program

(DRAP). The purpose of DSAP was to aid farmers in the transition from a regulated to a deregulated dairy system, so as to help them remain competitive in the market after the changes came into place (Edwards, 2000; Whetton, 2000). Farmers began receiving payments in September of

1999 and payments were made in quarterly installments over the next eight years. Nearly half of all farm payments went to Victoria as the largest producer of dairy in Australia, while the other 10 | Page A Study on the Effects of Regulation Change in the Dairy Industry half was dispersed between the remaining states and territories (Edwards, 2000); however, the highest average farm payments were found in New South Wales and Queensland, the areas hit hardest by the negative effects of deregulation (Whetton, 2000).

It was expected that some dairy communities would expand their operation and increase production under the new deregulated system, while other farmers would choose to leave the sector all together. An exit payment plan was set up under the DSAP for farmers who chose to leave the dairy sector. These farmers were provided with an exit payment of up to $34,000 to restructure their farm. In addition to payments provided to farmers, $33.9 million was allocated to providing support for dairy dependent-communities (Edwards, 2000; Whetton, 2000). These payments were issued based on community need as determined by the Dairy Regional Assistance

Program (DRAP), and were dispersed over a three-year period right after deregulation came into effect (Edwards, 2000). Early predictions expected an initial flat-lining of production during the adjustment period, but recovery of production levels as the remaining farms expanded their operation. Once the adjustment period ended, diary production was expected to increase once again

(Courtney, 2000).

1.2 Response to Deregulation

As with any significant policy change, the response to deregulation was varied with some supporting the decision to deregulate and others fearing the changes that it would bring. The largest concern from producers was the predicted fall in the number of dairy farms throughout the country. Early estimates suggested that as many as one third of producers would be put out of business once deregulation came into effect (Courtney, 2000). This decrease was not likely to be

11 | Page A Study on the Effects of Regulation Change in the Dairy Industry felt across the whole country however, as the dairy industry was predicted to grow in the South

Eastern states – particularly in Victoria which is the largest dairy producing sector – while there was a predicted decline in the dairy sector in areas such as New South Wales and Queensland

(Courtney, 2000). While the discussion around deregulation had been on-going for the past dec- ade, the pushback from producers was a result of the fact that there would be no phasing out period because the industry would be deregulated all at once (Courtney, 2000).

Along with the number of farms predicted to fall, farm income was also expected to decrease (Whetton, 2000), giving farms opting to stay in dairy incentive to expand their operations which would lead to lower cost of operation per animal. As a result, the number of dairy cows across the country was expected to stay the same, even with a decline in the total number of farms, as the larger farms would buy up the cattle from farms exiting the dairy industry all together (Courtney, 2000). With the expectation of the total number of dairy cows and production levels remaining the same it is surprising that there was a significant pushback from consumers, especially small supermarket owners (O’Brien, 2000).

The response from small supermarkets was a result of large chains promising record low prices for fluid milk once deregulation took effect. Under the regulated system market prices for fluid milk were almost twice as high as international market prices. Once the industry was deregulated the cost for drinking milk was expected to go down, which was one point of tension for producers and small grocers alike (Courtney, 2000; O’Brien, 2000). Larger supermarket chains aimed to take advantage of the new system by creating a monopoly over the fluid milk sector by offering prices to consumers with which smaller grocers could not compete. This led to growing

12 | Page A Study on the Effects of Regulation Change in the Dairy Industry concern from some of the smaller stores that they would be pushed out of the sector in a post deregulated milk war (O’Brien, 2000). Discussion around the “milk war” was a big concern to a lot of small producers and business owners, deregulation promised lower milk prices for the consumers but the cost of the lower price would be felt by not only dairy producers but small business owners as well if they proved unable to keep up with the competitive prices of the supermarkets (O’Brien, 2000).

Apart from the few who spoke out against deregulation, the general belief was that a deregulated economy would promote higher economic growth over time. This was largely due to the belief in growth after structural reforms – such as tariff reforms, reduced subsidies, and the deregulation of other agricultural sectors – which some argue has led to an overall increase of

GDP and a decline in unemployment rates in other countries (World Trade Organization, 1998).

The consolidation of farms into larger operations also promised to increase the productivity of dairy farms. The total number of dairy farms in the country had been falling steadily since 1975, resulting in fewer large scale farms with increased production rates (Whetton, 2000).

Regardless of the pushback against the decision to deregulate the industry across the country, one state had greater influence over the decision to deregulate than all the others: Victo- ria. In the years leading up to deregulation Victoria’s dairy industry represented a significant part of the agricultural sector, particularly in manufacturing. In 1996 (four years before deregulation) the dairy manufacturing sector was responsible for employing up to 20 percent of jobs in dairy communities throughout the State (Doucouliagos & Hone, 2000a).

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A key player in the decision to deregulate, therefore, was the State of Victoria, which not only had the highest level of dairy production in Australia but was also the state that was the least regulated at the time of these discussions. Ultimately, when Victoria state representatives agreed to the decision to deregulate it meant that the rest of the states would have to follow or risk getting pushed out of the local market due to cheaper dairy products from Victoria crossing state lines. It was the decision of Victoria to deregulate that finally determined the end of the regulated system (Courtney, 2000).

1.3 Economic Effects of Deregulation

The decision to deregulate in 2000 made a notable difference to the dairy sector, affecting a variety of stakeholders in the industry. The most notable stakeholder group affected by the newly deregulated system were dairy producers as the number of farms declined dramatically in the years following deregulation. Along with the producers however, deregulation also had an effect on how the government interacted with the dairy industry, and affected the retail cost of milk for the Australian public as consumers and taxpayers.

Producers

The decision to deregulate dairy in 2000 made a noticeable difference to the sector, affecting both production levels as well as farm size. From the 1980s up until deregulation in 2000 the dairy industry saw a huge spike in production rising from 5,432 million liters produced in the

1979-1980 production year to a record high of 10,847 million liters in the 1999-2000 production year (see figure 3). Australian data show that the level of production went down only slightly after deregulation and then rose to a production level of 9,730 million liters by 2015, almost as high as it was the year that the industry was deregulated. 14 | Page A Study on the Effects of Regulation Change in the Dairy Industry

The initial drop in production is not surprising as the total number of farms has dropped by half in the 15 years since the industry was deregulated (Dairy Australia, 2016b). This change in the number of farms was to be expected however and many farmers were preparing for deregulation in the years leading up to it by way of farm investments to increase the scale of their operation. Data shows that in the years leading up to deregulation there was a change in investment patterns with an increase in investment of capital stock and in plant and equipment and buildings

(Doucouliagos & Hone, 2000a). From 1995-2000 investment in plant and equipment rose from an average of 0.25% a year to an average 9.38% per year, showing a substantial increase in investment in new technology. Even more startling is that investment in buildings changed from an average decrease of 4.78% per year to an increase of 1.93%, showing that farmers were also investing in either maintaining or investing in new buildings on their property (Doucouliagos &

Hone, 2000a). 15 | Page A Study on the Effects of Regulation Change in the Dairy Industry

Increased investment in farm technology and buildings ties into what is known about cattle numbers in the country post deregulation. For although farm numbers were dwindling, the overall number of dairy cows increased from 1999-2000 and then returned to approximately the same amount as prior to deregulation by 2015 (see figure 4). This means that while farm numbers went down, farm size increased and dairy farmers were able to keep up national production levels.

The effect of deregulation at the farm level seems to have varied quite significantly by region. The average decline in farm gate prices after deregulation for fluid milk was approximately 19 cents per litre lower than it was in the regulated economy (NCC, 2004). However, the

16 | Page A Study on the Effects of Regulation Change in the Dairy Industry effects of deregulation varied significantly by state, depending on the percentage of milk that went into the market (fluid) milk sector or the manufacturing milk sector. For example, Victoria

- Australia’s largest milk producing state - was less reliant on fluid milk premiums prior to deregulation and had high export levels, Victoria farmers as a result were less affected by lower milk prices than New South Wales, Queensland, and Western Australia (ACCC, 2001).

While deregulation hit many Australian farmers hard, and many made the decision to leave the industry all together, Australia’s stake in the export market has remained strong over the years, keeping large export areas such as Victoria thriving. Dairy exports have been a big player in in the industry long before deregulation, and has continued to thrive even after the

17 | Page A Study on the Effects of Regulation Change in the Dairy Industry changes to the sector in 2000 (see figure 5). Data show that the quantity of exports has remained steady since 2000 and with an increasing value of dairy commodities over time, rising from

$791,197 to $1,108,126 in 2013.

Government

Government involvement under the regulated system meant that price controls for drinking milk were managed on a state-by-state level while government schemes instigated by the

Commonwealth supported manufacturing milk prices. The regulated system meant not only that state governments had to put time and resources into regulating an industry, but towards the be- ginning of the 1990s Australian state governments were coming under increasing scrutiny for maintaining a system that some believed to be in direct violation of the National Competition

Policy (Cocklin & Bibden, 2002). Due to the high prices that developed over time for fluid milk, a regulated dairy industry became increasingly difficult to justify, particularly in light of the deregulation of other agricultural sectors (ACCC, 2001). Once Victoria made the decision to deregulate, it was clear to other states that a regulated dairy industry could not remain profitable against competition from Victoria, and was therefore beneficial to government leaders to make the decision to deregulate.

Consumers & Taxpayers

Of all the stakeholders in deregulation the Australian consumer/taxpayer gained the most benefit from the regulation change. In the regulated market prices for fluid milk were twice as high as prices in the international market - averaging 47 cents per litre in Australia while global market rates sat around 21 cents per litre - and the 11 cent levy that was placed on fluid milk

18 | Page A Study on the Effects of Regulation Change in the Dairy Industry products served to subsidise export products, which did not benefit local consumers at all

(ACCC, 2001).

In the first few months after dairy was deregulated store prices for milk fluctuated across sectors, but a new floor was eventually set, six months after deregulation, when one of the large supermarket chains, Woolworths, announced a national price for their dairy products. This was the first time that consumers were guaranteed a national price for milk and the supermarket chain ensured their low prices by entering into two year contracts with producers (ACCC, 2001). After this announcement was made other large supermarket chains followed suit by lowering their own prices, solidifying the lower prices to consumers that deregulation had initially promised. Milk had since become a product that many supermarkets will supply at a loss in order to get people into their store (ACCC, 2001).

It is no doubt that the consumer has been the beneficiary of deregulation, with national prices consistently remaining below the levels that they were prior to deregulation, as well as increased choice of milk products in stores to cater to various preferential and dietary needs of the consumer (NCC, 2004). By 2015 Australia’s dairy prices remain low by international standards sitting around $0.32 a liter (Dairy Australia, 2016) in comparison to $0.97 a litre in Canada

(Dairy Farmers of Canada, 2015), or $0.87 a litre in the United States (statista, 2016).

1.4 Dairy Today

In the 16 years since deregulation, the number of dairy farms in Australia has dropped by half and production levels have remained stable, with little to no national production growth since the millennium. While the number of total dairy farms in Australia has fallen by half over 19 | Page A Study on the Effects of Regulation Change in the Dairy Industry the last 16 years, the farms that stayed expanded and filled that production gap so that the level of production now is almost as high as it was when deregulation came into effect. The industry has a whole however does not appear to be expanding and as a result dairy farmers have begun making demands to the government to ensure the sustainable future of the industry (Australia,

2014). The following subsections describe the recommendations made by the Australian Dairy

Council (ADC) as outlined in their 2014 report.

1. Research and Development: Some of the main challenges facing Australian farmers to-

day are the input costs that go into having a successful farm business. The combination of

high input costs such as technology and farm labour and low market prices for dairy

make it difficult for dairy farmers to develop a growing business. Due to these challenges

the ADC proposes that the government invest in extension programs which promote re-

search and development in the dairy sector. These investments are recommended to be

made in the educational sector in the form of increased funding for agricultural education

and vocational training. The ADC also recommends that the government explore a joint

approach to extension which takes advantage of opportunities towards structural change

in the sector and to renovate ways in which farmers interact with the dairy industry (Aus-

tralia, 2014).

2. International Trade: Since deregulation there has been an increased drive towards ex-

porting dairy products. It comes as no surprise then that the ADC is recommending that

the government consider more trade agreements so as to reduce export costs, specifically

high tariffs that some countries place on imported products. The ADC is particularly in-

terested in new markets opening up in South East Asia and the middle east and has made 20 | Page A Study on the Effects of Regulation Change in the Dairy Industry

a recommendation that the government enter into a Free Trade Agreement (FTA) with

China, and that they increase resources available to the Department of Agriculture to help

remove non-tariff obstacles to key export countries such as Saudi Arabia, Vietnam, and

the Philippines (Australia, 2014).

3. On Farm Capital Investment: Capital investment is a vital aspect of farming to ensure

continued growth and prosperity. However, many dairy farmers are currently struggling

with increased debt levels, which is inhibiting their ability to invest in their farm proper-

ly. This has caused farmers to look for investment elsewhere rather than continuing to

borrow from banks. The ADC believes that the government can aid in promoting alterna-

tive sources of capital by examining on and off shore sources and by providing the neces-

sary services to regulate the market so that investors can feel confident in these alterna-

tive methods (Australia, 2014).

4. Access to Overseas Labour Market: the final recommendation is that the government

provide dairy farmers with access to the overseas labour market in light of the fact that

finding young people to enter the industry within Australia had become increasingly dif-

ficult. The ADC recognizes that long-term solutions include schemes aimed at attracting

young people into the industry, but suggests that lifting limits on visas and incorporating

labour agreements and immigrant worker schemes is the best short term solution to the

industry’s current labour shortage (Australia, 2014).

1.5 Lessons Learned from Australia

Understanding the events that arose out of the deregulation of the Australian dairy industry is important as the lessons learned from this case can be applied to nations who are currently 21 | Page A Study on the Effects of Regulation Change in the Dairy Industry entering into, or considering, the removal of dairy regulations in their own countries. For Ireland and Canada, the case of deregulation in Australia presents a unique opportunity to learn from an example and even anticipate what they might expect in the years to come. From this case study we have learned the following lessons:

1. Farm size and productivity: in the first few years after deregulation milk production did

not decrease as farms absorbed the cattle from farmers who exited the industry. Further-

more, in the 15 years after deregulation the number of farms in the country have fallen by

half, with the existing farms expanding their operation and increasing their investment in

innovation and new technology.

2. The government’s structural adjustment package: while there was no official phasing out

period prior to the complete deregulation of the industry, the government by no means

left dairy farmers un-cared for. The structural adjustment package provided farmers with

the means to move past the changes in fluid milk prices and either invest in expanding

their operation or move into another sector.

3. Response to Deregulation: while there was some pushback from farm groups and small

distributors, the overall response to deregulation was positive. As the country was already

exporting a large majority of their dairy production the main concern was how it would

affect producers who were primarily in the fluid milk sector and not manufacturing milk.

The state of Victoria also had a virtual monopoly on the dairy sector as the country’s

largest milk producer and so the decision for all states to deregulation hinged on the deci-

sion from one region.

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4. The longevity of Dairy in Australia: the decision to deregulate led to a lot of changes in

the sector, the most notable being the decrease in total number of farms, yet it seems as

though dairy farmers rose to the challenge by increasing their operation in order to fill the

production gap from farmers leaving the industry. Looking at dairy associations today

however it is apparent that the sector may have come to a standstill, with international

demand for dairy not supporting a growing industry. The request of farming associations

for the government to enter into more trade agreements presents a worry about con-

strained demand in the global market, especially considering that avoiding surpluses was

the reason why many countries chose to regulate the sector in the first place.

It is through understanding past experiences that current and future expectations regarding changes to the dairy industry might be shaped. The lessons learned from the Australian case serve as a benchmark to understanding potential changes to the dairy sector in Ireland and Cana- da.

2.0 Ireland: Case Study

Ireland’s agricultural sector operates under the European Union’s (EU) Common Agri- cultural Policy (CAP), a long standing agricultural policy which was developed in the 1960s as a way manage the agricultural sector in EU member states. In 2003, the CAP underwent mid-term revisions and a decision was reached to end the current quota system in the dairy sector by 2015

(Giles, 2015). The following sections outline the history of the CAP and the vital role that it plays in Irish dairy and the responses to the decision to remove quotas from the dairy sector.

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2.1 Deregulation of Dairy Quota under the CAP

The Common Agricultural Policy (CAP) is one of the longest standing policies within the

EU. Developed in the early 1960s the CAP was designed to deal with damages to agricultural sectors due to war. The CAP worked to regain food stability in Europe by creating specific policies which encouraged production while providing the agricultural community a fair standard of living. The CAP later became instrumental in the modernization of farms throughout the EU providing aid to farmers working on land which was difficult to cultivate, as well as introducing regulations which encouraged the sustainability of the farming sector – both economically and environmentally (European Commission, 2015b). These efforts ensured the continuation of the farming sector throughout Europe. As farming began to thrive once again however, the EU faced the challenge of dealing with a surplus of agricultural goods, dairy in particular. With the supply greater than the demand, governments were forced to buy up and store much of the surplus in order to keep the market stable. This was a particularly difficult issue in the early 1980s when large surpluses of milk required the intervention of the EU to buy up as much as 1 million tonnes of butter and skimmed milk powder (Giles, 2015). It was expected that the EU would come up with alternative strategies to deal with the challenge of surpluses (European Commission, 2015b;

Giles, 2015).

The EU implemented a milk quota system in 1984. Introducing a system where farms were assigned quota was one of the solutions to preventing surpluses from occurring again (Eu- ropean Commission, 2015a; Giles, 2015). This system was regulated on a national level; each individual member state was awarded a specific amount of quota under the EU which the governments then distributed to farmers in their country (Reform the CAP, 2010). When quota was 24 | Page A Study on the Effects of Regulation Change in the Dairy Industry first introduced it was thought that regulating production would keep milk prices stable and at an affordable rate for consumers. Over time however the quota system proved to increase milk prices well above global market rates (Giles, 2015) as farmers were prevented from expanding their operation as costs of operation increased (Reform the CAP, 2010)

The quota system remained in place for three decades. A reformation of the CAP in 2003 proposed to put an end to quota by 2015 (European Commission, 2015a; Giles, 2015). The ra- tionale behind removing quotas was to decrease the cost of dairy products in Europe. While dairy quotas had served to prevent surpluses in the market, they came at the cost of the profitability of dairy farms at the farm level. Increasing production size would allow farmers to maximize farm efficiency. The argument for reformation has been that the CAP has limited the farmers’ ability to expand their operation and as a result many European farms are operating at a loss, which then has to be compensated by the government by way of direct farm payments (Reform the CAP,

2010). In order to localize milk production so that all European citizens are able to purchase locally produced milk, the CAP has been subsidizing milk production. By eliminating dairy quotas, the EU hopes to increase production rates and reduce the cost of dairy production. This will eliminate the influence that quotas previously had on market prices, as well as administration costs that all EU member states are subject to under the CAP, such as monitoring quota rights and production levels, all of which use up government resources (Reform the CAP, 2010).

European Dairy Post CAP Reformation

The latest CAP reform took place in 2013 after the decision to remove quotas was made during the CAP reformation in 2003, followed by intensive discussions in 2010 solidifying the

25 | Page A Study on the Effects of Regulation Change in the Dairy Industry decision. This reformation looked specifically for changes that could be made in the agricultural sectors in order to make rural areas more vibrant while encouraging agricultural sustainability and competitiveness (European Commission, 2015a). The reformation, which looked for changes that could be completed by 2020, sought to make the agricultural sectors more self-sufficient

(European Commission, 2015a), as farmers in the EU were relying largely on farm subsidies to remain operational.

The benefits of removing dairy quotas will only be felt in some areas of the EU, particularly the top 14 dairy producing nations: Germany, France, the UK, the Netherlands, Poland, Ita- ly, Spain, Ireland, Denmark, Belgium, Austria, Sweden, Czech Republic, and Finland (Giles,

2015). These countries currently make up more than 93% of the total dairy production in the EU.

Of these 14 top producing countries it is expected that dairy production will increase by 6.8-

23.2% between 2015 and 2020; yet the majority of growth is expected to occur in seven of the top nine producing countries: France, the UK, Germany, the Netherlands, Poland, and Ireland are expected to add between 7.6 and 21.5 billion liters of milk to their annual production by 2020

(Giles, 2015).

In Ireland, the removal of dairy quotas has been met with enthusiasm from much of the dairy community as dairy is far and above the most profitable agricultural sector in Ireland with an average farm income of $70,613 USD3 in 2013, whereas the national farm income averaged

3 All dollar amounts converted to USD. Euro to US dollar conversion using a EUR/USD exchange rate of 1.13. 26 | Page A Study on the Effects of Regulation Change in the Dairy Industry out at a mere $28,513 in the same year4 (Hanrahan et al., 2014). As one of the largest agricultural sectors in Ireland there is a belief that the years of dairy quotas only limited Irish dairy farmer’s ability to produce, and that without the quotas the sector might expand up to an additional 50%

(Boysen et al., 2016; Hanrahan et al., 2014). This predicted expansion of the dairy sector has largely to do with comparisons made to New Zealand and their expansion rates over the last 30 years. Ireland has a similar capacity for grass grazed dairy cows, and is comparable in size, population, and capacity for exports.

While it may be true that Ireland could increase their production and increase the profitability of the dairy sector, the lifting of quotas also comes with other regulatory changes. Should trade agreements - such as the ongoing Doha development round - lift current international tariffs, Ireland's dairy and beef sectors could become vulnerable as they are currently two of the highest protected agricultural commodities, and subsequently the two largest agricultural sectors in Ireland (Boysen et al., 2016).

The removal of dairy quotas also means that for the first time in over three decades’ Eu- ropean dairy will be subject to fluctuations in the Global market. Dairy exports will depend upon the government's ability to successfully negotiate free trade agreements (Giles, 2015). Needless to say the removal of dairy quotas will necessitate an overall readjustment of the sector in Ireland as farmers respond to not only the new found ability to produce more than they were previously

4 Irish family farm income is generated by subtracting all farm costs, overhead and direct costs, from the value of gross farm output. This is the standard unit of measurement for farm income in Ireland (Hanrahan et al., 2014) 27 | Page A Study on the Effects of Regulation Change in the Dairy Industry allowed to produce, but respond to free trade and tariff agreements which might make them vulnerable to lower cost competitors.

2.2 Response to Deregulation

Much of the response to the removal of the milk quotas has been positive in Ireland. The belief that lifting dairy quotas will expand the dairy sector significantly has been seen as beneficial to the country as dairy farming is one of the country’s largest agricultural sectors. A growing dairy industry will not only benefit Ireland’s overall economy but it will add value once again to much of the rural areas of the country where grassland is the primary natural resource. There is also less risk of overproduction in the present day than there was in the 1980s, this is in part due to the ability to easily process and export dairy products abroad, but there are also policies set in place today to protect the dairy industry. The Common Market Organization (CMO) sets a guaranteed price for butter and skim milk powder as a safety net for farmers should the issue of overproduction arise (AgriLand, 2015).

Removing dairy quotas also provides farmers with newfound agency over their business that they did not have under the old policy. Farmers now have the ability to determine how much to produce by looking at the local and global market (AgriLand, 2015). For many this new found control over their business is advantageous as many producers are looking towards expanding into the export market into the Middle East, specifically to the Arabian Gulf (Cronin, 2015). The main competition that Ireland will face in the Middle East is from dairy producers in New Zea- land.

This positive response to the end of dairy quotas in Ireland is directly related to an expectation that Ireland will catch up with the production rates in New Zealand now that the quotas are 28 | Page A Study on the Effects of Regulation Change in the Dairy Industry lifted. This expectation comes from the fact that prior to the CAP dairy quotas Ireland’s dairy production was just shy of New Zealand’s, with Irish farms producing approximately 5.4 billion litres a year (Cronin, 2015) while New Zealand's annual production sat around 7 billion litres

(White, 2015). Over the 31-year period of dairy quotas in Europe however production rates in

New Zealand have skyrocketed to 19 billion litres per annum while Ireland’s production remained at a mere 5.5 billion litres per year (White, 2015). As a result, when quotas were finally removed at the end of March in 2015, the Irish dairy sector was eager to begin growing their industry once again.

Expectations that there would be sufficient demand to support a growing milk sector in

Ireland come from a growing demand in the international market, particularly in Asia and the

Middle East, over the last five years. The OECD predicts that the demand for dairy may increase by as much as 168 million tonnes by 2022, with the majority of the demand (74%) coming from developing countries (OECD-FAO, 2013). However, Ireland is not the only country who has increased supply to meet international demand. There has been export growth in the US, New Zea- land, Australia, and Argentina and the call for imports into China and the Middle East has slowed down significantly as supply has begun to outweigh the demand for dairy products in those areas (OECD-FAO, 2013; White, 2015).

Even though the response to quota removals has been positive, some within the Irish dairy sector have become skeptical as the milk prices have not been as high as producers would like post CAP reformation. Since April 2015 farmers have been disappointed with significantly lower milk prices than in previous years, with prices down from $0.40 a litre in 2014 (White,

2015) to $0.25 a litre in 2016 (AHDB, 2016), and the response from farmers has been less than

29 | Page A Study on the Effects of Regulation Change in the Dairy Industry positive (White, 2015). Many farmers took out loans in anticipation of the CAP removal in order to expand their operations. The average dairy farm in Ireland has borrowed around $69,500, and the total agricultural bank loans in the country are estimated to be around $3.86 billion in March of 2015 (White, 2015). This only adds to the stress of dairy farmers who hoped to see the benefits of increased milk production sooner rather than later.

2.2.1 Economic Predictions

Removing the dairy quotas will undoubtedly have a large influence on the dairy sector in

Ireland. With the sector expected to increase by 50% by 2020, dairy farmers are expected to gain the most from this change in policy (White, 2015). This section outlines the predicted outcomes of quota removal on dairy producers, the government, and the Irish public as consumers and taxpayers.

Producers

The biggest change for dairy producers in Ireland is that they are no longer restricted under a national quota system that limits the amount that they are allowed to produce on an annual basis. Producers are now expected to monitor their own production rates based on demand trends in an open market system. While this may seem like a big change for some the European Com- mission fully intends to give producers the tools necessary to monitor demand and has set up a

Milk Market Observatory to allow for greater transparency in the global markets so that farmers can produce responsibly (AgriLand, 2015). The removal of quotas means that farmers now need to take greater responsibility in monitoring the state of the global market as they produce to ensure the long-term success of their business.

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One challenge that will face Irish dairy producers going forward is market volatility. Un- der the quota system producers did not have to manage their own production levels as they were set at the national level and therefore farmers did not have to deal with fluctuations in market prices. Under the new system dairy producers will likely have to accept the reality of lower prices for their products in a competitive market system. That being said, Irish producers can still count on a certain level of protection under the EU’s Common Market Organization (CMO). The

CMO protects farmers by maintaining control over the public buying in of milk products such as butter and skimmed milk, and could aid farmers with their private storage aid scheme should problems with surpluses in the market arise (AgriLand, 2015). This system was set in place to prevent similar occurrences with dairy surpluses that originally led the CAP to implement quotas.

Another safety net for Irish farmers comes in the form of direct farm payments, a system which was in place with the dairy quotas and remains as an option for governments to give aid to struggling farmers. Governments are given the option to aid farms in areas with exceptional cir- cumstances, such as environmental constraints, and can be determined on a regional level under the decoupled CAP direct farm payment scheme (AgriLand, 2015).

While increasing production is seen as an opportunity for many farmers, for others expansion might be a necessity to remain viable in the market. The unfortunate reality for many farmers is that lower prices paid by large processors in Ireland might be here to stay as a means to remain competitive in the global market. This means that long-term success of dairy farmers will likely depend on substantially increasing the scale of their operation. This is especially pru- dent regarding Ireland’s goal of exporting into the international market. The average dairy farm

31 | Page A Study on the Effects of Regulation Change in the Dairy Industry in Ireland today milks around 60 cows, whereas the average number of milking cows per farm in

New Zealand is 400 cows (White, 2015), and 284 cows in Australia (Dairy Australia, 2016).

The big advantage that Ireland has over other large producing countries, such as Austral- ia, however is their ability to graze cattle year round. While their production levels still need to increase before they’re on par with Australia’s production, the cost of milk in Ireland is significantly lower (see table 2), sitting at $0.24/litre whereas Australia’s retail price for milk is

$0.36/litre.

In order for producers to be successful in a volatile market they must maximize resilience in the face of price fluctuations by maintaining a low cost base in order to absorb shocks from a changing market, as well as generate surplus income during times where the prices are high in order to maintain operations during times where dairy prices drop. Fortunately for Irish producers they already have a relatively low cost base due to the abundance of grasslands and have consistently generated cash surpluses (Teagasc, 2015). The success of the dairy industry in Ireland will therefore depend on producer’s ability to maintain current operational standards in a growing yet volatile market.

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Government

When milk quotas were originally put in place, they were only intended to be around for five years, however the abolition date was pushed back several times until the EU started preparing for their soft landing in 2008. With international demand for dairy products on the rise, Eu- ropean governments were under pressure to remove milk quotas that were preventing European producers from expanding their dairy operations (AgriLand, 2015).

While government authorities are not the main beneficiaries of the removal of milk quotas, their role in how Irish dairy is produced has greatly changed since the CAP reformation. The

Irish government will benefit by the removal of the quotas by saving time and resources previously used to administer the quota system. Prior to the CAP reform individual governments were required to register for quota, compare rights with other countries, and compare actual production levels for each dairy farm (Reform the CAP, 2010).

Consumers & Taxpayers

Unlike motivations in Australia to deregulate as a means of bringing down consumer prices for dairy, Ireland consumers are not likely to experience a drastic change in dairy prices as liquid milk products only account for a fraction of total dairy products produced in Ireland - around 8.4% in 2014 - with the remainder going into processed goods, much of which is exported into international markets (Healy, 2015). Dairy prices in Ireland however are relatively low, and has therefore not been a significant part of the discussion on how quota abolition will benefit the Irish economy.

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2.2.2 The Future for Irish Dairy

There has been some debate in the media over whether or not the Irish dairy industry will in fact grow by 50% in the next 4 years (Healy, 2015), while some say that this target number is achievable others suggest that a 5% increase per year over the next four years is more realistic.

Regardless of how much the dairy sector is to grow in the next few years there is little doubt that growth is on the horizon (Astley, 2015). With the promise of increasing international demand for dairy Ireland is preparing to increase their presence in the international dairy sector in the near future.

2.3 Australia Comparison: Discussion

This section examines what the future might look like for Irish dairy based on the lessons learned from the Australian case study:

Farm size and productivity

The Australian case example showed farm numbers falling by half over a 15-year period with the production levels maintained through existing farms increasing in size in order to make up the difference from farmers who chose to leave the dairy sector. This change in farm numbers was largely do to the drop in farm gate prices, creating a need for more efficient farms. Irish farmers have also experienced a decline in farm gate prices since the abolition of quota. It is un- clear whether existing dairy farms in Ireland will be able to increase herd size and gain efficien- cies. Currently the majority of dairy cows are grass fed, and it is not clear if there is enough graz- ing land in Ireland to accommodate the type of expansion anticipated. Irish farmers may increase farm efficiency by converting from a grass fed model to barn fed, however such a change would come at a cost as Irish dairy is marketed as a high quality grass based commodity, which could

34 | Page A Study on the Effects of Regulation Change in the Dairy Industry be used to their advantage when competing with international dairy producers who do not graze their cattle.

Table 3 represents farm statistics for both Australia and Ireland and show that Australia’s annual milk production is almost twice that of Ireland. The data suggests that there is both room for increased cow numbers in Ireland as well as potential for Irish farmers to increase milk production per cow. Australia averages an additional 730 litres of milk per cow when compared to

Irish production. This has been accomplished in North America through better feeding, disease control, and advancement in genetics, all of which aid in increasing milk yields per cow (Cana- dian Dairy Commission, 2015). An alternative option for farm expansion could be found in Irish farmers bringing their dairy cows in doors, but that would mean a reduction in the health and quality of the cows and the milk that they produce.

It is possible that Ireland will not expand as much as expected. Even now it seems that the original predictions of increasing production by 50% may not be a realistic target. In Austral- ia production did not increase at all, but rather the number of farms decreased while production levels were maintained by consolidated farms. Ireland has yet to address the possibility of some

35 | Page A Study on the Effects of Regulation Change in the Dairy Industry dairy farmers going out of business and being bought up by expanding operations. If history has taught us anything it is that growing farm size is likely to be met with a reduction in total number of farms, and is something that Irish dairy producers should be wary of.

The government’s structural adjustment package

One of the important factors promoting a smooth transition in Australia from the regulated to deregulated dairy industry was the structural adjustment package that the government awarded dairy farmers to use either to expand their operation or to make the necessary changes to leave the industry. The reformation of the CAP awarded farmers no such package. Should farmers require additional aid under the new regulations they may find help in either the decoupled farm payments or in the CMO buying up manufactured surpluses. While this may provide farmers some safety against volatile market prices it does nothing to aid farmers who have taken out farm loans for expansion should they find themselves unsuccessful in the new market. Ire- land will likely find itself in a situation where many dairy farms are going out of business and being bought up by larger dairy producers, many farmers may find themselves on the losing end of the system.

Response to Deregulation

As in Australia the overall response to the abolition of dairy quotas has been positive in

Ireland. This is important as it makes the initial transition easier when there is not a large body of opposition. While the reduction in milk prices have caused concern for some, it has also encouraged people to take a more conservative look at what growth in the industry will actually look like, with more conservative estimates predicting around a 5% growth in production per year.

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As public response to any regulation change generally has to do with what is happening in the current climate, only time will tell whether or not dairy producers will continue their positive outlook on quota removals. Should Irish farmers be able to achieve the expected growth that was predicted prior to the CAP reformation, then the response should remain positive, however if they find expansion difficult or that they are not as competitive in the international market as they are expecting then the Irish government might begin to see some of the protesting that has been happening in other EU countries who opposed the policy changes.

The longevity of Dairy in Ireland

Irish dairy has been a significant part of the agricultural sector long before quota abolition, and will likely remain significant in the local economy, as local milk prices are expected to remain unchanged. The growing economies in Asia and the Middle East present opportunities for

Ireland to expand into new markets, however they will be competing with countries such as Aus- tralia and New Zealand who have significantly higher production rates and lower production costs. Even if Ireland reaches the projected 50% growth by 2020, Irish production rates will be a third of New Zealand’s dairy production (Astley, 2015). The entire industry would have to grow by much more than double to be comparable with the world’s largest dairy exporter. Fortunately for Ireland their production costs are still significantly lower than Australia, giving them a competitive edge. It is these low production costs that will likely mean that Irish dairy will be successful as an international competitor but the scale of expansion cannot be predicted.

3.0 Canada: Case Study

The Canadian dairy sector currently operates under a supply managed system which has been in place since 1966. Supply management works by assigning individual production quotas 37 | Page A Study on the Effects of Regulation Change in the Dairy Industry to farms – prices are then set at the provincial level and managed on an annual basis (Gifford,

2005). This system works to prevent surplus in the national market which is particularly important in the dairy sector due to the short shelf life of fluid milk products. Supply management also aids in stabilizing dairy prices as the government has managed the amount of imported dairy products through high tariffs (Canada) (Gifford, 2005). This case study examines the function of supply management in Canada, the potential threat of international trade to dairy producers, and what might happen to the sector should the Canadian government ever decide to deregulate the supply management system.

3.1 Supply Management and Canadian Dairy

Supply management systems generally operate in a closed market system; however, as trade agreements increase the range of open markets, the functionality of supply management has been questioned. In Canada, the government first implemented supply management in the dairy and poultry sectors in the 1960s as a means to control domestic production and prevent surpluses in the market (Gifford, 2005). Import prices remained low due to regulations within the General

Agreement on Tariffs and Trade (GATT), which allowed the government to impose high import quotas on dairy products. As the regulations began to change however, Canada’s ability to impose import quotas under the GATT disappeared. Import quotas and were replaced by import tariffs (Gifford, 2005). In recent years, the Canadian government has been entering into trade negotiations with both the European Union (EU) and the United States, causing producers to question what the new trade agreements might mean for dairy production in Canada under the current supply management system and whether the system may be eroded or abandoned.

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The dairy industry in Canada represents a substantial part of the nation’s agricultural sector. With over 12,000 farms across the country the dairy industry ranks third in farm revenue

(Canadian Dairy Information Centre, 2015). The Canadian dairy sector is also one of the most heavily regulated. All unprocessed goods are produced and sold locally – Canada imports processed dairy goods such as: cheese, butter, powdered milk, etc., while all fluid milk products are consumed at the local level (EcoResources, 2013). The supply management system avoids surpluses and deficits in milk products and allows dairy producers to remain self-sufficient, resulting in an independent system that does not rely on government subsidies to remain operational

(Dairy Farmers of Canada, 2015).

Supply management operates by having farmers purchase dairy quota. The farmer is able to produce based on the number of shares (quota) that the farm has purchased in the market. This system is run by the Canadian Dairy Commission, and is regulated at the provincial level, to monitor the supply and demand of dairy and use that to determine how much a farmer may produce in a given year to avoid overproduction. This method allows dairy to be produced locally at a competitive rate while keeping consumer products at consistent price as it determines the amount that is produced annually (Dairy Farmers of Canada, 2015). The system gives stability to dairy farmers by providing them with a standard price for their product, through the Canadian

Dairy Commission, as opposed to being held at the mercy of domestic and international market fluctuations (Dairy Farmers of Canada, 2015).

The supply management system has aided in preventing dairy from consolidating in one geographic location. Presently, Ontario and Quebec have the largest dairy sectors in the country,

39 | Page A Study on the Effects of Regulation Change in the Dairy Industry representing a collective 82% of the industry (see table 4). Nevertheless, dairy is produced in every province, the smallest percentage found in Newfoundland and Labrador with a mere 33 farms – or 0.3% of dairy in Canada. This is made possible because producers in any region of

Canada, be it small or large, are paid a set amount as determined by the regulatory system for their product at the farm gate level. The distribution of dairy quota reflects to some degree the regional distribution of the Canadian population.

Table 4: 2013 Numerical Breakdown of Canadian Farms by Province Province Number of Farms (Number and Percentage of Canadian Total) British Columbia 475 (3.9%) Alberta 571 (4.7%) Saskatchewan 166 (1.4%) Manitoba 321 (2.6%) Ontario 3,997 (32.7%) Quebec 6,038 (49.4%) New Brunswick 211 (1.7%) Nova Scotia 235 (1.9%) Prince Edward Island 187 (1.5%) Newfoundland and Labrador 33 (0.3%) Total 12,234 (100%) Data Source: EcoResources, 2015, p. 6

What supply management offers in terms of ensuring that dairy remains a viable industry in all provinces is one of the reasons why there is a strong push at the moment to keep the current supply management system unchanged in Canada. Should the government decide to do away with the current system, in favour of a market based one, dairy farming in Canada would likely see a drastic change.

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3.2 Supply Management and Free Trade Agreements

Canada has recently entered into two new trade agreements: The Common Economic and

Trade Agreement (CETA) with Europe, and the Trans-Pacific Partnership (TPP) with 12 trans pacific countries, including the US. As Canada’s supply management continues to restrict dairy imports the desire of Canada’s trading partners to gain more access to the Canadian dairy market has increased debates around the future of supply management in Canada (Cardwell et al., 2015).

The following subsections outline the previously mentioned free trade agreements as they pertain to Canadian dairy.

3.2.1 The Common Economic and Trade Agreement

Canada and the EU began trade negotiations in 2009 seeking to open up trading opportunities between Canada and Europe through the elimination of import tariffs (Global Affairs Can- ada, 2014, Sept. 26); CETA will open new markets in both Canada and the EU and is expected to strengthen their respective economies (European Commission, 2016; Global Affairs Canada,

2014, Nov. 4).

Canada has a long standing trade relationship with Europe. The main impact of the CE-

TA comes in the form of removing custom duties, or tariffs, with the majority of import tariffs to be eliminated once the agreement comes into effect. In a report on the CETA, the government of

Canada states that 98% of European tariffs will be removed for Canadian companies on the day that the agreement comes into effect (CETA, 2014).

The motives for Canada to establish a trade agreement with Europe have largely to do with creating access to Europe’s extensive market. Canada has a long trade history with Europe,

41 | Page A Study on the Effects of Regulation Change in the Dairy Industry producing millions in trade on an annual basis. In 2013 alone, the relationship between Canada and all EU member states generated over $66 million dollars USD5 in trade (Global Affairs Can- ada, 2014). Furthermore, the Canadian government estimates that the income generated from this two-way trade agreement will be equivalent to as much as 60 percent of Canada’s current GDP, and that one in five jobs will be connected to international business once the CETA comes into effect (Global Affairs Canada, 2014). Once the CETA comes into effect, open markets will allow for increased competition between Canada and Europe, which will strengthen the current trade bonds between the parties involved.

3.2.2 The Trans-Pacific Partnership

The Canadian government has also entered into free trade agreement with 12 Asia-

Pacific countries under the TPP. The final agreement was signed in February of 2016 by all 12 participating countries and is awaiting implementing legislation from each country before it comes into effect. The agreement seeks to create more trade opportunities between participating countries and encourage economic growth, productivity and innovation, and create new job opportunities (USTR, 2015). For Canada the TPP opens up a market of nearly 800 million people and a combined gross domestic product (GDP) $21.8 trillion (Global Affairs Canada, 2015).

Along with other free trade agreements the TPP will give Canadian businesses and producers access to over 60 percent of the world’s economy, with free trade agreements across Europe,

Asia Pacific, the Americas, and the United States (Global Affairs Canada, 2015).

5 All dollar amounts converted to USD. Canadian dollar to US dollar conversion using a CAD/USD exchange rate of 0.77. 42 | Page A Study on the Effects of Regulation Change in the Dairy Industry

Gaining access to these markets would be of special benefit to many agricultural sectors across Canada including: beef and pork, wheat and barley, canola oil, processed food and bever- ages, and wine and spirits. Exports in these agricultural sectors have grown steadily over the past six years with export values rising from $17.9 million dollars in 2010 to $26 million dollars in

2014 in TPP countries alone (Global Affairs Canada, 2015). With the preferential access awarded to Canadian businesses in all TPP participating countries this agreement presents special opportunities to much of the agricultural sector, one area that is excluded however is the dairy industry which under the current supply management system has not been exporting fluid milk products outside of Canada. So while there are many sectors excited about the potential for growth this agreement might provide Canadian dairy farmers remain pessimistic about the future, especially if the agreement leads to the end of the current supply management system.

3.3 Response to the Free Trade Agreements

Many involved in the dairy sector are unsupportive of the current trade agreements with

Europe and the Trans-Pacific. The response comes from the increased competition the trade agreements will bring, particularly in processed dairy products such as cheese. Supply management currently ensures that the Canadian population is provided with enough dairy, eggs, and poultry while providing farmers adequate pay for their product without the need for farm subsidies (Slomp, 2016). It does not guarantee producers special access to the fine cheese market nor does it promote the development of dairy exports. Free trade agreements also invite discussion around the usefulness of supply management in general (Cardwell et. al, 2015), with the onset of trade agreements often resulting in uproar from dairy producers demanding supply management protection.

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The argument around protecting supply management is a valid one because while some may argue that milk prices in Canada are higher than in other countries, such as the USA, Cana- dian tax dollars are not going towards subsidizing the dairy industry. So while Canadians pay a retail price of approximately $0.97 per liter for milk (Dairy farmers of Canada, 2015) and Amer- ican’s pay a retail price of approximately $0.87 per litre of milk (statista, 2016) the American public also pays approximately $3 billion a year in dairy subsidies whereas the Canadian public pays nothing in subsidies to dairy farmers (Dairy Farmers of Canada, 2015).

Canada’s supply management system is built on three pillars: import controls, managing production prices for farmers, and producer regulation (Slomp, 2016). These pillars ensure that

1) there is always enough milk for Canadian consumers without problems associated with surpluses, 2) farmers are provided with fair and adequate prices for their products, and 3) that milk is produced in a safe and healthy way according to government standards. Free trade agreements threaten the pillars of supply management by increasing the amount of processed dairy products that are allowed into the country which in turn increases international competition.

Another concern with the free trade agreements is what increased dairy imports mean for the longevity of the Canadian dairy industry. At present, supply management enables milk to be produced in every province as farmers are guaranteed fair prices for their milk, which allows smaller farms to operate as opposed to being swallowed up by larger farms. This is beneficial to the Canadian economy as the dairy industry provides jobs in every province, furthermore dairy farmers support rural communities, with 90% of the average farm income going back into farm operation and producers who reinvest into local economies by spending money locally (Dairy

Farmers of Canada, 2015).

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Most of the uproar around ensuring that Canada keeps supply management comes from the farming community, however there is also public concern regarding milk quality. There has been some media coverage regarding how the milk quality in Canada might change once trade agreements, specifically the TPP, are ratified. Pillar three of Canada’s supply management system ensures that milk produced in Canada meets government standards. One of the requirements of Ontario dairy producers is that there be no presence of growth hormones in the milk when it goes out for processing. This law was passed in the late 1990s after studies were conducted on the use of growth hormones and the effects that it has on the cow's health (Slomp, 2016). One of the main concerns around the TPP is what this will mean for milk products coming into Canada from the USA, as many American milk products still contain a synthetic bovine growth hormone

(rBGH), which is not currently legal in Canada. One of the commitments outlined in the TPP in- dicate that Canada and the US will enter into discussions around food and safety rules with the aim to harmonize differences. Unfortunately, this stipulation in the TPP could result in Canada lowering food and safety standards to meet American producer standards (Slopm, 2016). This is a large area of concern for many Canadian consumers who do not wish to have growth hormones in their milk products.

3.3.1 Economic Predictions

As the current government show no signs of removing supply management in Canada, many predictions around what would happen come from economists in favour of a free market system due to the fact that Canadian consumers currently pay among the highest prices for dairy products, particularly when compared to the US and Europe. As producers remain firm in their defence of supply management the argument is generally between the benefits of supply man-

45 | Page A Study on the Effects of Regulation Change in the Dairy Industry agement to producers and the costs of higher dairy prices for consumers. This section will examine the economic debate from the producer and consumer perspective to highlight both argu- ments.

Producers

Many economists have been quick to point out the problem with Canada’s supply management system as an inefficient economic model. The use of quotas has been particularly prob- lematic due to the fact that they have more than doubled since the 1990s with quota prices rising from $11,480/Kg/Day to $22,960/Kg/Day by 2006. This makes it increasingly more difficult for farmers to expand their operations as they have to raise funds not only for farm operations but also to purchase quota for the increased production they wish to add (Hansen, 2013).

The cost of quota makes it difficult for farmers to expand their production. Economists point out how increased production can aid in the economic efficiency of farm operations and help producers by exploiting economies of scale (Hansen, 2013). Without the ability to grow their operation many farmers are left with inefficient business models that are not as profitable as they could be under an open market system.

While limitations with the quota system cause some to argue for the abolition of supply management, others are not so optimistic about what the dairy industry might look like if the safeguards that supply management offers to farmers are not in place. Many predictions around what this change in the dairy industry might look like for Canadian farmers are based around what happened in Australia in 2000 (Leduc, 2015). A reduction in the number of farms and increase in farm production is one of the likely outcomes of removing supply management. Reduc- tion in dairy prices for consumers would be a likely economic benefit (Leduc, 2015).

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These changes represent only some of the changes that might occur should Canada decide to deregulate its dairy sector. One significant difference between Canada and Australia is the difference in experience in international markets. While Australia was already prominent in the export market, Canadian dairy products are primarily sold at the local level. If Canadian producers are to have a hope of competing against the US and Europe for the growing markets in

Asia and the Middle East, they would need to find a way to gain a foothold in international markets.

Consumers & Taxpayers

The main argument for removing supply management is that it is believed that in a open market system Canadian consumers would benefit from lower prices for supply managed products (Cardwell et. al, 2015). The argument that supply management has inflated dairy prices is well known, with Canadians paying higher prices than consumers in the US or Europe (Dairy

Farmers of Canada, 2015), it is believed that consumers would benefit greatly from an open market system.

Some even go so far as to argue that the supply management system is regressive in that it can be viewed as a system that transfers wealth from lower income families to higher income households, as the average Canadian household income was $52,000 in 2009 whereas the average dairy producer’s household income was $84,000 in the same year (Cardwell et. al, 2015).

What the argument for lower consumer prices does not take into account however is how supply management ensures a high standard for quality dairy that benefits consumers.

Those in favour of supply management point out the dangers of a free market based system that encourages competition with the US due to differences in laws regarding growth hor-

47 | Page A Study on the Effects of Regulation Change in the Dairy Industry mones. Canadian consumers are not paying that much more for milk than their American coun- terparts. The price of fluid milk in Canada, while higher overall, is not substantially higher than what people pay in the US. Although it is true that lower income families pay a greater percentage of their household income on food, only a small percentage of that can be attributed to dairy products; in fact, the average household income spent on dairy has actually fallen since 1990 from 1.2% to 1.03% in 2013 (Dairy Farmers of Canada, 2015).

In terms of benefits for Canadian consumers it may likely be a trade off between higher prices for milk produces that are hormone free and lower consumer costs with a reduction in milk quality.

3.3 Australia Comparison: Discussion

This section applies the lessons learned from deregulation in Australia to the Canadian context in order to speculate how the removal of supply management might affect Canadian producers.

Farm size and productivity

If the Canadian government ever decided to remove the current supply management system, Canadian farmers could almost certainly expect to see a reduction in the number of farms across the country. In the past few years Canada has already begun to see the number of farms go down, even with the current supply management system in place. The remaining farms would likely be in Quebec and Ontario where production is highest, while lower producing provinces, such as Newfoundland and Labrador, Saskatchewan, and Prince Edward Island, might see the disappearance of the dairy sector all together.

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The government’s structural adjustment package

The Australian government recognised that deregulation would be a challenging transition for many dairy producers, and so they provided dairy farmers with direct payments so that they could either expand their operation or transition their farm into another agricultural sector.

Should Canada decide to remove the supply management system it is likely that they would need to compensate dairy producers for the quota that has already been purchased. Unfortunately, the rise in quota prices over the years has lead to the majority of dairy producers spending millions in quota. The Australian government spent around $1.3 billion in their structural adjustment programs for dairy producers and dairy dependent communities, with farm payments averaging around $34,000; if Canada were to compensate farmers for their quota value, conservative estimates - which only account for the last 10 years of quota and not the full value of farm quota - put the buy out between $2.8 billion and $3.6 billion, almost three times the amount that the Aus- tralian government put into the structural adjustment package (Grant et al., 2014).

Response to Deregulation

Free trade agreements have encouraged discussion regarding the possible removal of supply management, and so far the response from the dairy producers have been overwhelmingly negative. While some economists point out the possible benefits of an open market system, Ca- nadian dairy producers have maintained their desire to keep the current system. This is very different from the response in Australia where much of the objection came from small supermarket owners. As with any policy change the politicians will have to take into consideration possible backlash, and so far the dairy sector has been very vocal about their objections.

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The longevity of Dairy in Canada

Canadian dairy currently operates under a system that provides enough dairy to meet the internal demands of the country. Table 5 compares Canada’s farm statistics with Australia and

Ireland. Current farm trends show Canadian dairy producers increasing production yields per cow, with falling farm and cattle numbers (Canadian Dairy Commission, 2015). The data show that Canada has a strong dairy industry even under current supply management restrictions. The real question is whether or not the same industry would thrive under an open market system.

Table 5: Average Farm Size Statistics – Country Comparison: Australia, Ireland, and Canada Australiaa Irelandb Canadac Average Herd Size 284 cows 60 cows 77 cows Average Farm Pro- 9,731 million litres 300,000 litres 630,537 litres duction Approx. Yield per 5,730 litres 5,000 litres 7,800 litres Cow Number of Farms 1,740 17,000 12,234d National Dairy Herd 1.74 million cows 1.14 million cows 987,000 cows National Milk Pro- 9.7 billion litres 5.4 billion litres 7.9 billion litres duction a Source: Dairy Australia, 2016 b Source: FIA, 2014 c Source: Canadian Dairy Commission, 2015 d Source: EcoResources, 2015

Based on the lessons learned from Australia and changes in the current international market regarding dairy it is unlikely that without current access to international markets Canada would follow the same trends of stable production that Australia experienced post deregulation.

This is because the cost of production in Canada is higher than in the US, Europe, and Australia, and thus the sector would take a substantial hit from significantly lower farm gate prices. The main difference between Canada and Australia was that the majority of milk production in Aus-

50 | Page A Study on the Effects of Regulation Change in the Dairy Industry tralia was already going into international markets at the time of deregulation, whereas the majority of Canadian dairy is sold locally. The removal of supply management would put Canadian producers in a very vulnerable position where they would be challenged to compete against countries producing at a fraction of the cost.

4.0 Conclusion

The dairy sector has seen significant change over the years, going from a product that was once primarily produced and consumed locally, to one that is shipped around the globe. As dairy exports become a major player in the international market, local dairy production changes as well. The Australian example proves that under the right conditions dairy can survive a significant change in policy. Australia remains a main player in the global dairy industry, and has kept up production levels 16 years after the industry was deregulated.

Since the deregulation of Australia’s dairy sector, the lessons from that regulation changed can now be applied to other countries who either have, or are considering, changing to an open market system for dairy. The most significant change to Australia’s dairy industry was the reduction in the number of farms, and the expansion of the remaining farms to make up the production levels. While Australia has maintained production levels the industry has not grown, something which Ireland is expecting to do. The Irish industry appears to have room for expansion, however they will also be competing for international markets in Asia and the Middle East with other large dairy producers. Ireland may also have to deal with the possibility of reducing farm numbers as in Australia, something that does not appear to be on the radar of Irish producers. This will depend on how much producers are able to expand on their current land, or if consolidation of farms is necessary for further expansion. Regardless of how they expand, Ireland’s 51 | Page A Study on the Effects of Regulation Change in the Dairy Industry low production costs make it likely that they will be able to grow their production levels and become a new player in the international market.

The future for Canadian dairy is less certain should the government abandon supply management. Many economists would like to see the end of supply management in Canada, while those in the dairy sector are set on keeping it. Should Canada decide to remove supply management, it is likely that they will follow a similar pattern to Australia and see a significant reduction in total number of farms. What is less certain is whether or not Canada would be able to be competitive in the global market, and maintain production levels as Australia has. There are several challenges to the success of Canadian dairy in a deregulated market: high production costs, high value of dairy quotas, and low dairy exports are all barriers to the success of Canadian dairy without supply management. Furthermore, the loss of the dairy sector in many parts of Canada could have negative ramifications on rural communities, particularly the ones that are dependent on dairy farms. The dairy industry not only provides jobs in rural areas but also reinvest in the local economy. Australia recognized the loss of dairy farms to rural areas and incorporated rural communities into their structural adjustment plan; the conversation around compensation in Can- ada however is starkly different with some indication that the government might buy quota to soften the loss to farmers but no indication of how the government would aid rural areas once dependent on the dairy industry.

While no one can know for certain how an industry will cope after a major regulation change, looking at what has happened elsewhere not only provides valuable lessons, but also gives context to the global market. As dairy moves from a local market to a global commodity,

52 | Page A Study on the Effects of Regulation Change in the Dairy Industry understanding the international context is essential in evaluating changes made at the local level, and can mean the difference between a thriving industry and one that falters.

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