Supply Management in the Dairy Sector of Canada

Abstract

This paper will analyze Canada’s supply management in the dairy sector. In the introduction section, it provides a brief overview of the dairy farming sector in Canada and its impact on the market. It also presents an introduction to supply management in dairy farming. Under the background of the country’s supply management, the paper will discuss the origin of supply management and its three major pillars, namely, quota allocation, price setting, and import restriction.

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Such pillars are in line with various economic principles, including the principle that commerce makes people better off. The paper will then discuss the major challenges and pressures affecting the system, including the Doha talks, which were aimed at opening domestic markets for imports. Lastly, the paper will present a conclusion, which will be a summary of the entire paper.

Introduction

Dairy farming is an important constituent of the Canadian agricultural sector. It is practiced in all provinces across Canada, where it forms the top agricultural commodity in most parts of the country. In 2011, the number of dairy cows was nearly one million. This figure was taken from 12,746 farms. Therefore, the average number of dairy cattle per farm was about 77. Nevertheless, the number of dairy cattle in the country has dwindled since 1971.

Today, Ontario and Quebec are two major dairy farming zones in Canada, constituting 49% and 32% of the entire Canadian dairy farms, respectively. Canada’s dairy farming sector is regulated through supply management. This system, which was created in the 1970s, is designed to manage competition, both locally and internationally. The supply of dairy products is restricted, a situation that has resulted in higher prices for dairy products. The strong supply management has led to higher incomes for dairy farmers when compared to farmers from other agricultural sectors. Imports are limited by the use of heavy tariffs.

For this reason, nearly all dairy products consumed in Canada are produced locally. Additionally, the country has recorded minimal dairy exports, especially because the local market consumes most of the produced dairy products. This paper will analyze the supply management in Canada’s dairy farming sector. It seeks to answer the question: How has the supply management influenced dairy farming in Canada?

Background of the Supply Management

The United Kingdom’s entry to the European Union restricted Canada’s access to the UK’s dairy market. This case resulted in the excessive production of dairy products that could not be adequately consumed locally. Farmers experienced great losses. Additionally, huge amounts of money were spent on storing excess product. Proposals for the enactment of policies to regulate the dairy output from the farms were made.

Some farmers came up with suggestions to create dairy cooperatives to acquire collective bargaining. Many dairy farmers enrolled in these cooperatives. During this time, milk production was seasonal. Additionally, prices for dairy products varied depending on the farmers’ negotiation skills. The Canadian government intervened by introducing the supply management system to control the dairy output and market demand.

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This strategy would protect farmers from exploitation and losses occasioned by oversupply. The country’s supply management depends on federal and provincial laws. It is structured around three primary components. First, the production quota for butterfat is designed to reflect its demand in the country. Secondly, the price of milk products must be commensurate with the cost of production (Campbell par.10). Thirdly, restrictions are put in place to limit the importation of dairy products into Canada.

Setting Production Levels

For liquid milk, the level of output is adjusted to match the demand at the provincial level. Regarding industrial milk, production levels are fixed at the federal level, where they are set according to the amount required by Canadian processing firms. On the other hand, demand by processing plants is informed by consumer demand at a given price. Price is fixed according to the cost of production incurred by producers, as well as an additional marginal processing cost.

However, it is not economically practical to monitor the large spectrum of dairy products and translate them into milk equivalents (Doyon 27). In this case, stocks of butter are used as the demand indicator for the national level. This approach is efficient because butter is only produced when the capacity of milk consumers goes beyond the demand for fluid milk. Therefore, an increase in butter points to the excess production of milk relative to market demand. Similarly, lower levels of butter are an indication that demand is higher compared to production.

Next, the aggregate demand is apportioned to provinces based on historical and population factors. Each province then allocates production quotas to dairy producers. In the past, quotas were apportioned on a historical basis where concentrated auction markets were established at the provincial level to manage future exchanges. Today, the quota is not exchanged between provinces. Due to the rising demand for quota, usually above the supply, the prices for quota have experienced a sharp increase.

The price of quota is about $40, 000, which is equivalent to an annual production of a single cow. Efforts have been put in place to bring down the price of quotas to about $25,000. Nevertheless, quota value stands at about half of the total value of an average dairy farm. For producers, the quota represents their market share for dairy products. Therefore, an increase in quota for a particular producer enables him to increase farm produce going to the market.

Setting Price Level

As observed earlier, the cost of production is used in setting the market price for dairy products. This price is achieved using the Canadian Dairy Commission’s (CDC) strategy of putting in place a support price. The support fee is a fixed amount at which CDC should buy butter and skim powder from the farmers. This price is used at the provincial level by the dairy boards to negotiate sales patterns with producers. The boards at the provincial level are responsible for allocating milk among processors following some pre-established and agreed-upon rules. Essentially, milk is apportioned on a class criterion, with the highest class obtaining allocation priority.

The classes range from 1 to 5. Class 1 represents products such as fluid milk and cream, while class four represents butter. Class 1 has a slightly different pricing strategy when compared to the rest. The prices depend on three factors, which include production costs, the availability of disposable income by consumers, and inflation levels. Producers are provided with a pool price, which is a weighted average that takes into account all the five classes. Price setting also factors in the quality of milk and its components. It is important to mention that milk prices in Canada are the highest in the world, and that price volatility is extremely low. These two factors differentiate Canada’s dairy market from the rest of the world.

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Restricting Imports

Restriction of imports helps to maintain the domestic prices higher relative to the international prices of dairy products. After the 1995 Uruguay Round Agreement, import tariffs in Canada were raised to discourage the import of dairy products. Currently, these rates exist in the range of 200% to 290%, with market access of only 5%. This range has the effect of making the importation of milk and milk products much less lucrative.

As a result, the Canadian market for dairy products is domestically oriented. Additionally, Canada exports minimal dairy products because the bulks are consumed locally. Dairy trade revolves around cheese, milk powder, and butter.

Like Canada, most countries have imposed import restrictions on these three products. Additionally, the US and the European Union sell their dairy products under the cost of production, a situation that has resulted in reliance on export subsidies to leverage this apparent loss. As a result, international trade negotiations are pressuring countries with import restrictions to reconsider. Part of this pressure targets Canada because of her strict import restrictions. This part will be discussed further in the section “external pressures.”

Pressures Directed at Canada’s Supply Management System

Internal Pressures

Access to Quotas

Dairy production quotas are designed to match consumption levels. In the past, quotas relied on historical factors. However, the current system has been adjusted to reflect both population and historical factors as the key determinants. At the provincial level, quotas are allocated to the existing producers based on quota holdings. A certain percentage of the quotas are also set aside for new entrants in the dairy sector. Canada’s dairy sector is mature, with reduced growth. For instance, between 2001 and 2010, the growth in milk quota was less than 1 percent. As a result, the increase in output at the farm level is offset by purchasing them using the quota of other farmers.

Traditionally, the regular exit of farmers was relied on to promote growth in the industry. However, recent trends have indicated a drop in the percentage of exits, which, in turn, indicates slow growth. Between 2001 and 2008, exit levels were up to four percent, although they have recently fallen to only two percent. The effect is that the price of quotas continues to rise rapidly. In some provinces, this price is as high as $40, 000 for a kilogram of butterfat.

High quota prices are seen as a major growth impediment because dairy investments are largely held in quota. In fact, the quota value represents about 60 percent of the entire worth of a dairy firm. A price cap (at $25,000) has been adopted to alleviate this problem. However, farmers whose output exceeds the quota cap are awarded even smaller quotas for the excess output. The effect is that successful purchasers receive minimal value for their excess output. By limiting production above the set quota, farmers are discouraged from employing competitive technologies that result in optimum output.

Dairy Ingredients and Structural Surplus

Changes in technology in the dairy sector have enabled the use of dairy ingredients to be used to increase yield. It takes roughly ten units of milk to generate a single portion of cheese. Protein-enhanced milk may be used to reduce this ratio to about 8 to 1. However, these dairy ingredients are not produced in Canada. In the past, dairy farmers relied on imports. Low tariffs were put in place for the import of these dairy ingredients. On the other hand, the use of the said ingredients resulted in increased levels of solid nonfat (SNF) (Dehinenet 89). SNF refers to solid components of milk, which are usually proteins, minerals, and lactose.

Changes in market trends in the 2000s led to a curb on the import of dairy ingredients. This change was because of dairy farmers’ pressure on the government to implement Article 28 of GATT, which allows a country to restrict import free tariffs. Because of the change in laws, farmers who wish to import dairy ingredients would have to contend with the high import tariffs put in place for dairy products. The main concern today is how to convert the huge amounts of SNF into marketable dairy commodities. Special classes of milk have been put in place to address the issue of SNF. The prices of these special classes of milk are adjusted to match international prices as a way of encouraging their disposal.

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However, there is a need to promote the consumption of SNF, especially with the growth of demand for non-food dairy products. Industries such as pharmaceuticals rely on dietary products to manufacture medicine and/or perform tests. Additionally, the current incentives should be addressed to fit the processors’ needs.

Today, guarantee margins to processors only exist regarding butter and skim powder. The margins discourage processors from processing other residual products. Furthermore, processors who wish to adopt Canadian dietary ingredients as opposed to imports, in the production of cheese, need to pay class 3a price (“Canadian Dairy Commission” 3). Class 3a price is higher compared to both special classes and imports. Clearly, this discourages processors from engaging in the production of non-milk products whose production is not subsidized. As a result, the levels of SNF remain high.

National Pooling, Board, and Quota Exchanges

In the past, each province operated its own pooling, which allowed negotiation with local processors according to the target prices and allocation of milk classes. This strategy was made possible by the fact that the processors were numerous at the time. However, the 1990s saw the concentration of processing plants, which transformed from provincial to national and multinational industries.

Today, eighty percent of Canada’s dairy output is processed in three major plants, which include Saputo, Agropur, and Parmalat processing plants. To prevent price arbitrage, larger pools have been established across several provinces. For example, the P5 pool brings together Quebec and Ontario. This agreement takes into account all milk markets across the two provinces. Thus, while milk is apportioned on a provincial basis, the processors take their product to the market on a national basis. This observation is a clear indication of the need to set up a national pool.

A countrywide pool can promote a universal allocation while at the same time allowing room for uniform transport policy. Additionally, it can lead to reduced costs of unprocessed milk programs while minimizing administrative costs. Importantly, allocation at the national level negates the aspect of disparity regarding raw milk. Instead, it improves the comparative advantage of different provinces.

For instance, some provinces do not have enough milk to allow for the production of commodities such as cheese. In these provinces, nearly all the milk, once used in producing butter and skim powder, is channeled to the production of cheese and yogurt in other provinces. At the same time, other provinces operate comparatively smaller butter and skim milk plants.

External Pressures

Doha Trade Talks

The Doha Round has resulted in significant pressure on Canada’s supply management system. The current debate weighs the possibility of larger market access, which can be achieved by abolishing super tariffs. In such a case, preserving the supply management requires a supply-regulated production. This production is allowed within the sensitive products provision contained in the Doha round. While this situation may pave a way for the stringent tariffs to remain in place, it is likely to advocate larger market access. The number of sensitive products that are allowable for each country remains a major concern. Hence, Canada’s best option is to allow larger market access by exporters as a favorable compromise.

If the sensitive products clause is not applied to any or some of the dairy products, Canada may have no option but to open up its markets for exporters. As a result, local producers may have two choices. The first choice is to maintain the current market price while reducing the production quota. Alternatively, they can maintain the current quota levels with a reduction in market prices. It is important to note that the recent appreciation of the Canadian currency has led to reduced protection for local producers because of the fall in the price of imports (Morali and Searcy 635).

Currently, Canadian dairy products have no influence on dairy prices at the international level or foreign exchange. Therefore, the reaction of local stakeholders to the opening of Canada’s dairy market revolves around product differentiation, reduced prices for milk classes, and a reduction of quota value.

Already, farmers are engaging in product differentiation as a precautionary measure against the effects of Doha on the Canadian dairy market. These efforts have been effected through the “100% Canadian Milk” program (Doyon 46). Additionally, lobbyists are pressuring the government to preserve supply management. Nevertheless, this plan does not take away the pressure that Canada would face opening its local market in the event a Doha deal is made because of two main reasons.

First, dairy farming constitutes only two percent of Canada’s GDP. Secondly, Canada’s agricultural sector thrives on exports in major areas such as beef and cash crops. For these two reasons, it is highly unlikely that the country would prefer dairy farmers at the risk of missing its major exports (Meckbach 30).

Conclusion

After the UK joined the European Union, Canada lost its greatest external market for its dairy products. The result was overproduction in the sector, which called for the enactment of policies that would control the production of dairy products to match market consumption. Therefore, supply management was conceived in the 1970s. This system has achieved various benefits for Canada’s dairy farmers. The prices of dairy products are higher in Canada compared to the international markets. This situation has favored dairy producers who can enjoy competitive returns. Additionally, high domestic prices protect farmers and processors from market volatility.

To safeguard the domestic market for Canada’s dairy products, the government has imposed tough import tariffs aimed to discourage the importation of dairy products. However, regulated production has resulted in various shortcomings. The quota system used to allocate milk discourages market entry for new farmers. There have been suggestions to move away from the provincial quota to adopt a national-based quota that can promote uniformity in milk processing across Canada. This strategy can reduce costs, such as transport and administrative expenses.

Works Cited

Campbell, Darren. Hike in Milk Prices Irks Food Producers and Restaurants 2016. Web.

Canadian Dairy Commission: Annual Report 2012. Web.

Dehinenet, Gerald. “Determinants of raw milk quality under a smallholder production system in selected areas of Amhara and Oromia National Regional States, Ethiopia.” Agric. Biol. JN Am 4.1 (2013): 84-90. Print.

Doyon, Maurice. Canada’s dairy supply management: comprehensive review and outlook for the future. Canada: Cirano, 2011. Print.

Meckbach, Greg. “Aggregation Aggravation.” Canadian Underwriter 83.3 (2016): 30-38. Print.

Morali, Oguz, and Cory Searcy. “A Review of Sustainable Supply Chain Management Practices in Canada.” Journal of Business Ethics 117.3 (2013): 635-658. Print.

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StudyCorgi. (2020, December 26). Supply Management in the Dairy Sector of Canada. Retrieved from https://studycorgi.com/supply-management-in-the-dairy-sector-of-canada/

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