Do federal dairy policies hurt district?

Edward Lotterman | Agricultural Economist

Published January 1, 1995  | January 1995 issue

With the possible exception of tobacco and cotton, milk production is the agricultural sector that has been subject to the most prolonged and profound intervention by the U.S. government. So whenever dairying encounters difficulties, some immediately question whether the government's dairy policies are somehow to blame.

Unfortunately, that is often a difficult question to answer. While the overall goals and basic policy instruments of dairy policy are fairly straightforward, the rules and procedures used to implement them have become mind-numbingly complex, and their true impacts over time are difficult to measure. THE U.S. DAIRY PRICING SYSTEM, a recent bulletin by U.S. Department of Agriculture economists Alden Manchester, Mark Weimar and Richard Fallert, does an admirable job of laying out the basic provisions without becoming bogged down in minutia.

Like most other federal agricultural polices, the current system of price supports and marketing orders dates to the 1930s. However, milk policies are quite different from grain policies, due in large part to differences in the nature of the product. Milk is perishable, and even processed dairy products, such as butter and cheese, are more expensive to store than grain or flour. Moreover, milk production historically was highly seasonal, fluctuating with succulent forage growth and the reproductive cycles of cows.

The result of seasonal fluctuations and difficult storage was extreme seasonal volatility in farm milk prices. According to Manchester, Weimar and Fallert, producers banded together early in this century in a number of dairy markets to bargain with milk processors over ways to reduce this price instability. Many adopted a classified price system where processors paid for milk according to its use. Milk for drinking was priced higher than that used to produce butter, cheese or other manufactured dairy products. These voluntary, private arrangements broke down under the pressures of the Great Depression, and dairy prices were low and unstable. A series of agricultural acts in the 1930s created a set of government marketing orders that replaced earlier voluntary agreements. In 1933 the government also began to purchase some products to raise prices.

The current system contains two basic elements. Price supports are the base for all other provisions. The government offers to buy butter, non-fat dry milk and cheese at prices that will maintain the minimum farm milk price levels specified in the prevailing farm bill. Market forces can drive farm prices above this minimum and do so in periods of low production during most years. Since the U.S. support price is above world prices for dairy products, import restrictions, first quotas and now tariffs, have been necessary.

Federal milk marketing orders are the second federal policy element. They set minimum prices for raw milk in each geographic region and for milk in three different classifications: for beverage use, for making soft products such as yogurt and ice cream, and for less perishable products such as nonfat dry milk and cheese. Orders also establish a pooling arrangement in which all individual producers in a given region are paid a "blend" price for their milk, based on the weighted average for milk processed for all uses rather than the specific use of milk produced on one farm or processed in one plant.

Specifying differentials between milk destined for different uses introduces an element of what economists term "price discrimination." Total revenues for producers are higher when separate prices are specified for milk going into different products for which consumers have different demand. To economists, the phenomenon is the same as for an airline that charges different prices for seats purchased with a 14-day advance or for immediate use, or a restaurant that offers senior citizen discounts. In all cases, the seller gets somewhat higher sales revenues than if all customers are charged one flat price. Nationally, the boost to farm revenues and the additional cost to consumers from this element of dairy policies is probably quite small compared to pure market forces or to the price support purchases per se.

But the marketing order system also establishes different prices for milk for drinking in different areas of the country. These have substantial impacts on the relative prices farmers receive for milk in different part of the country and on the prices that consumers pay for fluid milk.

The original rationale for this provision was that prices naturally would be lowest in the region with lowest production costs—in this case west-central Wisconsin—and would be progressively higher due to transportation costs as milk was shipped farther. Eau Claire, Wis., is the base point, and minimum prices for drinking milk get progressively higher as the distance from Eau Claire increases. However prices for milk going into cheese and dry milk powder are essentially the same across the country.

This provision, that fluid milk prices can be substantially higher in some parts of the country than others as a result of government regulation, has become the focus of a protracted controversy. As long as transportation costs were higher than the price differential, there was no market incentive for producers in low-cost, low-price areas to ship to higher-price regions. But increased transportation efficiency, combined in some cases with improved technology for removing some of the water from milk without causing a cooked taste, have made it economically feasible to ship milk at less cost than the difference in prices. If the price for milk in Atlanta, for example, was higher than that in Chippewa County, Wis., by more than the cost of trucking milk in, one might expect milk trucks to start rolling. However, the government's marketing order system tends to discourage such a response. "While the original 1937 act which created marketing orders specifically says that they are not to be used to ban shipments between different regions," says Jerry Hammond, agricultural economist at the University of Minnesota," in practical terms the orders create lots of impediments."

Such impediments, often some sort of charge on milk imported into a high-price region, have been the subject of litigation and congressional hearings for decades. The charges or other restrictions are usually cast in terms of the price pooling provisions described above, and generally remove much of the price difference incentive that would otherwise exist.

More recently, attention has focused on the implicit cross-subsidization between products that occurs in higher-price areas. "Their high margins on fluid milk allow them to sell manufacturing milk at prices that they couldn't survive on otherwise," says University of Wisconsin agricultural economist Ed Jesse.

As the negative effects of the current system on low-cost areas has become increasingly evident, producers, handlers and economists in Minnesota and Wisconsin have become increasingly restive under the existing system. "I see little social benefit in the present system," says Jesse. "Wisconsin and Minnesota would be much better off in the long run without the current system." Hammond echoes this opinion: "We might get slightly less for the 10 or 15 percent of our milk that goes for drinking locally, but we would get quite a bit more on the rest if the system were changed."

But milkers in high-price areas are loath to see semi-trucks of milk from the Upper Midwest ruin the good thing they have going and thus far have successfully fought substantive changes in the system. Harry Kaiser, associate professor of agricultural economics at Cornell University, thinks that may be changing. "Big changes are in the works," he says. "The word is USDA is gearing up on the order system."

One much-discussed alternative would be a system of multiple-pricing points, which could remove the automatic increases in price as one moves further from Eau Claire. Wisconsin Congressman Steve Gunderson has proposed simply scrapping the existing system. In the cost-cutting and deregulating atmosphere of the new Congress, that proposal might get a more serious hearing than in the past.