Key Points
This report evaluates current dairy policies and assesses the implications of a new and more market-based US dairy policy.
Tremendous productivity growth has allowed dairy farms and processors to become globally competitive and caused outmoded policies to be counterproductive to the dairy economy.
The concoction of old and convoluted US milk pricing regulations, selectively protectionist import barriers, and the recent subsidized margin insurance plan all benefit some farms or processors at the expense of taxpayers, consumers, and the broad dairy industry.
It is time to let the US dairy industry embrace its global competitiveness and innovate unencumbered by outdated policy approaches.
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Executive Summary
The US dairy industry has made remarkable improvements in productivity and policy over the past 30 years. Productivity growth has increased the industry’s global competitiveness and allowed prices to fall in real terms to the benefit of consumers. These gains have allowed a shift from milk policy that was dominated by border protection, production and export subsidies, and government regulations to a much more self-reliant and resilient dairy industry.
The 2014 Farm Bill cleared away several outmoded programs, such as price supports, export subsidies, and payment schemes that had distorted incentives and encumbered the industry for decades. However, it left in place or created new government programs that, while they provide relatively little long-term net benefit to the industry, continue to cost US consumers and taxpayers and cause incentives among farms and processors to produce in response to government program incentives rather than market incentives from consumers.
This report does not consider or evaluate environmental and related policies that affect milk supply and cost. Many environmental regulations—such as those dealing with local air quality, water quality, animal care practices, and greenhouse gas emissions—are probably the government policies that matter most to many dairy farms and milk processors. Some of these state and federal policies raise milk production and processing costs substantially and must be subject to careful analysis to assure that the environmental benefits match the economic costs.
Explicit and identifiable dairy export subsidies have been removed, the impact of import protection has lessened with increased global demand, and the US dairy industry has become a major commercial exporter of dairy products. The US exports much more milk than it imports, and this occurs with relatively little effective protection from foreign competitors. However, US tariff schedules are littered with dozens of high tariffs for specific dairy products, often tied to tariff-rate quotas (combinations of low and high tariffs) that are assigned to specific exporter countries. These hamper trade in those particular products, hurt US consumers, and generally divert effort from competitive markets and, instead, toward gaming the complicated trade policy system. Those tariffs could all be eliminated with little or no negative impact on producers or processors. Then the US dairy industry could focus on what it does well, adapting to competitive markets.
Within the United States, milk pricing and distribution across products is dominated by an 80-year-old array of price regulations of mind-boggling complexity. Federal Milk Marketing Orders (FMMOs) set minimum prices that raise the prices of beverage milk products on a regional basis while raising price variability and increasing price risk for farms and processors.
The high prices of beverage milk have reduced use and stimulated demand for products such as soymilk. These same high prices for beverage milk have driven farm milk toward manufactured products and through a price pooling scheme have created incentives for more milk production, especially in higher-cost regions. This is a system with real costs to milk buyers and sellers in terms of inefficiencies and putting incentives for innovation behind a heavy veil of regulations. Program administrators do a remarkable job trying to adjust to market forces within the limits of the regulations, but they cannot match the power of open competition and the incentives that competition creates. The FMMO system has far outlived whatever usefulness it once had.
The new dairy income support plan, the Margin Protection Program (MPP), represents a dairy income subsidy, and redistribution across farms, in the guise of risk management. It suffers from the same basic deficiencies as the rest of the US Department of Agriculture (USDA) risk management complex of programs, including crop insurance programs the Risk Management Agency administers. Several recent AEI reports have documented concerns with these programs.
Here I pose the same basic question that applies to USDA-subsidized insurance programs in general. What broad public purpose is served by offering heavily subsidized insurance to farm businesses that choose not to buy such insurance if offered without substantial subsidy? Milk producers undertake myriad activities to mitigate production and financial risk. Of course, dairy farming remains a risky business. But that fact in itself is not a rationale for subsidy. Without the MPP subsidies the United States may produce somewhat less milk, which would mean somewhat lower exports. But reduced dairy subsidies would mean that those resources would be put to use elsewhere in the economy where they would be more productive.
Removing subsidy programs and protection does not mean removing government from providing documented public goods that help support the dairy industry. Market information, research and development, and help in removing barriers and subsidies in other countries are all important roles for government that will facilitate a strong and resilient American dairy economy.
The US dairy industry is now competitive in world markets. It will be even more competitive, and consumers, producers, and taxpayers will gain if we cut the government red tape that restricts efficiency and keeps the milk industry from being even more innovative. The industry has made remarkable economic and policy progress. It is time to finish the project and set the cows free.
Introduction
The US dairy industry, which has long been an important and central part of American agriculture, has made remarkable gains over the past 30 years. Productivity has risen rapidly, and competitiveness has improved for both dairy farms and processing firms, many of which continue to be farmer-owned cooperatives. These gains have facilitated a shift from milk markets that were dominated by government regulations and subsidies to a much more self-reliant and resilient dairy industry.
In the 1980s, milk policy used high tariff walls and import quotas to keep milk products from the rest of the world out of the United States while using export subsidies to dump domestically produced milk products into world markets. The government policies dominated in domestic milk markets as well, with high congressionally mandated minimum prices implemented by the USDA’s purchase and storage of processed dairy products. When purchase and storage became excessively expensive, the USDA initiated a program to buy whole dairy herds and kill the cows while banning the dairy producer from producing milk.
In subsequent years, improved dairy farm and processor productivity and competitiveness, along with a recognition that federal dairy policy had failed to create or maintain an economically healthy industry, facilitated the shift away from many, but not yet all, of these policies.
This report summarizes the economics of the US dairy industry and recent US dairy policy. These summaries provide the background needed to evaluate current dairy policies and assess the likely implications of a new and more market-based US dairy policy. AEI has had a long tradition of evaluating dairy policy as a part of its broader program of work on agricultural policy effort.1
The current dairy farm policy in the United States revolves around two major programs. The longstanding (around since the 1930s) Federal Milk Marketing Order (FMMO) program covers most regions and regulates minimum prices buyers must pay based on the “end use” of the milk. Under the FMMOs, buyers must pay a higher or lower price for milk depending on whether they are using raw milk to make cheese, yogurt, or fresh beverages, among myriad other products. Farmers receive regionally determined and regulated weighted averages of these buyer-paid prices. California, the state that produces the most milk, has its own similar program, but it may soon join the FMMO system.2
The second major component of current US dairy policy is the Margin Protection Program (MPP), which only began with the Agricultural Act of 2014.3 The MPP is government-subsidized (net) revenue insurance that covers shortfalls in the difference between a national average price of milk and a USDA-calculated average cost of feed used to produce milk. The MPP has been operating for only a few years, has not satisfied its producer advocates, and has not been widely used by dairy farms.4
In addition to these two major programs, US dairy policy relies on several old and new measures, including some residual trade barriers. Import barriers used to be central to US dairy policy, but as discussed below they are now mainly an annoyance. US dairy farms continue to use agricultural policies such as laws and regulations that (1) benefit farmer-owned cooperatives, (2) facilitate and subsidize domestic and international market promotion, and (3) subsidize milk purchases in schools; for pregnant women, infants, and preschool children; and some minor programs. Finally, the 2014 Farm Bill created a new but up to now unused dairy product donation program that would authorize government purchases of dairy products when the milk margins are low.
This report does not consider or evaluate environmental and related policies that affect milk supply and cost. Many environmental regulations, such as those dealing with local air quality, water quality, animal care practices, and greenhouse gas emissions are probably the government policies that matter most to many dairy farms and milk processors. Some of these state and federal policies raise milk production and processing costs substantially and must be subject to careful analysis to assure that the environmental benefits match the economic costs.
After reviewing the remarkable productivity improvements and structural changes that have occurred in the US dairy industry and describing the contemporary policy environment, I argue that the current slate of dairy programs does little to benefit the industry and that there is little rationale for continuing the programs. I see marketing regulations that raise the price of beverage milk products as counter to public policy principles and that they have negative consequences with little benefit. They raise prices to consumers, especially children, who consume fresh beverage milk, and the programs do little except redistribute revenue among producers. Of course, milk and feed prices will continue to vary from month to month and year to year, but I find that government efforts to mitigate the consequences of such variability are likely to be counterproductive. I note that, as for crops, unless policies to deal with variability are accompanied by substantial subsidy, they do not generate much farm participation. I also note that, as with other farm subsidies, there is no rationale for regular and sustained income transfers from taxpayers to dairy farms.
Finally, then, I argue that moving to a more open market with less government encumbrance would allow the US dairy industry to become stronger.
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Notes
Paul W. MacAvoy, Federal Milk Marketing Orders and Price Supports, American Enterprise Institute, 1977; Joseph V. Balagtas, “Milking Consumers and Taxpayers: The Folly of U.S. Dairy Policy,” in American Boondoggle: Fixing the 2012 Farm Bill, edited by B. K. Goodwin, V. H. Smith, and D. A. Sumner (Washington, DC: AEI Press, 2011), http://www.aei.org/feature/american-boondoggle-series/. AEI analyses that include discussion of dairy policy in the context of farm policy more broadly are in Daniel A. Sumner, Agricultural Policy Reform in the United States (Washington, DC: AEI Press, 1995); and specifically in Daniel A. Sumner, Joseph V. Balagtas, and Jisang Yu, “US Dairy Subsidies Remain Convoluted and Costly,” chap. 9 in The Economic Welfare and Trade Relations Implications of the 2014 Farm Bill, edited by Vincent H. Smith (Emerald Group Publishing, 2015).
2. For a recent update in the FMMO system and current issues that may arise in the new farm bill, See Joel L. Greene, “Federal Milk Marketing Orders: An Overview,” Congressional Research Service, December 13, 2017.
3. Agricultural Act of 2014, Pub. L. No. 113-79.
4. See Randy Schnepf, “Dairy Provisions in the 2014 Farm Bill (P.L. 113-79),” Congressional Research Service, September 15, 2014, http://nationalaglawcenter.org/wp-content/uploads/assets/crs/R43465.pdf. It includes a side by side of the 2014 Farm Bill dairy title compared to prior law.