Dairy stooges

Back at GMU, Peter Boettke liked to compare tweaks to regulatory regimes to the Three Stooges doing plumbing. Every time Larry turns the monkey wrench to fix one pipe, he's bashing two other pipes that start new leaks. And then it all descends into slapping and nose-pulling as the basement floods.

Today's example: Canada's wonderful dairy supply management system. Some people hate the system for inflating the costs of dairy products for Canadian consumers. But I'm coming to love it for its comedy value. Consider mozzarella cheese.

Fifteen years ago, frozen pizza makers convinced Ottawa to exempt cheese for frozen pizzas from the high tariffs that otherwise protect the supply management system. Restaurants hated the move as frozen pizzas compete with Dominos and the like. This sparked some cheese smuggling. And, according to the Free Press, it also caused this:

A number of restaurant chains recently began circumventing hefty cheese tariffs by importing their mozzarella by way of pizza topping kits.

The Canada Border Services Agency last year designated the boxed cheese-and-pepperoni combinations as a food preparation, rather than simply cheese, meaning they could be imported duty-free.

So we had this big plumbing mess. Fixing one leak causes others.

That sent dairy farmers into panic mode, with the Dairy Farmers of Ontario telling delegates at a regional meeting last fall that the designation was having a "negative impact on domestic mozzarella sales and could have an even greater impact going forward."

The case is currently before the Canadian International Trade Tribunal, and is seen as a serious threat to Canada's farm supply management system.

The CBSA decision allowed importers to bring boxes of the pizza topping, consisting of about 20 per cent pepperoni and 80 per cent cheese, into the country duty-free rather than being hit with the 245.5 per cent tariff that is charged on cheese from outside Canada.

And now the Canadian government has created a new mozzarella milk class so restaurant and frozen pizza makers will be on the same footing. If you like blue cheese on your pizza, you're SOL.

Agriculture Minister Gerry Ritz blames Canadian high prices on economies of scale:

But there will likely always be a price gap between Canadian products and those coming in from bigger markets, particularly the United States, says Agriculture Minister Gerry Ritz.

"At the end of the day I can get a hotel room in the same chain cheaper in the U.S., I can get a steak dinner (for less), it just goes on an on and on," said Ritz.

"It comes down to economies of scale."

Economies of scale matter, but they're hardly a first order explanation for high Canadian dairy prices. New Zealand's supermarket duopoly, despite providing rather high prices for most other things, somehow manages to deliver us a kilo of good cheddar for $9 NZ. Canadians: have a browse down the Countdown (our version of Safeway) aisles. $1 NZD = $0.85 CAD; our 15% GST is included in all listed prices.

But please keep dairy supply management, Canada. Whenever somebody here wants to do something dumb, I love having Canada as "look what happens if you try that" exemplar.

Update: it looks like Canadian prices won't actually drop much.

CPP to bet on NZ dairy?

This, I like.

Recall that Canada runs a ridiculous dairy cartel. When I teased the Dairy Farmers of Canada about the high price of baby formula in Canada, they said I wasn't playing fair as Canada doesn't even produce baby formula; it's all imported. Meanwhile, Chinese companies are set to invest a few hundred million adding to New Zealand's already extensive capacity in that area.

But Canada has the world's best dairy system, if you ask the guys running the cartel.

What happens if you ask the Canadian Pension Plan Investment Board?

Mark Wiseman, chief executive of the $A170 billion fund, will visit Australia this month amid the group’s expanding portfolio of interests across the Tasman. ...

Mr Wiseman says he anticipates low growth in Europe and the US for years. He believes agriculture offers huge potential.

“Australia is one of the jurisdictions [where] we’re looking at the agricultural industry broadly, right from land on up through the infrastructure to support it, including things like ports,” he says in the UBS Global Leaders Insights Series on Sky News Business. ...

ANZ Bank has estimated that Australia, to take advantage of the export potential to meet the growing demand for food from the rising middle class in China and Asia more broadly, will require more than $A1.5 trillion in financing to the year 2050.

It says Australia and New Zealand could double the real value of agricultural exports by 2050, and that could mean up to an additional $A1.7 trillion (in 2011 dollars) in revenues over the next four decades if production increased and there was a shift to higher-value products. Australia has fallen behind in agricultural reform and investment, while New Zealand has become the world’s largest dairy exporter, having seized the advantage of China’s growing thirst for milk and opened the doors for reciprocal investment.

“One of the things that’s most interesting about agriculture is, unlike the other resources, it’s obviously a renewable resource and there’s a certain attraction to being able to invest in the development of renewable resources like agricultural products,” Mr Wiseman says.

Canada's basically ruled itself out of this market. Because of supply management.

I can imagine some Canadians who just might have preferred that the CPP were able to make those kinds of investments in Canada.

Recall that it doesn't have to be that way. There's a way out. Buy out the cartel.

Black markets in everything: Cheese edition

A determined government can induce black markets in anything. Canada's 300% tariffs on dairy imports, designed to protect Canada's dairy cartel, seems to have induced a new cross-border smuggling trade. Where booze flowed South from Canada during America's prohibition, now cheese makes its way north.

Here's World Report:
 

Contraband cheese.

And there are allegations that Canadian police officers were involved in the smuggling.

I want to see a CBC cutesy version of Boardwalk Empire based around this concept. Nucky Thompson and the Dairy Cartel. Or, maybe better, a Christopher Guest documentary.

HT: Chad Wellington

A permeating puzzle

Canadian supporters of supply management note that they're helping to protect Canadians from "permeate" milk. Or at least my Twitter friend from the Canadian Dairy Lobby keeps needling about use of permeate.

Permeate is a concentrated byproduct from cheese-making that, in diluted form, can be added into fluid milk. You can also get it through ultrafiltration: ultra-filter the milk, then add stuff back in varying proportions depending on the blend you want to achieve. It's relatively high in lactose, so it could make milk less friendly for those with lactose intolerance, but it otherwise seems pretty innocuous. Most supermarket milk in New Zealand uses permeate; it's been a bit controversial in Australia.

You could tell a story about how while supply management keeps prices up, it also avoids the introduction of a lower calibre product. If the product isn't as nutritious or is less safe, and if poorer customers aren't able to make good choices weighing nutritional quality and price, then you could start building a story about supply management being less bad for poor consumers than the standard cartel story would lead us to believe. I still wouldn't much believe the story: banning the practice if it really is unsafe would be a more direct solution than having a dairy cartel. But maybe there's some second-best case.

Except that story really requires that permeate milk be the low-tier product in systems that have both.

Klondyke is the main local brand in Christchurch providing guaranteed permeate-free product. They mostly sell in dairies (small corner stores). And the dairy on my commute home that sells milk for $2.69/2L sells Klondyke. That's $0.94/L Cdn. So the discount brand milk is permeate-free. The main brands sold in the supermarket use permeate. You'd pay a premium in the supermarket for varieties that do not have permeate, but none of them advertise as permeate-free: SilverTop sells for a bit more because cream is expensive; organic milk has the usual organic premium; A2 milk has the small market niche premium.

My read from this is that nobody really here cares about permeate addition to milk. I buy raw unpasteurised milk when it's convenient; I don't much care that there's permeate in the supermarket stuff when we buy supermarket milk. You can't tell a story from New Zealand's mixed market (permeate and non-permeate) about how "Only the rich can afford additive-free milk in a free dairy market": the cheapest stuff is permeate-free and while Klondyke tried pushing permeate-free as a selling point, it didn't lead to anything like the outrage over permeate that picked up in Australia.

Bottom line: while permeate is used in New Zealand, it's awfully hard to go from that to a "supply management helps make sure pure milk is available for everybody and not just the rich" kind of story. And even if that were the thing you worried most about, it isn't hard to just ban the sale of milk that has added permeate - supply management is about the least efficient way of achieving that end, if that's an end you want to achieve.

Reference prices

Canadians looking for a reference price for milk in a free market could do worse than the series being put out by consumer.org.nz. Their Commodity Price Tracker has nice price graphs for the cheapest available brand or variety of each of these, from June 2011 to present, at supermarkets and convenience stores. Think of it as the price you'd expect poorer cohorts to be paying for store-brand or no-name product if they're not shopping around a lot - lower prices can be available if you shop around. Two dairies on Ferry Road on my commute home have been having a minor price war on milk, with one at $2.79 and the other at $2.69 for a 2 litre bottle, or about $1.87 CAD after removing our 15% GST. The signs advertising those prices have been out for months.

From the June 2012 figures, all reported in Canadian dollars (1 NZD = 0.80 CAD) and after having subtracted GST (15%, otherwise included in price).

• 500 grams salted butter: $2.46
• 1 kg mild cheddar: $6.35
• 2 litres standard homogenised milk: $2.27

In all cases, you should probably compare with prices available in major metropolitan Canadian areas; remote areas of New Zealand will have higher prices. Note too that most grocery items wind up being more expensive here because of fixed costs and small markets: broccoli runs $2/head in winter and maybe $1/head in summer ($NZ on all of these, including GST); bread's about $2/loaf; rump steak's usually around $12/kg and scotch fillet, on sale, is usually around $23/kg. Kiwifruit, in season, can be less than $1/kg.

I'm not sure what current Canadian prices are on any of these; unfortunately, there doesn't seem to be any Canadian supermarket that puts its prices online. I wonder why New Zealand is so much more advanced on that one - our supermarket industry is at least as oligopolistic as the Canadian one and the fixed costs of the system can't be spread across as many people. 

Dairy freedoms

Excerpts from a productive Twitter conversation with the Canadian Dairy Lobby.

@EricCrampton I believe in freedom too, just don't believe I can/should impede freedom of others! All good things in moderation...
— Ron Versteeg (@RVersteeg1) July 24, 2012

@RVersteeg1 And the freedom for a farmer to have a cow and sell its milk without having to buy permission from a cartel?
— Eric Crampton (@EricCrampton) July 24, 2012

@EricCrampton Does not override the freedom of a majority of Canadian farmers to get a fair price for their milk....
— Ron Versteeg (@RVersteeg1) July 24, 2012

@RVersteeg1 What of the freedom of a majority of milking machine manufacturers to get a 'fair' price by setting their own cartel?
— Eric Crampton (@EricCrampton) July 24, 2012

A good answer would have talked about cyclical weather effects hitting ag but perhaps not other industries; I'd then have pointed to potentials for insurance or hedging, and that plenty of industries face cyclical demand but haven't managed to establish a government-enforced cartel.

If freedom means "the freedom to get the price I want by making it illegal for anyone to compete with me", we've moved completely to EngSoc.

Insurance Markets

Frances Woolley has a few worries about ending supply management in Canada. She's right that it's worth worrying about whether and how we'd compensate those losing their quotas. The rest seems to put a bit too much weight on dairy lobby scaremongering.

But one bit in the comments section seems worth further expansion. "Greg" there wondered why dairy farmers aren't insured against the potential loss of quota rents:

Canada's dairy farmers are in business. They ought to be holding insurance against the loss of their quotas, the same as with other capital. If they aren't, well, they made that decision.

Frances replied saying that such insurance markets are impossible:

Insurance works through risk pooling, i.e. car insurance works because not everybody has car accidents at the same time. The elimination of milk quotas is a correlated risk - i.e. if one farmer loses their milk quotas, everyone will lose milk quotas. It's not possible to buy private insurance against highly correlated risks (which is why, for example, house insurance doesn't cover acts of war, crop insurance doesn't exist without government subsidies, etc).

Let's twist things around. Imagine that ICE Futures Canada defined and started trading a very particular set of futures contracts. The contract would read something like the following:

This contract pays $1000 if, at Dec 31 2013, the average auction price for dairy quota in the previous six months across all provinces was under $5000 or if supply management ceased to exist.

There are a few proposals floating around to get rid of supply management. CD Howe's was to expand the supply of quota over time to erode it; others say do away with it and compensate the losers; others say do away with it without compensation. You'd need to be a careful to define what "supply management" means for purposes of the contract. But the low quota price option is to guard against "erode the rents" plans.

It's pretty easy to imagine people being willing to trade this contract. Suppose that the true value of the contract were $100: a 10% chance that Canada gets rid of supply management by the end of next year. Dairy farmers have a whole lot of wealth tied up in their quota. They should be willing to pay more than the fair-odds price for the contracts. Other dispersed risk-neutral people should be happy to sell at a premium above the fair odds price. Or, you could do it through option contracts.

So long as farmers are willing to pay a premium to lay off risk affecting a good chunk of their asset base, and so long as there are other folks willing to sell them bits of that kind of insurance, this works. No one guy would want to take on all that risk because then he has even more at stake than the dairy farmers. But it wouldn't be a bad small bit of a portfolio for somebody whose other positions don't go south in case of the abandoning of supply management. Or, you could imagine some large corporates who'd do well if Canada got into the Pacific trade deal being willing to short those contracts - if Canada gets rid of supply management and into the TPP, the corporates do better through trade but lose on the contracts; if Canada doesn't, they win on the contracts and lose on trade.

And, if there are enough of the risk-neutral investors, we could start getting some market-based assessments of the probability of doing away with supply management.

I don't know the regulatory framework within which ICE operates. But a few contracts on policy like this could be awfully helpful.

No transitional gains traps?

Don Wittman is right: the transitional gains trap is a bit of a puzzle.

Recall first how the transitional gains trap works. One a rent-seeker has a rent conferred upon him, the value of that rent is capitalized into whatever draws the rent: the quota permit for Canadian dairy farmers; the taxicab medallion for New York taxi firms; the liquor licence for permit holders in places where licences are in restricted supply, for example. After that capitalization happens, the owner of the permit earns only a normal return on the total value of his capital, including the capitalized value of his regulatory rents. Permits change hands such that whoever earned the windfall initial gain takes his rent and leaves; eventually, nobody who currently owns the permits has earned any kind of excess return by having owned them. But try to get rid of the regulatory inefficiency that draws the rent and each and every one of these permit holders will scream blue murder as you're wiping out a good chunk of their capital: some permit holders could easily go bankrupt over it if they took out loans to buy the business and both they and the bank were counting on a continuing flow of regulatory rents.

Now, Wittman would rightly point out that if this is really so inefficient, there has to be a move that buys out the losers out of the gains to the winners. If it's Kaldor-Hicks efficient, this has to be the case. If you run the compensation, then the policy switch is Pareto-efficient.

The usual answer is that the transactions costs are too high to prevent the move towards more efficient policy. But in the case of taxis, or the Canadian dairy cartel, that really doesn't seem to be the case. For dairy, as I've suggested many times, all you need to do is put a tax on dairy products in Canada at the same time as you abolish all of the tariffs on imports and abolish supply management. The tax keeps the price to consumers a bit below where it was prior to the shift and is sufficient to pay off the bonds you issue to buy out the quota holders.

But, there's a reason that opaque transfers are preferred. That reason? Voters. Don't believe me? Read the comments section on Stephen Gordon's Globe and Mail piece where he suggests my "tax dairy and buy out the cartel" solution. For example:

professor_x

2:56 PM on November 16, 2011

I read the word screaming clear TAX.

We want to TAX dairy to make it even more expensive to 34 million Canadians who have to pay off $30 billion dollars in outstanding quota values.

Opaque transfers are opaque. Nobody understands tax incidence, never mind this kind of thing.

Add in the generalized worries about trade, insecurity issues about the Americans, and just general weirdness about food, and you wind up with voter support for a policy that makes them worse off. I'd batted back some of these fallacies. Even if Canada gets rid of supply management, Canada will still have a dairy sector; if Canadians want to ban GE milk, or milk where hormones are used in production, they can do it by direct regulation; and, if Canadian dairy farmers want to form a voluntary cooperative to get some efficiencies of scale while avoiding being contract operators for others, Canada has a strong tradition of agricultural cooperatives.

The best counter-argument I've heard is that the government can't constrain itself against bailing out farmers, so the one-off payment is likely to be followed by some additional support down the line. But isn't it better for government to try to come up with some mechanisms for self-discipline? It's a general purpose technology worth developing. And it's hard to believe that the costs of any potential future support package would trump the cost the supply management system imposes every year with certainty.

Martha Hall Findlay, Canadian Liberal Party leadership contender, makes the case for abolishing supply management in combination with a temporary tax on dairy used to fund a transitional support package for dairy farmers. She suggests the main problem is overcoming dairy farmer resistance and points out that dairy farmers are a trivially small proportion of the voting population; there's no reason that the Conservatives, or anyone else, couldn't just abolish the system, lose every single dairy farmer vote, and not expect much difference in the allocation of seats in Parliament.

I love Findlay's proposal. But I worry that the problem isn't the angry dairy farmers voting against incumbents. Rather, it's angry dairy farmers putting up ads on TV scaring voters about imported milk combined with voters really not understanding that a temporary tax on milk, under this system, reduces the cost of milk rather than increasing it.

I expect that the Canadian Dairy Cartel will use the threat of this kind of public campaign to negotiate for a bigger payout. So it's good to see the folks at EconomyLab helping to inoculate voters against the "make voters dumber" campaign that's likely to come. But if Stephen Gordon or Mike Moffatt were to put something up slowly explaining why free trade in agriculture won't mean that Canadian consumers are suddenly forced to drink poisoned milk, that would probably also be pretty useful. I know it's obvious to us, but it isn't obvious to the folks who can veto the play.

Dairy Puzzle

Dairy products are cheaper in New Zealand than in Canada, where the dairy cartel keeps prices high.

But the Dairy Farmers of Canada VP Ron Versteeg points me to an interesting puzzle: FAO stats showing NZ consumption of some dairy products is lower than that in Canada.

Here's an FAO table showing NZ and Canadian consumption. Or, at least, I'd expect that this has to be per capita consumption rather than production given that total NZ production is higher than total Canadian given relative herd sizes.

I threw these into Excel and plotted the series as ratios: in each case, the line shows New Zealand per capita consumption as a multiple or fraction of Canada's. You might need Java enabled for the graph to work.

We consume a lot more butter than do the Canadians, and more whole milk, but a lot less cream.

Here's the aggregate consumption data for 2007, the last year for which there's data.

Country	Item	Consumption (kg/capita/yr)
Canada	Butter, Ghee	2.51
New Zealand	Butter, Ghee	9.33
Canada	Cheese	12.73
New Zealand	Cheese	4.92
Canada	Cream	8.85
New Zealand	Cream	0.17
Canada	Milk - Excluding Butter	206.83
New Zealand	Milk - Excluding Butter	103.79
Canada	Milk, Whole	35.45
New Zealand	Milk, Whole	54.22
Canada	Whey	7.38
New Zealand	Whey	n/a

A few puzzles:

• Cheese here costs about NZ$9/kg including 15% GST - that's about Cdn$6.30. And, honestly, standard cheap cheese here tastes better than the somewhat rubbery stuff with the chemically orange food colouring I remember from back home. But NZ cheese consumption is very low relative to Canada's.
• Differences in standard fluid milk prices don't seem huge. Ron says his local supermarket supplies at $4.47 Cdn for 4 litres, or NZ$1.42/l; we pay NZ$4.49 for 3 litres, or $1.50/l, though the dairy on my drive home sells it for $1.35/l. Price differences seem small. But NZ drinks a lot more milk than Canada.
• The totals in the FAO table don't match the components; the difference would have to be stuff like ice cream that's not included. But if it's right, then Kiwis are consuming about half as much dairy product as are Canadians despite that dairy products here, compared to other food items, are relatively cheap.

Any candidate hypotheses?