It is forbidden except where it is compulsory

It's illegal to run a cartel in most western countries. Government have great big agencies whose whole job is to look out for price-fixing, other forms of collusion, or mergers that do more to promote monopoly than to enhance efficiency. I'm an antitrust skeptic, but I know that isn't a majority position in economics.

Canada is no exception on antitrust vigilance. And, it looks as though things have been getting tighter. Where I'd previously understood Canadian competition law as weighing equally producer and consumer surplus and allowing activities that reduced consumer surplus if they were sufficiently efficiency-augmenting, it looks now like they're putting more weight on effects on competition per se.

Here's one summary of Canadian cartel regulation. Cartels are illegal. Arrangements with competitors to control supply, allocate territories, or fix production, are punishable as an indictable offence with up to a 14 year prison sentence and up to a $25m fine. 

So cartels are pretty illegal.

Except where they are compulsory.

A group of Manitoba fishermen formed a voluntary co-op and tried to sell their fish to a processing plant in Chicago. What happened next? [HT: Mom]

Court was told that the WWM co-op, which represents about 300 fishers in the areas of Duck Bay, Lundar, Ashern and Lake Winnipegosis, had obtained a licence in December 2010 to sell fish to the U.S. independent of the Freshwater Fish Marketing Corp. so long as it wasn’t competing with the monopoly for customers.

The co-op found a customer in Chicago, a fish processing plant, but unknown to the co-op, the processing plant was then re-selling the co-op’s fish to another customer in New York, which happened to be an existing customer of the Freshwater Fish Marketing Corp.

Court was told that the co-op was instructed to stop selling to the Chicago processor but continued to do so and its license was subsequently revoked in June 2011.

The co-op decided to continue selling to the Chicago processor, which resulted in one of its shipments being seized in July 2011.

Stevenson and the co-op were originally charged with three counts of selling without a licence but the other two charges were stayed once they pleaded guilty to the one charge.

They got $2000 fines for trying to break the government-enforced cartel.

Look back at the anti-cartel legislation.

Section 45 - conspiracy

Section 45 provides that:

• every person commits an offence who, with a competitor of that person with respect to a product, conspires, agrees or arranges:
• to fix, maintain, increase or control the price for the supply of the product;
• to allocate sales, territories, customers or markets for the production or supply of the product; or
• to fix, maintain, control, prevent, lessen or eliminate the production or supply of the product; and
• every person who commits an offence under the above-mentioned subsection is guilty of an indictable offence and liable on conviction to imprisonment for a term not exceeding 14 years or to a fine not exceeding C$25 million, or to both.

Section 45 is a criminal offence and, as such, to obtain a conviction, the prosecution has the burden of proof to establish the offence ‘beyond a reasonable doubt’.

So one part of the government throws people in jail for forming cartels while the other part of government fines people for not being in the cartel.

Canada, you're schizophrenic. Seek therapy.

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.

No fish for you

If you're a fisherman on Manitoba's lakes, you can only sell your fish to the government's monopsonist Freshwater Fish Marketing Corporation. I've heard different stories about its establishment: some stories had it that the FFMC was set up to protect small fishermen against big corporations who'd otherwise exploit them; others had it that the system was meant to encourage efficiency through centralised processing. Or maybe it was both of them.

It really isn't working out very well for fishers based far from the processing plant. And it isn't working out for fishers who have put in the yards to identify markets for fish that the FFMC has deemed to be of very low value. Fishers cannot sell some species of fish to the FFMC at any kind of profit, but they're also forbidden from selling those fish to other willing buyers. And so the fish are left for the birds to eat.

Bartley Kives of the Winnipeg Free Press investigates.

Up on Lake Manitoba, Kenyon believes he has the answer — or had it, before he wound up in a legal dispute with Freshwater Fish, the source of most of his income.

In 2009, Kenyon and his daughter, Amanda Stevenson, pooled the resources of 300 west Interlake fishers, many of them Métis or residents of First Nations, to form the WMM Co-Op, with an eye to shipping rough fish to the United States.

Although Freshwater Fish has the exclusive right to buy Manitoba fish bound for the export market, it provided the WMM Co-Op with an export licence with the provision none of the fish wind up in any market already served by the Crown corporation. In December 2010, Kenyon’s group struck a deal to sell mullet and carp to Schafer Industries, a Thomson, Ill., operation that’s successfully found buyers for U.S. rough fish.

Some fishers living far from Winnipeg claim they don’t sell mullet to Freshwater Fish because it isn’t worth the shipping cost to the Plessis Road plant. In 2011, Schafer Fisheries sent its own trucks to Manitoba to pick up approximately 450 kilograms of rough fish — until Freshwater Fish pulled WMM Co-Op’s export licence.

Freshwater Fish says Schafer was reselling some of that fish to A&B Famous Gefilte Fish, a New Jersey processor that has bought product from Freshwater Fish.

"It was going into customers in the New York area," Wood says. "They were not operating under the terms of the licence that required them to sell to a new market.Under the law, we had no option but to remove their licence."

The licence was pulled in May 2011. Incensed WMM Co-Op fishers, who were receiving a better price from Schafer, continued to fish.  

In July 2011, Manitoba Conservation officials seized 17,000 pounds of carp and mullet sitting in a shed in Duck Bay, which sits north of Pine Creek First Nation on Lake Winnipegosis. The co-op’s directors, including Kenyon and Stevenson, were charged under the Freshwater Fish Marketing Act.

The seizure incensed Schafer Fisheries, which hoped to buy a total of 1,350 kilograms of mullet and carp from WMM.

"I don’t know where Freshwater gets off saying those were their customers," says Mike Schafer, the second-generation operator of the company started by his father in 1955. "I didn’t go after any business I didn’t already have. I sell those fish every week. I don’t understand why they’re a problem."

Canada's politicians spend a lot of time talking about the importance of "value-added" in exports. I guess processing by-catch rather than leaving it to rot doesn't count as adding value.

Canadian supply management policy remains firmly stuck on the stupid setting.

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.

Supply Management Cartels

Remember the great maple syrup heist of a couple of months ago? The National Post's Graeme Hamilton traces the problem back to source.

Beyond the jokes about sticky-fingered thieves, the crime has exposed a simmering war in the woods over syrup production and sales. And it has shed light on an unexpected accomplice in the growing illicit syrup trade: The province’s enforcement of a syrup cartel that has, since it was instituted a decade ago, helped spawn Prohibition-style smuggling and illegal sales.

Since the Federation of Quebec Maple Syrup Producers tightened its supply-management system, introducing quotas and a single sales agency in 2002, a thriving black market has developed. The theft from the strategic reserve was certainly the most brazen assault on the federation’s strict control of the industry, but it was far from the first one.

Supply management was implemented in the name of ensuring producers were getting a “fair” price for their product, and over the past decade prices for the now-controlled product have predictably and steadily climbed. Producers who exceed their quotas must transfer the excess into the strategic reserve, which is intended to cushion the effect of a bad season.

But for many, the federation’s zealous oversight goes too far. Cases before the Régie des marchés agricoles et alimentaires, the administrative tribunal that enforces the law governing the maple-syrup industry, give an indication of tactics used by the federation to enforce its cartel. Inspectors use aliases to stage phoney illegal syrup deals to ensnare bootleggers, just like undercover police conducting drug stings. And the Régie can order producers to provide utility bills and bank statements if they are suspected of selling their syrup outside the approved market.

Read the whole thing. A whole lot of the maple syrup theft investigation looks rather more like cartel enforcement against chiselers.

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.