There are three ways to reduce the price of a product. The first is through technological innovation - the reason why the price of computing power and memory storage is now so low. The second is to cut wages, or the price of other inputs. Even though the basic technology of sewing t-shirts has not changed in decades, textile manufacturers have kept costs down by shifting production to low-wage locations.
The third way to reduce prices is to eliminate rents. For example, manufacturers can charge thousands of dollars a year for Thalidomide - a 50 year old drug with very low production costs - because they enjoy patent protection. Eliminating that patent protection - and the rents it brings - would reduce the cost of Thalidomide to patients.
Milk and cheese costs more in Canada than in most other countries. The question is: why?
The basic technology of milk production hasn't changed for thousands of years: feed in, milk out. Cows aren't paid, so wages should not an issue. Hence most people explain the price difference between Canada and the US in terms of market rents. There are high tariffs on imported dairy products, and restrictions on the quantity that can be produced domestically.
The picture below shows a textbook analysis of the impacts of milk quotas and tariffs, and what would happen if they were eliminated.
This might be called the fat-cat farmer model of the dairy industry. With quotas and tariffs, the market equilibrium is Q2. On the margin, the availability of imported (albiet taxed) milk and cheese is what limits the amount Canadian farmers can charge. Canadian market prices are thus determined by the (after tax) price of foreign imports. Farmers enjoy rents, or super-normal profits, equal to the difference between the domestic supply curve, which measures their cost of production, and the price they receive for their products.
Elimination of milk quotas and tariffs would, in this story, lead to an increase in milk imports, and a fall in the price of milk. Domestic farmers would stay in business - they just wouldn't enjoy the super-normal profits they were earning earlier. In fact, domestic farmers even stand to gain by the possibility of expanding milk production. On balance, the gains to consumers would outweigh the rents lost by farmers (and the government's reduction in tax revenue) by the amount shown in yellow, the "welfare gain" from eliminating tariffs and quotas.
The problem with this analysis is that it fails to take account of the structure of the Canadian dairy industry, and that of its international competitors.
First, because the value of Canadian dairy quotas has become capitalized, a production quota is part of a farmer's working capital. In some parts of the world, a successful farmer expands her operation by building more barns and growing her heard. In Canada, a successful farmer expands production by buying more quotas.
To the extent that new entrants to the dairy industry have to purchase quotas, the presence of quotas increases costs, and thus shifts the domestic supply curve upwards. The federal government could decide, tomorrow, to eliminate milk quotas and import tariffs. That would not eliminate the debt farmers have incurred to buy quotas - but it would wipe out dairy farmers' most important capital asset.
Second, American dairy farmers have spent decades competing on price. Canadian farmers have spent decades competing on quality (or not competing at all). Consequently, American and Canadian dairy farmers use different farming methods.
In parts of the US, for example, cows are fed bovine growth hormone (BGH), which allows them to produce more milk for a given amount of feed. Canadian dairy farmers are not allowed to use artificial growth hormones and, as a result, have higher costs.
Canadian dairy farms are also much smaller, on average, than American dairy farms. Agriculture Canada, drawing on the 2006 Canadian census of agriculture, paints a bucolic pictures of the typical Canadian farm: "It is a family-owned operation with a herd of about 60 cows. The farm owners are in their mid-forties and have built up considerable equity in their operation." By way of contrast, the US Department of Agriculture, reporting on the corresponding US agricultural census, observes:
Results of the 2007 Census show that concentration in milk cow production has increased in the last five years. In 2002, 24 percent of farms with milk cows produced 74 percent of the total value of U.S. sales of milk and other dairy products. In 2007, the same percent of farms produced 81 percent of the total value of sales of milk and other dairy products.
Odds are, if you're buying milk imported from the US, you're buying milk produced in a large-scale, corporate owned dairy operation, with at least 1,000 cattle. The major objections to such operations are environmental (think of the mess thousands of dairy cows make) and considerations of animal welfare. With thousands of cattle in a single operation, it is logistically impossible to do anything other than treat the cows as living machines, giving them no opportunities to graze grass, feel the sunshine, or enjoy the bovine good life.
Last, but by no means least, dairy products are subsidized throughout the world - in Europe through the Common Agriultural Policy, and in the US both directly through supports to dairy farmers, and indirectly through subsidies to corn and soy producers. Although the current US system is up for renewal, there are no plans to completely eliminate agricultural subsidies. The Canadian dairy industry would have much lower costs than they do at present to compete with subsidized farmers elsewhere.
Now one could argue that, if European taxpayers are prepared to subsidize our stilton and cambonzola, we should stop complaining and dig in. The resources currently devoted to producing expensive Canadian cheese can then be freed up for other uses. But I wouldn't advise making this argument in the presence of a dairy farmer.
If Canadian farmers' costs are substantially higher than the costs of dairy producers in the US and Europe, the predicted impact of elimination of the current system of quotas and tariffs looks more like this:
The observant reader will notice that I shrunk the welfare gain in this second picture by changing the shape of the demand curve. It's an open question: how much more milk would the average Canadian consume if dairy products were cheaper? (Which leads to the immediate follow up question: how much weight would we gain, and would we be better off in the long run?) In the first picture, unless milk consumption increases, there is no welfare gain, all that happens is that resources are transferred from farmers to milk consumers (which is good for consumers, but bad for farmers). In the second picture, there are still welfare gains even with an inelastic demand for milk, because of the gains from trade - but they are smaller than with a more elastic milk demand curve.
The true impact of an elimination of quotas and tariffs in the Canadian dairy industry probably looks somewhere in between these two extremes. We really don't know.
Here are the questions that I would like to ask anyone who is advocating elimination of quotas and tariffs:
- How precisely are existing dairy quotas to be eliminated? Over what time period? What compensation (if any) will be paid to current holders of quotas? What transitional supports will be available?
- What structural changes will have to take place in the Canadian industry to allow Canadian dairy farmers to compete with imports?
- Will (is) milk imported from the US produced with bovine growth hormone be labelled as such?
- How much more milk would an average Canadian consume if quotas and tariffs were eliminated?
I don't know the answers to these questions, but I would say to those who would like a radically re-structured Canadian dairy industry: be careful what you wish for.