Published in the National Post on April 8, 2010
By William B.P. Robson and Colin Busby
Since the early 1970s, “supply management” has subjected Canadian dairy, poultry and egg production to government-mandated cartels. Introduced to increase producer power vis-à-vis intermediaries and consumers, and thus raise farm incomes, supply management supports higher-than-market prices by administering producer prices and restricting farm output through production quotas, while high tariffs prevent food processors and consumers getting alternative supplies from abroad.
The initial allocation of quotas in the 1970s was free; today, most farmers trade existing quotas to one another through provincial exchanges. Generally speaking, national bodies oversee the overall system and the distribution of quotas to each province. Provincial boards oversee most of the pricing of supply-managed goods, the annual sale of quotas on exchanges and the enforcement of quota limits.
Primary producers who received production quotas at the outset, or bought them subsequently, benefit from these schemes. Consumers, and much of the domestic food industry, face higher-than-free-market prices and a more limited selection of products. As standard analysis of monopolies would lead one to expect, these arrangements impose losses on consumers that exceed the gains to producers.
The complexity of this system has increased over time and the context surrounding it has changed. Initially, proponents feared that without supply management there would be a decline of family-sized production and significant vertical integration. But these shifts have happened anyway, in both supply-managed and other agricultural sectors.
The system hurts the interests of Canada as trading nation because high, inflated tariffs effectively undercut Canada’s potential role as a positive force in multilateral trade liberalization talks. The defence of production limits at home, combined with, for example, tariffs on dairy imports of as much as 250%, leaves our negotiators in an hypocritical position.
At home, government control of entry has blunted competition, hampered innovation, and slowed entrepreneurship.
Meanwhile, production quotas have enormous market value — a fact that inhibits abrupt abolition of the system, yet at the same time suggests a route toward phasing it out over time. Because quota provides the right to produce a cartel-controlled good — fluid milk, poultry, and eggs, for example — the quota itself is valuable.
Many factors determine a production quota’s value: product prices; interest rates; perceptions of risk; expected growth of demand, and assessments of the likelihood of trade liberalization. At $28-billion in 2008, the aggregate value of production quotas in Canada was up threefold from 1995, with the average supply-managed farm holding some $1.5-million of paper permits.
For farmers of supply-managed products, the income associated with owning quota can be assessed in comparison with the return from investing in alternatives, such as financial instruments. One alternative would be long-term federal government bonds — a relatively risk-free investment with a yield of about 4%. If quota holders held those instead, the resulting income would have been a minimum of $1.1-billion in 2008.
The distortions created by supply management are worsening as the system entrenches. To the extent that farmers borrow against the value of quota, the cartel generates political risk for financial institutions, giving them a vested interest in maintaining a damaging system. Delaying ameliorative action would not help.
At a time when the economic slump has pushed government budgets deep into the red, making them hungry for revenue, why not monetize the asset: sell more quotas?
How might this look like for Canada’s dairy farmers? The program could involve coordinated sales of quotas under the auspices of each provincial agency, with the provinces receiving the revenue. The formula for administering producer prices for dairy prices would be abandoned, and the federal government would phase its tariffs out over the life of the program.
Were the dairy system reprogrammed to expire in 20 years there would be an initial, unavoidable correction to the total quota value resulting in a balance sheet adjustment for dairy farmers. Making a few simple assumptions, and assuming a discount rate of 4 %, access to only 20 years of protected markets and decreasing returns to quotas, there would be an immediate drop in total dairy quota values from $21 to around $10-billion. This sizeable drop in quota value occurs because quota values would now reflect a limited time horizon of diminishing superior returns.
Above market returns would remain robust for dairy farmers in the short- and medium-term, however, and the gradual schedule of quota expansion would leave around $11-billion in guaranteed profits for producers, in discounted terms. Because an annual auction of new quotas could raise roughly $0.3-billion in provincial government revenues over the next 20 years, however, funds would be available to cushion the blow — to provide transition packages to those dairy farmers that may decide to leave the business, for example.
Maintaining producer milk prices above market levels for a limited period would encourage the more efficient producers to purchase more quotas today and reap privileged market returns. The fact that quota values would decline over time would nonetheless pressure producers to devise strategies for working without quota supports.
The costs of the system are mounting — both domestically and in Canada’s international relations. Canada needs to arrive at international trade negotiations with coherent intentions on liberalizing markets. Hence it is neither responsible nor realistic to assume supply management should persist indefinitely.
William B.P. Robson is president and CEO of the C.D. Howe Institute and Colin Busby is a policy analyst at the Institute. Their study can be found at cdhowe.org.
