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IDFA's DAIRY POLICY PROPOSALS
Chapter 2:
Current Federal Dairy Policies
Don't Meet The Dairy Industry's Needs
"As global demand for
milk and new dairy products expands, the roles of policies
that support prices are diminishing, while the roles
of flexibility and innovation aimed at improving competitiveness
are growing."”
Introduction
Current federal dairy policies are largely products
of a bygone era in the history of milk production and
processing. Although the U.S. dairy industry is poised
for a new prosperity, anachronistic federal programs
threaten that progress and present obstacles to future
economic growth and environmental sustainability. Current
programs are simply not consistent with the guiding
principles that will ensure long-term competitiveness
and financial success for farmers, cooperatives, and
private processing operations.
Maintaining the same or similar dairy programs in the
2007 Farm Bill would be a risky proposition for the
industry given what we know about current policies and
the needs of the industry. Those risks are described
in this chapter along with the benefits to the industry,
consumers, and taxpayers of moving past counterproductive
and unsustainable policies toward programs that meet
the needs of the entire industry.
Dairy's Dilemma: A
Modern Industry Saddled with Antiquated Policies
Remarkably, two of the three core federal policies governing
the nation’s dairy sector have their roots in the
1930s and have changed little despite all of the dramatic
changes in dairy farming, milk and dairy product consumption,
dairy processing and transportation, and competition.
Both the Milk Price Support Program (also referred to
as the Dairy Price Support Program) and the Federal Milk
Marketing Orders were designed to address a unique set
of realities challenging the U.S. dairy industry in the
Great Depression era. At that time, the precursor to the
price support program was put in place to address the
gross imbalance between production and consumption that
threatened to drive many dairy farms out of business and
put regional milk supplies in jeopardy. The Federal Orders
were created, in turn, to ensure local milk production
close to every populated area of the nation. Clearly,
one could argue that Federal Orders were needed in an
era before today’s refrigeration, sophisticated
transportation equipment, and high tech processing methods.
Both the Milk Price Support Program (also referred
to as the Dairy Price Support Program) and the Federal
Milk Marketing Orders were designed to address a unique
set of realities challenging the U.S. dairy industry
in the Great Depression era. At that time, the precursor
to the price support program was put in place to address
the gross imbalance between production and consumption
that threatened to drive many dairy farms out of business
and put regional milk supplies in jeopardy. The Federal
Orders were created, in turn, to ensure local milk production
close to every populated area of the nation. Clearly,
one could argue that Federal Orders were needed in an
era before today’s refrigeration, sophisticated
transportation equipment, and high tech processing methods.
Today, however, modern processing, packaging, and transportation
technologies enable beverage milk to be shipped long
distances in short periods of time, ensuring supplies
of fresh milk to all locations in the nation. Nonetheless,
the Federal Order system still governs the prices that
dairy farms receive for their milk production. It should
come as no surprise that the imposition of a 70-year-old
pricing system on a dynamic domestic market frustrates
progress, clashes with market opportunities, and creates
the need for an unending series of complex policy refinements.
The price support program has also become a counter-productive
policy tool that long ago failed to keep up with the
needs of the dairy industry and its customers. Some
of the problems attributable to the price support program
have been compounded by the Milk Income Loss Contract
(MILC) program, an income-enhancement program that was
overlaid on the price support program safety net in
the 2002 Farm Bill. Even worse, the two programs work
at cross-purposes to increase production distortions,
create further incentives for continuing government
purchases of dairy surpluses, and compound regional
divisiveness in the industry.
The
Price Support Program:
Producing for the Government Rather Than for Markets
For the past six decades, under the price support program,
the federal government is authorized to purchase and
store surplus dairy products, including cheese, butter,
and nonfat dry milk powder (NFDM). The purchase and
storage program started when the dairy industry was
young, lacked the capacity to manage inventories, and
did not face a growing demand for innovative dairy products.
Although the $90 billion dairy industry now
has the capacity to manage inventories and faces growing
demand opportunities, the government's buying and storage
powers under the price support program were never terminated.
Through the price support program, taxpayer dollars
have, in effect, provided incentives to dairy processors,
especially milk powder plants in recent years, to produce
and package dairy products for delivery to the government
rather than the marketplace. In the 1980s, until price
support levels were gradually lowered, the cost of government
purchases of surplus dairy products reached record heights,
exceeding $2 billion dollars a year. More recently,
in 2002, the federal government still purchased a staggering
680 million pounds of NFDM equal to nearly 45% of total
U.S. milk powder output that year.
 In
addition to the cost of purchasing the dairy products,
the taxpayer picks up all of the transportation cost
and the additional costs incurred for storage, which
may last for years until USDA is able to channel the
government stocks back into the marketplace. If the
stored dairy products are not donated, the government
may sell products back into commercial channels, which
has the market-distorting impact of competing with commercial
sales, adding to supply, and driving down prices to
processors and ultimately to dairy farmers.
Other agricultural industries learned lessons about
the destructive impacts on markets when the government
supported prices through purchasing and storing commodities
more than two decades ago. Like the dairy industry,
program crop commodities, such as wheat and corn, relied
on price supports starting in the 1930's. As a consequence,
with the exception of World War II when food was in
short supply, the U.S. was not competitive in commercial
export markets and government grain stocks remained
very large. In the 1985 Farm Bill, Congress put reforms
in place. Although grain growers’ incomes were
protected, prices were allowed to clear the market at
unsupported levels and USDA was removed from the grain
purchasing and storage business. Only the Dairy Price
Support Program remains as a lasting testament to the
failed government purchase-and-storage price support
programs of the past. Today, demand for butter, nonfat
dry milk and cheese is strong. For the foreseeable future,
market prices for those products are expected to remain
well above levels that trigger dairy price support purchases
by the federal government.
Long-Neglected Market Opportunities
1. Price Support
Impedes U.S. Processors from Meeting Demand for Innovative
Products
Until very recently, the federal government had been
such a loyal customer that many dairy processors, particularly
nonfat dry milk powder (NFDM) operations, have ignored
potential growth opportunities. Although USDA lowered
the price the government pays to purchase NFDM in 2001
and 2002, over 2.5 billion pounds of NFDM was purchased
during the 2000-04 period. The western states have accounted
for over 90 percent of all federal purchases of the
product. With only a few exceptions – see the
“DairiConcepts” success story in the box
below – the large western powder plants converted
surplus milk production, which was stimulated by federal
price and income support programs, into NFDM for sale
to USDA.
This virtually risk-free dependence on federal purchases
removed the incentive for companies to diversify and
invest in the production of high-value dairy products
of the future that can be made from skim milk. The fact
that the U.S. is the largest importer, rather than an
exporter, of milk protein products is testimony to the
distortions that current programs can create. According
to a May 2004 report by the U.S. International Trade
Commission, “U.S. government support for SMP [skim
milk powder] reduces the incentives to produce milk
protein concentrates and casein in the United States.”
If the government were no longer a customer, the industry
would automatically look to the market, not USDA, to
guide its investment and production decisions and would
take responsibility for managing its own inventories.
Without the price support program, dairy plants would
be able to respond effectively to market signals.
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"DairyConcepts":
The Power of Market-Based Ideas
How one plant kicked the habit of selling
to the government and found prosperity by producing
innovative products that replace imports.
In 2002, DairiConcepts became
the first U.S. commercial operation producing
milk protein concentrates (MPC) in the United
States. This 50/50 partnership between the world's
top dairy exporter, Fonterra, and the largest
U.S. farmer-owned cooperative, Dairy Farmers
of America (DFA), combines Fonterra's marketing
services and protein technology with DFA's stable
supply of high quality fluid milk. The plant
was converted from a nonfat dry milk "balancing"
plant that sold exclusively to the USDA government
purchase program to allow production of dairy
products in commercial demand. This plant and
another new MPC plant, both in New Mexico, are
poised to replace imports during seasonal supply
differences between the Northern and Southern
Hemisphere to match rapidly growing customer
demand. Producing these products without government
subsidies or support, the plant has a capacity
to capture up to 40% of U.S. domestic MPC demand
as well as growing value added export opportunities.
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2. Undercutting
U.S. Dairy Export Potential
Despite having the largest and one of the most efficient
dairy production and processing industries in the world,
the United States has lagged far behind competing countries,
such as Australia and New Zealand, in dairy exports.
Until recently, exports have accounted for only about
3% of U.S. dairy production, most of which was shipped
as either donations or subsidized sales of USDA owned
surplus dairy products under the Dairy Export Incentive
Program (DEIP).
In 2004, the export situation for NFDM improved significantly
due to the rise in world prices above the U.S. price
support level. Total U.S. NFDM exports have more than
doubled with nearly 80% being shipped to foreign markets
without export subsidies. By 2005, as world prices remained
above price support levels, more than 40% of all the
NFDM produced in the country was exported. These results
demonstrate the export-inhibiting character of the price
support program and strongly suggest that the recent
NFDM export surge will likely reverse course when world
prices again fall below the U.S. support price. The
only way to ensure that NFDM makers will not have the
incentive to produce for a guaranteed government price
and buyer is to replace the price support program with
a farm safety net that does not prevent market prices
from providing adequate incentives for NFDM makers to
supply growth markets.
3. Undermining Export Market Expansion for U.S. Products
and Services
The price support program has not only impeded the
growth of U.S. dairy exports, but has also placed a
serious roadblock in the way of export market expansion
for many other U.S. agricultural and nonagricultural
products and services. According to the World
Trade Organization, the price support program has
monopolized a disproportionate 32% of the country’s
total allowable trade-distorting subsidies under current
global trade agreements. The success of the next “Doha”
round of global agreements to reduce barriers to global
trade in agricultural and nonagricultural manufactured
products and services will depend largely on the ability
to reach agreement on cuts in trade-distorting agricultural
subsidies, such as the Dairy Price Support Program.
As long as this program remains, it contributes heavily
to the forces that are impeding progress in multilateral
trade negotiations.
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Dairy Exports Uninhibited
by Price Supports: A Recent Success
Story
How a Midwestern dairy processor harnessed market
forces to capture export market share
Expanding markets for whey
in recent years – including greatly increased
exports – serve as a model for industry
growth without government intervention. Whey
has never been dependent on government purchases
under the Milk Price Support Program. Whey is
a co-product of cheese production that at one
time was thought to have little use in the food
industry. Now whey products are valuable ingredients
for myriad food processing and industrial purposes,
and exports have taken off. In 2005, whey exports
represented 40% of all U.S. whey product production.
They continue to rise. Increased whey exports
have had a positive impact on farmers’
prices. It is no surprise that Minnesota-based
Davisco Foods International recently won the
Exporter of the Year Award, given by the U.S.
Dairy Export Council and Dairy Field magazine.
Davisco is the world's largest manufacturer
of whey protein ingredients, which are increasingly
in demand as ingredients in food, beverage,
and pharmaceutical products.
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From
Bad to Worse: Direct Payments and Price Supports
at Cross Purposes
In the 2002 Farm Bill, Congress exacerbated the situation
by overlaying the MILC income-subsidy payment program
on the price support program. The MILC program was enacted
without congressional hearings or input from the public,
USDA, or producer groups on the design of the program.
With the addition of MILC program payments, government
purchases rose to one of the highest levels seen in
the history of dairy programs. The combination of the
two programs created a cycle of counterproductive spending.
While USDA was spending hundreds of millions of dollars
to prop up milk prices, MILC payments triggered additional
milk production that, in turn, contributed to additional
purchases by USDA to prevent milk prices from falling
further. As prices were driven down to price support
levels, MILC payments increased to compensate for the
price declines. And so on.
The MILC program has increased regional divisiveness
in the industry. Small-to-medium sized farms, which
dominate milk production in the East, Southeast and
Midwest, are placed at a competitive disadvantage by
rules governing the 2.4 million pound annual cap on
payments. Under certain circumstances, large farms may
receive payments for the full 2.4 million pounds allowed
under the cap while smaller farmers that produce more
than 2.4 million pounds a year may not. On the other
hand, large farms are hurt because they lose more revenue,
due to the MILC program's price-deflating effects, than
they can recover from MILC payments capped at 2.4 million
pounds of output.
Under current market conditions neither the MILC program
nor the price support program provide an effective safety
net for dairy farmers. Milk prices are rising, making
MILC payments and price support purchases unlikely,
yet many dairy farmers’ incomes are still being
squeezed by high feed costs. The time is right to design
a safety net for dairy farmers that addresses revenue
rather than price and is consistent with the guiding
principles for smart and effective dairy policies discussed
above. As milk prices fluctuate, this safety net would
continue to protect dairy farms while minimizing market
and trade distortions, treating all segments of the
industry fairly, and providing benefits to society as
a whole.
Trade Prospects Further Hampered by Unfair Tax on Imported
Dairy The 2002 Farm Bill created a new, protectionist trade
barrier designed to impose assessments on imported dairy
products. The intent was to use the import assessment
to fund domestic promotion programs. The dairy producer
promotion program, or "check-off program",
has been mandated since 1984, when a majority of U.S.
dairy farmers voted to pay into a fund through assessments
on each gallon of milk that they produce. The 2002 import
assessment was never implemented because the U.S. Trade
Representative determined that it would not comply with
U.S. obligations under the World Trade Organization
(WTO).
The dairy import assessment program should be repealed
in the 2007 Farm Bill for the following reasons:
- It taxes a business without providing any service.
Imported dairy products won’t benefit from the
promotion programs. Fluid milk imports are virtually
non-existent and the volume of cheese imports is capped
by strict quotas. Imported high-protein dairy ingredients,
used predominantly in food products outside the dairy
case, would not benefit from cheese and milk advertising
- It is protectionist, trade-distorting and invites
a WTO challenge. Maintaining the U.S. program invites
retaliation and runs counter to the U.S. position
seeking greater market access for U.S. products in
multi-lateral trade negotiations.
- The assessment levied on importers would go to a
generic fluid milk and cheese promotion board, not
to dairy farmers. Other countries have domestic agricultural
promotion programs, and do not tax U.S.dairy imports
to offset or contribute to the cost of their advertising.
- It is an unjust and unreasonable tax on U.S. consumers.
The cost of the assessment could well be passed on
as a de facto tax on purchases of dairy products even
though quotas and tariffs already raise consumer prices
for imported cheese and other dairy products.
Needless
Federal Order Restrictions Result in Lost Marketplace
Opportunities
Forward contracting is a standard, business management
tool used to manage risk by dairy and crop farmers nationwide.
It enables farmers to enter into advance-pricing agreements
with the buyers of their output. Through these voluntary
arrangements, farmers can choose to avoid unfavorable
price declines and improve their planning and investment
decisions by locking in favorable prices in advance
of the delivery of their commodities.
Unfortunately, roughly one third of the nation’s
dairy farmers don’t have the option of entering
into such beneficial agreements since they are prohibited
from doing so by federal government regulations. Only
dairy farm cooperatives are permitted to offer forward
contracts for milk pricing. As a result, those dairy
farms that sell milk to thousands of privately owned
dairy processing plants are prevented from using this
common sense tool to reduce the financial risk of doing
business.
For several years, through a federal pilot program,
USDA had the authority to allow all milk manufacturers
and sellers (see box below) to enter into voluntary,
long-term contracts for milk supplies. However, the
program expired in 2004, leaving tens of thousands of
dairy farms without recourse to forward contract. All
dairy farmers and processing plants should be on equal
footing when it comes to business management tools.
By denying so many dairy farms access to this risk-reduction
tool, current law reduces the ability of dairy farms
to take responsibility for the success of their operations
and increases their dependency on government programs.
The inability to forward contract a significant portion
of the nation’s milk supply has ripple effects
that will hurt the competitiveness of milk and other
dairy products. If food processors cannot forward contract
for dairy ingredients as a result of dairy processors
being unable to forward contract for milk, they will
choose alternatives to dairy ingredients, thus losing
markets for dairy farmers and cooperatives.
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Forward
Contracting for Dairy Farms: A Proven Track
Record:
How an Iowa dairy farmer beat the odds thanks
to a forward contracting pilot program
When Brad Feuerhelm, a dairy
farmer in Le Mars, Iowa, wanted to go into the
dairy business, he turned to the local milk
buyer, Wells' Dairy, maker of "Blue Bunny"
ice cream. With a mutually agreeable, long-term
forward price contract in place, Feuerhelm was
able to get a fair, stable price for his milk,
avoiding volatile price swings in the market,
and obtain favorable financing. While many dairy
farmers in Iowa were unable to sustain their
dairy operations, Feuerhelm's "Plymouth
Dairy" flourished. In 2000, when Congress
authorized a Dairy Forward Contracting Pilot
Program, many milk sellers and buyers, like
Feuerhelm's Plymouth Dairy farm and Wells' Dairy
ice cream plant, entered into voluntary and
mutually agreeable long-term forward contracts.
Today a similar arrangement would be impossible,
because the dairy forward contracting authority
expired in 2004.
"As a dairy farmer, I contend with the volatility
and uncertainty of the dairy industry on a daily
basis. There is simply no reason not to implement
tools that allow us to plan effectively, manage
risk and price fluctuations, and increase efficiency."
- Brad Feurhelm
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A Plodding Federal Order Bureaucracy Hamstrings a Dynamic
Industry Nearly 70% of the nation's milk is supplied and sold
under the pricing regulations established under USDA’s
70-year-old Federal Milk Marketing Order system. Federal
Orders were established to address a unique set of realities
challenging the U.S. dairy industry in the Great Depression
era. At that time, given the absence of today’s
refrigeration, sophisticated transportation equipment,
and high tech processing methods, Federal Orders were
established to ensure local production close to every
populated area of the nation.
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Federal
Milk Marketing Orders Under
this dairy subsidy program, the government supports
farm income by setting minimum dairy prices. In
order to ensure adequate local fluid milk supplies,
every county across the United States has a government
milk price, but dairy farmers in some states have
opted out of the federal price setting system.
Under the FMMOs, milk is priced using four classifications:
Class I - fluid milk
Class II - yogurt & cultured products
Class III - cheese
Class IV - butter & powder
Authorized
in the Agricultural Marketing Agreement Act of
1937 at 7 U.S.C. 601-674
Fact Sheets:
http://www.ams.usda.gov/
dairy/orders.htm
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Although those Depression-era conditions obviously
no longer exist, Federal Orders still regulate minimum
prices paid to farmers for their milk. While the concept
of the government setting milk prices may sound simple,
the reality is a complicated system of paperwork, regulation,
and uncertainty. Milk processors are required to record
thousands of daily business transactions, on a monthly
basis, and pay USDA over $50 million to operate the
system. These reports must provide details about the
location and volume of milk procurement, product composition
and volume, marketing plans, and prices paid. The government
paperwork and intervention doesn’t end there.
Processors must wait until the end of every monthly
reporting cycle to know the final price they have to
pay for the milk they purchase. At that time, after
USDA compiles records from every processing plant in
each milk marketing order, processors are told by USDA
how much more money they owe farmers for the milk they
purchase, or whether they get a refund.
USDA also makes changes to this complex Federal Order
milk pricing and reporting system through a regulatory
process that begins with a proposal for a change in
Federal Order pricing mechanisms, through a USDA administered
hearing. These hearings add a powerful element of uncertainty
to planning for future innovations and adaptations to
changing market conditions.
The frequency and duration of USDA FMMO hearings can
paralyze the industry and prevent dairy farmers and
processors from competing with other food and beverage
industries not encumbered by uncertain and untimely
government price intervention.
Changes in the classified pricing system often result
in lowering milk prices in some regions and increasing
milk prices in other regions because the FMMOs are designed
to influence where and how much milk is produced. The
classified pricing system does this by making the farm
prices for milk used as a beverage higher than milk
used in other dairy products. Thus, in regions of the
country where most of the milk goes into cheese and
other dairy products, the FMMO system penalizes producers
with lower prices. Fluid milk consumption per capita
is declining, so by making the prices for fluid milk
higher -- classified pricing increases the milk supply
and lowers consumption -- which lowers the prices to
dairy farmers in all regions. The regionally based pricing
system doesn't fit anymore. Every tweak to the pricing
formulas creates "winners and losers" in one
region versus another, or one dairy product class versus
another.
Dairy is the only U.S. commodity that has both a marketing
order system that requires the government, at the approval
of producers, to set minimum prices and on top of this
has additional federal dairy support programs. In fact,
the United States is only one of two countries in the
world that still intervenes in dairy pricing rather
than allowing the marketplace to set prices. All other
countries of the world allow the market place to set
dairy prices, and utilize other types of support for
the farming sector, or none at all.
The rules under the classified pricing system are extremely
complicated and constantly in flux. It is common for
multiple dairy processing plants in the same state to
have different sets of federal rules about how much
each plant has to pay for milk. This complexity and
uncertainty is a disincentive to invest in processing
facilities and innovative dairy products.
Dairy processors aren’t the only companies placed
at a competitive disadvantage by the Federal Milk Marketing
Order system. Any food or beverage manufacturer producing
milk based drinks, or using dairy ingredients, is adversely
affected by the complexity of federal order pricing,
the frequent and lengthy regulatory changes, and the
constant uncertainty the system creates.
Conclusion: Dairy Policy at an Unprecedented Crossroads
Federal dairy policy has had an enormous impact on
the performance and future prospects of the entire dairy
industry. The stakes have rarely been higher. Never
before have both the need for reform been so great and
the conditions for reform so favorable.
The risks for the entire dairy industry of keeping
current policies intact in the next Farm Bill are extremely
high. Promising market opportunities could be lost and
environmental challenges will go unmet unless federal
policymakers mandate programs that are consistent with
the four guiding principles delineated in the previous
chapter. Current federal dairy policies are inconsistent
with those principles and can put industry prosperity
in jeopardy, prevent all segments of the industry from
reaching their potential, and add unnecessary uncertainty
to the industry’s planning and innovation processes.
The current subsidy programs – the price support
program and the MILC program – are each fundamentally
flawed and out of step with the forces that will define
the industry’s future. Worse yet, neither program
is providing an effective safety net. Federal regulations
that prevent universal forward contracting deprive tens
of thousands of dairy farmers of an important, proven
risk-management tool. Despite serious environmental
challenges and rising consumer concerns about agricultural
sustainability, current policy fails to provide dairy
farms with adequate incentives to improve environmental
stewardship. And an arcane, out-dated Federal Order
pricing system, which is compounded by a cumbersome
regulatory apparatus, undermines the industry’s
ability to respond to market signals with certainty
and in a timely manner.
The next chapter presents a blueprint to guide federal
policy makers in creating a transition between current
under-performing policies rooted in the past and a new
era of forward-looking policies that reflect the modern
dairy industry, its dynamic market environment, and
the needs of the customers it serves.
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