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IDFA's DAIRY POLICY PROPOSALS
Chapter 3:
A Blueprint for a Transition
to Dairy Policy Reforms
"The effectiveness of continuing government purchasing
of surplus dairy products through the price support
program, versus offering alternative risk management
programs, should be considered in the next Farm Bill.
Continued growth of revenue insurance products, use
of long term contracting and other risk management tools
could be more effective and less market distorting than
the price support program."”
Introduction
The 2007 Farm Bill offers an unprecedented opportunity
to usher in an era of modern dairy policies that meet
the needs of today’s dynamic dairy industry and
provide the nation with real economic and environmental
benefits. The blueprint for policy reform in this chapter
charts a course for a transition from the narrowly focused,
unpopular policies of the past to programs that will
achieve industry-wide goals and generate widespread
public support.
As previous chapters have demonstrated, current policies
have failed largely because they are in conflict with
one another, stifle innovation, and send the wrong economic
signals. Current dairy policies distribute impacts inequitably
across the industry, undercut the nation’s trade
obligations and export expansion prospects, and impose
heavy costs on taxpayers while providing little if any
benefits to society as a whole.
As described in Chapter 1, dairy policies should meet
fundamental principles to ensure that they guide the
industry towards continued success. These principles
are: government support must minimize impacts on market
prices and production, be equitable across all segments
of the industry regardless of size or region, and serve
national interests, including compliance with global
trading obligations.
Various alternative programs could meet these principles
– some are well developed and some are new proposals
with merit. All deserve examination. This paper suggests
five key reforms to point the way toward a new generation
of dairy programs and policy processes:
- Transition from the Dairy Price Support Program
and the Milk Income Loss Contract program to alternative
programs;
- Establishment of a direct payment program for dairy
farms that is consistently available because it is
not tied to a price trigger, and could improve environmental
stewardship;
- Availability of revenue insurance and voluntary
forward contracting for all dairy farmers;
- Further reduction of trade distortions, including
repeal of the Dairy Import Assessment Program;
- Establishment of a blue-ribbon commission that
would assess the Federal Order system and recommend
actions needed to eliminate fundamental flaws of the
system and lay the groundwork for a modern market-oriented
framework.
To minimize disruptions and provide policy makers with
time to develop revenue insurance and green payment
programs, it is anticipated that a transition period
would be needed to phase out current programs and put
their replacements in place.
A More Effective and Equitable
Dairy Farm Safety Net
The nation’s dairy farms should have an income
safety net to protect them from the worst-case impacts
of downturns in revenue. Unlike current policy, however,
the proposed policy blueprint reflects the critical
assumption that a dairy farm safety net must be consistent
with the needs of the entire dairy industry and the
overall economy. As discussed in the previous chapter,
the price support program fails to meet this essential
criterion.
In short, the price support program and the MILC programs
should be replaced with programs to protect dairy farms
against downturns in revenues due to severe adverse
changes in prices, yields, and costs. In addition, the
government should remove restrictions on preventing
tens of thousands of dairy farms from using forward
contracting of milk sales to protect against future
severe milk price downturns and to enhance revenue predictability
for planning purposes.
These recommendations would be enhanced by the establishment
of a payment program that would secure environmental
benefits for the nation while providing participating
dairy farms with additional income regardless of changes
in market prices.
Variations of these policy proposals or similar non-market-distorting
ideas could achieve the same result: a safety net that
protects income, minimizes the impact of federal programs
on dairy markets, and gets the government out of the
business of purchasing and storing dairy products. The
proposals are examined in greater depth below.
1. Dairy Farm Revenue Insurance
Dairy farming, as much as any farm business, is subject
to the risks of market price downturns, increased production
costs, and to disease and weather-related events that
can substantially affect farm output. Milk prices are
among the most volatile of all agricultural commodities,
in part due to the very federal programs that intervene
in the dairy production marketplace.
A common-sense safety net for dairy farms would prevent
the bottom from falling out of their operations as a
result of severe drops in price and output, while avoiding
the negative impacts of the price support program. While
the price support program offers a last line of protection
for farmers from price declines, it offers no protection
against price volatility, high input costs, or reductions
in milk output resulting from natural forces, such as
adverse weather or disease.
A dairy revenue insurance program, on the other hand,
could be designed to provide a safety net that provides
a buffer for dairy farmers against severe declines in
all critical aspects of farming risk, without the serious
adverse impacts of the price support program.
The details of an effective operation would depend
on the type of revenue insurance program chosen by Congress
and designed by the Administration. At the most basic
level, revenue insurance protects insured farmers from
severe losses by making payouts to them when revenues
drop below a designated level. The programs are made
available by the federal government – in this
case the U.S. Department of Agriculture (USDA). Private
insurance companies administer the programs with federal
government oversight. Each year, farmers decide the
type and level of protection they desire and pay insurance
premiums to the private insurance companies. USDA subsidizes
the premiums to make the program attractive to farmers
and may subsidize the administrative costs of the private
insurance companies to ensure that the programs remain
financially sustainable.
Revenue insurance programs also enable the costs of
the safety net and the price and yield risks to be shared
among farmers, taxpayers, and private insurers. With
current price and income support programs, consumers,
and taxpayers bear all of the financial risk and cover
all of the costs of protection. Today’s modern
dairy farm sector is well-positioned to make the transition
from Depression-era entitlements to programs that enable
dairy farmers to share the risks and costs of the farm
safety net.
In addition, a federal dairy revenue insurance program
would reduce the production and trade-distorting impacts
of the federal dairy safety net. Previous experience
with revenue insurance programs has taught program managers
how to design the insurance packages in a way that eliminates
the incentive for dairy farmers to increase production
to capitalize on anticipated insurance payouts.
Insurance-based safety net programs could also be
designed to incorporate protection against increases
in costs. Purchased feed is often the most costly input
needed to produce milk, and its costs can be even more
volatile than milk prices. To account for this important
variable, net-revenue or price-cost-margin insurance
programs can also be designed and offered to dairy farmers.
Revenue insurance programs designed as risk management
tools that provide a safety net against severe downturns
in revenue have the added benefit of complying with
the nation’s international trade obligations.
Unlike the price support program, for example, they
would neither distort market prices nor create barriers
to imports. Currently, as discussed in the previous
chapter, both the price support program and the MILC
program are considered to be trade distorting under
WTO rules and undermine the ability of U.S. trade negotiators
to reach agreements that would open new markets for
U.S. farmers, manufacturers, service and financial industries.
For nearly a decade, federal farm revenue insurance
programs have enabled crop farmers to protect themselves
against the risks of price and output declines. Since
the 1996 Farm Bill, USDA has offered crop farmers the
option of enrolling in farm revenue insurance programs
as part of the federal crop insurance system. The popularity
of the programs has dramatically increased. Between
1996 and 2006, revenue insurance program costs increased
from 30% to 56% of total federal crop insurance expenditures.
Whole farm revenue insurance programs, including dairy,
have also expanded in recent years. AGR-Lite, for example,
a farm revenue insurance program initiated in Pennsylvania,
is now offered in 28 states, and a new revenue insurance
program specifically tailored to dairy farms is currently
being considered by USDA. Experience with these path-breaking
programs sets the stage for and provides the expertise
necessary to craft and implement a successful dairy
revenue insurance program through the 2007 Farm Bill.
A broad spectrum of stakeholders and authorities, including
agricultural policy experts, public interest organizations,
and farm commodity groups, have endorsed revenue insurance
programs as a replacement for current farm commodity
programs in the 2007 Farm Bill. For example, American
Farmland Trust, a leading agricultural conservation
group, the Agriculture Task Force of the Chicago Council
on Global Affairs, which is comprised of former high-ranking
public officials, economists, and agricultural policy
experts, and the National Corn Growers Association have
publicly expressed support for revenue insurance programs
in the next farm bill.
This type of new safety net is far superior to continuing
or raising price support levels. It allows bottom line
protection against severe declines in farm revenue,
but reduces the level of government intervention and
the extent to which the safety net would distort the
dairy marketplace.
2. Dairy Payments for Sustainable
Production
The 2002 Farm Bill, for the first time ever, authorized
income-enhancement subsidies to the nation’s dairy
farmers through the MILC program. MILC payments are
direct subsidies that increase farmers’ incomes
well above the level protected by the price support
program safety net. In return for these income enhancements,
dairy farmers are not required to provide any benefit
to the taxpayers that fund them. They simply have to
produce milk, which would be produced in sufficient
quantities to meet consumer demand in the absence of
the payments.
Payments that provide substantial benefits to producers
and address environmental challenges facing today’s
dairy farms would be far superior to dairy income-enhancement
that distorts milk production.
Dairy farmers throughout the country face serious environmental
challenges, such as maintaining the quality of groundwater
and surface waters. According to USDA, low cost manure
management systems are no longer adequate to meet air
and water quality concerns. The MILC program has actually
compounded these problems by stimulating unnecessary
increases in milk production without providing incentives
for improved stewardship. By eliminating the MILC program
and establishing a “green” payments program,
the federal government could provide income-enhancement
opportunities for dairy farmers with a payment that
promotes environmental stewardship and that is not linked
to production and price.
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Rewarding Dairy
Farmers for 'Environmental Services'
How government
and farmers can team up to protect
water quality and reduce the nation’s energy
dependency
In the Spring of 2006, construction
of a regional methane digester began in Cayuga
County, NY. The New York State Energy Research
and Development Authority and U.S. Department
of Agriculture provided $1.5 million to fund the
facility, which will use manure from area farms
and food processing waste to power several county
office buildings. Energy costs are expected to
be reduced by about 20 percent for the locations
powered by the methane processing facility. This
pilot project is an excellent example of how potentially
polluting dairy farm wastes can be transformed
into something valued by non-farmers in the area.
Government payments could be used to create additional
incentives for dairy farmers to invest in and/or
supply methane digester plants that convert manure
into biogas, a renewable fuel that can be used
to generate electricity. |
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“Green” payments have few if any negative
impacts on the U.S. economy. Unlike MILC payments, they
are not tied to milk prices and would have minimal effects
on output. As a result, they would not be in conflict
with our current global trade obligations and would
not serve as a roadblock to negotiating expansion of
global market opportunities for our agricultural, industrial,
and services industries. In December of 2006, Bob Gray,
Executive Director of the Council of Northeast Farmer
Cooperatives, a dairy farmer lobbying group, said that
green payments “merit serious consideration as
a potential piece of the Farm Bill.” He also observed,
regarding the Doha round of global trade negotiations
that “if the trade deal included significant cuts
in commodity programs, including MILC, then possibly
a green payment program could take their place.”
This decoupling of direct payments from milk prices
would also have advantages for dairy farms. In contrast
to MILC payments, payments would not decrease or vanish
when milk prices increase since they are based on environmental
performance not price fluctuations. Instead of filing
production reports and waiting for a MILC payment rate
to be triggered by price, dairy producers could receive
payments and help for ongoing stewardship. Payments
could promote comprehensive nutrient management plans,
best management practices, and include incentives for
adopting additional conservation practices. Many producers
are doing this already. Green payments for dairy could
compliment other USDA programs, such as the Environmental
Quality Incentives Program (EQIP), which pays for the
actual on farm costs of installing new systems.
3. Dairy Forward Contracting
Advance pricing of milk, through forward contracting
arrangements between farmers and dairy processors, is
an essential element of any dairy farm safety net that
requires no new federal program or expenditure. It would
require only the removal of current restrictions on
forward price contracting between dairy farms and dairy
processing plants that deprive a minority of U.S. dairy
farmers from using this powerful risk management tool.
Through forward contracts, dairy farms have the ability
to lock-in favorable prices over time and avoid the
risk of unfavorable price fluctuations. Unfortunately,
approximately one-third of dairy farmers are unable
to take advantage of this attractive method of planning
and price protection. Under highly restrictive current
law, only farm cooperatives and their farmer members
are allowed to engage in these risk-reducing safety
net arrangements. All other dairy farmers in Federal
Milk Marketing Order areas are at the mercy of the often
extreme variability of marketing order prices.
Under these circumstances, many of the nation’s
dairy farms are arbitrarily robbed of the ability to
harness competition for their milk supplies to lock
in favorable prices and plan for price stability. As
noted by Craig Donohue, CEO of the Chicago Mercantile
Exchange, in a letter to Congress, “private firms
in livestock, grains, cotton and other commodities…..have
always had the ability to forward contract with producers.”
Donohue added that, “it is an unfair anomaly that
dairy farms….should be singled out and treated
differently.”
A USDA study of the impacts of the federal milk forward
contracting pilot program that expired at the end of
2004, confirms the benefits provided by advance pricing
arrangements between private dairy processing companies
and their farmer suppliers. The report found that dairy
farmers who participated in the pilot program enjoyed
far-more-stable milk prices than their counterparts
who were unable to forward contract their milk sales.
The removal of restrictions on forward contracting
would enable all farmers who sell milk for processed
products other than beverage milk (i.e., Classes II,
III, and IV) to voluntarily engage in forward contracting
with their processor customers. Dairy farms would not
be required to engage in these advance pricing arrangements.
However, given the popularity and demonstrated benefits
of forward contracting, it is anticipated that it would
be widely used by dairy farmers currently prevented
from doing so.
Besides putting many dairy farmers at an unnecessary
economic disadvantage, current restrictions on forward
contracting unnecessarily add to the cost borne by taxpayers
and consumers of protecting dairy farms against severe
price declines. If all dairy farmers had the potential
to utilize forward contracting, they would not have
to be as reliant on the federal government to stabilize
their incomes. The overall level of financial risk in
the U.S. dairy farming sector would decline and, as
a result, the need for and cost of a government-provided
farm safety net would be reduced as well.
4. Repeal of the Dairy Import
Assessment
The dairy import assessment authorized in the 2002
Farm Bill remains a threat to the long-term trade prospects
of the industry and must be eliminated before it can
do lasting damage. The case against the assessment is
compelling and multi-faceted. As was revealed in Chapter
2, the assessment will not help farmers and is unfair
to consumers and importers, could be in violation of
our global trade obligations, and may provoke a WTO
challenge and retaliation.
Although it has not been implemented, as a result of
a wise decision by the U.S. Trade Representative, it
hangs like a cloud over an industry poised to capitalize
on global trade opportunities and leadership in market-oriented
innovation. Congress should use the imminent opportunity
offered by the 2007 Farm Bill to repeal the assessment
and help make federal dairy policy more equitable, more
market-oriented and more consistent with the nation’s
global trading obligations.
5. Establish a Blue Ribbon
Commission to Review the Federal Milk Marketing Order
System
As earlier chapters have demonstrated, Federal Order
pricing regulations were put in place for a Depression-era
dairy industry and marketplace. Dramatic changes in
the industry and dairy markets have not been matched
by significant reform of the Federal Order system or
even timely changes in the many complex regulations
that make up this Federal Order system. The underlying
structural problems of this out-dated system for pricing
milk need to be reconsidered. The fact that the system
was established seven decades ago to address industry
conditions that no longer exist begs the question of
whether the system, in its current form, can still be
justified or maintained.
To many dairy farmers and dairy processors, the Federal
Order system long ago outlived its usefulness, despite
an endless series of adjustments that have not solved
the system’s structural problems. This is not
surprising. The fundamental composition of the Federal
Order pricing system is inconsistent with the structure
and geographic make-up of today’s dairy industry.
USDA, which administers the system, faces the impossible
task of trying to successfully impose regional and pricing
relationships from the 1930s onto a 21st century dairy
industry. And today's industry has been fundamentally
reshaped and is subject to an entirely new array of
market forces. Accordingly, some believe that the only
way to fix the problem is to eliminate federal pricing
of milk through Federal Orders and allow milk to be
priced in the marketplace along with every other perishable
agricultural commodity. However, many others disagree
and want to maintain the system, or find ways to improve
it.
Given the fundamental flaws in the Federal Order system
and the challenges they pose for the industry, IDFA
recommends that Congress establish, in the 2007 Farm
Bill, a blue ribbon commission of stakeholders and experts
that would review the merits of the Federal Order system
in its entirety and make policy recommendations to Congress
and the Secretary of Agriculture. This Commission could
also consider ideas that have surfaced in the debate,
such as creating one Federal Order, bringing California,
which has its own state order, into the federal system,
and voting on amendments – which are too complex
to do in the 2007 Farm Bill without careful consideration.
Too many businesses and farms are affected to proceed
without consensus on fundamental Federal Order changes
of this magnitude.
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