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.
