Tuesday 15 November 2011

Keep Canadian supply management in play

Conflicting reports emerge on whether Stephen Harper is really prepared to open up the Canadian Dairy cartel. This is understandable: there will be really large political costs if Harper abandons supply management. Why? Every dairy farmer in Canada owns quota: a permit giving the farmer the right to milk a cow. Those quota permits cost real money. The price varies from province to province, as each province is allocated a different amount of quota. In October of this year, that price ranged from $25,000 in Quebec to $40,000 in British Columbia.

That quota value is really important to dairy farmers; it's the nest egg a whole lot of small farmers can pass on to the next in line. Abolishing the quota system means abolishing some farmers' retirement or inheritance plans. That's not the kind of thing folks accept without a fight. Think the Canadian Wheat Board has been contentious? That's just a single desk seller. If there are capitalized rents anywhere, they'll be in land values for farms especially suited to growing quota crops; that many farms opt out by growing non-board crops suggests the value of those rents is pretty limited. At best, the system provides transfers to small farmers who don't want to handle their own marketing arrangements and, perhaps, offsets some market power enjoyed by the ports, rail lines, and grain companies. Abolishing it wouldn't immediately destroy a substantial portion of any farmer's asset portfolio, but there's still a non-trivial subset of western grain farmers who really want to keep the system.

It's exceedingly unlikely that any Canadian politician can simply abolish the quota system. The benefits of the system are highly concentrated in the capitalized rents embodied in the trading prices of dairy quota. The holders of that quota will fight very hard to make sure that the system stays in place. The costs of quota management are dispersed among thirty-odd million Canadians who have to pay more for butter, ice cream, chocolate, cheese, and baby formula than they'd otherwise have to pay. Mancur Olson's Logic of Collective Action takes hold: if you think the CWB's ads trying to save the Board's single desk tug at heartstrings, wait 'till you see the ads featuring small dairy farmers facing the eradication of their retirement nest eggs.

Gordon Tullock suggested there isn't any real way out of a transitional gains trap. Here's how the trap works. The regulatory barrier confer excess profits on those holding the asset in fixed supply, like New York Taxicab medallions (now trading at $1 million) or Canadian dairy quota. The initial set of people who held the asset when asset prices jumped enjoyed a windfall gain, but most of those medallions, or quota permits, trade on the open market and are bought by people who can only earn a normal profit if the system stays in place. At that point, the system really benefits nobody - everyone earns only a normal rate of return on investment. But it's impossible to abolish because the political costs of imposing massive capital losses on permit or medallion holders is too high.

But I think there is a way out.

The cartel arrangement has to be inefficient - it destroys some value in the process of taking money from consumers and giving it to producers. Dairy farms are smaller and less efficient than they could be. Processors have to use less suitable milk substitutes. So long as there is some inefficiency associated with the system rather than there just being a transfer, it's possible in theory to abolish the system and transfer some of the consumers' gain back to producers to compensate them for their loss.

How would you do it in practice? Start by buying out the quota held by dairy farmers: abolish the quota system while paying farmers for the value taken. This will not be cheap. Where does the government come up with the money to pay the farmers? Institute a new and temporary tax on all dairy products. The supply management system, as best I understand it, winds up charging larger excess prices for industrial milk, where price inflation can be more hidden, than for fluid milk. Set the tax proportionate to the excess price that currently obtains in different parts of the system. That tax would pay off a bond issue used to fund the farmers' compensation. When the bonds are retired, the tax is retired.

The benefits of this accrue immediately. CD Howe proposes a great plan for a gradual elimination of the quota management system. But I'm not sure that's enough to get Canada into serious trade negotiations: I don't think New Zealand would look kindly on Canadian promises to abolish quota in a decade - just look at how seriously Canada's taken its promises under Kyoto. The immediate buy-out of quota farmers lets free trade in dairy start very quickly. The dairy tax would be TPP compliant as it would be assessed on all milk, whether domestic or imported. There'd be some technical hassles about appropriate tax treatment of milk embodied in products, but that can be worked out.

If I take off my economist hat and put on my libertarian hat, I'd go a bit further and say that quota compensation could be based on a fraction of quota value rather than on full quota value to save some money and in recognition that Canadian dairy farmers have been ripping off consumers for decades. But that's a trivial detail.

The same logic holds for poultry and eggs.

A tax and compensation regime can get Canada out of supply management very quickly while largely attenuating the political fallout. It would let Harper make some trade progress without slitting his throat in Quebec and Ontario. It can and should be done, and that right soon.


  1. Question: if this way out of transitional gains traps is a (near) Pareto improvement, why isn't it ubiquitous? Maybe it's an amazingly brilliant and original idea that would spread like wildfire if only you could get a few politicians to listen to you. But as much as I'd like this to be true, I'm sceptical.

    My theory is that voters, not understanding the nature of capitalised rents or the higher prices this sytem causes, would see this policy as a "tax hike on staple dairy products" to fund "kickbacks to Harper's farmer voters". Maybe lower dairy prices will reduce the strength of the first argument, but if dairy prices increase for some other reason, it'll be easy for voters and rival politicians to blame the tax hike (and/or the abolition of the cartel), so the risk is high. The second occurs because while the cartel is effectively a kickback to Canadian farmers, it's obfuscated, so most voters don't realise it or else think it's a side effect of a good policy (for "food security" or some other mumbojumbo). Write them all large cheques (that they don't even need to use to keep farming with) and it looks like an unwarranted gift to farmers with no public benefit.

  2. @Henry: Your answer is consistent with the reasoning behind opaque as opposed to transparent transfers.

    But I think Canada's past the tipping point where informed opinion's turned against continuation of supply management; it's real costs are becoming too apparent. What's keeping it in place is fear of backlash from dairy farmers, who are still very able to run a Bootleggers & Baptists campaign on this one. Compensating those harmed by the change takes the wind out of that.

  3. It's not mumbojumbo, we produce a quality product! Canadians are leaders in milk quality, animal husbandry and food safety. Abolishing the quota system will make us cut costs to compete with the Americans that will flood out border. I for one am not willing to take less care of my cows so we can all consume a cheaper product.

  4. Your comment tells me that you expect consumers really don't value the service you're providing. Otherwise, they'd stick with your product rather than buying cheaper imports.

    Would it make you happy if I put a 300% tariff on any of the input goods you use and claimed that my workers being happy justified forcing you to pay more?