Canadian Dairy

Terrence Corcoran reports that Stockwell Day remains set on scuppering the WTO negotiations if Canada's ridiculous supply management system is put under threat. Effects of supply management in Canada?

Canada is a dairy industry production backwater. Over the last 10 years, the value of Canadian exports of dairy products has dropped by 30% to $255-million. Last year, Canada had a dairy product trade deficit of $422-million.

Supply management keeps Canada out of the world market for dairy products, although some plants do export to the United States and elsewhere under a bizarre program that in fact does nothing but protect consumers from low-cost made-in-Canada cheese and ice cream. It’s called the Imports for Re-Export Program (IREP).

Two IREP examples: There’s a Baskin-Robbins ice cream plant in Peterborough, Ont., that imports cheap American milk and cream at U.S. prices, turns the cheap milk into ice cream, and then exports the cheaper ice cream to the United States. But that cheaper ice cream cannot be sold in Canada. For Canadians, Baskin-Robbins has a separate production run that uses overpriced, supply-managed milk and it then sells overpriced Canadian ice cream. No wonder Canadian ice cream sales are falling.

At a Parmalat cheese plant near Belleville, Ont., American milk is used to make Black Diamond cheese for export to the United States. But the Black Diamond cheese made for Canadian consumers must use more expensive Canadian milk.

Even with the IREP import-export scheme, Canada’s cheese and dairy product manufacturing sector is going nowhere. A whole sector of the economy is stalled, unable to grow and expand nationally or internationally.

For most things, if you want to get a ballpark comparison from NZ to Canada, New Zealand is about order of magnitude smaller. Not on dairy though. 2007 dairy exports for New Zealand: $6.3 billion (about $4.5 billion Cdn). On that one, we're more than an order of magnitude bigger than Canada, or two orders of magnitude bigger than you'd expect given everything else about the two countries.

The Canadian ice cream manufacturing stories remind me of the stories of the bad old days in New Zealand, when a Kiwi entrepreneur realized he could make a lot of money by having a Japanese company disassemble the televisions coming off the end of the line, ship them to New Zealand, reassemble them here, and undercut the price of domestically produced TVs despite charging multiples of the world price: importing television parts was allowed, but not televisions. Writes Alan Gibbs in 1990:

Naturally, I and other manufacturers didn't rush out and tell you that. No fear.

We told you how indispensable we were to the New Zealand economy. In addition to enlisting the Manufacturers' Federation in our service, one of my businesses had a whole floor of people in a building on The Terrace who did nothing but tell politicians, bureaucrats and anyone else who would listen how valuable we were.

I am afraid, however, that the truth is that most of those businesses relied on heavy protection, they were a disaster for the economy, and ultimately when we had to shut them down, they were a disaster for us also.

A typical example was the television assembly industry.

We would go to Japan and explain to wide-eyed Japanese that our government wanted us to assemble their TV sets in New Zealand.

They could hardly believe their ears.

They said no one assembles Japanese TV sets. "Do you have cheaper labour?" they asked. "Make your own tubes? Transistors? Anything?"

"No," we said, "we just have to make them in New Zealand, and because there are only a few of us permitted to do this, we make good money doing it."

After much time and explanation and shaking of heads, the Japanese finally agreed to sell us the bits to assemble their sets in New Zealand.

However, they explained this was very costly.

They were making tens of thousands of sets a day and we only wanted parts for a few thousand each year.

At great cost they contracted outside people to come in, sort out all the pieces we needed and put them in boxes.

They got engineers to write out all the instructions in English for reassembly, and shipped them on their way.

Naturally, someone had to pay for this, and on average they charged us, as a special favour, 110 percent of the price of the finished goods - all boxed ready to go to the retailer - for the parts.

We then opened a factory, imported much machinery, paid the highest wages in the neighbourhood, employed the most intelligent engineers to decipher the instructions, used a great deal of electricity, and finally produced a TV set with negative New Zealand content at twice the imported price.

Thanks to Roger Douglas and David Caygill, that nonsense has gone in the TV industry and many others.

As a result, TV sets and many other goods have halved in price.

I think the saddest party in this story is not really the consumer who got ripped off but the people in that industry who worked their guts out but, due to no fault of their own, made no contribution to the society in which they worked in exchange for the goods and services they consumed.

They may as well have been digging holes and filling them in.

They were, in fact, on welfare and the welfare cost was much higher to society than the dole.

Gibbs there was in a debate on tariffs sponsored by Federated Farmers of New Zealand. The free traders won in New Zealand. Will Canadian dairy farmers ever stop being welfare bludgers? It's hard to imagine their ever even sponsoring an open debate on the topic.

Utility enhancing constraints and dairy

In his grad public choice class, Gordon Tullock liked to tell a story from his early career as a State Department official in China, where he was stationed prior to being overrun by the Communists (as best I understand the story).

He said it was common practice for labourers to pull barges up canals using ropes. Another worker would watch over them with a lash, making sure everyone was pulling hard. When he inquired into the practice, he found that the team was paid based on how quickly they would get the barge up the river. None of them, while pulling, could monitor the others to ensure nobody was shirking. And they all knew they'd be tempted to shirk absent a monitor. And so they found it beneficial to assign someone with a whip to watch over the team. The team chose one of their own to stand over them all with a whip, to make sure everyone did his share.

Bernard Hickey today points to more evidence of animal neglect and cruelty in New Zealand's dairy industry. If you go and read the horror stories, be sure to go for the unicorn chaser afterwards.

The Ministry of Agriculture and Fisheries has almost no staff assigned to check into animal welfare complaints. Fonterra, the large dairy cooperative that purchases the vast majority of milk produced in New Zealand, will not get involved in animal welfare cases except where a farmer has been convicted and has not fixed the problem that led to conviction. Of course, since there are almost no animal welfare inspectors, probability of conviction is slim.

Hickey worries that these stories could tarnish New Zealand's dairy image and hurt our position as the largest exporter of the world's traded milk. It's possible. I don't know the probability, but it's possible. Fonterra is residual claimant if New Zealand's dairy industry takes a big hit on this kind of issue. Sometimes, it's worthwhile for a cooperative to designate a whipmaster, and Fonterra seems well placed to take on the job if its shareholders/members want it.

If Fonterra doesn't want to act as whipmaster itself, is there anything that would stop Fonterra from voluntarily paying a levy to the government to fund the hiring of more MAF officers whose sole role would be ensuring animal welfare on Fonterra cooperative farms, then slapping some "animal friendly" stickers on all brands of Fonterra milk? Fonterra's annual turnover is $19.5 billion, with payout to shareholder members of about $9 billion. Would a million or two to equip a team of vets be all that costly in the grand scheme of things? What risk of PR disaster would be sufficient to make the expenditure worthwhile? If there's no impediment to this kind of thing, and Fonterra chooses not to do it, it suggests that Fonterra does not weigh terribly heavily the risks of brand deterioration due to some of its farmer members' rather terrible practices and sees little potential for selling premium "Don't be Evil" product.

Let's hope that Bernard Hickey is successful in making Fonterra deem these kinds of investments worthwhile.

Previous post: animal welfare.

Update: Bernard Hickey's links are broken; try here here here.

Transitional gains traps

I'm wrong about this, but I don't know why I'm wrong. I know that I'm wrong

1. Because it's never been done and
2. Because Tullock says there is no solution

But I don't know why I'm wrong. Maybe you can help me out.

Tullock in 1976 wrote about the Transitional Gains Trap. Suppose that the government puts in place a regulation that confers rents on a few companies. So each of those companies earns an extra $1 million per year, now and forever. The value of the new rental stream has to be capitalized into the price of the fixed asset that draws the rent. And so New York City taxicab medallions, which give their owners the right to run a vehicle as a taxicab, sell for about $750,000. The link is from the homepage of a firm that provides loans to help folks buy taxicab medallions. And in Canada's ridiculous dairy quota management system, the right to milk a cow costs about $25,000. The value of the rent gets capitalized into the asset that's in fixed supply: the permit to run the cab, the right to milk a cow, the land that's eligible for tobacco growing, and so on.

After that capitalization has taken place, the person benefiting from the rental flow is again earning only a normal rate of return on his investment. All of his gain was transitional: the rent-seeker gets a one-off increase in capital value, but no ongoing benefits. Of course, over time, ownership changes; the new owners never enjoyed the transitional gain and earn only a normal rate of return.

Tullock says that, as consequence, reform is well-neigh impossible. While the folks getting the rent are not made better off by it, getting rid of it would impose massive capital losses on them; they'll then lobby up to the expected value of the capital loss to prevent it. And, he says further that there's no way out of it.

The solution seems remarkably simple in principle; since it's not been done, I must be wrong.

For New York Taxis, the City of New York stumps up to buy out all existing medallion holders at a price equal to the average selling price in the quarter prior to folks started talking about a buy-out. They finance this rather large purchase ($750K times about 13,500 licenses = $10 billion) by a bond issue. They then put in place a specific sales tax on taxi rides that leaves the post-change price lower than the prices charged under the medallion system but nevertheless is sufficient to pay off the bond because of reduced deadweight losses and increased numbers of cab rides. The tax expires when the bonds are fully paid off.

The scheme compensates the losers from the change by a tax on the beneficiaries. In the absence of companies that exist solely to facilitate medallion sales, it would be Pareto efficient; instead, it's likely only Kaldor-Hicks. We could imagine some compensation to Medallion Financial Group, though, that would still make the whole thing Pareto.

In the Canadian dairy case, it would be much more complicated because of the way that the Canadian system runs cross-subsidies from "industrial" milk to consumer fluid milk: the tax would have to be on the portions of milk sales that currently earn a premium. Otherwise, it would be similar but would cost a lot more -- best guess, around $25 billion. 978,000 cows * $25,000 per permit.

Think about those numbers. The capitalized value of the rents conferred by the Canadian dairy system and the New York City taxicab system together amount roughly to thirty percent of New Zealand GDP. Ugh.

Ok, so why am I wrong? It looks Pareto to me. What am I missing?

American disappointments

I drove from Winnipeg, Manitoba to Fairfax, Virginia late in the summer of 1998 to start grad school at George Mason. I remember stopping in Pennsylvania (80% sure it was PA...it was a long drive) at a Sheetz gas station to fill up and finding a petition next to the gas bowser. Customers were invited to take away a form to mail to their Congressman protesting Pennsylvania's proposed move to mandate minimum gas prices, which Sheetz (a discount brand) rightly recognized as an attempt by the big guys to squeeze out the discounters. I was crushed. The Canadian press likes to paint the US as some horrible jungle of rampant individualism where government stays out of folks' way; I hadn't fully believed it, but I'd hoped for it.

Kiwis are experiencing similar disappointment currently. New Zealand had started talking about a free trade agreement with the US under each country's prior administration; things seemed to be moving forward with the change in administrations. And then the US pushes through massive dairy export subsidies. Says prominent Kiwi economics commentator Bernard Hickey:

I have previously argued in this piece “Why an American Free Trade is a ludicrous and dangerous idea” that it would be a mistake for New Zealand to negotiate a Free Trade Agreement with America. It would open the door for the lobby groups for US agriculture, pharmaceutical and movie/music interests to gut any deal so it was worthless, or even worse, force us to change our copyright laws and shut down Pharmac.

I said Americans lie and cheat on trade policy. They protest they want free trade, but regularly act to restrict trade and subsidise their exporters. Lobbyists dominate the trade agenda in America. Here is more proof of that.