Tuesday, April 26, 2011

Milk wars and Anti-Dumping

While there are many questionable assumptions in some economic theories, there are also many solid foundations to economic analysis. One of these was identified by Coles in its submission to the Senate inquiry into milk pricing (available in the Coles factsheet here).

The farm gate price dairy farmers receive is set by the world price because most Australian milk products are exported.

The first implication of this fact is that because prices are set by global markets, domestic buyers cannot buy at prices below the export market price - although they could perhaps be higher.

By following this logic Coles, or any other domestic dairy retailer, cannot exhibit bargaining power as a buyer from milk processors (or distributors). Dairy processors would simply sell all their products abroad, whereas the only alternative for retailers is to buy imported dairy products with associated freight costs.  Processors can then bargain the price up to the price of the retailers next best alternative of imported products. Thus, even though we are net exporters of dairy products we still pay a retail price for domestic dairy products very close to the retail price for imported dairy products.

And to provide further evidence against dairy industry claims, even if Coles did have market power, one must question why Coles would not already be getting milk for the lowest price anyone would be willing to produce for?

The sceptic in me might even go so far as to suggest that upsetting the political milk cart might have been a publicity strategy for Coles itself. News outlets have told the public that Coles is aggressively dropping prices for months now – all free of charge. You really can't buy publicity like that.

Of even greater concern than the media beat-up, and public perception of danger from falling milk prices, is that the law entrenches protection of local industries from international competitors through anti-dumping laws. As the Productivity Commission describes

Australia’s anti-dumping system seeks to remedy the injurious effects on Australian industry caused by imports deemed to be unfairly priced. It allows local industry to apply for anti-dumping duties on goods ‘dumped’ in Australian markets at prices below those prevailing in the exporter’s domestic market or to apply for countervailing duties on goods that have been subsidised by the government of the country of export. Where the dumping or subsidization results in material injury to local industry, anti-dumping or countervailing duties can be applied.

I would have thought that the Productivity Commission would at least understand that export prices cannot be above domestic prices.

In fact, I would have thought that the Productivity Commission would be more interested in local price impacts when the shoe is on the other foot – when it is our exporters who receive protections against foreign competition. For example, fruit and vegetable growers get massive protection from foreign food under the guise of pest and disease control. These producers get to sell to international markets at the global market price, but can sell to the local market at a higher price since there is not competition from imports. This explains why food in Australia and New Zealand can be so expensive even though we are massive food exporters.

The Productivity Commission’s second justification for anti-dumping has a lot more promise – that foreign government s have subsidised their own producers to give them an unfair advantage in global markets.

Yet I can’t help but feel that foreign producer subsidies give the same effect as foreign natural production advantages, such as mineral deposits, labour prices and skills, long term capital investments and so on. Such natural comparative advantages benefits all trading partners as well. So why are unnatural advantages achieved through subsidisation of one sector by others in that country not also beneficial?

These subsidies simply change the comparative advantages in production of different goods. Our response, rather than protect our now disadvantaged producers, should be to adapt to our new relative specialisation.

But what happens when the foreign country removes its subsidy?

The immediate impact is that the total level of production of both trading partners falls as the relative price of the subsidised good increases while the ability of other producers to increase production levels takes time to be realised through capital investments.

This shock will be felt in both countries but one must reason that such impacts will be mitigated by the subsidising country should they decide to cease their current policy. For example, they may phase out the subsidies over a long period of time to allow industry to adjust. The other trading partner also benefits from these decisions.

In this light we could argue that protection of industries from foreign subsidised competitors is a kind of economic insurance against foreign policy risk.

The final problem with anti-dumping laws is the enforcement. Don Boudreaux explains quite clearly how any subsidies other than a direct cash payment or tax break are almost impossible to define.

Another important reason springs from the fact that subsidies are surprisingly difficult to define and identify. The classic case of a government paying a producer a fixed amount of money per unit of output is straightforward. But beyond this blatant method of subsidizing producers, things quickly get fuzzy and foggy.

Does a government subsidize an industry if it cuts that industry's taxes?

How about if the government builds a first-rate system of highways, roads and bridges in proximity to the chief firms in an industry?

Is an industry subsidized if it benefits from a government-financed engineering school?

How about if some of the industry's firms are paid by government to build cutting-edge military equipment?

Are firms that depend upon export markets subsidized if their government provides a top-flight navy to ensure the safety of cargo ships sailing under that country's flag?

Do governments that use tax revenues to maintain law and order and ensure reliable enforcement of contracts subsidize businesses within their borders?

Answering such questions is surprisingly difficult. And, sad to say, if Uncle Sam commits himself to protecting American producers from foreign competition whenever that competition is subsidized, these producers will exploit the ambiguous nature of subsidies as they petition Washington for protection from competitive pressures. They will too freely and loosely allege that their foreign rivals are subsidized.

In the end, these laws and the controversy around milk prices is evidence that economic illiteracy is extremely common, and that political outcomes often override better economic outcomes. But we need to see these economic debates as they are – rent seeking behaviour of existing producers trying to avoid real competition.


  1. Good to see you back Cameron.

    It may surprise you to know that I spent the period between 1984 and 2000 as a Qld milk distributor.
    The supply chain is;
    producer - processer - distributor - retailer.

    The major retailers such as Coles Woolworths etc are extremely well organised and very professional, the major processers are multi national corporations who are also well organised and professional, the distributors are reasonably well organised, but the farmers are an unprofessional poorly organised group with deep divisions between states.

    In the colloquial - they are gonna get screwed. They got screwed in the deregulation of the industry, and now it will happen again for the same reasons. When the current farm gate prices come up for renegotiation, we will again see a jump in suicide rates in the industry as long term farmers fail in a market of falling milk prices.

    There are just some issues that fall outside of pure economic analysis.


  2. Hi

    it was quite challenging to read this. If you write for your self with no intention of getting non-economists to read your work then fine, but please try to write something clear and straight forward, rather than rely on the double negative implication.

    I'm left wondering what you think about things after reading it twice. Peters comments in contrast are quite readable and comprehensible.

    early on two examples are:

    "The first implication of this fact is that because prices are set by global markets, domestic buyers cannot buy at prices below the export market price - although they could perhaps be higher."

    one needs to think and reflect on what this means (or at least I did)

    "The implication which follows is that Coles, or any other domestic dairy retailer, or in fact domestic dairy retailers as a group, cannot exhibit market power as a buyer from milk processors"

    I really don't know for certain if I know what you want to say. While I don't request you write for the lowest common denominator your writing could be less like "comprehension yoga" and make the points clear simply. Or is there an ulterior motive in writing that is like following a road through the Dolomites?

    just a comment

  3. Thanks for the feedback obakesan. There is an art to explaining things well and concisely - an art that takes some time to learn. But I do assume readers have some degree of economic knowledge. It is not designed to intentionally confuse, but to intentionally make a specific point.

    In any case, I tried to make the text you quoted more clear.

    The point of the whole thing is that just because we export goods doesn't mean we get cheaper prices than the foreign buyers. In fact we can pay more. But when this situation occurs in reverse (foreign producers selling to us below their local price), our own producers get protection from a rather unworkable protectionist law

  4. Hi Cameron

    don't mean to be a nitpicker, but as a physical science graduate / a software developer and a bloger I know that writing for the public can be fraught. I continue to strive to develop my communication in the areas I write about to bring ideas to people who wouldn't otherwise consider these topics.

    Thanks for your paragraph clarifying it ...

  5. Peter, I appreciate your valuable input once again,

    I would say that my experience with farmers and farm lobby groups shows a massive diversity in the talents of the group. Many farmers treat their farm as a business, keeping up to date with innovations, investing for the long term, while many simply run the farm inefficiently as a family legacy. If farmers come under pressure as a group from the buyers of their products it is these inefficient operators who will be forced off the land to be replaced by better farmers.

    I have no problem with that. Consumers should not subsidise the lifestyle of lazy producers.

    One farmer's comment sticks in my mind. On a farm tour in the Darling Downs one cotton grower pointed to his neighbours property (massively paraphrased)

    "See that guy, he has no idea what he's doing. I could grow (insert forgotten quantity here) hectares of cotton yielding 10bales a hectare with the water he has. But all he has this year is a couple of hectares of sunflowers. As soon as he sells up I'm buying that farm."

  6. Cameron - you need to understand that different areas of milk production, produce at different rates and levels of efficiency. As a general rule it isn't so much the difference in the farmers, although that has a bearing. After all it's the cow that produces, the farmer just milks.

    It's fine if you don't want milk production in NSW, Qld, NT, and WA and are happy with all of our milk being produced in Victoria, because that is where the best dairy country is. It is also fine if you are ok with not having fresh milk available nationally, and instead using a uht version as it is in Europe, or a reconstituted milk mix as it is in Darwin, but this is a big country and carting reduced milk all over the continent may not be the best solution. People may not be ready to accept compromises in their milk just yet. Governments can be overthrown for less that stuffing up the milk supply.

    It is difficult to explain the dynamics with perishable goods like dairy products, where milk can be used for so many products, but the most important and the most lucrative is fresh milk. All of the custards, yoghurts, cream, butter, fromage fraiche, cottage cheeses, hard cheeses, powdered milk, condensed milk etc are really by-products of fresh milk production.

    I'm not saying that we can't do it better, and I'm not connected or unduly sympathetic towards farmers, but I will say that a purely analytical approach is destined to fail due to the nature of the product itself. If it was iron ore or mineral sand then stock piling and distributing would be fine, but a MASSIVELY high volume daily shop delivery short shelf life product has it's own peculiar challenges.

    Really I'm not disagreeing for the sake of disagreement. Milk is a big industry that can't change overnight.

    If there are changes, it won't be an economist or a politician telling the angry Mamas that their children will have to go without fresh milk or drink a lesser product, it will be the guy at the corner store who can't get supply because Coles bought up the whole supply and have it in a warehouse somewhere.

  7. Peter, if retailers really could control farm gate prices they would stop cutting prices once it became uneconomical to farm - you wouldn't want to screw your suppliers so much that no one is left to supply to you.