Government Pricing Policies In The Dariy Industry

I grew up on a family dairy farm and have always known the government had some sort of control over the pricing of milk. I wasn't sure exactly how or why they decided to stick their nose into the dairy industry until just recently. The government started regulating milk prices back in the 1930's. I found an article written by Chris Edwards in June of 2009 that outlined 5 ways in which the government intervenes into the dairy markets.
The first way is through marketing orders. Marketing orders are essentially a minimum price set by the federal government. Two-thirds of the milk produced in the U.S. is sold under these marketing orders, with much of the remaining one-third sold under similar state government schemes. These marketing orders work essentially like cartels to limit competition. Entrepreneurs are not allowed to operate outside of the marketing order system to provide milk to consumers at a lower price. The system also prevents lower-cost milk from area's of more efficient operation such as the Midwest from gaining any market advantage over higher-cost milk from other regions.
The second way the government intervenes is through price support programs, which keep the price of milk artificially high by guaranteeing to purchase any quantity of milk produced at a minimum price. This program creates a steady demand and higher prices.
The third way the government intervenes is through an income support program. This program provides monthly payments to dairy farmers when the market price drops below target levels. These payments tend to encourage overproduction which as we learned drives the price of milk down.
The fourth way is through trade barriers which limit the amount of dairy products that can be imported into the U.S. These barriers are intended to keep prices artificially high.
The fifth method used by the government is export subsidies. This method is used to entice the dairy industry to export milk. It is necessary because with the artificially higher prices received in the U.S. nobody would want to export any milk and receive a lower international price.
I remember a few years back the government sponsored a milk buyout program trying to reduce the amount of milk being produced to give a higher price to the dairymen. Under the buyout program producers were paid higher than normal prices to send their milk cows to slaughter. They had hoped this decrease in cows would decrease milk production. Their idea was a complete failure. Producers saw the buyout as an opportunity to get rid of their low producing cows at a better than normal price and in turn used that money to buy better replacement heifers. The program actually ended up hurting dairy producers that didn't participate and also beef producers because the beef market was flooded with dairy cows causing the price of beef to go down.
All these different government programs make one wonder what it would be like if the government didn't step in and regulate things. They have probably saved many small family dairy operations such as my family's or at least prolonged their existence. At any rate they are costing the consumers lots of money every year.


Xavier said...

I grew up working on a farm as well, so government intervention related to agriculture has been interesting to me as well. My dad is a hay farmer and most of the hay he sells is to dairies, so his business has been impacted by the items discussed in the original post. Certainly the price of hay would have fallen during the time that the government tried to reduce the amount of milk produced, since many of the cows were going to the slaughter rather than eating hay to produce milk like they normally would in a market without intervention. The sticky part about the government subsidies and price floors and ceilings is that those actions cannot be done in isolation. The market as a whole will in some way or another be impacted, even if there is only intervention with the dairy industry.

Dr. Tufte said...

-1 on Farva for spelling.

I think this is a generally excellent essay. What an MBA student should take away from this is not a suspicion of the government as some omnipotent mover and shaker, but rather a recognition that most of their policies are bumbling at best, and destructive at the worst. This is what happens when economic policies are designed by people who are not conversant in the basics of managerial economics.

I would correct Farva a bit: marketing orders are not like cartels, but more like price floors. There are a number of similarities. Both lead to higher prices, and push some marginal people from buying to not buying. But they are different too: price floors create excess supply (a big problem in the dairy industry), while cartels limit excess supply temporarily, while diverting that pressure into the forces that will break down the cartel.

BTW: how's this for government idiocy? At the national level, for many decades, marketing orders determined the price of all milk nationwide by the distance of the retailer from Eau Claire, Wisconsin. Nothing in their about costs, demand, tastes and preferences, refrigeration costs, or spoilage realities in sub-tropical climates.

A good metaphor for Xavier's position is that the economy is like a water balloon. Government regulatory policy is like squeezing it on one side. This causes bulges on the other side. But, you can't solve that problem by squeezing that bulge because it will just come out in another spot.

Lando said...

This was a great post by Farva. We have had experience with the dairy buyout in the past. However, in the dairy buyout, dairymen where asked to pay into the buyout program administered by the government. All of our milk is shipped to Gossner foods and Gossner foods did not require us to pay into the buyout program. DFA did require that all dairies that produced milk for them, must pay into the program. The last year we paid into this useless program was in 2008 where we pulled 20,000 off of the bottom line to pay in. We then realized that this will never work for one reason:
Sexed semen – Large dairies make their revenue off of milk volume sales. Dairies get milk only from females. So what does the dairyman want when their cows produce offspring? Heifers. Due to innovations in technology dairies are able to use sexed semen to artificially inseminate their cows and generously increase the likelihood of getting heifers. This allows the dairy that is doing the buyout to sell all of his cows at a premium, then when he is able to, bring back his cow numbers very rapidly. So after a few years, we would still have the same number of producing cows, and whoever does the buyout makes out well, and those who paid into the program trying to help get burned.
Related to economics, the governments goal is to reduce milk supply to increase price, the problem is that when that supply curve shifts, it does not stay shifted long before it is back to where it once was.

Lando said...

Question Dr. Tufte:
Can we edit a comment we have made on someone's post? I cannot see how. My comment should have the word foods capitalized in Gossner Foods. Thanks.

Dr. Tufte said...


1) You can't directly edit a comment.
2) I accept comments made like the last one indicating that you would change an error if you could. But I prefer that you:
3) Copy your comment to the clipboard, open Blogger.com, delete the comment, open a new comment, paste in your old comment from the clipboard, and correct your error before saving. You may notice that there are a few comments here and there that say "removed by the author" or some such. That's what they did.

Dr. Tufte said...

I loved the end of Lando's (main) comment.

It is very typical of regulation that this sort of thing happens with supply (or demand for that matter). Broadly, it's called regulatory capture.

Specifically, it usually results from the fact that the business is maximizing profits, while the bureaucrat is maximizing ... something ... I dunno' ... job security maybe. The point is that the regulator doesn't have an incentive to keep the profit maximizing business from gaming the regulation.