November 9, 2006 No. 24

The U.S. dairy program, administeredthrough federal and state governments,subsidizes milk production and regulatesdairy prices. The current system costs tax-payers more than $4 billion per year in sub-sidies and adds millions of dollars to thegrocery bills of American consumers andto the costs of food product manufacturers.

By boosting prices, the dairy programencourages overproduction. It also penal-izes more efficient farmers in the futileattempt to prop up smaller dairy farmersand stem the tide of decades of changes inthe dairy market.

In order to preserve domestic pricesabove the world prices for dairy products,the U.S. government maintains prohibi-

tively high tariffs on imported dairy prod-ucts. That invites scorn and retaliationfrom our trade partners and is one moreagricultural program that exposes theUnited States to charges of hypocrisy as itseeks to paint itself as a country in favor offree markets and opportunity for all.

A better policy would be one thatallows farmers to make their living, likeother entrepreneurs, from markets ratherthan a government check. As Congressprepares to draft a new farm bill, worlddairy prices are unusually strong. Thus,this is the perfect time for the govern-ment to fundamentally reform dairy pol-icy in the United States with minimal“disruption” to dairy farmers.

Milking the CustomersThe High Cost of U.S. Dairy Policies

by Sallie James

Sallie James is a policy analyst with Cato’s Center for Trade Policy Studies. Herarticles have been published in the Australian Journal of Agricultural andResource Economics and the European Review of Agricultural Economics.

Executive Summary

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Introduction

The American dairy industry operates underone of the most complicated programs in U.S.agricultural policy. Using a complex system ofprice supports, dairy market loss payments, fed-eral and state marketing orders, classified pric-ing, and export subsidies, the government sup-ports the dairy industry from behind a tariff walldesigned to insulate U.S. dairy producers frominternational competition and to prevent theentire house of cards from crashing down.

By keeping prices artificially high, guaran-teeing income supports, and preventing importcompetition, U.S. dairy farmers produce dairyproducts regardless of market demand. Thatencourages overproduction, which puts furtherstrain on the price-support system and thestocks of dairy products the government mustbuy to maintain it. Consumers of dairy prod-ucts and food processors who use dairy prod-ucts as inputs pay above-market prices, whichcreates welfare losses. Taxpayers must foot thebill—to the tune of more than $4 billion peryear—for dairy programs that provide over 40percent of dairy farmers’ incomes and depressworld prices through exports of subsidizeddairy products.

The dairy program in the United States ispartly a reaction, and certainly a key contributor,to the gross distortions in world dairy markets.The global dairy trade is characterized by veryhigh tariffs and restrictive tariff rate quotas, evenafter progressive liberalization from previousmultilateral trade negotiations. The global mar-ket for dairy products is, consequently, “thin,” inthat only 7 percent of global dairy production(measured in milk equivalent terms) is traded.1

Exports are dominated by a few main exporters,so fluctuating supplies from those countriescause volatile movements in prices.

The Doha round of trade talks amongWorld Trade Organization members, suspend-ed indefinitely, could have made inroads to cor-recting the inefficiencies in world agriculturalmarkets, including dairy. For example, WTOmembers had agreed at the Hong Kong minis-terial meeting in December 2005 that they

would cease all export subsidies by 2013. Thatagreement was meaningful because dairyexport subsidies, especially from the EuropeanUnion, are a major contributor to global dairymarket disarray. But that pledge may be aban-doned unless the Doha round can be revived.

Congress is due to draft a new farm bill in2007. That presents an opportunity for policy-makers to play their part in correcting the dis-tortions in dairy markets at home and abroad.It is an opportunity that Congress can seizeregardless of what, if anything, eventually hap-pens in the Doha round. By significantlyreforming the U.S. dairy program, the govern-ment could reduce the burden on taxpayers andconsumers, including downstream industries inthe food-processing sector. Current policy con-tributes to disarray in world markets for dairyprices, aggravates our trade partners, andinvites retaliation from them in the form ofdispute settlement action. It also contributes tothe rancor over global trade liberalization andtherefore is a burden to U.S. consumers andindustries that would benefit from freer andmore open markets in other sectors. Almostone third of the amount that the United Statesis allowed to spend on trade-distorting supportis spent on dairy programs. The significantcosts of supporting dairy farmers demand fun-damental reform of the current policy.

This study will provide a background on theU.S. dairy program: how it began, its objec-tives, and how its various elements contributeto market distortions. The costs to consumers,taxpayers, and trade partners will be explored.The study will conclude by suggesting changesto the dairy program that would better serveAmerica’s interests.

A Dairy Program Designed for Another Era

Like many of the commodity programs inplace today, U.S. dairy policy originated in the1930s. The dairy price-support system wasauthorized by the New Deal–era AgriculturalAdjustments Act of 1933, which was part of abroad program to control supplies and prices

2

The significantcosts of supporting

dairy farmersdemand

fundamentalreform of the

current policy.

3

paid to producers. The depressing economicconditions of that time, combined with a lack ofprocessing and storage capacity, led Congress tocreate the Federal Milk Marketing Order sys-tem (explained below) in 1937. In 1949,Congress made the milk price support programpermanent, with the ostensible purpose of assur-ing an adequate supply of milk and a level offarm income to maintain productive capacitysufficient to meet future needs.

The 2002 Farm Bill (more formally, theFarm Security and Rural Investment Act of2002) removed the permanent authority givenby the 1949 act, but did renew the programuntil the end of 2007.There have been changesin the milk price support program over theyears, bringing it to a lower “safety net” level,and changes in the minimum prices of butterand skim milk powder (also called nonfat drymilk). Congress and the U.S. Department ofAgriculture have regularly tinkered with thefederal milk marketing orders (which establishminimum prices that handlers must pay formilk). However, the type of support given tothe U.S. dairy industry is largely unchangedsince the early 1930s, and the market remainsextremely distorted.

The Federal Agriculture Improvement andReform Act of 1996 reduced the dairy sup-ports and specified that they should be com-pletely eliminated in 1999.2 However, fallingdairy prices in the late 1990s saw Congressauthorize emergency dairy support in two stepsto the end of 2001, and then to the end of 2007through the 2002 Farm Bill.3

If the nature of government intervention islargely unchanged from the depression era, thedairy market itself is not. Shifts in consumptionpatterns, technology, and production methodshave made the price controls and other inter-ventions of the government increasingly damag-ing. On the demand side, consumption of dairyproducts has changed from primarily fluid milkto more cheese and processed products. In the1930s, fluid milk made up over 60 percent of thetotal amount of milk sold, whereas only 36 per-cent of milk was consumed in fluid form in2002.4 Additionally, consumption patterns haveshifted from retail (direct) sales to restaurant and

food processor use.5 The federal milk-marketingorders impose higher costs on consumers wholive further from certain milk producing areas.The shift in consumption from highly perish-able, fluid milk to more processed products hasled to an increase in demand for ingredientssuch as milk solids and protein products. Thecurrent price support system, with its emphasison fluid milk products, discourages farmers fromproducing those niche products experiencinggrowing demand.6

On the production side, there has been anincrease in the average farm size and consoli-dation of the industry, with more of thenation’s milk being produced by fewer, butlarger, farms. Since 1980, the number of dairyfarms has fallen by over 70 percent. There arefewer dairy farms overall, but the average sizeof dairy farms is increasing: from an averageherd size of about 30 cows in 1980 to morethan 100 milk cows today. Technologicalchange, economies of scale, and increased pro-ductivity have led to a large concentration ofproduction: 3 percent of all dairy farms (thosewith more than 500 cows) produce over 40percent of all milk in the United States.7 Asimilar trend can be seen in processing, manu-facturing, and distribution plants, where plantshave become larger and fewer.

There has also been a regional shift in dairyproduction: less expensive land, larger access tolabor and feed, and a more favorable climatehave led to a shift to the west and southwest ofthe country. California has been the largestmilk-producing state since 1994, overtakingtraditional dairy areas in the Upper Midwestand Northeast.8 Improved processing, trans-portation, and storage techniques mean thatdairy markets are regional, if not national, inscope.

In an effort to prop up the less productiveareas of the country, policies such as the feder-al milk-marketing order system stifle innova-tion and prevent the most efficient producersfrom growing. And the original goal of thedairy program—to ensure adequate supply ofmilk—is no longer relevant. Indeed, theUSDA states that “[the] market . . . is growingmore slowly than milk production capacity.”9

Shifts inconsumptionpatterns,technology,and productionmethods havemade price controls and otherinterventions of the governmentincreasinglydamaging.

Objectives of the DairyProgram

U.S. dairy policy is pursued through twosomewhat linked objectives: price or incomesupport and regulated or “orderly” marketing.Price and income support are provided by theMilk Price Support Program, the Milk IncomeLoss Contract, import barriers, and the DairyExport Incentive Program. Federal and statemarketing orders regulate markets.

Price SupportUnder the Milk Price Support Program,

also called the milk support purchase program,the Commodity Credit Corporation will buyany amount of cheese, butter, and nonfat drymilk offered for sale at specified prices (cur-rently $1.05/lb. for butter, $0.80/lb. for nonfatdry milk, $1.1314/lb. for block cheddar and$1.1014/lb. for barrel cheese) from processors.The MPSP is designed to ensure that the aver-age plant that produces those items will be ableto pay dairy farmers the announced support

price for the milk they supply. Instead of buy-ing fluid milk to support the price, the CCCthus indirectly places a floor on the price ofmanufacturing milk, by creating guaranteeddemand for the products for which it is aninput.The 2002 Farm Bill set the support pricefor milk at $9.90 per hundredweight (hundredpounds) until 2007.

Although the prices that the CCC will payfor products are allowed to be reviewed semian-nually, the prices are, according to the Office ofManagement and Budget, “out of alignmentwith each other and their respective marketprices.”10 That is to be expected when govern-ments intervene in markets: bureaucrats respondmuch more slowly than independent actors in amarket. One can be almost certain that milkprices in a free market would fluctuate moreoften than twice a year. In any event, as Figure 1shows, the U.S. domestic price of manufacturinggrade milk (the average price paid for milk thatcan be used only in butter, powder, and cheese)has generally been above the support price sinceabout 1990, due to the influence of yet otherpolicies and market-driven premiums.

4

The prices that theCCC will pay for

products are,according to the

Office ofManagement and

Budget, “out ofalignment with

each other and theirrespective market

prices.”

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Support price

Average annual m-grade price

Figure 1U.S. Annual Support Price and Average Annual Manufacturing Grade Milk Price,1990–2004

Source: U.S. Department of Agriculture, National Agricultural Statistics Service, QuickStats website,www.nass.usda.gov.

U.S

. Dol

lars

Year

Trade BarriersIn practice, the milk price support program

has been playing a relatively minor role inkeeping the domestic U.S. price for dairy prod-ucts above the world price, at least in recentyears.11 Far more important are the importrestrictions that prevent cheaper products fromcountries such as Australia and New Zealand,and from the heavily subsidized EuropeanUnion, from entering the U.S. market.

Domestic price supports would be impossi-ble if imports were unrestrained, because thenthe price floor would be undermined by cheap-er imports. Imports of dairy products to theUnited States are limited by a series of tariffrate quotas, which establish a two-tier systemof tariffs: a certain threshold amount ofimports is allowed to enter duty free or at areduced tariff rate (called the “in-quota rate”),whereas imports above that quota enter at ahigher, often prohibitive, rate. Most out-of-quota tariffs are specific tariffs (i.e., specified asa certain dollar amount per unit). Table 1shows the general (i.e., most-favored-nation)tariffs for certain dairy products.

In addition, some dairy products are subjectto “special safeguards,” whereby temporary addi-tional duties may be applied to the out-of-quota(i.e., higher) tariff rates to prevent low prices orimport surges from “injuring” a domestic indus-try.These prevent especially competitive importsfrom reaching U.S. food processors and con-sumers, who would benefit from lower prices.

The effect of these tariffs is, not surprising-ly, very little import penetration. Butter is themost commonly imported product, albeit withan import share of only 7.3 percent of produc-tion. Cheese imports are equal to slightly lessthan 5.4 percent of production.

Although the value of imports to the UnitedStates is growing (by 18 percent between 2003and 2004), this is primarily due to higher inter-national prices for dairy goods, because the vol-ume of dairy imports that year increased by only4.6 percent.

Income SupportThe Milk Income Loss Contract is an

income-support program that provides monthlypayments to milk producers when market pricesfall to a certain level. The MILC program wasintroduced in the 2002 Farm Bill: prior to that,direct payments from the government to dairyfarmers were in the form of ad-hoc “supplemen-tal” or “emergency” payments (introduced in fis-cal year 1999 and renewed until FY01) thatdairy farmers successfully sought to make per-manent. MILC is separate from the dairy pricesupport program outlined above but has an indi-rect (and undermining) effect on milk prices byencouraging production. The MILC programexpired in September 2005, but Congress,through budget appropriation legislation passedearly in 2006, extended the program untilAugust 2007. MILC payments are limited: theycover eligible milk production up to 2.4 million

5

Import barriersprevent especiallycompetitiveimports fromreaching U.S. foodprocessors andconsumers, whowould benefit fromlower prices.

Table 1U.S. Tariff Rate Quotas on Selected Dairy Products

Product In-Quota Tariff ($/kg) Out-of-Quota Tariff ($/kg)

Fluid milk, 1-6% fat 0.043 0.15Cream 0.032 0.772Butter 0.123 1.541 to 1.646Skim milk powder 0.033 0.865Whole- and butter- milk powder 0.137 1.556Cheddar Cheese 10(%) 1.227American-type cheese 10(%) 1.055

Source: Harmonized Tariff Schedule of the United States, chapter 4 and additional notes.

pounds per operation per federal fiscal year.Farmers receive MILC payments when a refer-ence market price falls below the target price of$16.94 per hundredweight and the payment isequal to 34 percent of the difference betweenthe two prices multiplied by the amount pro-duced (up to the 2.4-million-pound limit).12

The program shields farmers from theeffects of “price volatility,” but only on the neg-ative side. Thus it really only protects againstprice falls rather than volatility per se. Asidefrom being unfair (how many other non-farm-ing entrepreneurs in America receive govern-ment insurance against the inherent risk ofrunning their own business?), this asymme-try—making payments when prices fall belowa certain level, but not requiring anything offarmers when prices rise—creates productiondistortions and moral hazards (i.e, it createsincentives for farmers to be less careful aboutproduction decisions). It also costs a consider-able amount of money—an estimated $425million in FY06 and $502 million in FY07—and has cost more than $2 billion since 2002.13

Outlays on the MILC program have occasion-ally been lower than the revenue raised by dis-posing of surplus inventory (as in FY04, forexample), so that the net outlays have beennegative. But that situation is the exceptionrather than the rule and does not take intoaccount the deadweight losses to society frominefficiencies and distortions and the damagedone to the milk price support program (seebelow). Figure 2 shows the net outlays by theCCC on all dairy programs (i.e., price support,MILC payments, and dairy export subsidies).

Market (Dis)ordersThe Federal Milk Marketing Order system

aims “to promote orderly milk marketing rela-tionships to ensure adequate supplies of milkand dairy products to meet consumers’ demandsat reasonable prices.”14 FMMOs were estab-lished in the 1930s as a response to peculiarcharacteristics of the milk market: the perisha-bility of milk, the perceived monopsony powerof milk buyers, and temporal patterns of milksupply and demand. It sets minimum regional

6

Making paymentswhen prices fall

below a certain levelbut not requiring

anything of farmerswhen prices rise

creates productiondistortions andmoral hazards.

Figure 2Net Outlays by CCC for Dairy Programs

Source: Keith Collins, chief economist, USDA, Testimony before the Senate Committee on Agriculture, Nutrition andForestry, presented by Joseph Glauber, July 20 2006, http://www.usda.gov/agency/oce/newsroom/congressional_testimony/Dairy%20Testimony7-20-2006.pdf. Figure for 2007 is an estimate.

prices of milk according to its different uses.Thefour classes of milk established by federal ordersare as follows:15

Class I – plain and flavored whole milk andfat-reduced milks,Class II – milk used for cream,cottage cheese,frozen desserts and other food products,Class III – milk used to produce hard cheesesand cream cheese,Class IV – milk used to produce butter, andany milk product in dried (e.g., powdered)form.

The prices of Classes II, III, and IV are thesame nationwide and are calculated by the USDAusing impenetrable formulae—hardly a model of“orderly marketing.” Class I attracts the highestminimum price, and is equal to the highest of theClass III or IV price plus a location differentialthat varies from region to region,usually accordingto how far the production region is from the milksurplus regions of the Midwest and West.Ostensibly, this is to ensure that adequate suppliesof fresh milk are available in densely populatedconsumption areas, which historically were a longdistance from where production and processingoccurred. By setting a higher minimum price formilk, the FMMOs try to encourage the move-ment of milk from areas where it is plentiful towhere it is relatively scarce. Over 80 percent ofmilk produced in the United States is marketedunder regulated pricing systems (both federal andstate marketing orders). Milk prices vary withinthe United States, partly because of these market-ing orders and the restrictions on moving milkfrom one order area to another.16 The restrictionsalso prevent consumers from enjoying the benefitsof competition because lower-cost milk frommore efficient milk-producing regions cannot besold at a price below the government-mandatedminimum in any region.

Mandating a higher price on fluid milkmakes sense if the government’s aim is to trans-fer wealth from consumers to producers: sincedemand for fluid milk is less price-elastic, fluidmilk can ‘absorb’ higher prices with a relativelymild effect on demand. Aside from transferringwealth, however, there is no reasonable rationale

for mandating a higher price for fluid milk thanfor other products. If consumers demand freshmilk they will pay a price to have their demandmet. Producers would adjust the ratios of thegoods they produce in response to marketdemand rather than an obscure government for-mula.

The FMMO system is especially redundantnow that some of its original aims—to accountfor the perishability and high transport cost ofmilk, and the buying power of milk buyers—areof lesser importance. Transport, production, andstorage technologies have evolved to reduce prob-lems with perishability.Farmers’ cooperatives thatpool resources to market their milk have lessenedthe disparity in market power between farmersand dairy product manufacturers.

Rather than pay producers directly for theirmilk, FMMOs use revenue or price pooling,whereby each producer within an order area ispaid a uniform use-weighted average or“blended” price. Total receipts in each orderarea are calculated by multiplying the classprices by the amount of milk used in each class.Then, total receipts are divided by the amountof milk (in hundredweights) sold to handlers,so that a blended price per hundredweight isestablished. In that sense, it does not matterwhat products are made from each individualproducer’s milk; the same minimum blendedprice is paid to each producer in an order area.

In practice, market conditions and contrac-tual arrangements mean producers generallyreceive a higher than minimum price for theirmilk. This is called the “over order premium”and will flow directly to the producers or coop-eratives supplying the milk (i.e., it is not sharedby all producers in a market area). Presumably,the market will continue to provide “premiums”when demand for products of a certain qualityexists, and thus there is no reason to continuethe FMMO system that is based on 1930sideas, technology, and market conditions.

Export SubsidiesThe support price, when it is effective,

makes it uneconomic for American exportersto sell their products abroad because domesticprices are higher than world prices. The Dairy

7

The Federal MilkMarketing OrderSystem is based on1930s ideas,technology, andmarket conditions.

Export Incentive Program aims to “developexport markets for dairy products where U.S.products are not competitive because of the pres-ence of subsidized products from other countries.”17

The rationale, implied in the DEIP’s missionstatement, is based on supposedly unfair exportsubsidies from other countries (notably theEU). The DEIP was first introduced in the1985 farm bill and subsidizes the export ofselected dairy products by giving exporters ofdomestically sourced products a check to allowthem to sell their goods abroad at world priceswithout incurring a huge loss. By removingsurpluses from the domestic market, the DEIPmay, like the foreign aid program, indirectlyplay a role in the milk price support program.

WTO commitments to reduce export subsi-dies as well as domestic support (discussedbelow) constrain American outlays on theDEIP. The Federal government spent approxi-mately $55 million in 2002 under the DEIP.18

In recent years, however, world dairy prices haveincreased such that spending on the DEIP wasnegligible in 2004 and 2005.19 For example, theworld price for nonfat dry milk (skim milk pow-der) increased by almost 30 percent between2003 and 2004, cheese by 55 percent, and butterby 39 percent.20 Consequently, the USDA didnot provide any export subsidies for nonfat drymilk in 2005, and subsidized only cheese in thatyear (albeit to the maximum level allowableunder WTO rules).21 As countries cut globalexport subsidies because of their trade liberaliza-tion commitments, world dairy prices are likelyto trend higher and the USDA expects favorableconditions for U.S. exporters of dairy products inthe years ahead, continuing recent impressivegrowth in dairy exports.22 Now is the time toremove a redundant and potentially costly pro-gram that damages international relations.

In addition to the policies outlined above,dairy farmers also benefit from ad hoc “emer-gency” assistance and “market loss payments,” aswell as general farm provisions such as subsi-dized electricity and water. Dairy cooperativesalso are exempted conditionally from anti-trustprovisions, as regulators believed that grantingoligopoly power to cooperatives would addressthe buying power held by processors.

Peculiarities/Perversions in the ProgramNot surprisingly, these interventions in mar-

kets cause many problems, some of them over-lapping and others in direct conflict. Considerthe perverse effects of the Milk Income LossContract and dairy price support, for example.One (the MILC) encourages overproduction,which causes downward pressure on the price,while the other (the Milk Price SupportProgram) attempts to hold the price up. TheUSDA itself has acknowledged the perversity ofthis situation:

The price support program establishes asafety net floor under milk prices— pricesare allowed to fall enough to induce a cor-rection in oversupply or underconsump-tion. However . . . the results are partiallymuted by the MILC program, which, byproviding production-linked funds tomilk producers, may encourage produc-tion and retard the supply adjustment.The result is that milk prices stay lowerlonger than they otherwise would,increasing the likelihood of larger CCCpurchases, and raising government costsfor both programs.23

Paying above-market prices for dairy goodsimposes significant costs on consumers. TheOrganization for Economic Cooperation andDevelopment estimates that in 2004 the U.S.Consumer Support Estimate for milk, which (ifnegative) is a measure of the burden on con-sumers from agricultural policies that createhigher prices, was –26 percent.24 That meansthat there was an implicit tax on milk of 26 per-cent of consumption expenditure, at farm gateprices (i.e., what the farmer receives). In 2004,the average all-milk price paid to dairy farmerswas $16.13 per hundredweight. Given that thereare, on average, 11.6 gallons in a hundredweightof milk, then a gallon of milk at the farm gatecost $1.39. The implicit tax therefore amountedto 36 cents per gallon. Assuming that tax ispassed on to the consumer, the average Amer-ican paid “tax” amounting to $7.56 in 2004(assuming the average consumption of about 21gallons of milk),25 or about $30 per year for a

8

Paying above-market prices for

dairy goods imposessignificant costs onconsumers: in 2004

the implicit tax ondairy consumption

was 26 percent.

family of four.That implicit tax does not includeany “taxes” paid on other dairy products, such ascheese and butter.

By raising prices above the competitivemarket-clearing level, the price support provid-ed by the MPSP, the FMMOs, and the DEIPand import restrictions creates surpluses. Thesurplus milk is then diverted to the productionof other, more storable products such as cheese,butter, and milk powders and concentrates.Thus, the price supports generate a kind ofcross-subsidy whereby consumers of premium(in this case fluid) dairy products subsidize theproduction (and therefore the producers andconsumers) of lower-priced manufacturedproducts. A World Bank study has suggestedthat this implicit consumption cross-subsidycould be construed as an export subsidy if theUnited States then exports the lower-pricedmanufactured products.26

The FMMO system in particular adds tothese production distortions by pooling theprices received for milk. Absent the distortionscaused by U.S. dairy policy, farmers wouldrespond to the marginal price offered for theirproduct. But under the FMMO system, theprices paid are a blended price of all milk class-es. The price received by any farmer is thus anaverage price rather than a price based on theactual use of their milk. If their milk did not goto a processor for fluid milk production, butother farmers’ milk in their order area did, theywill respond to a blended price that is higherthan the value that the market assigns to theirparticular product.

Some of the products that the governmentbuys from dairy farmers to support prices arenot sold on the domestic or international mar-ket at all: they are given away as food aid or asdomestic drought relief. This can have unin-tended consequences. For example, in 2003,following a drought in some Plains states, thefederal government gave farmers and rancherspowdered milk from the stockpile accumulatedthrough the price support program. USDAbureaucrats thought the farmers could use themilk to feed livestock. Instead, some farmerssold the powdered milk, for windfall profits, ina secondary market that reached non-drought-

stricken states and other countries such asMexico and New Zealand.27

Federal Milk Marketing Orders have alsoled to perverse consequences for dairy manu-facturers. When the government sets the min-imum prices that processors have to pay formilk, they provide for a “make allowance,” apart of the pricing formula that takes intoaccount the cost of turning raw milk into amanufactured product. However, the cost datathat is used to calculate the allowances is fromthe late 1990s and does not reflect the costs ofproduction today. Dairy processors are losingan estimated $26 million per month as long asthe data remain out of date.28 Surely a freemarket system that allows contractual arrange-ments that are negotiated directly betweenproduct manufacturers and sellers of milkwould provide a far more “orderly” way of mar-keting products.

The USDA has admitted to the futility ofthe dairy program in the United States:

Because they have modest effect on pricesand returns, Federal dairy programs havea limited impact on profitability and via-bility of dairy farms…by increasing farmlevel returns, these programs may enablehigh-cost farms to remain in the businesslonger, but only in the short to mediumterm. In the longer run, high-cost farmswill have difficulty competing with low-cost dairy producers.29

Note that in this context, “Federal dairy pro-grams” do not include trade barriers, which, asdiscussed above, are the main source of protec-tion and support to American dairy farmers.

Even with the trade barriers in place,though, the market seems to be a step ahead ofthe government. Milk protein concentrates,which are extracted from fluid milk and used incheese production and other manufacturedproducts, are efficient to ship long distancesbecause most or all of the water has beenextracted. Imported milk proteins are typicallycheaper than domestic milk solids. And, so far,the government has not been able to restricttheir entry using tariffs or tariff rate quotas

9

The USDA hasadmitted to thefutility of the U.S.dairy program:“Federal dairyprograms have alimited impact on profitability and viability ofdairy farms.”

because the products were developed after thescheduling of concessions in the WTO. Inother words, most of the products under dis-cussion were not invented when the tariffswere put in place and WTO rules prohibit newimport restrictions.

Consequently, imports of those products areincreasing rapidly—imports doubled from 1998to 1999 alone—and thus are undermining theprice support system, according to dairy farm-ers.30 Although the growth in imports of theseproducts has fallen somewhat since the peak of2000, the National Milk Producers Federationwas concerned enough to file a formal challengeto the way that the U.S. Customs Service classi-fied dairy products as a way around the lack oftariffs. That challenge was unsuccessful, but theNMPF has indicated that it will appeal thedecision.31 Previously, they had lobbied the fed-eral government to consider imposing anti-dumping and countervailing duties.32

As the Farm Bill comes up for renewal andas lawmakers look for ways to reduce the bud-get deficit, the dairy program is a prime exam-ple of a policy that belongs in a bygone era. Itis in America’s interest to remove a programthat the Office of Management and Budgetsays is “causing unnecessary expenditures,product accumulation well above use, and sig-nificant market distortions.”33

Does the U.S. Dairy Program Squarewith WTO Commitments?

In addition to the costs of U.S. dairy pro-grams to domestic consumers, taxpayers, andfood product manufacturers, U.S. dairy policiesare damaging to our trading relationships. TheUnited States agreed, as part of its commitmentsunder the Uruguay Round of the GeneralAgreement on Tariffs and Trade (the predeces-sor to the WTO), to freeze and then reduce thevalue of its agricultural export subsidies by 36percent over a six-year period. The current ceil-ing is $594 million per year for all 13 agricultur-al commodities covered by the commitments(the Agreement on Agriculture precluded thesubsidization of commodities not previouslysubsidized). According to the last export subsidynotification made by the United States (cover-

ing 2002), the total spending on agriculturalexport subsidies was $31.5 million, all of that onbutter and butter oil, skim milk powder (whichcomprised the greatest share of subsidizedexports on a volume basis), and cheese.34

Recently, the international markets have beenstrong and yielding prices above the supportprice in the case of nonfat dry milk, so govern-ment outlays on the DEIP have been relativelylow. The latest information available from theUSDA’s Foreign Agricultural Service indicatedthat the total spending on the DEIP in the fis-cal year 2004 was $2.68 million.35

It thus appears that the United States isprobably within its commitment levels forexport subsidies. However, export subsidies areamong the most trade-distorting kinds of sub-sidies. The fact that other WTO members,such as the EU, continue to use export subsi-dies does not excuse the United States frompursuing its own destructive and misguidedpolicies, even if the spending is within the legallimits established by the WTO. The DEIP is aredundant and inflammatory policy and shouldbe abandoned immediately.

The Uruguay Round negotiators also includ-ed a limit on the amount of trade-distortingsupport the United States could pay its farmers(trade-distorting support is that in which thesubsidies are linked to production of specificcommodities). The current ceiling on those so-called “amber box” subsidies is $19.1 billion peryear.The United States has not made a notifica-tion to the WTO on its domestic support out-lays (including export subsidies) since 2004, andthat notification covered the two marketingperiods before the 2002 Farm Bill. The lack ofinformation in the meantime is a significant irri-tant to other WTO members.

According to the 2004 notification, theaggregate measure of support (AMS, the annu-al measure of total trade-distorting support) todairy in 2001 was $4.483 billion (almost all ofthat in market price support), which comprisedjust over 31 percent of the total trade-distort-ing support that year.36 Despite the lack of offi-cial information to the WTO, however, we canglean some rough estimates of the more recentAMS amounts for dairy. For example, the mar-

10

As the Farm Billcomes up for

renewal and aslawmakers look forways to reduce thebudget deficit, thedairy program is a

prime example of apolicy that belongs

in a bygone era.

ket price support component of the AMS isequal to the “price gap” (the difference betweenannual prices fixed by policy and the worldprice in the fixed base period, 1986–88) multi-plied by the amount produced. The author cal-culated that in 2003, the price support compo-nent of AMS was $3.49 billion. Adding theapproximately $1.8 billion in MILC paymentsfor that year, assumed to be amber-box becausethey are linked to market prices, yields a prod-uct-specific AMS for dairy at $5.3 billion in2003. Daniel Sumner, an agricultural econo-mist at the University of California–Davis,estimated that total AMS in 2003 was approx-imately $9.5 billion, so dairy supports likelyconstituted over half of total trade-distortingsupport that year.37 More recently, the pricesupport component reached approximately$3.6 billion in 2005 (MILC figures for yearsbeyond 2003 are not available to the author’sknowledge). According to the USDA, over thelast decade, dairy has made up on average 55percent of the total AMS to all agriculturalcommodities in the United States.38

Whatever the exact figure, it is clear that sup-ports to dairy farmers contribute a large share oftotal trade-distorting support to agriculture.Anyone who favors increased global trade—andanyone who thinks that the United States shouldabide by its WTO commitments—ought tofavor reducing or eliminating these subsidies.

In fairness to the U.S. dairy program, thereference international price used to calculatethe aggregate measure of support in the WTOis very much out of date: $7.25 per hundred-weight, based on the average price in 1986–88.This peculiar aspect of the methodology meansthat the AMS for dairy will continue toincrease, even if the domestic support price iswell below the current international price,unless the base period prices or calculationmethod can be renegotiated.39

According to the USDA, the United Statesfederal government spent approximately $2.5billion in 2002–03 on price and income sup-port,40 a figure that differs from my calculationsabove because of the use of different time peri-ods and methodologies for measuring support(note that it is my calculations that would be

closer to the WTO-relevant figure). TheOECD uses an even broader definition of pro-ducer support and calculates that the annualmonetary value of transfers from consumersand taxpayers to milk producers was $11.3 bil-lion in 2004. Note, however, that this figure isalso not an accurate guide to the AMS for2004, since the OECD’s calculation includes alltransfers to farmers from agricultural policy,whereas the AMS calculation used by theWTO includes only support linked to produc-tion and excludes the effects of tariffs andexport subsidies.

As a percentage of gross farm receipts,OECD calculations suggest that over 40 percentof American milk farmers’ income is derivedfrom government policies (most of that as mar-ket price support and trade barriers). In total,support to dairy producers accounts for over 24percent of total PSE to all commodities, makingmilk the second largest recipient of governmentsupport after sugar.41

A WTO ruling in 2004 found that the pay-ments given to U.S. cotton farmers were not inaccordance with the U.S. obligations to theWTO. But that ruling has implications beyondjust cotton because it clarified the type andamount of subsidies that the United States canproperly give to its farmers. It thus appears thatthe United States is vulnerable to future chal-lenges from its trade partners based on currentWTO rules. Daniel Sumner, in a 2004 studyon the cotton ruling, explicitly mentioned thedairy program as a potential target:

The price discrimination and poolingschemes under the milk marketingorders stimulate overall milk productionand divert milk from beverage productsthat are generally not traded internation-ally to the production of cheese, milkpowder, and butter, which are the maintraded dairy products . . . the net result isa lower price of the tradable productsand displacement of imports or stimula-tion of exports.42

As Sumner explains, if the result of those dis-tortions is ‘serious prejudice’ to the trading

11

Anyone who favors increasedglobal trade—andanyone who thinksthat the UnitedStates should abideby its WTOcommitments—ought to favorreducing oreliminating dairysupport.

interests of other WTO members, then claimsagainst the United States under the Agreementon Subsidies and Countervailing Measures arelikely to be successful unless there are signifi-cant changes to the program. Such claimswould be even more likely to succeed if com-plainants could show that exports are stimulat-ed in large enough quantities to have an appre-ciable effect on world markets.

Foreign dairy exporters suffering from theeffects of the subsidies paid to American dairyfarmers also face prohibitive U.S. import tariffson dairy products. Given that WTO negotia-tions are not currently a promising avenue forincreasing market access, would-be exportersmay look to bilateral or regional deals with theUnited States, although the terms of thosedeals usually mean limited and delayed accessfor ‘sensitive’ agricultural products such asdairy. If trade deals don’t improve marketaccess opportunities, frustrated exporters willlikely instigate dispute settlement proceedingsat the WTO. Disputes are rarely in the inter-ests of a smoothly operating trading systemand will have adverse consequences for produc-ers of other industries targeted for retaliatorytariffs.

At a time when the multilateral trading sys-tem is in peril from failed WTO negotiations,proliferating preferential trade deals, and slow-er growth, the United States has much to gainfrom showing leadership and commitment tofree markets and liberal trade. By radicallyreforming the payments and protection it givesto dairy farmers, the United States will con-tribute to a fairer global market for dairy, signalits broader commitment to reform of the agri-cultural sector and consequently to the goal ofmore open trade, and benefit dairy consumers,taxpayers, and U.S. food processors.

Prospects and Vehicles forReform: Doha

The suspension of the Doha round of tradenegotiations is a setback for those hoping forfreer world trade and less distorted markets.The various offers on the table, including the

proposal put forward by the United States,would have required substantial cuts to thetotal allowable level of trade-distorting supportpaid to agriculture and would have led toincreased market access in the form of lowertariffs and expanded tariff rate quotas. Thenegotiations were, however, suspended in July2006 with no current prospect of renewal.

Many dairy markets, particularly in themajor developed countries, are characterized byheavy government intervention that obscuresmarket signals and affects investment deci-sions. In 2003–04, OECD countries main-tained an average dairy PSE of over 40 percentof gross farm receipts.43 Average tariffs(including in-quota and above-quota tariffs)for dairy products are at the upper end of therange for agricultural commodities, with pro-hibitive above-quota tariffs of over 1,000 per-cent for some products.44 The extensive,although decreasing, use of export subsidiesdepresses world prices and adds to volatility. Arecent USDA study opined that “much of theworld trade in dairy products is driven more bypolicy intervention than by market factors.”45

It is difficult to gauge what would have hap-pened had the Doha round been successful,because of differing assumptions about howexactly the commitments would look and howthey would be implemented in practice. Arecent World Bank study found that the largestnet welfare gains from global dairy trade liberal-ization would accrue to the “Quad” countries(the EU, United States, Canada, and Japan).46 Itis not a coincidence that those countries havethe most distorted dairy markets: reformingthose markets thus produces large consumergains (through lower prices) and reduced bud-getary costs that, in aggregate, negate the lossesaccruing to previously protected farmers.Further-more, the World Bank study concludedthat the largest welfare gains would be capturedby those countries that can attract foreign directinvestment, take best advantage of technologyimprovements, and have the ability to overcomesupply and marketing constraints to supplyproducts that meet strict quality and food safetystandards. Many American dairy producerswould be well placed to do just that.The USDA

12

The United Stateshas much to gain

from showingleadership and

commitment to free markets and

liberal trade.

study showed that the United States wouldmaintain its position in most export markets asa result of global trade liberalization and evengain slightly in its exports of nonfat dry milk.47

The World Bank study, using 2000 as itsbase year, estimated that full global trade anddomestic liberalization in dairy would see pro-duction fall by 7 percent in the United States.Producer prices would fall by 12 percent andthe balance of trade would change dramatical-ly, with a 61 percent fall in dairy exports and a130 percent increase in imports.Those changesare approximately three times greater than thechanges that would occur through domesticreform alone. But since consumers would see awelfare gain of 4 percent and taxpayer outlayswould fall by $147 million, the net welfare gainto the U.S. economy from global dairy liberal-ization would be $729 million.48

In an interesting 2004 study the InternationalTrade Commission included a table of the pricegaps between U.S. domestic prices and worldprices for certain dairy products. Creamery but-ter in the United States was 60 per cent moreexpensive relative to the world price; natural,processed, and imitation cheeses, 40 percent; dry,condensed, and evaporated milk products, 35percent; fluid milk, 13.65 percent; and icecream/frozen desserts, 20 percent.49 Trade liber-alization, according to the ITC, would see con-sumer prices fall, along with production andemployment in the dairy sector.

An Australian Bureau of Agricultural andResource Economics study in 2001 estimatedthe effects of a doubling of tariff rate quotas anda halving of tariffs in dairy.Those results showeda decrease in dairy production by about 1.2 per-cent in the United States but estimated that theeffect on farm gate prices would be “small andmanageable.”50 Cox et al. found that full tradeliberalization in dairy markets would lead toonly small changes in prices (–0.4 percent) andproduction of milk in the United States.51

The USDA study mentioned above esti-mated that removing price support programsin the United States would lead to only a 0.2percent drop in milk prices. The price of butterwould increase by about 0.7 percent, but theprices of cheese and nonfat dry milk would

decrease by 0.2 percent and 1.1 percent, respec-tively. Production was estimated to fall by 0.1percent, but as the authors point out, “a contin-uation of 1-percent productivity growth inmilk production per year would offset any loss-es to U.S. milk producers.”52

On balance, model results on the effects ofunilateral reform (in the absence of multilater-al reform opportunities) suggest that it wouldbe in America’s interest to remove the distor-tions to the U.S. dairy market regardless ofwhether other countries liberalize. Consumers,dairy foods manufacturers, taxpayers, and moreefficient producers in the United States andabroad all stand to gain.

Should the Doha Round get back on track,the United States’ offer to reduce its allowablelevels of trade-distorting support to $7.6 bil-lion (its latest offer in the Doha Round of tradetalks) would make it very unlikely that dairysupports could remain as they are. Withoutreform, they would comprise well over half oftotal allowable trade-distorting support. Ofcourse, some largely cosmetic ways around cut-ting the total value of support could have beenfound, such as changing the nature of the sub-sidies to less trade-distorting kinds of supportthat are not subject to the same reduction com-mitments, or by declaring the products con-cerned “sensitive,” and thus excluded fromreductions in tariffs. But a successful Dohaoutcome would have been a useful pressure forreform that has now been removed.

The 2007 Farm Bill:New Hope?

Even in the absence of a successful outcomefrom the Doha round, America’s budget deficit,vulnerability to WTO disputes, and reputationas a liberal economy demand that Congressseize the opportunity presented by the rewritingof a new Farm Bill to reform significantly thedairy program. The Bush administration, to itscredit, has proposed $1.2 billion worth of cuts tothe dairy program, including a three-cents-per-hundredweight “assessment” on all dairy pro-duction in their FY07 budget request. However,

13

It is in America’sinterest to removethe distortions inthe U.S. dairymarket regardlessof whether othercountries liberalize.

similar measures were proposed in the previousfinancial year and were ignored by the congres-sional agriculture committees.

Ideally, all price supports, trade barriers andother market distortions should be removed,paving the way for a market where products flowto the use for which they are most highly valuedby consumers, where producers are free to nego-tiate directly with buyers on the basis of thequality and quantity of the milk they supply, andwhere milk prices can respond to supply anddemand.That may help farmers, too. As a recentarticle pointed out, regulated prices under thecurrent system can fall even as retail prices formilk stay the same and input costs rise, becauseprices for farmers are set by government formu-la based on prices of milk and cheese elsewherein the country rather than local conditions.53

At this time of relatively high global dairyprices, removing the price support should bepolitically easier and should be done first.Similarly, the Dairy Export Incentive Programhas been used only rarely over the past few years.Abolishing it would send a positive signal totrade partners. It will signify that the UnitedStates remains committed to removing market-distorting subsidies, at a time when that com-mitment is being questioned.

The damaging Federal Milk MarketingOrder system should also be abolished. It iscreating regional divisions, hampering invest-ment and productivity gains in the most pro-ductive regions, and is no longer relevant totoday’s markets or technology. Its potential as atarget for dispute settlement action should be aconcern to anyone who values a free, open, andstable global trading system.

Removing import barriers is an overwhelm-ingly beneficial reform—a favor that Americanlawmakers can bestow on the nation withoutany permission from trade partners. Whether ornot it is done as part of trade negotiations,removing barriers to cheaper and a wider varietyof goods is in America’s interests. Unilaterallyremoving these economically damaging tariffswould also, like ceasing the export subsidy pro-gram, reassure trade partners. It is important theprice support system be abolished before tradebarriers are removed; attempting to hold prices

up in the face of unrestrained imports would cre-ate large dairy stockpiles at taxpayers’ expense.

The Milk Income Loss Contract shouldalso be abolished. Farmers who are concernedabout income security will have access to for-ward contracting, so they can manage pricevolatility without being reliant on—or behold-en to, as the case may be—the governmentpricing system. As for concerns about foodsecurity, there is no reason to believe that theUnited States cannot produce the quantity andquality of fluid milk demanded by consumerswithout government support. In any case, withfreely flowing trade the United States canimport those goods for which it does not havea comparative advantage or where there aredomestic shortfalls. Modern transportationand refrigeration techniques would minimizethe limits that dairy product perishabilitywould otherwise place on trade to and withinthe United States. And, with free trade in fluidmilk between states, we could expect highlyefficient producers in fast-growing dairy stateslike California to supply the rest of Americawith fresh, wholesome milk that could not cur-rently be supplied from sources abroad.

Lessons from Down UnderUseful lessons can be learned from the dereg-

ulation experience of other countries. Althoughthe Australian dairy policy differed in manyrespects from the U.S. dairy policy (for example,domestic quotas controlled production in themajor milk-producing states), there were someparallels. Australian state and federal govern-ments provided support to dairy farmers throughprice floors, restricted imports, and export subsi-dies from the mid-1980s.

The Australian government initiated reform ofthe Australian dairy industry in the mid-1990s,after the relative prices of market and manufactur-ing milk became increasingly distorted (despitetheir being basically identical products). As part ofits general reform program for the Australianeconomy, the government began phasing outmarket support and export subsidies. After thecomplete, overnight deregulation of fresh milkpricing in July 2000, there was an immediate andsubstantial decline in milk prices—a 35 percent

14

All price supports,trade barriers and

other marketdistortions should

be removed.

decline in the case of raw milk for processing anda 16 percent decline in retail prices (althoughexport prices were unusually high at this time,which would have cushioned the domestic priceeffect for those farmers with export interests).Over 17 percent of farms had retired from theindustry after three years, although this was reallyjust an acceleration of the trend toward retirementthat had been evident for some time and wouldhave also been exacerbated by the severe droughtthat occurred contemporaneously.54

The Australian government gave transitionassistance to farmers in the order of A$2 billion(approximately $1.5 billion), but payments werefully decoupled from current or future produc-tion decisions, which meant that farmers had toadjust immediately to market signals. That gavethem a strong incentive to consider their viabil-ity and make structural changes as necessary.Since the incentives given to them were directlyfrom the market, and not channeled throughgovernment filters, farmers were aware of thefull effects of the change to their industry andcould make investments in scale and in produc-tivity improvements necessary for them to beinternationally competitive. Since the Australiangovernment’s reforms, the percentage consumersupport estimate for milk has fallen from 40 per-cent to 14 percent.55 The number of dairy estab-lishments in Australia has declined significantly,but the average herd size has increased and, aftersome period of adjustment immediately follow-ing reform, milk production and export perfor-mance has recovered.

The New Zealand experience generally isone from which many countries can learn: it hasthe lowest level of support for farmers in theOECD and, in the years since its own deregula-tion in the mid 1980s has seen the value of theeconomic activity in its farm sector increase byover 40 percent in real terms and productivitygains of an average 5.9 percent.56 In 2000, NewZealand, a nation of just over 4 million inhabi-tants, comprised over 31 percent of world dairyexports with a 1 percent PSE for milk.57

Those lessons have taught us that there are afew ways that government can minimize thedisruptions that can occur from reform, includ-ing rent-seeking behavior from firms. Changes

should be announced in advance and in as pub-lic a manner as possible so that consumers andfarmers know what to expect from reform andcan adjust purchasing and investment decisionsaccordingly. Minimizing the adjustment timewould minimize the ongoing cost of these inef-ficient programs to consumers and taxpayers.

Financing the TransitionPolitical considerations mean that eliminating

dairy programs and a wholesale withdrawal ofgovernment intervention in dairy markets isunlikely without some sort of “compensation” forfarmers.Usually,however,compensation is paid bytaxpayers or consumers: when Australia reformedits dairy market in the 1990s, the buyout of dairyfarmers was financed by a consumer tax on milksold domestically. Certainly that seems to beunfair; essentially it is asking the very same peoplewho had been paying above market prices fordecades to then pay the price for reform. If any-thing, it would have been more fitting for con-sumers to seek compensation from the dairy farm-ers who had benefited from a protected market.Similarly, financing transitional adjustment fromgeneral revenue is adding insult to taxpayers’ sig-nificant accumulated injury.

If compensation is deemed absolutely neces-sary to enact reform, the fairest way to finance itwould be to tax those producers who choose toremain. Producers will decide to either stay inthe industry and pay a tax to finance the adjust-ment for their least efficient brethren or see thatthey are no longer competitive in the dairy mar-ket and should allocate their resources to someother industry for which they would be betterable to compete.

Some may choose to leave farming altogether,although since their land is not valueless and atleast some of their skills are transferable, it is likelythat many farmers could turn their attention toother crops. If some sort of buyout is politicallyinevitable, then surely it is better to ensure that thepayout is limited and is financed by the very peo-ple who have benefited from taxpayer and con-sumer support over many years. In short, con-sumers or taxpayers should not and would not haveto finance an outcome they have long deserved: amore efficient market for dairy products.

15

Consumers ortaxpayers shouldnot and would nothave to finance anoutcome they havelong deserved: amore efficientmarket for dairyproducts.

The large budget deficit, significant costs toconsumers and downstream producers, andAmerica’s interests in free and open marketsdemand that Congress use its opportunity inthe next farm bill to abolish the federal dairyprograms. These outdated policies are stiflinginnovation and irritating our trade partners andare egregiously out of date with modern dairyfarming. Given historically high world dairyprices, now is an opportune time to implementfundamental reforms with a relatively smallpolitical and taxpayer cost of adjustment.

Notes1. Food and Agriculture Organization of the UnitedNations, “Dairy and Dairy Products: Why Is ReformSo Difficult?” Farm Trade Policy Brief no. 11, ftp://ftp.fao.org/docrep/fao/008/j6829e/j6829e01.pdf.

2. The political economy surrounding the FAIR Actof 1996 is analyzed in David Orden,Robert Paarlberg,and Terry Roe, Policy Reform in American Agriculture:Analysis and Prognosis (Chicago: University of ChicagoPress, 1999).

3. Daniel A. Sumner and Joseph V. Balagtas,“United States’ Agricultural Systems: An Overviewof U.S. Dairy Policy,” working paper, University ofCalifornia Agricultural Issues Center, http://aic.ucdavis.edu/research1/DairyEncyclopedia_policy.pdf.

4. U.S. Department of Agriculture, Economic Effects ofU.S. Dairy Policy and Alternative Approaches to MilkPricing, Report to Congress, July 2004, http://www.usda.gov/documents/NewsReleases/dairyre port1.pdf.

5. James J. Miller and Don P. Blayney, Dairy Back-grounder, U.S. Department of Agriculture EconomicResearch Service, LDP-M-145-01, July 2006, http://www.ers.usda.gov/Publications/LDP/2006/07Jul/LDPM14501/.

6. International Dairy Foods Association, “IDFAConcerns with Failed Dairy Programs Echoed byUSDA, Others at Senate Agriculture Committee’sDairy Hearing,” news release, http://www.idfa.org/news/stories/2006/07/green_testimony.cfm.

7. U.S. Department of Agriculture, Economic Effectsof U.S. Dairy Policy.

8. Miller and Blayney.

9. U.S. Department of Agriculture, Economic Effectsof U.S. Dairy Policy, p. 35.

10. Office of Management and Budget, “Dairy Price

Support Program Assessment,” http://www.whitehouse.gov/omb/expectmore/detail.10002436.2005.html.

11. Miller and Blayney.

12. Before the Deficit Reduction Act of 2005 thepayment rate was 45 percent of the differencebetween the two prices.

13. Ralph M Chite, “Dairy Policy Issues,” CRSReport for Congress, June 16, 2006, http://ncseonline.org/NLE/CRSreports/06Jul/RL33475.pdf.

14. Ibid.

15. California, which accounted for over 20 percentof U.S. milk production in 2003, uses five end-useclasses in its state marketing orders. The revenue-sharing system in California also differs from thatof the Federal milk-marketing order system asdescribed below.

16. Sumner and Balagtas.

17. Dairy Export Incentive Program web page,http://www.fas.usda.gov/excredits/deip.html.(Emphasis added.)

18. Charles E. Hanrahan, Agricultural Export and FoodAid Programs, CRS Issue Brief for Congress (Wash-ington: Congressional Research Service, Library ofCongress, 2005).

19. Ibid.

20. International Dairy Foods Association, DairyFacts 2005 Edition (Washington: IDFA, 2005).

21. Ibid.

22.Keith Collins, chief economist,U.S.Department ofAgriculture, Testimony before the Senate Committeeon Agriculture, Nutrition and Forestry, presented byJoseph Glauber, July 20 2006, http://www.usda.gov/agency/oce/newsroom/congressional_testimony/Dairy%20Testimony7-20-2006.pdf.

23. U.S. Department of Agriculture, Economic Effectsof U.S. Dairy Policy, p. 50.

24. Organisation for Economic Co-operation andDevelopment, Agricultural Policies in OECD Countries:Monitoring and Evaluation (Paris: OECD, 2005),Table III.25. Hereinafter OECD.

25. International Dairy Foods Association, DairyFacts 2005 Edition (Washington: IDFA, 2005).

26. Tom Cox and Yong Zhu, “Dairy: Assessing WorldMarkets and Policy Reforms:Implications for Develop-ing Countries” in Global Agricultural Trade and Develop-

16

Given historicallyhigh world dairyprices, now is an

opportune time toimplement

fundamentalreforms with arelatively small

political andtaxpayer cost of

adjustment.

ing Countries (Washington: World Bank, 2005).

27. The flood of powdered milk to New Zealanddepressed prices, resulting in an official complaintfrom New Zealand to the USDA. Gilbert M. Gaul,Sarah Cohen, and Dan Morgan, “Aid to RanchersWas Diverted for Big Profits,” Washington Post, July19, 2006, online edition.

28. International Dairy Foods Association, “IDFAConcerns with Failed Dairy Programs.”

29. U.S. Department of Agriculture, Economic Effectsof U.S. Dairy Policy.

30.National Milk Producers Federation,“NMPF Fore-casts Billions More in Farm Losses If Imported DairyProteins Are Not Addressed by Tariff Legislation,”press release, December 11, 2003, www.nmpf.org.

31. National Milk Producers Federation, “NMPF toAppeal U.S.Customs Service Ruling on Milk ProteinConcentrate Imports,” press release, April 14, 2003,www.nmpf.org.

32. National Milk Producers Federation, “NMPFto Pursue Trade Policy Options to Counter Importsof Milk Protein Concentrate,” press release, January17 2001, www.nmpf.org.

33. Office of Management and Budget.

34.World Trade Organization,“Notification of ExportSubsidy Commitments to the WTO Committee onAgriculture,” G/AG/N/USA/53, Supporting tableES:1, 2 June 2004, http://docsonline.wto.org.

35. Foreign Agricultural Service, “Dairy ExportIncentive Program: Summary Data for Fiscal Year2004,” http://www.fas.usda.gov/excredits/quarterly/2004/04%20DEC%20DEIP%20table.pdf.

36. Calculations based on data contained in “U.S.Notification to the WTO Committee on Agricul-ture,” G/AG/USA/N/51, March 17, 2004, support-ing table DS:4, http://docsonline.wto.org.

37. Daniel A. Sumner, “Boxed In: Conflicts betweenU.S. Farm Policies and WTO Obligations,” Cato In-stitute Trade Policy Analysis no. 32, December 5, 2005.

38. Suchada Langley, Agapi Somwaru, and MaryAnne Normile, “Trade Liberalization in InternationalDairy Market—Estimated Impacts,” USDA Eco-nomic Research Report no. 16, February 2006, p. 2,http://www.ers.usda.gov/Publications/ERR16/.

39. James J. Miller and Don P. Blayney, Dairy Back-grounder, U.S. Department of Agriculture Economic

Research Service, LDP-M-145-01, July 2006, http://www.ers.usda.gov/Publications/LDP/2006/07Jul/LDPM14501/.

40. U.S. Department of Agriculture Farm ServiceAgency, “Milk Price Support Program Fact Sheet,”July 2004, http://www.fsa.usda.gov/pas/publications/facts/html/MPSP04.htm.

41. OECD.

42. Sumner, “Boxed In,” pp. 24–25.

43. OECD.

44. Food and Agriculture Organization of the UnitedNations.

45. Langley, Somwaru, and Normile, p. iv.

46. Cox and Zhu.

47. Langley, Somwaru, and Normile.

48. Cox and Zhu.

49. U.S. International Trade Commission, “The Eco-nomic Effects of Significant U.S. Import Restraints,”Publication 3701, fourth update 2004, Investigationno. 332-325, June 2004.

50. Ian Shaw and Graham Love, Impacts of Liberal-ising World Trade in Dairy Products, ABARE ResearchReport 01.4 (Canberra: ABARE, 2001), p. 5.

51. Cox, T. L., et al. “An Economic Analysis of theEffects on the World Dairy Sector of ExtendingUruguay Round Agreement to 2005,”Canadian Journalof Agricultural Economics 47(1999): 169–83.

52. Langley, Somwaru, and Normile, p. v.

53. Bruce Mohl, “On State’s Dairy Farms, PricePressures Are Breeding Trouble,” Boston Globe, July23, 2006.

54. David Harris, “Industry Adjustment to PolicyReform: A Case Study of the Australian DairyIndustry,” Rural Industries Research and Develop-ment Corporation Publication no. 05/110, August2005, www.rirdc.gov.au.

55. OECD.

56. Federated Farmers of New Zealand, Life afterSubsidies: the New Zealand Farming Experience 15Years Later, August 2002. Copy in author’s files.

57. Ibid. See also OECD.

17

Trade Briefing Papers from the Cato Institute

“Who’s Manipulating Whom? China’s Currency and the U.S. Economy” by Daniel Griswold (no. 23; July 11, 2006)

“Nonmarket Nonsense: U.S. Antidumping Policy toward China” by Daniel Ikenson (no. 22; March 7, 2005)

“The Case for CAFTA: Consolidating Central America’s Freedom Revolution” by Daniel Griswold and Daniel Ikenson (no.21; September 21, 2004)

“Ready to Compete: Completing the Steel Industry’s Rehabilitation” by Dan Ikenson (no. 20; June 22, 2004)

“Job Losses and Trade: A Reality Check” by Brink Lindsey (no. 19; March 17, 2004)

“Free-Trade Agreements: Steppingstones to a More Open World” by Daniel T. Griswold (no. 18; July 10, 2003)

“Ending the ‘Chicken War’: The Case for Abolishing the 25 Percent Truck Tariff ” by Dan Ikenson (no. 17; June 18, 2003)

“Grounds for Complaint? Understanding the ‘Coffee Crisis’” by Brink Lindsey (no. 16; May 6, 2003)

“Rethinking the Export-Import Bank” by Aaron Lukas and Ian Vásquez (no. 15; March 12, 2002)

“Steel Trap: How Subsidies and Protectionism Weaken the U.S. Industry” by Dan Ikenson (no. 14; March 1, 2002)

“America’s Bittersweet Sugar Policy” by Mark A. Groombridge (no. 13; December 4, 2001)

“Missing the Target: The Failure of the Helms-Burton Act” by Mark A. Groombridge (no. 12; June 5, 2001)

“The Case for Open Capital Markets” by Robert Krol (no. 11; March 15, 2001)

“WTO Report Card III: Globalization and Developing Countries” by Aaron Lukas (no. 10; June 20, 2000)

“WTO Report Card II: An Exercise or Surrender of U.S. Sovereignty?” by William H. Lash III and Daniel T. Griswold(no. 9; May 4, 2000)

“WTO Report Card: America’s Economic Stake in Open Trade” by Daniel T. Griswold (no. 8; April 3, 2000)

“The H-1B Straitjacket: Why Congress Should Repeal the Cap on Foreign-Born Highly Skilled Workers” by SuzetteBrooks Masters and Ted Ruthizer (no. 7; March 3, 2000)

“Trade, Jobs, and Manufacturing: Why (Almost All) U.S. Workers Should Welcome Imports” by Daniel T. Griswold (no. 6;September 30, 1999)

“Trade and the Transformation of China: The Case for Normal Trade Relations” by Daniel T. Griswold, Ned Graham,Robert Kapp, and Nicholas Lardy (no. 5; July 19, 1999)

“The Steel ‘Crisis’ and the Costs of Protectionism” by Brink Lindsey, Daniel T. Griswold, and Aaron Lukas (no. 4; April 16,1999)

“State and Local Sanctions Fail Constitutional Test” by David R. Schmahmann and James S. Finch (no. 3; August 6, 1998)

“Free Trade and Human Rights: The Moral Case for Engagement” by Robert A. Sirico (no. 2; July 17, 1998)

“The Blessings of Free Trade” by James K. Glassman (no. 1; May 1, 1998)

Trade Policy Analysis Papers from the Cato Institute

“Leading the Way: How U.S.Trade Policy Can Overcome Doha’s Failings” by Daniel Ikenson (no. 33; June 19, 2006)

“Boxed In: Conflicts between U.S. Farm Policies and WTO Obligations” by Daniel A. Sumner (no. 32; December 5, 2005)

“Abuse of Discretion: Time to Fix the Administration of the U.S. Antidumping Law” by Daniel Ikenson (no. 31; October 6,2005)

“Ripe for Reform: Six Good Reasons to Reduce U.S. Farm Subsidies and Trade Barriers” by Daniel Griswold, Stephen Slivinski,and Christopher Preble (no. 30; September 14, 2005)

“Backfire at the Border: Why Enforcement without Legalization Cannot Stop Illegal Immigration” by Douglas S. Massey (no.29; June 13, 2005)

“Free Trade, Free Markets: Rating the 108th Congress” by Daniel Griswold (no. 28; March 16, 2005)

“Protection without Protectionism: Reconciling Trade and Homeland Security” by Aaron Lukas (no. 27; April 8, 2004)

“Trading Tyranny for Freedom: How Open Markets Till the Soil for Democracy” by Daniel T. Griswold (no. 26; January 6,2004)

“Threadbare Excuses: The Textile Industry’s Campaign to Preserve Import Restraints” by Dan Ikenson (no. 25; October 15,2003)

“The Trade Front: Combating Terrorism with Open Markets” by Brink Lindsey (no. 24; August 5, 2003)

“Whither the WTO? A Progress Report on the Doha Round” by Razeen Sally (no. 23; March 3, 2003)

“Free Trade, Free Markets: Rating the 107th Congress” by Daniel Griswold (no. 22; January 30, 2003)

“Reforming the Antidumping Agreement: A Road Map for WTO Negotiations” by Brink Lindsey and Dan Ikenson (no. 21;December 11, 2002)

“Antidumping 101: The Devilish Details of ‘Unfair Trade’ Law” by Brink Lindsey and Dan Ikenson (no. 20; November 26,2002)

“Willing Workers: Fixing the Problem of Illegal Mexican Migration to the United States” by Daniel Griswold (no. 19; October15, 2002)

“The Looming Trade War over Plant Biotechnology” by Ronald Bailey (no. 18; August 1, 2002)

“Safety Valve or Flash Point? The Worsening Conflict between U.S. Trade Laws and WTO Rules” by Lewis Leibowitz (no. 17;November 6, 2001)

“Safe Harbor or Stormy Waters? Living with the EU Data Protection Directive” by Aaron Lukas (no. 16; October 30, 2001)

The mission of the Cato Institute’s Center for Trade Policy Studies is to increase publicunderstanding of the benefits of free trade and the costs of protectionism. The center

publishes briefing papers, policy analyses, and books and hosts frequent policy forums andconferences on the full range of trade policy issues.

Scholars at the Cato trade policy center recognize that open markets mean wider choicesand lower prices for businesses and consumers, as well as more vigorous competition thatencourages greater productivity and innovation. Those benefits are available to any countrythat adopts free trade policies; they are not contingent upon “fair trade” or a “level playingfield” in other countries. Moreover, the case for free trade goes beyond economic efficiency.The freedom to trade is a basic human liberty, and its exercise across political borders unitespeople in peaceful cooperation and mutual prosperity.

The center is part of the Cato Institute, an independent policy research organization inWashington, D.C. The Cato Institute pursues a broad-based research program rooted in thetraditional American principles of individual liberty and limited government.

For more information on the Center for Trade Policy Studies,visit www.freetrade.org.

CENTER FOR TRADE POLICY STUDIESBoard of Advisers

Jagdish BhagwatiColumbia University

Donald J. BoudreauxGeorge Mason University

Douglas A. IrwinDartmouth College

José PiñeraInternational Center forPension Reform

Russell RobertsGeorge Mason University

Razeen SallyLondon School ofEconomics

George P. ShultzHoover Institution

Clayton YeutterFormer U.S. TradeRepresentative

PresortedFirst Class

U.S. PostagePAID

Permit #1906Southern MD

Nothing in Trade Briefing Papers should be construed as necessarily reflecting the views of theCenter for Trade Policy Studies or the Cato Institute or as an attempt to aid or hinder the pas-sage of any bill before Congress. Contact the Cato Institute for reprint permission. Additionalcopies of Trade Briefing Paper are $2 each ($1 for five or more). To order, contact the CatoInstitute, 1000 Massachusetts Avenue, N.W., Washington, D.C. 20001. (202) 842-0200,fax (202) 842-3490, www.cato.org.

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