Got (Local) Milk?

Date: 5 Oct 1999 | posted in: agriculture | 0 Facebooktwitterredditmail

NOTE: This article originally appeared in the Fall 1999 issue of the New Rules Journal

A few years ago, New England tried to save their local dairy farms with a regional pricing structure called a dairy compact. Now Congress has nixed the compact’s renewal, blunting one of the small dairy farmer’s only tools for surviving.

Dairy farms are an essential feature of New England’s culture and the character of its rural landscapes. Indeed, one can hardly think of Vermont without picturing rolling pastures, red barns and black-and-white dairy cows. But this scene may not last for long. New England’s dairies are fast disappearing and the effort to save them has produced a heated congressional battle hardly befitting the serene image these farms evoke.

There are many reasons New England’s small dairies are declining, but the most significant have to do with changing economics. Milk prices haven’t kept pace with rising costs of production. Small dairies have been unable to weather sharp price declines in an increasingly volatile market. What’s more, it’s cheaper to produce milk in other regions, where massive corporate dairies are expanding, taking advantage of the latest technologies and producing more milk for less.

To save their dairy farms, the six states of New England took an unprecedented step in 1996. With authorization from Congress, they formed the Northeast Interstate Dairy Compact, which enables the states to collectively set a minimum price that dairy farmers receive for milk sold in New England.

Other regions want to adopt the New England model. Five mid-Atlantic states are seeking to join the compact and fourteen southeastern states have petitioned Congress to allow them to form their own.

But the federal law authorizing the Northeast Compact expired October 1. Attempts are underway to resurrect it, but the prospects seem grim. Although it may well prove short-lived, the Northeast Interstate Dairy Compact offers an opportunity to examine the economic impact of drafting farm policies that make the survival of local, small-scale producers their primary goal.

Opponents of such policies describe them as protectionist and argue that they distort the market by artificially raising prices. If it’s cheaper to produce milk in other regions and large-scale dairies can do it more efficiently, then why preserve obsolete farms?

Supporters counter that paying a few cents more for a gallon of milk is rather trivial compared to what’s at stake. The region’s 3,000 dairy farms are not only integral to New England’s culture, but they maintain open space in an area anxious to ward off the sprawling urbanization of the eastern seaboard. Dairies yield important economic benefits for rural communities. The typical New England dairy – a small, family farm with about 90 cows – requires more than $400,000 in inputs annually, nearly 75 percent of which are purchased locally. Local economic benefits accrue from the output of dairy farms as well: milk is usually processed, bottled and distributed within a relatively localized area. Moreover, supporters argue, losing this local supply of fresh milk is nothing to take lightly. Dependence on distant milk processors may well lead to higher consumer prices over the long term.

A Dairy for Every Dale

Ensuring that fresh milk flowed in every corner of the country has in fact been the primary goal of national and state dairy policy for the last 60 years. The federal government began regulating farm-level milk prices in the 1930s under the Agricultural Marketing Agreements Act (AMAA). The aim was to ensure a stable supply by setting a minimum price that processors had to pay farmers for their milk. According to most economists, the market conditions that necessitated price regulations then still exist today. Because milk is perishable and expensive to ship, and there are relatively few processors in a given area, dairy farmers have little leverage to negotiate a fair price.

Today,the U.S. Department of Agriculture (USDA) sets milk prices using a complex formula based on the market for cheese in the Upper Midwest. These prices vary from region to region and generally increase with distance from Eau Claire, Wisconsin. Producing milk in some regions has always been more difficult and expensive than in others. To an extent, the federal system was designed to reflect these differences and to create incentives to supply certain areas, like the Southeast, that were once plagued by chronic shortages of fresh milk.

Congress intended the federal pricing system to be complemented by state regulation and, under the AMAA, allowed states to set higher prices within their borders. This enabled states to address the particular needs of their local markets and to establish minimum prices that best protected the state’s producers and consumers. At one time, nearly half the states maintained milk prices above the federal level.

With this dual approach, nearly every state was able to maintain its own dairy industry. Although cheese markets have long been national in scope and dominated by a handful of states, beverage milk rarely came from very far away.

The Birth of the Northeast Dairy Compact

State pricing rules were rolled back beginning in the 1960s, as interstate milk transportation expanded. Some states abandoned their price programs as cheaper imported milk undercut locally produced milk. Others tried to apply their regulatory systems to both in-state and imported milk, only to face invariably successful legal challenges under the Constitution’s Commerce Clause, which bars states from regulating interstate trade.

The last decade has seen renewed interest among states in mandating higher milk prices, largely in response to major changes occurring in the industry. Large dairies are replacing small dairies. The number of dairy farms has declined from more than 300,000 in 1980 to just 92,000 today. Many of these large dairies are locating where costs of production are lowest: in the West, a region that now leads the nation in dairy production. Much of the East, in turn, has become a milk “deficit” region, dependent on dairy foods imported from other areas. New England supplies roughly 60 percent of its own dairy needs. The Southeast is in danger of losing its dairy industry all together.

To save their farms, Connecticut, New York, Massachusetts, Vermont, New Hampshire and Minnesota implemented milk pricing rules in the early 1990s. All were overturned by the courts, however, because states do not have the authority to regulate milk entering or leaving their borders.

Although the Constitution bars states from interfering with interstate commerce, it does contain a mechanism (Article I, Section 10) that allows multiple states to form a regional compact and collectively regulate trade. Compacts must be approved in identical form by each state involved and then by Congress.

According to William Van Alstyne, professor of law at Duke University, during the last two centuries, Congress has authorized some 300 interstate compacts, nearly all of which were enacted to settle boundary disputes, allocate shared natural resources or administer bridges and other shared infrastructure.

In the late 1980s, Vermont Representative Robert Starr and Daniel Smith, legislative counsel for the Vermont House, galvanized a movement to use this constitutional provision in an unprecedented fashion: to create a regional dairy compact that would give New England the authority to set minimum farm prices for milk consumed within its territory.

By1993, all six New England states – Maine, New Hampshire, Vermont, Massachusetts, Connecticut and Rhode Island – had passed compact legislation. In 1996, Congress approved the Northeast Interstate Dairy Compact.

How it Works

The Northeast Dairy Compact is governed by a commission composed of delegations from each state. Each delegation must include both farmers and consumers. The commission has the authority to establish a minimum farm price for beverage milk, known as fluid or Class I milk. Other classes of milk, those destined for manufacture into cheese, butter, ice cream and other products, are not regulated by the commission. Nationally, about 30 percent of milk is sold as fluid milk. New England, like other deficit regions, drinks a larger share, about 45 percent, of its locally produced milk.

Prices are established through a public hearing process. The commission takes testimony to determine the price necessary to provide a reasonable rate of return to producers and distributors, while taking into account the ability of consumers to purchase milk. Pricing decisions require a two-thirds majority of the member states and must also be approved by a two-thirds margin in a producer referendum.

The commission implemented its first price regulation in July 1997. The minimum price for fluid milk was set at $16.94 per hundredweight (cwt). (One hundred pounds of milk is equivalent to 11.6 gallons.) Whenever the federal price for the New England region drops below the compact price, milk processors who supply the New England market must pay the difference to the commission, which in turn distributes this premium to dairy farmers. The premium has averaged $1.06 per cwt over the last two years.

The commission diverts a percentage of the premium to cover its costs and to negate the Northeast Compact’s impact on school milk purchases and the Women, Infants and Children (WIC) food program.

The compact price applies to all fluid milk sold within New England. Processors outside of New England are subject to the price rules for any milk they sell in New England. Likewise, farmers outside of the region are eligible for the premium if their milk is consumed within New England.

Has the Northeast Compact Helped Dairy Farmers?

Since its inception, the Northeast Dairy Compact has generated $68 million in additional income for dairy farmers. This amounts to a 3 percent increase in total milk receipts, or 45 cents per cwt. Because all farmers who have fluid milk sales in New England are eligible, dairy farmers in New York, part of the region’s traditional “milkshed,” have received more than one-quarter of the benefits to date.

It’s still too early to tell whether the compact has slowed the decline of dairy farms. Popular opinion in New England is that it has, but statistics don’t yet bear this out. In Vermont, 145 dairy farms failed in the two years prior to the compact. In the two years since, 150 farms have gone under. But Vermont officials contend that changes in the capital gains tax concurrent with the start of the compact are to blame for the numbers, because many who planned to sell their farms waited for the tax changes to take effect.

Small dairy farmers say that, while the added income is significant, the Northeast Compact’s biggest benefit is the price stability it creates. “Because dairy farmers can’t store or stockpile their milk due to its perishable nature, they really have no leverage in the market,” according to Leon Graves, commissioner of Vermont’s Department of Food and Markets. “When a drastic price swing occurs, they have no recourse but to settle for it no matter how great the cost of production has been. Those of us who already belong to the existing Northeast Dairy Compact have been able to soften the blow to our farmers.”

A particularly brutal blow came this past spring when the federal government cut producer milk prices by 37 percent across the nation. The price drop meant dairy farmers outside of the Northeast were losing money every time they sold a gallon of milk.

Has the Compact Hurt Consumers?

When the Northeast Dairy Compact first took effect, the retail price of milk in New England jumped by 26 cents per gallon. Dairy farmers and compact supporters accused processors and retailers of taking advantage of the highly publicized policy to raise their prices. Within a couple of months, retail prices declined and have remained fairly flat. According to William Thomas, a dairy economist at the University of Georgia, New England’s milk prices are comparable to the national average.

Even if the entire cost of the compact has been passed on to consumers, it only amounts to about $2.50 per person annually (or 10 cents a gallon). This is a small price to pay for viable dairy farms and locally produced milk, according to Kathy Lawrence of Just Food, a New York City-based organization that works to increase the availability of locally grown food to low income citizens. “Will we get better consumer prices as more farmers go out of business and our food production is monopolized by mega-corporations?” she asks.

Could a Dairy Compact Save Farms in Other Regions?

Underthe current law, six states – Delaware, Maryland, New Jersey, New York, Pennsylvania and Virginia – are allowed to join the Northeast Compact provided that at the time of entry the state is contiguous to a participating state and receives the consent of Congress. Five have declared their intent to join. In addition, fourteen southeastern states (including Virginia) have petitioned Congress to allow them to form their own.

These states are facing much the same situation as exists in New England: higher production costs, disappearing dairy farms and increased dependence on out-of-state milk. Conditions are particularly dire in parts of the Southeast, which will probably lose their dairy farms altogether within the next year or two. Without a local supply, state officials fear that consumers in these areas will ultimately pay higher milk prices.

Dairy farmers in the Upper Midwest, once the undisputed capital of the dairy industry, have fallen on hard times as well. Wisconsin and Minnesota rank first and second in the number of dairy farm failures, with a combined total of more than 10,000 since 1993.

But producers here say a dairy compact would be of little help. Less than 20 percent of the region’s production is sold as fluid milk. The rest is converted into cheese, most of which is shipped to other states. A compact premium would apply only to fluid milk consumed within Minnesota and Wisconsin, and, since this is only a small fraction of the area’s total milk production, the premium would have to be quite high to make much difference. Farmers fear that a high premium would force retail prices up and reduce demand.

Furthermore,Upper Midwest dairy farmers believe that the expansion of compacts in the East will hurt their export-driven industry. They advocate a more market-oriented approach and argue that policies designed to support local dairy production are outdated now that milk can be shipped longer distances. Dairy processors agree. “We don’t need a dairy farm in every backyard in New England,” contends Kathleen Nelson of the International Dairy Foods Association, which has joined with Upper Midwest farmers to convince Congress to let the Northeast Compact die.

“The Northeast Dairy Compact is a cartel that rewards farmers in one region at the expense of farmers in the Upper Midwest,” argues Paul Zimmerman of the Wisconsin Farm Bureau Federation. He believes that, by raising prices, compacts encourage more milk production. Increased production means fewer opportunities for the Midwest dairy industry to supply eastern markets. It also lowers milk prices nationwide, because excess milk is manufactured into “storable” products like cheese, and the more cheese, the lower the price of cheese. Since the entire federal milk pricing system is based on the price of cheese, the lower the price of cheese, the lower the price of milk.

Milk production has indeed risen 4.6 percent in New England since 1996, compared to 1.7 percent nationally. But milk production varies with the weather and New England has enjoyed two mild winters.

Regardless, New England is a drop in the national milk bucket, representing less than 3 percent of total production and unlikely to have much influence on national prices. What worries farmers in the Upper Midwest is the addition of five more states and the formation of a new southern compact. Combined, the compacts would represent nearly 40 percent of the nation’s milk production and 60 percent of its consumers.

Supporters of regional compacts contend that several factors mitigate against increases in production. The Northeast Compact premium is fairly small. It would be still smaller if excess milk were converted to cheese, since this would lower the fluid milk percentage, which would lower payments to farmers. An unreasonably high compact price would encourage out-of-state producers to ship more milk into the compact region, undermining the compact’s purpose. Finally, the Northeast Compact is required to reimburse the USDA’s Commodity Credit Corporation for any surpluses it purchases as a result of increases in regional milk production greater than the national average. (This is federal program that acts as an emergency safety net for the industry.)

Bylaw the Northeast Dairy Compact Commission must take steps to ensure that the premium “does not generate additional supplies of milk.” Two supply management proposals are currently under consideration. One would establish a production quota for participating dairies. The other would divert a portion of the current premium to farmers who did not increase production over the previous year and would be weighted to provide smaller dairies with a disproportionately larger share of the diverted benefits.

Neither is of much comfort to farmers in the Upper Midwest, who feel increasingly under siege. Butthe real threat to these farms arguably lies, not to the east, but to the west. Dairy production in the West has jumped more than 20 percent in the last five years and the region now accounts for 37 percent of the nation’s milk supply. Half of this comes from California, which surpassed Wisconsin in 1993 to become the nation’s number one milk producer. Dairy is big business in California, where the average farm has more than 600 cows – eleven times the size of an average Upper Midwest farm – and commands significant economies of scale.

No longer able to compete in the West, the Upper Midwest’s only salvation is to replace declining Southeast and Northeast production with Midwest milk, according to Ed Joiner, dairy farmer and chairman of the Louisiana Farm Bureau Dairy Advisory Committee. “In other words, they feel we must die for the Midwest to survive.”

Recent changes to the federal milk pricing system have moved the Upper Midwest closer to its goal of a uniform national dairy policy indifferent to local production costs. Regional differences in federal milk prices are being narrowed under the new rules, giving Upper Midwest producers a boost, while lowering prices along the coasts.

Should Congress fail to renew and expand the dairy compact model, these changes in the federal pricing system will accelerate the loss of eastern dairies. While Upper Midwest farmers may benefit in the short term, this free market approach to dairy policy holds out little long term hope for this region’s farms. Although many of the newest Midwest dairies house hundreds or even thousands of cows, the vast majority of farms here are small family operations. They may be able to produce milk more efficiently than their counterparts in the East, but they cannot match the scale economies of the latest generation of corporate dairies.

Though perhaps not as competitive on the simple measure of price, a local, small-scale dairy industry generates significant social and economic benefits for rural communities and, some argue, produces the best long-term value for consumers. As much of the eastern U.S. has concluded, these advantages easily justify policies that support local farmers, even at the risk of paying a few cents more for a gallon of milk. [!]

Stacy Mitchell is a researcher with The New Rules Project of the Institute for Local Self-Reliance.
© 1999 Institute for Local Self-Reliance

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Stacy Mitchell

Stacy Mitchell is co-director of the Institute for Local Self-Reliance and directs its Independent Business Initiative, which produces research and designs policy to counter concentrated corporate power and strengthen local economies.