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Monday 24 July 2017

Production limits are not the way forward for under pressure dairy sector

EU Commissioner Phil Hogan. Photo: Reuters/Francois
EU Commissioner Phil Hogan. Photo: Reuters/Francois
Alan Matthews

Alan Matthews

Commissioner Phil Hogan announced at the July Agricultural Council that the Commission would propose legislation to introduce an EU-wide voluntary milk supply reduction scheme in the autumn.

This will be funded by €150m out of the additional €500m of new EU money made available for this latest farm aid package from the CAP budget without requiring recourse to the crisis reserve.

What sort of impact might this scheme have on the EU milk market and the EU milk price when it is introduced? This depends primarily on how responsive buyers of milk and dairy products are to an increase in the milk price along the supply chain.

If buyers are very sensitive to an increase in the price, then limiting supply will have little impact.

Despite the growing importance of exports of dairy products to a highly competitive world market, the demand for EU milk and dairy products is probably still relatively unresponsive to price. I estimate that, for every 1pc that EU milk supplies are reduced, the EU milk price will increase by just under 2.5pc.

However, the mechanics of a voluntary milk reduction scheme make the situation more complicated. DG AGRI officials estimate that paying farmers an incentive of 14c for each kilo of milk that they reduce their supply by in the last quarter of this year compared to the same quarter in 2015 could remove 1.1m tonnes from the market.

Against this it should be remembered that the amount of foregone milk that farmers are paid to remove will not be the same as the net impact on the market.

Part of the reason is that the higher milk price that results because some farmers reduce production will encourage other farmers (including farmers in New Zealand and in the US) who might have reduced production not to do so. Conversely, it may encourage dairy farmers who might otherwise have slowed down their expansion plans not to do so. This rebound effect is one reason why the net reduction in milk supplies will be less than what the budget has financed.


Another reason is that many farmers availing of the scheme will be those who had planned to reduce production regardless, and for whom the incentive paid will just be an additional bonus.

Incentive

This is particularly likely because the recently-published DG AGRI short-term market outlook projects that milk production in the second half of this year in the EU will be lower than last year in any case.

Another factor to bear in mind is that, for those 'new' farmers attracted into the scheme who would otherwise not have reduced production, not all of the 14c/kg incentive is a pure gain.

Farmers still earn a significant and positive gross margin on milk delivered to their processors, even if the dairy enterprise is losing money when overhead costs such as family labour are considered (but before taking into account the value of any direct payments received by the farm).

Despite these caveats, the new scheme is likely to increase monthly milk prices by up to 3-4pc in the final quarter of the year. This assumes, as I expect, that demand will be high and that the budget will be exhausted by December.

These higher prices will result in additional revenue to dairy farmers, on top of the budget injection itself.

I estimate that the total gain to dairy farmers is likely to be around €300m, but it could be more depending on whether Member States use their €350m share of the package to further incentivise supply reduction or not.

I am not a fan of supply management schemes. Paying farmers not to produce is not a good use of public money. But of the various options to implement supply management, including collective action by the dairy industry under Article 222, or the reintroduction of mandatory quotas, this voluntary scheme is certainly preferable.

In particular, introducing mandatory production limits would hurt a large number of dairy farmers and would have serious long-term negative effects on the industry.

The voluntary scheme will be complex to administer and the details of how this will be done remain to be worked out over the summer. Paying agencies must put application forms in place.

There will need to be a system of checking applicants' stated production levels last year, and farmers will only receive the money after the three months is over and their actual deliveries can be confirmed.

How farmers who overstate their intentions initially and then fail to comply must also be addressed.

This is the first time that the EU has introduced a temporary supply management scheme and its impact will be closely watched.

If it is deemed to be successful, this precedent will no doubt form part of the debate on the common market organisation regulation in the next CAP reform.

Alan Matthews is Professor Emeritus of European Agricultural Policy at Trinity College

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