An Often Overlooked Reason for High Grocery Prices: Canada's Supply Management System
In the end, it benefits almost no one, including most dairy farmers
Understandably, a lot of people are quite upset about “sky-rocketing” grocery prices over the last little while, and a lot of these frustrations have been directed at large grocery retailers, especially Loblaw Companies Ltd. and its President Galen Weston Jr. However, much too little of the blame is being directed at federal and provincial governments in Canada who legally require higher prices in dairy, eggs, and poultry (DEP), via the enforcement of “supply management”: a system that was designed to create and enforce a legal cartel to the detriment of not only consumers, but also non-DEP farmers, restaurants, and even many participants in the DEP industries.
Even worse, there is no real political opposition to the system since all major parties endorse it — the only one to come out officially against supply management is the People’s Party of Canada under Maxime Bernier, but it is hardly worth mentioning.
In fact, on November 23, 2005, a motion supporting the supply management system was unanimously passed in the House of Commons. This unanimity is remarkable considering how political parties tend to disagree with each other just for the sake of disagreement. It even reminds me of the following classic Adam Smith quote from The Wealth of Nations, which applies to both the members of the cartel and to the politicians who support it:
People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices…. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies, much less to render them necessary.
It is therefore the purpose of this issue of the Walls and Bridges newsletter to explain the system of supply management and why it is so bad for so many people, as well as why it appears to be so politically risky to oppose it. I will also cite similar historical examples of protectionism — specifically the dairy industries in Australia and New Zealand, and Canadian wines — to show how deregulation can actually benefit everyone (producers and consumers) if only our political leaders have the courage to stand for all of their voters rather than just the special interests.
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The History of Supply Management
In her excellent research paper for the University of Calgary’s School of Public Policy, Martha Hall Findlay (2012) explains that pressures on Canadian governments by dairy farmers started as far back as 1890 with the appointment of the first Dominion Dairy Commissioner. However, it was not until 1970 when the first fully national system of supply management was created, starting with dairy and then expanding to eggs in 1972, turkey in 1974, chicken in 1978, and chicken hatching eggs in 1986.
The motivations behind the supply management system were not unique to Canada, as governments around the world wanted to ensure a “fair” return for farmers, as well as stability in prices and supply for both processors and consumers. In their minds, the system was necessary to reach these goals because world markets were volatile and world prices were unstable; dairy producers could do nothing about it on their own because they lacked market power. These governments also agreed dairy farmers should be compensated for having to adhere to high health and safety standards.
So how does supply management work? Unlike free markets where prices are jointly determined by demand and supply — where demand represents what consumers are willing and able to pay for the product — the supply management system determines prices based primarily on costs of production. Furthermore, the federal government levies substantial protective tariffs to keep out foreign competition, and production is controlled through a regulated system where farmers are not allowed to produce more than their individually-alloted quota.
Under this system, the Dairy Commission (comprised mostly of dairy farmers) sets milk prices, while the national Milk Supply Management Committee determines the national production level — the provinces have the authority to manage the supply of raw milk for table milk and cream. Furthermore, prices differ according to the use of the product — for example, the highest prices are for milk that go to the tables of consumers (“table milk”) and cream, followed by milk sold to processors for ice cream, yogurt, and sour cream; cheese is next, then skim milk powder, and finally butter.
Initially, the federal government simply blocked foreign competition outright, but that approach became difficult given international pressures for Canada (and other countries) to lower trade barriers, first under GATT and then the WTO. So Canada allowed tiny quotas of DEP imports to adhere to international “minimum access commitments” at low tariffs, and then levied prohibitive tariffs above those quotas.
To be clear, the quotas are so small to be essentially meaningless; one example given by Findlay (2012) is the quota for yogurt, which amounted to the equivalent of one rounded-teaspoon per Canadian per year. As of 2012, the tariff rates above quota were 168% for eggs, 238% for chicken, 246% for cheese, almost 300% for butter.
With respect to how much each farmer is allowed to produce, they are each provided a maximum quota because overproduction would obviously be counterproductive for the purposes of the cartel. The quota is transferrable, so the average price of a cow in 2012 was $28,000 over-and-above the amount the cow would be worth apart from the quota — double the value from ten years earlier.
Since Findlay’s paper was published, there was more pressure from the international community for Canada to back away from supply management. Most prominently, the Canadian government had to make concessions on this front to become a member of the Trans-Pacific Partnership (TPP), as well as when renegotiating NAFTA. These moves upset the dairy producers who benefit from supply management, and for that reason the federal government did all it could to keep the system as strong as possible, while all opposition parties did the same.
Supply Management Hurts Almost Everyone
Consumers
Obviously, consumers are negatively affected by supply management since they must pay more for less. Furthermore, while proponents of the system argue it still leads to higher quality food, the evidence is not there, particularly when considering the post-deregulated dairy industries in Australia and New Zealand, as well as Canadian wine producers after 1988 — but more on them later. Even so, health and safety regulations can exist without supply management, as they do in many other Canadian industries.
There are also negative equity implications of supply management because consumers who are harmed the most from it also often have lower incomes, e.g., single mothers who especially need milk for their children.
Farmers Protected by Supply Management
By design, the supply management system is meant to benefit the producers of dairy, eggs, and poultry. Therefore, it is unsurprising when Findlay (2012) argues incomes of dairy farmers are higher than other farmers, and the average dairy farmer is better off than the average consumer who pays the higher prices. In other words, the supply management system effectively robs from the poor and gives to the rich.
But many DEP farmers are still worse off from supply management because despite the argument that the system protects the family farm, Findlay (2012) informs us that the number of dairy farms fell during the first 40 years of supply management from 145,000 to 12,746; according to the Canadian Dairy Commission, it has since fallen further to 9,739 as of August 1, 2022, and 80.6% of these farms are in Ontario and Quebec (more on that later). Thus, since total milk production remained relatively constant during all these decades, the remaining farms became much larger and more sophisticated than what one might call a “family farm”.
To be fair, the author adds that the number of dairy farms in the U.S. also dropped from 591,870 in 1971 to 67,000 in 2008, so supply management was not to blame for the dramatic decline in dairy farms in Canada — but it did not stop it, either.
Now, as the remaining farms increased in size they were able to take advantage of economies of scale, meaning their average costs of production fell. That implies prices should fall, too, but in reality they have risen by more than inflation, while milk prices in the U.S. rose less than the prices of all consumer goods. Even during the last year when inflation rates rose quite a bit, Dalhousie University’s Sylvain Charlebois found that repeated price increases by the dairy cartel were not justified by cost data.
So why do farmers not take advantage of economies of scale? One reason provided by Findlay (2012) is the prices they receive are calculated on a cost-plus basis, so they have no incentive to innovate. Furthermore, efficient dairy farmers are penalized by the system because they are discouraged from expanding and becoming more productive. The value of a dairy cow also acts as a barrier to new entry that might encourage more innovation, since the cows are too expensive for new entrants.
On that note, there was recently a video produced by a dairy farmer who complained that under this system, he was required to dump 30,000 litres of milk rather than sell it, because he was not allowed to produce above his quota. You can see that video below.
Dairy Processors, Non-Dairy Farmers, Restaurants, and Bureaucracy
The system is also bad for processors who make cheese, yogurt and ice cream because they have to pay the higher prices, too, meaning they cannot compete on the world market where prices are so much lower. Therefore, not only are they dissuaded from expanding operations in Canada, but they also cannot compete elsewhere. In other words, their opportunity costs of processing dairy are too high, incentivizing them to take their capital investments — and the jobs that go with them — abroad.
With respect to non-dairy farmers, supply management hurts them by keeping them out of foreign markets closed to Canada because our governments stubornly insist on keeping the supply management system. After all, our trading partners rightly wonder why they should open their markets to us when we will not do the same in return.
Then there are all of the restaurants in Canada who must pay higher prices for the food they buy. It is for that reason the Canadian Restaurant and Food Services Association is vocally against the system.
Finally, Findlay (2012) details a significant amount of bureaucracy needed to administer the system, “with the focus on regulation, making adjustments, fighting over provincial quota, fixing loopholes, lobyying politicians, and defending system against increasing opponents.”
Cases where Deregulation Worked for Everyone
The Wine Industries in Ontario and British Columbia
Recall motivations for supply management included giving Canadian dairy, egg, and poultry farmers and consumers stable production and prices, because the farmers could not survive if they had to compete in world markets. Therefore, proponents of the system feel threatened by calls to end the system.
However, Findlay (2012) recalls the same fears being raised by Canadian wine-makers when Canada signed its free trade agreement with the U.S. in 1988. Contrary to these expectations, with some transition assistance from provincial governments, many wine producers in Ontario and B.C. ended up thriving under the deregulated system, winning international awards and creating new tourist industries. They were able to do so because competition motivated them to use higher-quality grapes and become more productive. In fact, both producers and consumers were better off with the deregulations because wine producers were able to lower their costs and open up to new export markets, thus increasing sales; Canadian consumers were able to drink better wine from both Canada and the U.S.
Australia Ends Supply Management
Findlay (2012) explains Australia was a pioneer in supply management, going back to the 1920s when it implemented its system for the same reasons as Canada. However, by 2001 it realized the system was not all it was cracked up to be, so with input from the dairy industry itself, it made a solid plan to end it as seamlessly as possible.
Specifically, it made transition payments to dairy producers every quarter for eight years, and also levied a temporary retail levy on milk. The resulting prices were higher than they would have been under the free market, but they were still lower than under supply management — and they ended after eight years. In the end, farm production rose and so did exports, and the industry became more internationally competitive as productivity rose.
The New Zealand Experience
To be clear, New Zealand never had an actual supply management system. Findlay (2012) explains that its dairy industry was always driven through cooperatives that were export-oriented. Instead of a quota system, the country had a simpler system of tariffs and subsidies, so deregulation did not require the transition payments that Australia had, and Canada likely would need to have.
Furthermore, in New Zealand all farmers were protected under the regulated system, not just dairy, eggs, and poultry, and the subsidies came from government coffers. Nonetheless, the farmers themselves realized in 1984 the system was too distortionary, so they were on the same side as everyone else who wanted to end the regulations. In the end, New Zealand was able to deregulate faster than Australia, and dairy became its largest export.
Political Motivation for Supply Management
Despite many politicians privately admitting supply management should end, they are too afraid to admit it pubicly because they say it would be political suicide; every party wants to get as many seats as possible in vote-rich Ontario and Quebec where (as stated earlier) more than 80% of dairy farmers exist. It is for that reason that all major political parties openly support the dairy cartel.
But is it really political suicide, or are they fooling themselves? Findlay (2012) conducted some analyses where she found that only 13 ridings in all of Canada had 300 dairy farms with an average of 80,000 registered voters each: eight in Quebec and five in Ontario. She found that even if the (then) governing Conservatives lost all of these seats — and they did not have all of them in the first place — then they would have still had a majority. Therefore, the Harper government could conceivably have ended supply management and still been in majority territory.
Furthermore, the author reminds us that there would still be many voters in all federal ridings, including non-dairy farmers and consumers, who want to see an end to supply management — at least they would if they knew that was why prices are so high. But the problem is the dairy industry is much more organized than non-dairy farmers and (especially) consumers. That is why Andrew Scheer was able to win the Conservative leadership race in 2017 with support from dairy farmers who fought to ensure he beat Maxime Bernier, the only leadership candidate to openly oppose supply management.
Therefore, while it is possible a party could win a general election while opposing supply management, it is much more difficult to do so in leadership races where the general population does not vote, and where special interests therefore have much more power to influence who is leader in the general election.
Before ending, it is interesting to note that when Stephen Harper was Prime Minister of Canada, he ended the Canadian Wheat Board (CWB) — a marketing board for wheat and barley in Western Canada. While the CWB was not the same as supply management, Harper had no problem taking away its monopoly powers, fighting unsuccessfully to do so until he won his majority in 2011, and was then able to end it by 2015. It might seem contradictory that Harper would support supply management but not the CWB, until you remember that the latter only applied to Western Canada where the Conservatives face little-to-no political competition, especially in Alberta and Saskatchewan; supply management, on the other hand mainly benefits Ontario and Quebec farmers, and all parties need all the votes they can get there.
Summary Remarks
In summary, supply management needs to end, and we need a government that has the courage to make it happen. Of course, it would be optimal to have the dairy industry be at the table when making the necessary changes, which is why I agree with Findlay (2012) that we should follow the Austalian model of de-cartelization.
Thank-you for reading until the end, and I look forward to writing for you again next week. One of the benefits of a paid subscription is the ability to comment on any and all of my posts, so I hope you will do me the honour of paying for a subscription and then letting me know what you think of my writing (whether positive or negative), and what you would like to see in the future. As long as you are respectful, you can say whatever you want to me!