In his second contribution to this #MilkCrisis debate, Alan Matthews considers contributions thus far and also the recent development of EU-wide voluntary reductions as part of a €500 million package.
Since this #MilkCrisis debate was initiated by ARC2020 the policy environment has changed, with the announcement at the July AGRIFISH Council that the Commission would propose legislation to introduce an EU-wide voluntary milk supply reduction scheme. This will be funded by €150 million out of the additional €500 million of new EU money made available for this latest farm aid package from the CAP budget without requiring recourse to the crisis reserve.
In the specific context of the EU dairy market, I agree that reducing supply will increase milk prices. The necessary condition for this is that the demand for raw milk by milk buyers should not change much in response to an increase in its price. In technical terms, this means that the demand for raw milk should be price-inelastic.
Despite the growing importance of exports of dairy products to a highly competitive world market, it is still the case that the demand for raw milk by EU processors is relatively unresponsive to price. I estimate that, for every 1% that EU milk supplies are reduced, the EU milk price will increase by just under 2.5%.
Implementing such a scheme is not straightforward. DG AGRI officials estimate that paying farmers an incentive of 14c for each kilo of milk less that they deliver to their processor in the last quarter of this year compared to the same quarter last year could remove 1.1 million tonnes from the market. However, 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 which results because some farmers reduce production will encourage other farmers who might have reduced production not to do so, or will 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 anyway planned to reduce production, and for whom the incentive paid will just be an additional bonus. 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. Indeed, the European Milk Board (EMB) in its response to the Commission’s announcement argues that this amount is too low to attract sufficient participation. This suggests the Board believes that farmers are still earning a significant and positive gross margin on milk delivered, even if when overhead costs including the cost of family labour are taken into account the dairy enterprise is losing money (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 3-4% in the final quarter of the year (assuming 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. Based on my calculations, the total gain to dairy farmers is likely to be around €300 million but could be more depending on whether Member States use their €350 million share of the package to further incentivise supply reduction or not.
I argued in my previous contribution to this #MilkCrisis debate that supply management schemes in the dairy industry belong in the past. But of the various options to implement supply management (including collective action by the 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, Dublin, Ireland. He is a past-President of the European Association of Agricultural Economists and is currently a member of Ireland’s Climate Change Advisory Council. He is a regular contributor to the blog capreform.eu on issues relating to the EU’s Common Agricultural Policy.