H.R. 5288, the Dairy Price Stabilization Act of 2010, is a proposal that would create a national program that fundamentally changes the inherent incentives in the U.S. dairy industry that promote constant production growth regardless of the market’s ability to absorb that growth.

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Dairymen are no different from any other businessmen – they respond to incentives. What incentives currently exist in the highly-regulated dairy industry? The incentive to grow, grow, grow. Every morning, dairymen across the country wake up with one question in mind – how do I get the most amount of milk into my tank? There is little or no thought about the market demand for the milk you are producing.

While this type of produce, produce, produce mentality makes a lot of sense to individual dairymen, it makes absolutely no sense to the dairy industry as a whole. Producers need to realign the incentives in our industry and the DPSA would do this. The proposal would create a real, tangible, financial incentive for dairy producers to watch and manage the amount of milk that goes into their tanks.

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First off, the program must be both national and mandatory. It would be mandatory only in the sense that every dairy in the U.S. would have operate under the same rules. The decision about whether to grow or not would continue to rest solely on the individual dairymen, as it does now. There is nothing in the DPSA that prevents growth by a producer.

H.R. 5288 would operate on a facility-by-facility basis and milk production would be measured on a quarterly basis. For each facility, an “allowable milk marketings” will be determined for each quarter. The “allowable milk marketings” will be equal to the facility’s production during the same quarter in the previous year (i.e., the third quarter of 2009 would be compared to the third quarter of 2008), plus a pre-announced level of year-over-year allowable growth (normally 3% year-over-year growth).

For producers that want to expand their share of the market and grow beyond 3% year-over-year, a market access fee would be paid. The producer would have a choice under the DPSA to pay the market access fee on:

The DPSA would certainly change the way dairymen throughout the U.S. think about growth, although it would do nothing to stop any dairy from growing. For dairies interested in expanding, the DPSA envisions a market access fee that is modest enough to be budgeted as an expense during that dairy’s expansion (i.e., a dairymen that expands his herd would budget to pay the market access fee in the first year he expands and that expansion then becomes part of his benchmark production).

This point cannot be reiterated enough – the DPSA is not designed to stop growth and expansions by dairies. The program is designed to give dairies a tangible reason to manage their production. If a dairy wants to increase their share of the market, there is a knowable, budgetable market access fee that must be paid. But for those dairies that are not in that expansion mode, there is a financial incentive to make sure that facility’s production stays at or below their “allowable milk marketings.”

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The intent of the DPSA is to minimize the “cyclical” volatility that our industry has. While this “cyclical” volatility has been with the industry for many years, it has continued to get worse, with longer and deeper financial wrecks (i.e., 2009 is worse than 2006, which was worse than 2003,etc.). Cornell University’s model shows that by implementing a program like the DPSA, we could minimize this cyclical volatility (that report can be found at http://dairy.cornell.edu/CPDMP/Pages/Publications/Pubs/GMP_Report.pdf).

If you look at previous reports from 2007, the Cornell University model predicted that without any policy changes, we were destined for a wreck in the dairy industry in 2009, before we ever experienced the dramatic rise in exports followed by the rapid collapse. The cyclical volatility alone was going to make 2009 a devastating year for the industry.

What we are experiencing in 2009 is a double-whammy – not only was the industry destined to be on the losing end of the “cyclical” volatility this year, but at the same time we are dealing with a collapse of the global economy, drying up a chunk of the export market we have relied on in the past couple years, and rapidly driving our milk price to government support levels. And while the DPSA could not have forecasted or prevented the sudden loss in demand, Cornell University modeling has demonstrated that it could still be effective in greatly shortening the amount of time we experience these low prices, and give us the hope of a stable market once we emerge from this wreck. This very fact – that a long-term stable market could allow dairies to recover the decade’s worth of equity that they’ve lost in this current wreck – is the kind of hope and optimism we need in the dairy industry right now.

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The first part of the answer to this question is that there are still pretty significant tariff rate quotas on most domestic dairy products which makes any kind of a flood of dairy products into the U.S. unlikely.

Secondly, the main goal of the DPSA is to minimize price volatility, not significantly enhance prices over what they would otherwise have been. So the relative position of the U.S. dairy industry in relationship to the other dairy producing regions of the world would not be significantly changed from the current situation.

On the positive side, the slightly higher, but more stable milk prices under the DPSA would still allow us to compete in some export markets and perhaps as a more steady seller to countries rather than an opportunistic supplier. More stable prices may also help expand domestic market opportunities.

Finally, by a large margin, the New Zealand dairy industry is the low cost producer in the world. Their entire industry is engineered for exports. They will sell their production for whatever price they can get. It is futile to try to under-price them. But, they are subject to weather-related variations in production and they are limited by land base as to what they can produce.

If the U.S. can get control of its production and bring it into line with demand, which is the goal of the DPSA, this will go a long way toward stabilizing world prices and therefore lead to a situation where there is not a substantial difference between the world market and the U.S. market.

With all this said, H.R. 5288 still includes a fail-safe.  A producer-referendum is required after three years of operating the DPSA, giving producers an opportunity to eliminate the program if it is not successful in stabilizing milk prices or maintaining a healthy import/export balance.

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The Gramm-Rudman assessment was clearly a milk tax. It was imposed on producers specifically to charge them for the costs of carrying out the national dairy programs. The DPSP is not a tax. It is a tool which establishes a financial incentive for individual producers to manage their milk production so as to keep the overall milk supply in line with demand.

The “market access fee” that expanding dairies would pay under the DPSA does not go to the government; it goes directly back to those producers who hold their production in check. That simple production discipline creates room in the market for the increased production, and does not depress the market price for all. And whether you are growing and paying the market access fee, or holding your production and receiving your share of the market access fees, the whole industry is enjoying a stable and profitable business climate. It’s a win-win.

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First, let’s dispel the notion that the dairy industry is a free market. It’s not. In fact, most American dairy producers support the pricing regulations we currently have – most notably the pooling regulations – because of the justifiable fear that absent the regulatory presence of the government, processors would exploit producers.

For decades the pooling and pricing regulations of the government have provided a relatively stable business environment which enabled the U.S. dairy industry to prosper. However, in past decade, the producers’ ability to rapidly increase production in response to any positive margin in the price of milk exceeds the markets ability to absorb that production. This fact virtually guarantees that the industry will suffer from a boom/bust cycle. Those booms in price destroy demand for dairy products and the inevitable following busts destroy producers. The current system is broken.

The DPSA offers a uniquely American solution to this age old problem. Canada and Europe took a very different route when faced with supply-driven problems – they adopted rigid quota programs to get their domestic supply and demand in balance. That has never been an acceptable option to the vast majority of American dairy farmers.

Instead, the DPSA creates a modest incentive program which allows for growth and freedom of choice for dairy farmers without the establishment of quota, which becomes capitalized. Cornell University’s Program on Dairy Markets and Policy has demonstrated that this type of program offers great promise for a stable and profitable future.

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The U.S. dairy industry already has a default “supply management” in place. When we go through wrecks like 2006 and 2009, thousands of dairy farmers have to shut down because they simply cannot hemorrhage as much money as their neighbors. That’s how we get rid of excess production – producers bleed until enough die off. Is that really what we want?

And what about new entries into the industry – a component of any healthy industry? In Canada and Europe, new entries are virtually shut out, with the cost of quota in the tens of thousands of dollars per cow. What about the U.S.? One could argue that we’re even worse. In Canada and Europe, you may have to invest a lot of capital in production quota, but at least your price is stabilized and profitable once you’re in business. In the U.S., you may be able to get your dairy built, but how could any new dairyman survive the wrecks like we’ve experienced recently without massive amounts of familymoney behind him? If we allow this volatility in the industry to continue, the only dairies left will be hose with the huge family fortunes available to keep the dairies operating through these huge swings. That is simply not a healthy industry.

A simple change in the incentives can make the U.S. dairy industry viable (and bankable) again, and the DPSA is the only idea being discussed that would do that.

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