Canada, dairy and the TPP

[This post was first published in the Fairfax NZ Sunday Star Times on 27 April 2014.]

Canada and New Zealand are currently in serious negotiations as to future rules for the Trans Pacific Partnership (TPP). In relation to dairy products, we sit on different sides of the debate. We want free access. In contrast, they want to retain their supply management quotas which control how much milk is produced, and hence protect the farm-gate price of milk.

The widespread assumption in New Zealand is that free trade will open up new markets in Canada. The current dairy market there is 8 billion litres per annum. To put that in perspective, our total milk production in New Zealand is about 20 billion litres per annum. So on the surface, free trade could open up exciting new opportunities.

A recent report from The Conference Board of Canada places a different perspective on matters. They agree with New Zealand that Canada should get rid of its supply management scheme. However, they see the outcome being that Canada would rapidly transform its industry and become a major exporter.

They develop two scenarios, one being of an industry producing 14 billion litres of milk by 2022 and the other being an industry producing 20 billion litres by that time. Take off the shackles, they say, and Canada can rapidly develop a world class industry focused on trade into Asia.

A visit to a Canadian dairy farm can be like a journey back through a time machine. An average Canadian dairy farm has about 80 cows and the farm produces only one third the milk of an average USA dairy farm. Most of the Canadian farm capital is in the value of the quotas. Labour inputs are high. However, the post-farm gate part of the industry appears to be efficient, and hence retail prices, at least for fresh milk, can be somewhat lower than in New Zealand.

The Conference Board of Canada has looked across the Pacific to New Zealand with admiration for what we have achieved, but we are seen as somewhat irrelevant to the future. In terms of size, they describe New Zealand as a ‘shire’ which is rapidly running up against production constraints. Essentially, they think that their cost of producing new milk will be less than ours.

In Canada’s favour is a highly efficient feed production industry. They look across the border to the USA and see the costs of milk production of large scale American dairy farms and reckon, based on their own feed grain and production capacity, that they can match it. They have figured out – correctly – that production costs per litre on the best American farms are already comparable to in New Zealand. In fact their data suggests that for the largest American dairy farms the costs are actually lower in the USA than in New Zealand. Using current exchange rates, there is a very good chance they are correct.

In all scenarios, the Conference Board of Canada sees the USA as being the dominant dairy trading nation of the future, with New Zealand as No 2 but a long way behind. They also assume in all scenarios that overall global trade in dairy products will increase. They correctly assume that temperate countries have a major competitive advantage for dairy production over tropical and sub-tropical countries, but that global income growth and hence demand will come from the tropical and sub-tropical countries.

The Conference Board of Canada argues that the average Canadian dairy farmer family is about seven times as wealthy as other Canadian families. Essentially, they have had it good for many years and they do not need too much sympathy. They suggest that quotas could be bought out by the Government at the purchase price by the current owners rather than the current market price for this quota. This would be a manageable buy-out cost by the Government, and it would provide a safety net for those who had recently bought quota at high prices.

The one issue on which I disagree with the authors is the speed at which the Canadian growth might occur. Fortunately for New Zealand, the anti-liberalisation forces in Canada are well organised and will put up a big fight. I see it as likely that Canada will indeed forego its dairy supply management system, but the transition will be gradual, and hence so will be the unleashing of the shackles.

The big message for the New Zealand dairy industry is that the North Americans are coming. Their housed cow total mixed ration system of farming is cost competitive with our pasture-based systems, and the environmental issues are more easily managed. Whereas our system is constrained by the size of ‘Shire New Zealand’, their systems can be scaled up. The only question is whether this will occur only in the USA or whether Canada too will join the party.