It is thus an opportune time to evaluate the EU’s response to the crisis, and to see what lessons might be drawn for how the Union can address similar problems in other farm sectors in the future. My view is that there is a lot to be learned from the dairy crisis, and that the outgoing Commissioner deserves credit for the way she handled it.

EU milk prices improving

Let us first review the evidence that the milk market is improving. The trends in the EU market prices (proxied by the German price and represented by the blue line) and the EU intervention price (the red line) for butter and skim milk powder (SMP) have been graphed by CLAL.it and are reproduced below.

The German butter price is now back to the level of 2002 before the cuts in intervention prices. The recovery in SMP prices has not been as strong, but even so these are now comfortably above intervention levels. EU dairy farmers also benefit from an additional €5 billion per year in the form of direct payments (3.5c/kg milk) to compensate for the reductions in intervention prices.

Farm prices are responding to the better prices for dairy products, although with some lag. The average EU price for standardised 4.2% fat milk, according to the LTO, has risen to €27.06/100kg in October 2009 from its lowest point of €23.74/100kg in April. It is now back at the levels of Spring 2007, before the big run-up in prices in 2008.

The recent USDA market outlook for dairy products in 2010 foresees continued strong prices into 2010 as economic growth recovers particularly in developing countries. While the large stocks of SMP in particular overhanging the market are seen as a negative factor, it observes that in the US most of these stocks are committed for domestic food programmes and that the EU is unlikely to release its stocks on to the market soon for fear of the political fallout from producers.

The Commission’s response to the dairy crisis

Assuming that prices continue to strengthen throughout 2010, it is useful to review what lessons were learned for crisis management when faced with a substantial fall in the price of a farm commodity. The Union’s responses to the collapse in domestic milk prices in 2009 can be divided into market management measures and income support measures.

Among the market management measures were

In total, the Commission expects to spend up to €600 million on market measures this year.

Among the income support measures were:

Reflections on the Union’s response to the dairy crisis

A first observation to make is that, while the Commission did resort to market management measures such as intervention and export subsidies, much more emphasis on this occasion was put on income support measures.

It was noticeable that the Commissioner firmly set her face against any increase, even temporarily, in intervention prices and against a reduction in quotas, arguing that both would be against the spirit of the Health Check intended to move the CAP in a more market-oriented direction.

Although the future of export refunds after 2013 is uncertain (the EU has committed to their elimination but only in the context of a successful outcome of the Doha Round in which similar disciplines applied to other forms of export support), it is likely that the greater emphasis on direct income support measures in response to crisis is here to stay. While the loud voices calling for stronger support measures as part of a food security policy for Europe would doubtless like to see stronger market management measures, these are effectively beggar-my-neighbour responses unless undertaken as part of a global framework (e.g. a global stocks policy).

A second observation is that the income support measures included both a relaxation of state aid restrictions (allowing Member States to fund payments to producers) and a Community scheme. While the national state aids were permitted only in the context of a measure taken as part of a wider response to the economic crisis, they do flag a possible direction for future responses to agricultural market crises. When the figures come in, it will be interesting to assess how much use the individual Member States make of this opportunity.

A third observation is that the payments will be made to producers only with a lag (the exception is the speeding up of the disbursement of the standard Single Farm Payment). This means that payments will reach farmers after the crisis has passed and when incomes are already recovering. Clearly, payments should reach farmers at the time when they are most needed, and hopefully the decision to allow the Commission to respond to future dairy market crises on its own initiative may facilitate this in future.

A fourth observation is that there is now little headroom in the EU budget up to 2013 to fund unexpected crisis management measures. The outgoing Commissioner has made clear that funding the €300m emergency aid from the 2010 budget has utilised any remaining headroom and, apart from the use of the safety margin, any further call on the agricultural budget would trigger the financial discipline mechanism requiring a cut in direct payments.

Price volatility on agricultural markets is expected to increase in future (though whether this is a reasonable presumption to make deserves further analysis, and the outcome depends on the interaction between production shocks and their distribution where climate change is expected to increase volatility, trade policies and their implications for price transmission from world to national markets, and government behaviour particularly with reference to stocks).

Presumably these lessons will be analysed by the High Level Experts’ Group on Milk which is looking into the medium and long-term future of the dairy sector and which will deliver its final report by the end of June 2010. A very useful input is the report on price volatility in the dairy sector commissioned by the European Dairy Association and written by my Irish colleagues Michael Keane and Declan O’Connor.

The 2009 EU dairy market crisis was handled well by the outgoing Commissioner. There was no back-tracking in the direction of CAP reform, and a number of innovative new instruments to address income volatility in a particular sector are being tested. The lessons learned from this experience will be an important input into the discussions on the shape of the CAP post-2013.

Update 5 January 2010: When writing this post, I had not seen that the French have made use of the national state aid provision to provide up to €700 million to farmers affected by the crisis. Aid under this new scheme can be granted until 31 December 2010 and will take the form of direct grants, interest rate subsidies, subsidised loans as well as aid towards the payment of social security contributions. See http://europa.eu/rapid/pressReleasesAction.do?reference=IP/09/1866&format=HTML&aged=0&language=EN&guiLanguage=en,

The main move was to make an additional €280m of public money available under the Article 186 ‘disturbance clause’ which allows the Commission to step in at short notice when the market collapses. The milk market has hardly collapsed and this is something EU finance ministers may wish to consider when they meet to consider the approval of the move on 19 November.

What the money is to be spent on is yet to be decided, although private storage for cheese has been mentioned. No, this doesn’t mean that members of the public can get a subsidy for filling their fridges with cheese, although anything is possible in the Alice Through the Looking Glass world of the CAP.

What is significant is what was in the Franco-German document that has not been acted upon: official intervention buying of chesse, additional funding for school milk schemes (funding for fruit yoghurt had already been agreed) and more targeted export assistance and subsidies for skimmed milk powder to be used in animal feed.

It was this last measure which had the greatest potential for damage. Commissioner Fischer Boel dismissed it by saying that she had not received any convincing evidence that it would increase demand. What it has done in the past is seriously distort other markets, e.g., for pigmeat.

The notion of freezing quotas had already been knocked off the agenda in September, a singularly ill thought out proposal which would have done nothing in the short run and delayed adjustment in the longer run.

It is worth noting that milk prices have been increasing, by 2 per cent in August while butter has gone up by 4 per cent in France, 8 per cent in Germany and even more in the UL. Intervention buying of skimmed milk powder has virtually come to a halt because the market price is higher that the intervention price.

Complaining that the farm ministers “have been plucking off my last feather”, she said that this would be the last time:

“There will be no possibility for any delegation to come and ask for more money now. And I say this as I see some other sectors of agriculture facing some problems.”

I hope some of this largesse will be funded from the 99 million euro in levies against member states that have exceeded their milk quota.

With only a few months left in office, this may well be a promise she’s able to keep, though who’s to say what goodies her successor will wish to serve up while settling into his or her new job. One thing is for certain, the farmers will still be there with their begging bowl. After all, Jackie Cahill, president of the Irish Creamery Milk Suppliers’ Association welcomed Fischer Boel’s latest move as follows:

“It is a totally inadequate response with the income situation we have. It is not going anywhere near solving the crisis.”

No good deed goes unpunished.

Yet again the tractors blockaded central Brussels this week with a few thousand farmers hurling eggs and chestnuts to reinforce their calls for a bail out. Dairy farmers across Europe are hurting because of low prices for which there are two – perhaps three – main reasons.

First, after a significant price spike during the ‘food crisis’ of winter 2007/08, prices have fallen back dramatically. Some of this is due to the lagging nature of the upward supply response, as farmers increased output to make the most of higher prices, both in the EU and elsewhere. While fresh milk is not traded globally, butter and milk powder are, so what dairy farmers in New Zealand do can have a big effect on fresh milk prices in the EU. Second, the global economic downturn has seen a reduction in demand for dairy products in the middle classes of developing countries like China and India. Third, and while there is less in the way of concrete evidence on this point, it has been suggested that imbalances of power in the relationships between farmers, milk processors and retailers means that prices received by farmers are depressed.

Commissioner Fischer Boel is holding the line against any new EU-funded bail out for the dairy sector. What she is in effect doing is passing the responsibility back to national governments, offering them the chance to use national state aids, in the knowledge that finance ministers are rather less enthusiastic than farms ministers when it comes to opening the coffers for the benefit of a group who are already in receipt of more handouts than most. This move is yet another indication that national co-financing will play an ever greater role in the future of EU farm aid, something that I have argued for.

At the same time as saying a polite but firm ‘no’ to dairy farmers she is also setting up an inquiry into the dairy supply chain to find out whether there is any evidence of abuse of market power. This is a good thing. Farmers have long been the victims of a highly concentrated retail sector but even if there is a smoking gun it’s hard to see what remedy can be applied. Perhaps supermarkets can be persuaded not to use dairy products as a ‘loss leader’ to attract customers though that presents its own problems, such as higher prices for shoppers. The inquiry will report to Mrs Fischer Boel’s successor by June 2010.

At the most basic level we are witnessing a shake-out of the less competitive dairy farmers in the EU and in my view there is very little that can, or should, be done by governments beyond the provisions of the welfare state that apply to all citizens and businesses. The fact that the shake-out has been delayed for so long by a system of milk quotas that kept high cost farmers in business is not be a reason to pour new money into the sector. While manning the blockades and trashing their own produce, farmers argue that they deserve special help because the future capacity of Europe to produce milk is at stake. I disagree. It is certain that we will see fewer dairy farms in the future, but those that do remain in business will be larger and more succesful, the result being that production will remain at relatively constant levels, varying in line with demand and global supply. We may well worry about the growth of grotesque livestock mega-farms as seen in the United States and there needs to be a regulatory framework in place to ensure Europe avoids going any further down that path. But one thing is for sure, the raw milk that goes into the daily pinta or Europe’s world-beating variety of cheese is never going to come from New Zealand.

Global prices surged in 2007, but this led to more production which came on to the market as the recession ended.

The simple fact is that there are too many inefficient dairy farmers in Europe. A slimmed down dairy sector would be more globally competitive. However, despite the opposition of Britain and Denmark, one suspects that a policy fudge is on the way.

The report first makes a convincing case that the collapse in milk prices has nothing to do with the relaxation of EU dairy quotas as part of the ‘soft landing’ to their elimination in 2015. For the first point, EU milk production actually fell by 0.9% in the marketing year 2008/09 despite the 2-2.5% increase in quotas. The real sources of the crisis are the weakness of global demand and a powerful surge in output from major non-European producers.

Thus the Commission refuses to reverse its policy to gradually increase quotas in order to reduce quota rents to zero by the time the quota policy is eliminated in 2015. This is a direct response to the demand by the new dairy farmer lobby group European Milk Board for the limitation of quotas in order to manage supply.

However, the second point made by the report, and emphasised by the Commissioner in her blog, is that phasing out quotas does not mean that dairy farmers have been left completely to the mercies of the free market. The EU has made use of its traditional instruments of market management, including public intervention, aids for private storage, and export refunds. Export refunds for butter, for example, at the beginning of July were €650 per tonne, compared to a world market price (based on Oceania quotations) of €1,348 per tonne.

Also, part of the reduction in milk prices at farm level was compensated in the 2003 CAP reform by an increase in direct payments worth around 3.5c/litre.

The report also highlights various options open to Member States to support dairy farmers through the CAP Health Check reforms of the national envelope, the use of modulated rural development funds and the use of money from the European Economic Recovery Programme.

Despite these measures, however, it is clear that European dairy farmers are hurting. At the same time, there is little evidence that European consumers are benefiting in terms of lower consumer prices for dairy products. Figures in the annex to the report show that despite a reduction in the farmgate price of milk of 28% between Q4 of 2007 and Q1 of 2009, the price of the food category ‘milk, cheese, eggs’ (which includes other milk products but excludes butter) increased by 4%, with higher increases in some Member States. The pattern is similar across most Member States and strongly suggests the exercise of market power by retailers in the dairy supply chain.

Milk prices have fallen over the past few months to a point where many less competitive dairy farmers are not able to turn a profit. Relative to market demand, too much milk is being produced at too high a cost. Of course in a normal market there would be a supply response until prices returned to equilibrium levels. But this far from a normal market. In the EU, when prices go down and less competitive dairy farmers stop turning a profit, they do not respond by cutting production. On the contrary, they keep on producing and organise mass protests in national capitals calling on their farm ministers to do something to get prices back up.

Why are milk prices in decline? According to EU Agriculture Commissioner Mariann Fischer Boel,

“The problem we are facing today is not the result of increased production in the EU but rather the combination of increased production in a number of third countries… and a decreasing demand in EU and on the world market.”

The way that the EU keeps milk prices above their true market levels is through a system of production quotas, not unlike the OPEC oil cartel. The only farmers who are allowed to sell milk in the EU are those who own or lease quota. Over-quota production is discouraged by a system of fines. (It works a little differently in Italy where politically powerful dairy farmers continue to produce over quota but instead of paying the fines they force their government to pay the fines for them. I’m told that the new quota won by Italy in the health check deal last year are being allocated to the very same farmers who persistently broke Italy’s quota limits.)

Milk quota keep prices up across the board and benefit all farmers with quota, not just those ‘in need’ of subsidy. A system that serves to keep less competitive farms in business and also provide windfall profits to the more competitive producers. However, some of the more competitive producers would like to expand their production to achieve further cost efficiencies but are unable to do so because they have not got sufficient quota to cover the increase in output. Quota can be bought and in some countries like the Netherlands, buying or leasing quota is one of the main running costs for dairy farmers, alongside traditional expenses such as renting land and buying feed.

In short, the EU’s more competitive dairy farmers (those based in places where the climate is conducive to dairy farming) would on balance like to see the quota system end. Less competitive dairy farmers (those that are very small or are farming in places that are not conducive to dairy farming e.g. half way up mountains or in very dry or very cold places) would like to see quotas preserved. All things being equal one would expect that consumers of milk and dairy products would like to see cheaper milk through the phasing out of quota.

The push for a postponement of quota reform is being led by German farms minister Ilse Aigner. Michel Barnier, her outgoing French counterpart, has also defended quota:

“If it was up to me we’d keep the milk quotas in some form or another… We have to be very careful not to exacerbate the current overproduction.”

Faced with a problem of overproduction or a fall in demand, allowing prices or output to fall is just not a politically acceptable option. Unless, of course the cut in production is called a ‘milk strike’ such as that organised last year by BDM, the German milk producers federation, and which is again being threatened. More evidence of agriculture policy as the triumph of politics of economics.

While not countenancing “a complete re-orientation of the EU dairy policy” Commissioner Fischer Boel has not ruled out a postponement of this year’s planned quota increase. Few expect Fischer Boel to be in post next year, so a short term fix must look rather attractive.

More at EUBusiness.com

Update (20h00): EU Observer reports that the Commissioner gave short shrift to any ideas about reopening the November deal. It quotes her as follows,

“I am not going to re-open the agreement that we made in the health-checK. I hope this is clear enough so we can stop this blurred discussion that is sending totally the wrong signal to the farmers. Farmers believe sometimes that one minister or another will be able to put pressure on the commission to re-open the whole discussion. This is not going to happen. It is actually dead, this idea.”

What is likely to happen, judging by past experience, is that exporting countries like New Zealand will lower their prices in response in order to retain global market share. The net effect is that world prices are depressed even further and this does not help EU producers or certainly not the more efficient ones who are seeking to compete on the world market.

Wheeling out the old policy instruments may give partial satisfaction to farm lobbyists, but it is not really going to help prices or farm incomes. The unpalatable fact is that an internationally competitive EU dairy industry might have a better chance of bringing prosperity to EU dairy farmers. But that would mean marginal farmers in politically sensitive areas like Bavaria and Britanny going out of production. And that is too high a price to pay for a net efficiency gain.

Faced with a drastic drop in dairy prices, the EU is to buy 30,000 tons of butter at a guaranteed price. Over three times as much skimmed milk powder is to be purchased – 109,000 tons. In addition, export subsidies will be given to skimmed milk powder, butter, butter oil and cheese. These subsidies are, of course, particularly damaging to developing countries where they undermine the viability of local farmers. As Oxfam has pointed out, once the EU starts using them, other countries may follow suit.

Officials argue that, by historical standards, the amount being bought is more of a butter molehill than a mountain. In 1986, the EU bought 1.23 million tons of unwanted butter. However, farm organisations have argued that more intervention may be required. The fall of the rouble has dented one important export market. The price of a ton of skimmed milk powder has roughly halved since the summer of 2007.

As far as other intervention stocks are concerned, the EU has 717,810 tons of cereals in the grain mountain and 41,422 tons of sugar, while the wine lake has 2.3m hectolitres of wine in it.

Let’s hope it’s not back to the future.

What is at stake here is a deeply divided industry. Parts of the European milk sector, largely found in Northern Europe (although also in Italy’s Po Valley) is an efficient, hi tech branch of the food industry that is well capable of competing on the international market and has a strong export orientation. But there are also a lot of marginal dairy farmers who are conservative in outlook and manage to ‘get by’ economically with the help of political protection. This is given to them by groupings like the CSU in Bavaria.

Member states in the north and west of Europe, especially the UK and Denmark, have criticised the Health Check accord as a missed opportunity to set the EU dairy industry on the road to a prosperous and expansionist future. Member states to the south and east have lamented the prospect of more milk coming on to the market at a time when dairy farmers’ incomes are coming under sustained pressure.

Kirsten Holm Svendsen, policy director of the Danish Dairy Board, commented, ‘Restricting milk production in Europe will only generate higher support volumes from non-European dairy nations. Thus, by refusing to liberalise dairy production, the EU gives up the expanding European dairy market to the Brazilians.’

The Danes are also concerned that the new support mechanisms available to dairy producers under ‘Article 68′ of the Single Farm Payment regulation will allow member states to effectively re-introduce coupled support of the dairy sector, with a consequent distorting impact on competition.

The possibility of creating a new coupled dairy cow premium from 2010 is regarded as a negotiating victory for Austria. Outgoing Austrian farm minister Josef Proll said that the biennial reviews of the milk market would allow the Commission to put the planned quota increases in hold if there were to be any risk of exceptional market disturbances – or even to cut quotas. Thus, even modest steps in the direction of market liberalisation could be threatened.