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Through provincial marketing boards, farmers negotiate minimum prices with dairy processors. The third pillar is high tariffs. Currently, Canada imposes high tariffs on foreign dairy products. This restricts the amount of milk entering Canada, ensuring that domestic producers maintain their market share.

This policy was designed to ensure that (1) farmers receive a 鈥渇air return鈥� 鈥� meaning that farmers鈥� earnings are commensurate with their investment and labour and that (2) consumers have consistent access to high-quality dairy products. However, this concept of 鈥渇air return鈥�, which forms a part of the Canadian Dairy Commission (CDC)鈥檚 founding mandate, has undermined competition within the industry by raising barriers to entry, distorting pricing parameters, and reducing incentives to compete. Instead of receiving a return based on a competitive market, which traditional economics would treat as 鈥渇air鈥�, some dairy producers (often smaller, inefficient farms) are receiving a return well above this price. Moreover, some farmers, particularly those unable to expand their operations, are receiving returns well below this price. Despite arguments that this system has kept the dairy industry afloat in Canada, the number of dairy farms has declined nearly 93% since the implementation of DSM. Moreover, based on calculations by the OECD, Canada's support for dairy supply-managed products amounted to $46 billion between 2000 and 2017, with an average annual expenditure of $2.7 billion per year. Further, the system contributes to the average consumer paying over聽$500 more per year for dairy products, with approximately 189,000 Canadians being pushed into poverty because of prices from DSM per year.

This policy lab challenge seeks to assess whether Canada should retain its supply management regime for dairy over the long term or reform it. This report ultimately argues that DSM, as it currently exists, should be gradually reformed to introduce more competition into the industry over the long term. These reforms should aim to achieve a 鈥渇air return鈥� for producers guided by the principles of competition, and further, allow all consumers, particularly lower-income households, access to high-quality dairy products.

OVERVIEW

The report presents an analysis of the current state of DSM in Canada using the lens of competition policy and offers recommendations intended to reform Canada鈥檚 dairy sector over the long term based on this scope. From a review of gray literature and stakeholder interviews, competition has not been used as a guiding frame to comprehensively analyze the dairy industry and drive reform, making it a novel approach to the issue of reforming DSM over the long term.

By leveraging the mandate of the Competition Bureau (CB) to administer and enforce the Competition Act, this report aims to first identify aspects of DSM inconducive to competition using the CB鈥檚 Competition Assessment Toolkit (CAT) to argue that farmers are not receiving a 鈥渇air return鈥�. By way of the Bureau鈥檚 advocacy directive, this report then proposes a comprehensive advocacy plan for CB to motivate the industry to gradually incorporate greater competition over the long term that addresses the competition-related issues identified.

The report relies on information and evidence collected during a series of interviews conducted with subject-area experts in agricultural economics, competition policy, and the dairy industry from across Canada and abroad. It also draws from a broad range of both academic and gray literature on agricultural policy, competition economics, dairy farming practices, and trade negotiations.

KEY FINDINGS

First, this report contains several key findings on the current state of competition within the Canadian dairy industry. These key findings center on assessing DSM using the CB鈥檚 CAT: barriers to entry, competitive parameters, and incentives for firms to compete with one another. Ultimately, deficiencies in these criteria distort a more competitive view of 鈥渇air return鈥� that farmers receive through DSM and limit lower-income consumers鈥� access to dairy products.

1. BARRIERS TO ENTRY

There are several barriers to entry and expansion within the Canadian dairy industry which serve to erode its competitiveness. These include the quota system, which regulates access to licenses to produce milk, and strong tariff barriers which deter foreign entry into the retail market.

Quotas

Quota prices have historically been high, reaching $50,000 per quota in Alberta as of January 2023. These prices have prevented many potential farmers from entering the dairy industry, allowing incumbent farms to maintain their market share. Further, current efforts to manage quota costs in eastern Canada by capping its price are too restrictive. This results in demand for quota outstripping supply, and thus, limiting farmers鈥� ability to develop economies of scale and lower their production costs. Moreover, as quota can be used as collateral during loan transactions, incumbent farmers can sustain higher borrowing habits, allowing them to bid up the cost of farmland and price out potential competitors.

Tariff Barriers

Along with high quota prices, Canada鈥檚 trade policies are designed to protect its domestic dairy industry through high tariff rate quotas (TRQs), preventing foreign firms from expanding into the domestic market. Compelled by a combination of lobbying and public pressure campaigns, Canada has historically refused to eliminate its high tariff rates on dairy products, which range from 200 to 300%. This barrier limits the entry of lower-cost foreign products, allowing domestic producers to charge higher prices without potentially losing market share to competitors from abroad.

2. COMPETITIVE PARAMETERS

DSM has also eroded competition within the industry by limiting farmers鈥� capability to set the price and quantity of their products. This is highlighted by the Canadian Dairy Commission鈥檚 (CDC) price-setting method and the quota system.

CDC Pricing Formula

The pricing formula used by the CDC limits producers鈥� ability to determine the value of their product. The聽CDC employs a pricing system that incorporates both production costs and the consumer price index (CPI) to establish the price paid to farmers for their milk. However, this approach has implicitly subsidized high- cost farms. By offering a price for milk that considers the expenses incurred by these farms manually instead of being determined by the market, the system essentially cushions them from the full impact of their financial burden. This practice weakens the incentive for such farms to actively seek ways to lower their costs and increase efficiency. In addition, it also contributes to high farmgate prices, which are the prices paid by provincial marketing boards to producers, as these farms continue to participate in setting the cost of production in the CDC formula.

Quota Restrictions

The nature of quota systems set by the CDC prevents farms from setting the quantity of products that they want to produce. Farmers who exceed their assigned quotas may face penalties. Beyond deciding whether or not to purchase more quota, these restrictions limit producers鈥� ability to set the quantity of the product they desire to sell, and thus, distort free market parameters.

3. COMPETITIVE INCENTIVES

Canada鈥檚 system of DSM also limits incentives for the industry to become more competitive by funding rent-seeking behavior in the form of lobbying and reducing high-cost producers鈥� incentives to lower their costs or exit the industry.

Lobbying

The Canadian dairy industry engages in a significant amount of lobbying, much of which is funded by the proceeds from DSM. Labeled as one of the most powerful lobbies in Canada, the Dairy Farmers of Canada (DFC) spends $80 to $100 million CAD per year in lobbying efforts on Parliament Hill. Along with private donations, these campaigns are funded in part through administrative fees charged by provincial marketing boards, thus highlighting the intimate relationship between supply management and its profits being used to support political messaging in favor of the system.

Pricing Formula

As outlined above, the formula used by the CDC to set the farmgate price of milk also effectively acts as a subsidy for high-cost producers, reducing their incentive to lower their costs or exit the industry. By setting these prices using the average cost of production, the majority of high-cost producers can afford to cover the cost of their inputs, reducing their incentive to exit the industry.

RECOMMENDATIONS

The Competition Bureau can begin to rectify these issues by using its advocacy capacities, in line with its mandate, to promote a new vision for the Canadian dairy industry that encourages a 鈥渇air return鈥� premised on the principles of competition and lower retail prices for consumers. Recommendations are based on three pillars: 1) Transparency, Advocacy, and Governance, 2) Pricing, and 3) Quotas. They will be introduced using a phased approach 鈥� working to first make the public aware of the impacts of DSM on dairy prices and to advocate for the CDC to be more transparent and accountable. This aims to help both make the system itself more malleable to change and to incite greater public support for reform. Concurrently, the Competition Bureau should advocate for pricing and quota changes that will introduce more competition into the industry and lower retail prices. It is important to note that each recommendation is designed to be independent, and thus, not contingent on the success of another recommendation to be implemented successfully.

RECOMMENDATIONS ON TRANSPARENCY, ADVOCACY, AND GOVERNANCE

The combination of a general lack of public awareness of how DSM functions and its impact on consumers, as well as the CDC鈥檚 narrow governance structure, have enabled the system to operate with limited opposition. These issues contribute to the maintenance of DSM, which fails to provide farmers with a 鈥渇air return鈥� and factors into high milk prices. This pillar is designed to make the proposed changes in the following pillars more feasible by helping to spur public pressure and promote governance change to support competition in the long term. However, they are not contingent on this pillar鈥檚 success.

1. The Bureau should advocate that Statistics Canada create a dairy retail pricing index to compare retail prices for dairy products across provinces and peer countries (including the United States, EU, Australia, and New Zealand)
2. The Bureau should advocate that the CDC expand the size of its executive board to strengthen accountability and diversify the number of stakeholders represented.
3. The Bureau should advocate that the CDC strengthen the methodology used to survey farms to allow interregional and interprovincial comparisons and release in-depth survey results to the public to increase awareness of the health of Canada鈥檚 dairy industry.

RECOMMENDATIONS ON PRICING

The current DSM system fails to achieve its goals by distorting pricing parameters within the dairy industry and lessening producers鈥� incentive to compete. These issues in turn contribute to farmgate prices for farmers that are above those that would exist within a competitive market and lead to higher retail prices for consumers.

1. The Bureau should advocate for the Department of Finance Canada that all milk alternatives be exempt from the Goods and Service Tax (GST) to ensure that plant-based and animal-based dairy products can compete on a level playing 铿乪ld.
2. The Bureau should advocate for the CDC to reform its methodology for calculating the cost of production to bene铿乼 low-cost, high-quality producers and lower the farmgate price of milk.

RECOMMENDATIONS ON QUOTA

Currently, DSM does not allow for quota to be accessed by the most ef铿乧ient farms in Canada, preventing farmers from achieving economies of scale that can lead to lower milk prices. High quota prices act as a barrier to entry for new farmers looking to enter the industry. This system also limits the market鈥檚 competitive parameters by preventing farmers from setting their own production targets.

1. The Bureau should advocate for the CDC to implement a national quota auction to efficiently allocate quota to low-cost, high-quality dairy producers.
2. The Bureau should advocate for the CDC and provincial marketing boards to introduce interprovincial. trade of quota to allow dairy production to shift to lower-cost regions.
3. The Bureau should advocate for the Department of Finance Canada and Global Affairs Canada to expand. low-tariff quotas to allow certain foreign dairy products to enter the Canadian retail market.