After some discussions, it appears that my previous post on supply management (here) has been understood as a manifesto for dismantling supply management. Yet, nowhere in that post, did I convey such opinion. What I wrote is that current dynamics, if not addressed, may lead to the implosion of supply management. So, let me just rephrase my rationale and clarify some of its elements.

Before anything else, we must acknowledge the successes of supply-management for the Quebec economy. The average income of Quebec dairy farmers’ families is now above the average Canadian family, as is their net worth (see table below). Saputo and Agropur have become world-class dairy processors with a global footprint. The milk is of the highest standards of quality and safety. But when looking at the future, one can see some clouds gathering.

First, the quota market is currently not allowing any meaningful investment to fulfil the potential productivity and efficiency gains at the farm level. For Quebec, this means that the efficiency gap with other provinces will increase. In the meantime, although there has been a unique opportunity to deleverage, debt is still growing in dairy farms as excess liquidity is directed to non-dairy investments such as farmland. So, we see, on one hand, assets that are accumulating within farms waiting for the right time to exit and, on the other hand, farms turned towards the future that are investing in non-dairy assets and taking on more debt.

When the time will come to re-invest in dairy production, the scale of investment will likely be large (modernization, farm transfer, etc.). Do we know for sure that the farms we think will take on most of these investments will be able to do so ? I do not have a definitive answer to that question but I’m sceptic because, from my time in banking, I remember that the most efficient farms have been among the most leveraged. While they will certainly have some spare capacity to invest, I question the adequation of their aggregate investment capacity to the scale of the investment that will be needed.

That inadequation would become apparent if a major event was to happen, resulting in a significant increase in cost (major drought leading to insufficient feed availability) or fall in price (major disease outbreak linked to popular dairy products). Then, the number of exiting farms may jump dramatically requiring the farms left to take on the missing production capacity over a relatively short period of time. Consequently, I think there is a risk to see production below demand long enough that the processors would have no choice but to import from other provinces (the least damaging to supply-management at the national level but not for the Quebec share of quota) or from the US (once the gates are open…).

Leaving the worst-case scenario aside and considering a more gradual exit of the less efficient farms, the capacity of dairy farms to invest will still be mainly determined by their capacity to take on more debt. And that could happen in a context where there will be pressure to temper milk price increase and where interest rate will increase in all likelihood. It is also worth remembering here that any decrease in quota value may make it more affordable but it also may also markedly decrease the net worth thus limiting the borrowing capacity of farms, especially in cases where the quota had been leveraged a bit too much.

Perhaps all this is far-fetched and I may end up completely wrong. Yet, I have not read or heard anything to convince me there is no risk.

If I had to suggest a way to reform supply management in the dairy industry, I would choose one based on the deregulation of the quota market along with the creation of regional markets and with a cost-of-production benchmark excluding a greater proportion of the less efficient farms. I would add another measure to prevent any lasting overpricing of quota (and the related risk of over-indebtedness) that is to set up limitations in the use of quota as a collateral in credit structuring.

Supply management needs to be reformed and that rethinking might also extend to the objectives of supply management themselves. Quebec, Canada and the world have changed, the dairy industry has changed and so will supply management. This is not a question of ideology ; this is a question of being realistic.

I’m asking these questions because I see a risk that could be managed. I would not mind coming to the conclusion that there is a trajectory for supply management to last and be able to support prosperous dairy farms and processors for another generation. But I maintain that these issues need to be investigated more thoroughly in order to better anticipate the coming of the black swan that will provoke the demise of supply management. Here comes to mind the Titanic, unsinkable until it met an iceberg.

Sometimes it feels as supply-management is a dogma and not a public policy that could be debated and reformed. We should remember that history offers plenty of examples of such dogmas relegated to the museum of ideas.