Posted: Thursday, January 03, 2013 12:00 PM
Stephenson: 'Original rules unwieldy at best and foolish at worst'
Congress has avoided the so-called "dairy cliff" by extending the 2008 Farm Bill on New Year's Day.
But headlines shouting the price of a gallon of milk at the grocery store would have doubled if Congress had failed to act showed a fundamental misunderstanding of how retail prices are set, according to economists at the University of Wisconsin.
Farm policy would have reverted to a 1949 permanent law that would have tripled the current support price and doubled current milk prices paid to farmers.
However, the retail price of milk would have increased only by 50 percent at most, said Brian Gould, professor of agricultural and applied economics at the University of Wisconsin-Madison.
That's because farmers don't get 100 percent of the retail price, only about 50 percent. Based on current retail prices of $3.50 a gallon, prices could have moved to as much as $5.25 a gallon, he said.
Processing, distribution and retailing costs are about half of the total costs of today's gallon of milk, and those costs would not change with a change in the farm milk price, said Mark Stephenson, director of dairy policy analysis at the university.
The percentage increase in cheese prices would have been even less, with only about 35 percent of the retail price reflected in milk prices, Gould said.
The media frenzy over skyrocketing milk prices was part of the larger, more complex discussion of congressional actions. To ensure price supports for commodities and an adequate food supply, Congress in 1949 passed the Agricultural Act of 1949, which is permanent law.
Farm bills are not permanent law but contain legislation that will be enacted over the life of the bill and sunset unless renewed or extended. If that doesn't happen, farm policy reverts to the 1949 law, which contains the Dairy Price Support Program, a predecessor to the Dairy Product Price Support Program.
The 1949 program requires USDA to set a minimum support price and purchase as much cheddar cheese, butter and nonfat dry milk as anyone wants to sell to the Commodity Credit Corporation at announced purchase prices, Stephenson said.
That minimum support price must be set within 75 percent to 90 percent of parity, which was based on price relationships of inputs and products sold during 1910 to 1914. Today 75 percent of parity would be a milk price of more than $38 per hundredweight, he said.
"Advances in farming technology and management make the direct application of the original rules unwieldy at best and foolish at worst," he said.
International Dairy Foods Association agrees. Calculating today's milk support price based on a concept of parity with cost of production would have resulted in an "enormously ridiculous" price, said Jerry Slominski, IDFA's senior vice president for legislative and economic affairs.
"It's a concept we don't use at all anymore. It was abandoned decades ago," he said.
There's a significant difference in cost of production today, and dairymen wouldn't be in business if their cost of production was that much higher than the price of milk, he said.
"It's an age-old formula. Cost of production has gone down in reality, but the formula has continued to go up," he said.
If the support price had jumped from the current $9.98 per hundredweight to $38 per hundredweight, the option to sell to the government at higher prices than the market would primarily be executed by dairy co-ops, which represent roughly 90 percent of the U.S. milk production, he said.
While the government does not set milk prices, it does set minimum prices, and the upward pressure of that would eventually increase real market prices, Gould said.
Processors that are not co-ops would have had no choice but to pay more for milk and raise the cost on their products and hope they can continue selling product, Slominski said.
It would have raised their input cost dramatically and been disastrous to the entire industry, causing demand declines, a flood of imports and decimation of years of successful export efforts. And when the program ended, there'd be no home for the flood of milk in the country, he said.