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Is the Dairy Debate Asking The Wrong Question?

Published on: 17:58PM May 17, 2013

Here's what the real focus should be, say two young and very smart dairy economists.

The debate over dairy policy has boiled down to whether or not to have supply management. But that may well be the wrong question, say two young (and very smart) dairy economists who spoke at the National Workshop for Dairy Economists and Policy Analysts in Boston last week.

Marin Bozic, a dairy economist at the University of Minnesota, and John Newton, a Ph. D. candidate in agricultural economics at Ohio State, say the real questions should center on the margin insurance program and the timing of the annual decisions. They are part of a team of economists from Michigan, Minnesota, Ohio and Wisconsin who have been analyzing dairy policy options contained in the farm bill.

As currently proposed in both the Dairy Security Act and the Dairy Freedom Act (a.k.a. the Goodlatte/Scott amendment that strips out supply management), margin insurance is designed in such way that "that the benefits of participation in either program very likely highly exceed the cost of compliance [even with supply management]," says Bozic.

The consequence of that could be a return of milk over-supply similar to the 1980s, all again financed by government. Here’s why:

• Lenders say the "big hurt" on producer bottom lines come when income-over-feed-cost margins fall below $6.50. Either proposal offers reasonably priced insurance (23¢ to 29¢/cwt.). And taking out that level of insurance removes 70% of catastrophic losses, says Bozic. The problem is that both programs try to do more, and offer high subsidies at even higher margin levels. For example, a study by the University of Missouri Scott Brown shows that a representative large dairy farm of 2,000 cows would benefit the most from insuring at $7/cwt. under the Dairy Freedom Act and $7.50/cwt. under the Dairy Security Act.

• The Dairy Market Stabilization Program (DMSP), or supply management, only delays expansion and does not cap it. Furthermore, DMSP only kicks in at $6.00, whereas average IOFC margins over the past decade were over $8.00. That means that DMSP would do little to prevent average milk prices from declining up to $2/cwt. in case of chronic milk oversupply.

• Insurance premiums are locked in for the five-year life of the program. "The dairy margin insurance program was originally intended to lock in a producer to a coverage level for five years," says Newton. "The premiums reflected the five-year commitment and were likely close to actuarially fair (given some level of subsidization)."

But now, farmers can change supplemental coverage annually while the premiums remain fixed. While 12-month price forecasts are far from perfect, they are much better than 60-month forecasts. So farmers have a much better chance of guessing margins—and thus how much supplement coverage to purchase.

The result is like taking out flood insurance only in years when the river is rising. Newton suggests the annual signup for the program be in March (like crop insurance), with coverage starting with the new fiscal year on Oct. 1.

The danger of the current farm bill debate is that DSA and DFA proponents are so locked into their positions and the rhetoric of defending those positions that the subtleties of the options are getting lost in the hyperbole.

If Bozic and Newton are right, farmers who sign up for margin insurance could be living off of insurance indemnities in the new policy regime. Those who don’t sign up could be in for a world of hurt. And the government could be funding far more than it bargained for.

Bozic and Newton’s presentations can be downloaded here.