Complicated Milk-Pricing System Leaves a Sour Taste

I seem to remember reading or hearing somewhere -- and this could go back as far as the fifth grade -- that milk is among the most complex of all foods.

It’s possible that whoever told me about this was referring to its chemical composition and the interaction of milk fats and solids and healthful proteins, all of which is intricate enough. But it’s child’s play compared with the system by which milk is priced and marketed in the state of California. That’s where milk really gets complicated.

This system has recently come under the scrutiny of the U.S. Supreme Court, thanks to a 1997 decision by the California Department of Food and Agriculture to impose some in-state financial assessments on milk imported from out-of-state farmers. These are similar to the assessments charged on raw milk purchased from California farmers, and likewise go into a statewide pool that pays for benefits such as transportation allowances and a form of income redistribution.

Nevada and Arizona dairymen complain that the rule amounts to the Ag Department’s version of taxation without representation.

They say they don’t get a chance to vote on the assessments (as do California farmers), that the pooling fee cuts into the amount they get paid for their milk and that, despite this, they are ineligible for the pool’s benefits. They also maintain that the rules hobble their ability to compete with California farmers, especially in the lucrative market for bottled milk. They also claim that the arrangement has cost them more than $20 million since it was implemented.

California farmers, for their part, assert that the rules give their out-of-state counterparts as good a deal, though not a better one, than they themselves get from the system. They further ask why, if the rules are so destructive to competition, out-of-state farmers have been able to more than double their share of the bottled milk market in this state to 20% in 2002 from less than 10% in 1995.

“Even with the changes,” says Geoffrey Vanden Heuvel, a prominent Chino dairy farmer, “we’ve been quite unable to stem the inflow.”

The Supreme Court’s review followed six years of litigation before federal judges in California, a time span that provides one indication of the system’s byzantine qualities. Another indication is that, without exception, those judges took great pains to avoid actually ruling on whether the system discriminates against non-Californians.

Their chosen dodge was to find that a 1996 federal law exempts California milk pricing from the commerce clause of the U.S. Constitution, which forbids states to interfere with interstate trade, and that therefore whatever California did about the issue was no concern of theirs.

Last month the Supreme Court rejected that argument. The justices dumped the whole thing back in the laps of their lower court brethren, leaving them to reconsider how milk gets from the dairy to the dairy shelf.

It is a process fraught with tension between the farmer and the processing plant that turns raw milk into pasteurized liquid, cheese and yogurt. These strains, in turn, explain why California farmers joined with the state Department of Food and Agriculture to defend the pooling plan in court, while the processors signed up with the out-of-state farmers to challenge it.

Peculiar Economics

The pooling plan applies to what may be one of the world’s most massively price-fixed commodities.

Federal and state marketing orders set minimum wholesale milk prices covering most of the country. And dairy cooperatives have on occasion tried to set prices in ways that, were the same maneuvers attempted by airlines or pro football owners, would promptly land them in the courthouse.

Such price-fixing, which rudimentary economics tells us drives up the price of milk for consumers, seldom raises much public fury because of another peculiarity about milk that dairy people seem to understand instinctively and that economists keep trying to fathom: Milk demand is inelastic.

You can move more or fewer cars off your sales lot by adjusting your rebates, but the shopper’s decision to buy a gallon of milk doesn’t seem to be affected much or at all by whether it costs $1.59 or $3.99. Experts speculate that this is because there aren’t many substitutes for cow’s milk. If you want milk, nothing else will do; it’s not like switching from Coke to 7-Up.

This has two related implications. One is that retailers have little incentive to lower prices, even when the wholesale price falls. (Groups such as Consumers Union are constantly railing about the outrageous supermarket markup on bottled milk.) Another is that dairy production and consumer demand seem to be largely independent of one another.

“The normal perfect market assumption that excess supply reduces consumer prices so that consumers demand more does not fit this market,” a group of Cornell University economists wrote rather perplexedly this summer.

It’s Not the Cheese

Conversely, the situation means that farmers have consistently produced more and more raw milk even though the per capita consumption of bottled milk has been on a long-term slide.

Most of the surplus winds up as cheese, demand for which has fortunately been rising. But processing plants still pay much more for raw milk destined to end up in the bottle than they do for milk destined for anything else.

Agriculture specialists say this is why the government milk-marketing controls in general, and the California pool in particular, are necessary. Dairy farmers used to compete so ferociously to sell their milk to bottling plants rather than cheese plants, the argument goes, that the bottling plants could exact concessions that undermined the whole dairy farm economy.

The answer was to make processors pay only part of the regulated wholesale price to the farmers and the remainder into the pool. The pool was then redistributed to farmers according to an arcane formula, so that everyone ended up with a “blended” wholesale milk price: In principle no one was to be stuck getting only the lousy cheese wholesale rate, but no one could reap a pure top-tier fluid-milk rate either.

California’s system resembles the federal interstate milk-marketing orders in effect in various regions elsewhere, but it is also more complicated in ways that are, trust me, far beyond the scope of this column. What’s more, because it is administered by a single state, the system ran into difficulties when it began to affect people on the far side of the California line.

‘Round-Tripping’

To some extent, those difficulties resulted from a sharp practice by California farmers. This was “round-tripping,” in which some California dairies apparently pretended that their milk originated out of state by shipping it briefly to Nevada or Arizona before delivering it to California processing plants. Those plants would then pay them a full price without accounting for the pool assessment, which was calculated only on California-origin milk.

State Ag officials say the 1997 rule change was targeted at round-tripping, not the out-of-state competitors. The idea was that calculating the assessment on all milk, regardless of its state of origin, removed the incentive to disguise California milk as Arizonan or Nevadan. By this argument the impact on the out-of-state dairies qualified as, at worst, collateral damage.

California dairymen prefer to portray the rule change more directly as a weapon trained deliberately on the out-of-state farmers, whom they charge with using their former exemption from the pool assessment to build market share, especially in Southern California.

“They found a loophole to exploit,” says Vanden Heuvel, who owns 1,450 head of dairy cattle. “We sought to defend ourselves.”

He contends that California processors were happy to buy the out-of-state milk because its bulk price undercut the milk-plus-assessment total of the local product.

Farmers vs. Processors

If all this suggests that there’s less than a feeling of unalloyed fellowship between California farmers and processors, that’s true.

By some accounts, the traditional tension between them intensified around 1997, the time of the rule amendments. Not only did the changes cut down on the profitability of buying out-of-state milk, says Rachel Kaldor, executive director of the Dairy Institute of California, a processors’ group, but at the same time a cooperative of Southern California farmers tried to put the squeeze on the factories.

They did this by imposing a surcharge on wholesale milk prices and at the same time reaching an agreement with Arizona farmers to keep their milk out of the market. Eventually the surcharge was removed and the Arizona milk returned, but by some accounts the ill will has scarcely ebbed.

“It was a perfect seamless situation where we were cut off from finding other sources of milk,” Kaldor told me, choosing her words carefully. “In this climate of hardball milk policy the agricultural co-ops left our members distrustful of the people we bought milk from.”

Among the consequences was the processors’ decision to join the challenge to the pooling system.

“It seemed like it was in our members’ interest to have the Supreme Court look at it,” Kaldor says.

Effect on Price?

Whether the court case will ever have any effect on the price of milk at the grocery is, given the opaqueness of the milk market, an open question. The out-of-state dairies hold out a price decline as a sort of abstract benefit of their quest.

“My gut instinct is that if there’s more supply competing for a market, prices do tend to come down,” says John Vetne, a lawyer representing Arizona farmers.

But he also notes that a final resolution is probably years away.

“We’ve been at this since 1996,” he says, “and we’re getting to the substance of the issues for the first time.”

Golden State appears every Monday and Thursday. Michael Hiltzik can be reached at golden.state@latimes.com.