California’s dairy dilemma

Although the recession drove many businesses into bankruptcy, times have been particularly hard for the state’s dairy farmers. Almost 400 California dairies have closed in the last five years — 105 in 2012 alone — plagued by soaring prices for feed and an antiquated regulatory system that keeps their prices artificially low, at least in the farmers’ view. The right solution for the long term would be to scrap the current approach in favor of a market-based one, but there’s little political will to take such a disruptive step. Instead, policymakers are debating ways to help dairymen at the expense of cheese makers — and their customers.

The government has long meddled with the markets for agricultural products in an effort to sustain farmers, but its role in dairy products is extreme. The federal government and numerous states set minimum prices that milk bottlers and dairy processors — the companies that make cheese, butter and other products from milk — pay for the raw milk they buy. Processors can opt out of the federal system, but in California, all buyers of Grade A milk must pay the minimum price applicable to the category of product they’re making. Cheese makers pay the lowest price, bottlers the highest.

The prices for each category are derived through complex formulas that try to mimic real-world production costs and yields, but ultimately are based on the government’s estimates of what processors ought to be able to do with 100 pounds of milk. At the heart of the calculation is the market price of butter and 40-pound blocks of cheddar — the factor in the equation least influenced by regulators.

Why shouldn’t farmers simply negotiate with processors, so that the price of raw milk rises or falls along with supply and demand? Because farmers have convinced lawmakers that processors always have the upper hand at the bargaining table. Cows have to be milked every day, and milk is bulky and perishable. Farmers who are unable to sell their milk can’t simply put production on hold and store their inventory until the market improves. As a result, dairy farmers say, bottlers and processors can make lowball offers that farmers can’t afford to reject.

Dairies tried to level the playing field more than 200 years ago by forming cooperatives, enabling farmers to pool their sales rather than competing with one another. Congress went further in the Depression-ravaged 1930s, establishing the price-setting system that now covers most of the milk sold by dairies in the United States. California launched a similar system in the 1960s, setting lower milk prices for processors in the hope of encouraging more investment in cheese plants. The more processors that set up shop in California, the more milk farmers produced and sold. And with farmers pooling their revenue, dairies didn’t care where they sold their milk — they only cared how much they sold.

Now, California farmers find themselves locked into a system based on the economic realities of the 1960s, not the 21st century. Unlike dairies in other states that grow their own feed, California farmers typically occupy fewer acres and rely on low-cost feed from other suppliers. That approach allowed them to produce milk at lower cost than dairies in other states, at least at first. In the last seven years, however, the enormous global demand for corn — powered in part by the demand for corn-based ethanol fuels — has caused feed prices to almost double.

Meanwhile, California’s minimum prices — especially the one paid by cheese makers — have fallen further and further below the federal system’s prices. The main reason is that Washington assigns a higher value to whey, a byproduct of cheese making that can be turned into such things as protein supplements. State officials have been reluctant to raise the price that cheese processors pay for milk for fear of driving out smaller companies that can’t afford the equipment needed to convert whey into marketable goods.

Lawmakers have offered at least two proposals to help dairy farmers squeezed by low prices and high costs. Assemblyman Richard Pan (D-Natomas) has introduced a bill that would require the state to factor into the minimum price of milk a much higher value for whey, bringing the price paid by cheese makers in line with the federal government’s minimum. That could increase minimum prices $2 per hundred pounds of milk sold, or about 20 cents per pound of cheese. Although the bill would exempt small cheese makers, cheese producers complain that it could still put about a dozen processing plants out of business. They also argue that it would hurt their ability to compete as well as pinching consumers’ pocketbooks.

Meanwhile, in Washington, six House Republicans from California are backing a bill that, if dairy farmers approved, would create a new federal milk marketing order for California that would incorporate some unique complexities of the existing state system. The change would make the dairies’ milk subject to higher minimum prices, but it would also allow cheese processors to opt out of the pooling arrangement. Such flexibility wouldn’t necessarily help the dairies, but it would move the system a step closer to letting buyers and sellers determine prices without the government’s manipulations.

The potential drawback with simply raising the price that cheese makers must pay is that it would encourage more milk production at a time when there’s arguably too much supply. Only recently has California’s milk production begun to dip, despite prices that farmers say are ruinously low. Even in a market as distorted as this one, the low price paid by cheese processors is a sign that there’s still too much supply. A crude and painful way to correct that problem is to maintain the status quo, reducing the supply of milk by driving more dairy farmers out of business.

The farmers’ allies argue that even if the system needs a thorough overhaul, dairies need help in the near term. Nevertheless, policymakers need to step carefully to avoid inducing farmers to increase production far beyond the demand for milk or the processors’ capacity to use it. They should also ask why in the 21st century we’re still relying on a decades-old regulatory system that causes more problems than it solves.