Dairy Policy Reform and Trade Liberalisation

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This report is an attempt to improve understanding of the dairy sector through an analysis of the trade and economic effects of the main policy measures (subsidies) applied to it. In particular, it examines the effects of both milk price support measures and milk quota systems. The removal of individual policy measures is modelled in order to assess the impact of international dairy trade liberalisation on production, consumption, trade, prices, income, and welfare.

The primary focus of this report is the impact of policies and reform in the OECD area, although the consequences for other economies are also examined. In addition, this report offers economic insights into the workings of complex dairy policy measures and provides a discussion of the potential of the dairy sector -- globally and in individual countries -- as it adjusts to liberal trading conditions.

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Trade and Economic Effects of Milk Quota Systems

The analysis in this chapter illustrates some specific market, trade and welfare implications of operating milk quota systems. Milk production quotas were typically introduced as a tool to control the growth of surplus production and budgetary expenditures in order to improve the political sustainability of high price support. They have also been used as a rural development policy and as a producer price stabilisation tool. Quota systems increase the transfer efficiency of market price support (MPS) by reallocating part of the price support benefits from input suppliers directly to farmers in the form of quota rent. Although consumption is restrained by high prices, quotas reduce the impacts of excess production resulting from MPS on trade and world markets. The impact of quota systems very much depends on the level at which the production limit is set and on the adjustments that are made in other policy tools However, a quota system comes with its own set of problems, in particular those due to the inefficiencies that it may create, the costs that it imposes on consumers, the difficulties and costs of administration that may arise for governments, the difficulty in setting the quota at a level that would match production (or trade) under free trade conditions and the vested interests that it generates. The existence of quota systems also requires the continuation of high border measures, that is, quota systems allow a domestic market to be managed only if that market is isolated from external sources of supply. This, however, is uncertain in the context of multilateral trade reform. Furthermore, a quota right is a licence to sell milk at the supported price and as such it is an incomegenerating asset. With time, the value of quota, reflecting the difference between an underlying cost of production and the milk price at the quota level, becomes incorporated into the cost structure of dairy farms. Thus, quota imposition provides gains for initial beneficiaries, but subsequent generations can be locked into a higher cost structure. While initially a quota system might be seen as an attractive alternative, the vested interests and inefficient cost structures that are inherent to a quota may complicate reform efforts later on.

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