III The Impact of Dairy Reform

European Union dairy policy reform: impact and challenges

Roel Jongeneel1

Recent Common Agricultural Policy (CAP) reforms have affected dairy policy, including the milk quota system, and increased the market orientation of the sector. A modelling exercise, using the European Dairy Industry Model (EDIM), simulates an initial sharp decline in the EU milk price in response to the decrease in the intervention prices of butter and SMP after 2003, followed by a period of stability and an increase from 2007/08 as the demand for dairy protein products increases over time and EU milk supply is still restricted by quotas. The phasing out of the milk quota following the implementation of the 2009 Health Check is estimated to lead to an increase in milk production and a decrease in the milk price both within and without the European Union. The gap between EU domestic and border prices is expected to continue to narrow. Looking at developments in dairy markets between 2000 and 2007, the study finds that milk prices did not decrease as much as expected because the intervention prices were no longer binding, in particular for skimmed milk powder. The income of dairy farms increased as decline in milk prices was more than compensated by the introduction of dairy premium and higher farm productivity due to the increase in farm size. However, since 2007, incomes of dairy farmers have strongly fluctuated as both milk and feed prices have been highly variable in opposite directions.

The dairy sector makes a substantial contribution to the European Union’s agricultural turnover in many member states, as well as in the European Union as a whole. More than one million dairy producers supply close to 150 million tonnes of milk annually. At the same time, within the EU27, the size and agricultural importance of the dairy sector varies considerably between member states and across regions due to agronomic, economic, historic and other factors. The milk processing industry is estimated to employ about 400 000 people. As regards public expenditure, the total budget expenditure for the milk sector (including an estimate for the amount of direct aid) rose from about EUR 2 750 million in 2005 to about EUR 4 500 million in 2007 (ECA, 2009).

The EU dairy market is regulated by the Common Market Organisation (CMO) for milk and milk products, consisting of the classical combination of policy instruments (import duties, export refunds, and intervention purchases for butter and skimmed milk powder) aimed at supporting the raw milk price, and thus the incomes of dairy farmers. Alongside public intervention, there are other arrangements aimed at supporting the private sector’s stockholding role, such as mandatory and optional aid for private storage for butter, skimmed milk powder (SMP) and cheese. Moreover, measures exist which encourage domestic consumption, such as aids in the milk and the milk products sector, and which reduce the supply of specific products, such as the butter, concentrated butter and cream withdrawal scheme.

One of the most noticeable elements of the European Union’s dairy CMO is the milk quota system, which effectively limits the milk farmers can supply. Milk production in excess of the available quota rights is subject to a (prohibitive) levy (the super levy). Milk quotas were introduced in order to preserve the sustainability of the classical dairy CMO, which came under pressure from the increasing surplus of dairy products and the associated boost in expenditure on export refunds in the early 1980s. By controlling milk production, exports and export refund outlays were effectively curbed. As such, milk quotas indirectly contributed to stabilizing the raw milk price at a relatively high level, and thereby to supporting the agricultural income of milk producers. Since the milk quota regime was introduced, milk quota has become a scarce production factor which is reflected in significant quota rents, where these rents vary depending on member state, region and the possibilities of exchanging quota between farmers. In addition to the already mentioned border tariff protection, trade in dairy products is further influenced by an (import) licence system and tariff rate quotas, with the within-quota tariff being lower than the general applied (and bound) tariff.

In the course of time, European Union dairy policy has been further adjusted and directed to a stronger market orientation. Policy developments, including reductions of intervention prices and specific quota increases of various amounts to member states, together with most recent market developments, have recently caused quota to no longer be binding in most member states and regions of the European Union. With the Luxembourg Agreement following the Mid-Term Review (MTR) on 26 June 2003 (2003 CAP reform), the spotlight shifted again to the EU's milk quota regime, because the Agreement stipulated that the milk quota system should come to an end in 2015. Within the 2009 Health Check reform of the Common Agricultural Policy (CAP), the Council of Ministers endorsed the proposal of milk quota abolition, and suggested an increase of quota by 1% annually from 2009 to 2013 to allow a “soft landing” for the milk sector towards quota abolition. In this context, it is especially important to clarify what economic effects can be expected from abolishing the milk quota regime.

This paper aims at evaluating the main impacts of the European Union’s recent dairy policy reforms, i.e. the effects of the 2003 CAP reform of the dairy sector (see Council Regulations Nos. 1255/1999 and 1788/2003, later integrated into the Single CMO) and the 2009 Health Check reform. In addition, some future challenges will be discussed. This is done taking into account as much as possible the policy objectives of the CAP. Since these objectives concern issues at market level as well as at farm level, effects at both levels are examined.

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