oversight

Dairy Cooperatives: Role and Effects of the Capper-Volstead Antitrust Exemption

Published by the Government Accountability Office on 1990-09-04.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

GAO

-. - . .-. .-.. ._“_ .- -.-.....   ..-..._...._- ..-.I_.”__-.__i_”
                                                                ._.,l.-...-.“l--_l-_,--~-                                      .__-___


                                                               DAIRY
Svj,l (‘III II(~I~ I !)!)(I



                                                               COOPERATIVES
                                                               Role and Effects of the
                                                               Capper-Volstead
                                                               Antitrust Exemption

                                                                                                                -_.
                                                                                                                         2
                                                                                                                Illllllllllll
                                                                                                                      ll
                                                                                                                      142176




                                                                                            RELEASED
                                                              RESTRICTED--Not      to be released outside the
                                                              General Accounting Office unless specifically
                                                              approved by the Of&e of Congressional
                                                              Relations.


(;.A( I/ 1u :I21)-!w 1I(6
.__. . _   _ __..
               _.   _-.._.. _.-.   __.._._
                                        .._-...-._-..-. ,.-....--__--_-_-~_---_
Resources, Community, and
Economic Development Division

B-239877

September 4,199O

The Honorable Howard M. Metzenbaum
Chairman, Subcommittee on Antitrust,
  Monopolies and Business Rights,
Committee on the Judiciary
United States Senate

The Honorable Bill Bradley
United States Senate

In response to your request of August 4,1989, and the subsequent agreements with your
offices, this report discusses the limited antitrust exemption provided to agricultural
cooperatives by the Capper-Volstead Act, particularly as it pertains to the dairy industry. It
addresses dairy farmers’ continued need for this exemption, the effect of the exemption on
dairy prices, and the adequacy of oversight of cooperative pricing activities provided by the
U.S. Department of Agriculture.

The report recommends that the Secretary of Agriculture take actions to actively monitor
such activities and provides matters for the Congress to consider if such monitoring does not
occur.

As agreed with your offices, unless you publicly announce its contents earlier, we plan no
further distribution of this report for 7 days from the date of this letter. At that time, we will
send copies to the Secretary of Agriculture and other interested parties.

This work was done under the direction of John W. Harman, Director, Food and Agriculture
Issues, who can be reached at (202) 2766138. Other major contributors are listed in




Assistant Comptroller General
Executive Summq


             Since the early 1900s the Congress has provided farmer-owned agricul-
Purpose      tural cooperatives with a limited exemption from antitrust legislation to
             address the imbalance of market power between farmers operating rela-
             tively small farms and the firms that purchase farm products. However,
             many changes occurring in the agricultural industry since then have
             affected this balance of power. These changes have led competitors of
             cooperatives and others to question whether the exemption is still neces-
             sary and whether the exemption has allowed farmers, through their
             cooperatives, to restrict competition and raise prices.

             As a result of these concerns, the Subcommittee on Antitrust, Monopo-
             lies and Business Rights, Senate Committee on the Judiciary, and Sen-
             ator Bill Bradley requested GAO to study several issues pertaining to this
             antitrust exemption. As agreed with the requesters’ offices, GAO focused
             its study on the dairy industry, which represents the largest segment of
             cooperative business volume. Specifically, GAO agreed to (1) examine
             how changes in the agriculture industry, specifically in the dairy sector,
             may have affected the need for the antitrust exemption and (2) review
             economic research results to determine whether dairy cooperatives hav.e
             exercised market power in setting prices for their goods and the effect
             of such market power on consumers and the government. In addition,
             GAO agreed to examine how well USDA has carried out its responsibilities
             for assuring that agricultural cooperatives do not abuse their antitrust
             exemption, Because most aspects of GAO’S study were limited to dairy
             cooperatives, any conclusions made cannot be assumed to apply to all
             agricultural cooperatives and do not address more general questions
             about the effects of the antitrust exemption.


             To preserve farmers’ ability to organize cooperatives to jointly market
Background   their products, the Congress, in the Capper-Volstead Act (1922) and
             other legislation, granted agricultural cooperatives a limited exemption
             from federal antitrust laws. The Capper-Volstead act also provided that
             the Secretary of Agriculture would investigate cooperative activities to
             ensure that they did not monopolize or restrain trade to the extent that
             the price of any agricultural product would be unduly increased.’ In
             addition to the monitoring responsibility authorized by Capper-Volstead,
             the Federal Trade Commission has also monitored agricultural coopera-
             tives as part of its overall responsibility.

             ‘In its last report on agricultural cooperatives, Family Farmers Need Cooperatives-But Some Issues
             Need to be Resolved (CED-79-106, July 26, 1979), GAO questioned the adequacy of USDA’s moni-
             toring and oversight activities.



             Page 2                                 GAO/RCED-SO-186     Capper-Voletead   Antitrust   Exemption
                           Executive Summary




                           Several changes in the dairy industry, including technological advances
Results in Brief           and federal support for and regulation of dairy prices, have helped
                           increase the relative market strength of dairy farmers, acting indepen-
                           dently, over what it was at the time the Capper-Volstead Act was
                           passed. However, dairy farms, in general, remain relatively small com-
                           pared to processing and distribution firms that, in the absence of cooper-
                           atives, would purchase milk directly from dairy farmers. These firms
                           have also become more concentrated and therefore have the potential
                           for increased market strength. Without cooperatives, many dairy
                           farmers, because of the size of their operations, would continue to be in
                           a relatively weak bargaining position. Therefore, to the extent that the
                           increased market strength of processing and distribution firms and of
                           dairy farmers offset each other, the premise of the Capper-Volstead
                           antitrust exemption for cooperatives -that farmers cannot effectively
                           bargain independently because their operations are too small-remains.

                           Because cooperatives often sell their milk at prices above legally man-
                           dated minimums, concern exists that they are exercising market power.
                           However, research on whether cooperatives have actually influenced
                           milk prices has produced mixed results.

                           Examination of USDA'S oversight of cooperative activities provides little
                           additional insight on questions concerning cooperative market power.
                           USDA has not implemented a prior GAO recommendation to establish an
                           active oversight program. As a result, it has little information on cooper-
                           ative pricing activities and provides little assurance that cooperatives
                           are not inappropriately increasing prices for their goods.



Principal Findings

The Effects of Industry    Technological improvements in milk production and transportation are
Changeson Dairy Farmers’   among the changes that have helped increase the individual dairy
                           farmer’s relative market strength over what it was in the 1920s. For
Relative Market Power      example, improved refrigeration techniques allow farmers to transport
                           their products longer distances to take advantage of the best possible
                           prices. Additionally, in the 1930s and 194Os, the federal government ini-
                           tiated major dairy programs intended to protect farmers from severe
                           fluctuations in milk prices by, in effect, guaranteeing that milk prices
                           will not fall below certain minimum levels. These changes have limited
                           the ability of processing and distribution firms to exert market power at


                           Page 3                        GAO/RCEIMO-180   Capper-Volstead   Antitrust   Rxemption
                             Executive Summary




                             the expense of dairy farmers. Dairy farms, however, generally remain
                             small relative to these firms. For example, about 45 percent of dairy
                             farmers have fewer than 30 milk cows on their farms. In addition, there
                             are now fewer fluid milk processing plants, which may give the
                             remaining plants more market strength. For example, in 1964, there
                             were 3,836 independent fluid milk processing plants, and by 1988 this
                             number had declined to about 600 plants. Thus, because many dairy
                             farmers would remain in a relatively weak bargaining position if
                             required to market their products independently, they may still need the
                             option to form cooperatives to attain an equal bargaining position.


Researchon Cooperative       While processing and distribution firms may now be able to exert more
Pricing Power Inconclusive   market power, so may the dairy cooperatives because the cooperative
                             share of all milk delivered to processors and distributors has increased.
                             Several university- and government-affiliated dairy economists have
                             examined the relationship between a dairy cooperative’s market share
                             and its ability to obtain higher prices for its products. A strong positive
                             correlation between the two might indicate that part of the higher prices
                             obtained by cooperatives is a result of their market power. The results
                             of such studies have been mixed: while some analyses have found evi-
                             dence of significant positive correlations, others have not. Therefore,
                             GAO cannot conclude, on the basis of available studies, whether, or to
                             what extent, dairy cooperatives have exercised their market power in
                             setting prices.

                             Even if market power allows cooperatives to receive higher prices from
                             firms that purchase their milk, this market power may be necessary to
                             give dairy farmers equal bargaining strength with those firms. The
                             effect on consumer prices is uncertain and would depend on the relative
                             market power of cooperatives and the firms that purchase their
                             products.

                             Higher prices that cooperatives might receive, due to market power,
                             (and pass along to their member farmers) would most likely encourage
                             dairy farmers to increase production. This, in turn, can increase dairy
                             surpluses, thereby increasing government cost associated with the
                             purchase of surplus milk under the dairy price support program.


Limited USDA Oversight of    USDA oversight, which was established under Section 2 of the Capper-
Cooperative Activities       Volstead Act to prevent undue price enhancement (unjustifiably
                             increased prices) by cooperatives has changed little since GAO'S 1979


                             Page 4                        GAO/RCED-90-186   Capper-Volstead   Antitrust   Exemption
                    Executive Summary




                    report on agricultural cooperatives. GAO reported that USDA was not
                    actively monitoring cooperative pricing activities. Further, GAO reported
                    on concerns about whether USDA could at the same time effectively regu-
                    late cooperatives and promote their growth and development. Although
                    USIX has since clarified the separation of its oversight and promotion
                    activities, it still has no active monitoring system and, to satisfy its over-
                    sight requirements, it simply investigates complaints as they are
                    received. Further, the Federal Trade Commission’s role in overseeing
                    agricultural cooperatives has been reduced by the Federal Trade Com-
                    mission Improvements Act of 1980. Thus, even less federal oversight of
                    cooperatives may occur now than when we made our previous review.


                    Given the uncertainties surrounding the market power and pricing activ-
Recokmendation to   ities of agricultural cooperatives, GAO continues to believe in the need
the Secretary of    for more active oversight. Therefore, GAO recommends that the Secre-
Agriculture         tary of Agriculture direct his contingency committee responsible for
                    Capper-Volstead oversight to actively monitor cooperative pricing
                    activities.


                    GAO believes that the role of monitoring cooperative pricing activities is
Matters for         very valuable and, if USDA does not initiate active monitoring of coopera-
Congressional       tive activities, the Congress should consider assigning regulatory
Consideration       responsibility for cooperative pricing activities to the Federal Trade
                    Commission.


                    GAO discussed the information   in this report with responsible USDA offi-
Agency Comments     cials who disagreed with our view that active oversight of agricultural
                    cooperative pricing activities is necessary. They believe the present
                    system of responding to complaints received is adequate especially since
                    it is supplemented with antitrust law enforcement by the Department of
                    Justice and lawsuits initiated by private individuals. GAO continues to
                    believe that active oversight of agricultural cooperative pricing activi-
                    ties is important because of the uncertainties surrounding these pricing
                    activities.




                    Page 6                          GAO/RCED-90-186   Capper-Volstead   Antitrust   Exemption
Contents


Executive Sumrnary                                                                                                2

Chapter 1                                                                                                      8
Introduction             Legislative Background                                                                8
                         US, Cooperative Activity                                                              9
                         Federal Milk Marketing Orders                                                        10
                         Objectives, Scope, and Methodology                                                   11

Chapter 2                                                                                                     14
Premise of Capper-       Some Changes Have Expanded Dairy Farmers’ Marketing                                  14
                             Opportunities and Reduced Their Price Risk
Volstead Exemption       Relative Market Strength of Dairy Farmers Operating                                  16
for Dairy Cooperatives       Independently Remains Limited
May Remain Despite
Industry Changes
Chapter 3                                                                                                     20
Price Enhancing          Cooperatives Have Grown and Changed Over Time                                        21
                                                                                                              22
                         Many Factors May Explain Over-Order Payments
Effects of Capper-           Including Dairy Cooperatives’ Increased Market
Volstead Are                 Power
Uncertain                Relationship Between Cooperative Market Share and                                    26
                             Over-Order Payments Is Unclear
                         Conclusions                                                                          28

Chapter 4                                                                                                     29
Limited Federal          USDA’s Oversight Responsibilities                                                    29
                         Past Recommendations for Improved Oversight of                                       30
Oversight of                 Cooperatives
Agricultural             USDA Has Done Little to Improve Its Oversight Activities                             30
Cooperatives             FTC Oversight Restrictions                                                           31
                         Conclusions                                                                          32
                         Recommendation to the Secretary of Agriculture                                       32
                         Matters for Consideration by the Congress                                            32
                         Views of Agency Officials                                                            33

Appendixes               Appendix I: Cooperatives’ Share of Agricultural       Products                       34
                             Marketed (Selected Years)



                         Page 6                       GAO/RCED-90-186   Capper-Volstead   Antitrust   Exemption
                       Contents




                       Appendix II: Cooperatives’ Share of Farm Supply Items                                36
                           Purchased by Farmers (Selected Years)
                       Appendix III: Federal Milk Marketing Orders May Raise                                36
                           Milk Prices
                       Appendix IV: Review of Empirical Analyses of the                                     43
                           Relationship Between Over-Order Payments and
                           Cooperative Market Power
                       Appendix V: Major Contributors to This Report                                        50

Related GAO Products                                                                                        52

Tables                 Table 2.1: Size of U.S. Milk Cow Operations in 1988                                  17
                       Table 2.2: Number of Fluid Milk Processing Plants and                                18
                           Percentage of Sales by Type of Firm (Selected Years)
                       Table 3.1: Cooperative Share of Milk Delivered to Other                              21
                           Handlers, Processors, and Manufacturers
                       Table 3.2: Percentage of U.S. Production of Selected Dairy                           22
                           Products Manufactured by Cooperatives (Selected
                           Years)
                       Table 3.3: Frequency and Size of Over-Order Payments                                 23




                       Abbreviations

                       CWt        hundredweight
                       ccc        Commodity Credit Corporation
                       FIT        Federal Trade Commission
                       GAO        General Accounting Office
                       M-W        Minnesota-Wisconsin
                       USDA       US. Department of Agriculture


                       Page 7                       GAO/RCED-90-186   Cappe~~Volatead   Antitrust   Exemption
Chapter 1

Introduction


               In the late 1800s and early 1900s independent farms were typically too
               small and too numerous to deal effectively with the much larger firms
               operating in the supply, processing, and marketing sectors of the agri-
               cultural economy. Farmers tried to overcome this imbalance of market
               power by organizing cooperative associations to jointly market their
               products and buy farm supplies and services. However, in the early
                1900s some state courts sustained antitrust charges against agricultural
               cooperatives. As a result, all states enacted legislation authorizing coop-
               eratives’ existence. To preserve farmers’ ability to organize coopera-
               tives, the Congress enacted legislation in 1914 and 1922 to provide
               agricultural cooperatives with a limited exemption from federal anti-
               trust laws. This limited exemption remains in effect to this day. How-
               ever, changes affecting the agricultural industry since 1922 have raised
               the possibility that this exemption is no longer as necessary to farmers’
               economic success as in the past. Furthermore, the large growth of some
               cooperatives-both     in absolute size and in market share-has raised the
               concern that this exemption allows farmers to restrict competition,
               thereby raising consumer prices.


               The three basic antitrust laws are the Sherman Antitrust Act, enacted in
Legislative    1890; the Clayton Act, enacted in 1914; and the Federal Trade Commis-
Background     sion Act, also enacted in 1914. These acts are generally designed to pro-
               hibit anticompetitive practices.

               As larger marketing and bargaining associations of producers were
               formed, agriculture leaders started to question the application of the
               Sherman Antitrust Act to such associations. The Clayton Act of 1914
               clarified the role of farm cooperatives under the Sherman Act. Section 6
               of the Clayton Act exempted the existence and operation of agricultural
               organizations from antitrust laws if they were established for mutual
               help, did not have capital stock, and were not for profit. The Capper-
               Volstead Act of 1922 conferred the limited exemption upon a larger, but
               more specifically defined, class of agricultural associations. Section 1 of
               this act authorized producers of agricultural products to act together in
               associations, corporate or otherwise, with or without capital stock, to
               (1) collectively process, prepare for market, handle and market their
               products in interstate and foreign commerce and (2) have marketing
               agencies in common. However, Section 2 required oversight by the U.S.
               Department of Agriculture (USDA) to ensure that cooperatives did not
               abuse their limited exemption.




               Page 8                        GAO/RCED-90-186   Capper-Volstead   Antitrust   Exemption
                   Chaptar 1
                   Introduction




                   While the above legislation has regulated cooperative activity, other leg-
                   islation and government regulations have promoted agricultural cooper-
                   atives since the early part of the century. The Cooperative Marketing
                   Act of 1926 (7 U.S.C. 465) authorized farmers and their cooperatives to
                   acquire, exchange, interpret, and disseminate crop, market, statistical,
                   economic, and other similar information by direct exchange or through
                   common agents. The Agricultural Adjustment Act of 1933 was reenacted
                   and amended by the Agricultural Marketing Agreement Act of 1937. As
                   amended, this act (7 U.S.C. 601,608~) provides for establishing mar-
                   keting orders for specific fruits, vegetables, nuts, and milk.’ It autho-
                   rizes cooperatives to vote on behalf of their members on marketing
                   orders. Further, through the Internal Revenue Code, cooperatives are
                   provided special tax treatment. Most cooperative net income, unlike cor-
                   porate income, is taxed only once, as income either to the cooperative or
                   to its members.


                   Cooperative businesses are like other corporate business organizations
U.S. Cooperative   in their physical appearance, functions or services performed, and busi-
Activity           ness operations. Some distinctive features of cooperatives are that they
                   have democratic member-user control, provide goods and services at
                   cost, provide limited returns on money that members invest in the coop-
                   eratives, and are owned and financed by members.

                   US, agricultural cooperatives can generally be categorized as (1) those
                   that market primarily farm products; (2) those that purchase farm pro-
                   duction supplies for members; (3) those that provide services, such as
                   trucking, fertilizer application, and feed mixing; and (4) combinations of
                   these types. Appendix I shows that products marketed by marketing
                   cooperatives include dairy products, fruits and vegetables, poultry and
                   eggs, and grain and soybeans. Appendix II shows the types of supplies
                   handled by farm supply cooperatives, including feed, seed, petroleum,
                   and fertilizer.

                   In 1988 there were 2,988 predominantly marketing cooperatives, 1,836
                   predominantly farm supply cooperatives, and 113 predominantly ser-
                   vice cooperatives in the United States. These 4,937 cooperatives had a
                   net business volume (excluding business between cooperatives) of about


                   ‘Marketing orders are marketing plans that the producers and handlers of a particular agricultural
                   industry design and operate to work out solutions to general industry problems regarding supply and
                   demand. Marketing orders are voluntary. That is, producers must vote to have a marketing order
                   apply to their area before the order becomes effective.



                   Page 9                                 GAO/RCED-90-186     Capper-Volstead   Antitrust   Exemption
                   Chapter 1
                   Introduction




                   $66 billion in 1988. Farmers held 4.2 million memberships in these coop-
                   eratives. Marketing cooperatives accounted for 46 percent of member-
                   ship in 1988; farm supply cooperatives accounted for 61 percent; and
                   related service cooperatives accounted for 3 percent.

                   Cooperatives market a wide range of products. However, dairy coopera-
                   tives, which are the focus of this report, represent the largest share of
                   cooperative business -36 percent of marketing business volume in
                   1988. The 287 cooperatives that marketed dairy products in 1988 repre-
                   sented about $19.3 billion in gross business volume. Other farm products
                   representing large portions of net cooperative marketing business
                   volume in 1988 were grains and soybeans (26 percent) and fruits and
                   vegetables (13 percent).


                   Federal milk marketing orders, which apply only to milk eligible for
Federal Milk       fluid use, set minimum milk prices, acceptable marketing practices, and
Marketing Orders   terms and conditions of sale. Federal milk marketing orders evolved
                   from provisions of the Agricultural Adjustment Act of 1933 as reen-
                   acted and amended by the Agricultural Marketing Agreement Act of
                   1937. Orders are intended to (1) promote orderly market conditions in
                   fluid milk markets, (2) ensure consumers (both locally and nationally)
                   an adequate supply of good quality milk, (3) stabilize milk prices, and
                   (4) improve farmers’ income.

                   Each marketing order contains two basic provisions. One fixes the min-
                   imum prices that must be paid by milk handlers.* This provision
                   requires plants to base the value of the milk on the milk’s end use and to
                   use price adjustments or differentials based on butterfat content and on
                   the location at which delivery of the milk is made. The other basic pro-
                   vision specifies how the returns from milk sales are to be distributed
                   among dairy farmers.

                   Milk marketing orders use a system known as classified pricing to estab-
                   lish minimum prices that handlers must pay for grade A milk.3 Under
                   the classified pricing system, milk is classified according to its end use,
                   and different minimum prices are set for each class. Most marketing

                   *Milk handlers are defined as anyone who handles grade A milk from dairy farmers for distribution
                   in the market.

                   “Grade A milk is referred to as fluid grade milk because it is the only milk that can be used for fluid
                   purposes. Grade A milk producers must adhere to higher sanitation standards than those of grade B
                   milk. Grade B milk is referred to aa manufacturing grade milk because it can be used only for manu-
                   facturing purposes.



                   Page 10                                  GAO/RCED-90-186       Capper-Volstead   Antitrust   Exemption
                        Chapter 1
                        Introduction




                        orders have three classes of milk, Class I milk is used for fluid consump-
                        tion and includes whole milk, skim and low-fat milk, and milk drinks. In
                        orders with three classes, milk used to manufacture soft products, such
                        as ice cream and cottage cheese, is considered class II, while milk used to
                        manufacture hard products, such as butter, cheese, and nonfat dry milk,
                        is considered class III. Some orders that have only two classes of milk
                        put all milk except fluid milk into class II.

                        Class III minimum prices are the same in all orders, but minimum class I
                        prices vary among orders, largely according to an order’s distance from
                        the Upper Midwest.4 The class III price in each order is set equal to the
                        Minnesota-Wisconsin (M-W) price,” which is the average price manufac-
                        turers pay in Minnesota and Wisconsin to purchase grade B milk. The
                        price of grade B milk is not regulated by federal milk marketing orders.
                        However, it is influenced by the federal dairy price support program,
                        which is intended to establish a floor on grade B milk prices.6

                        The class I minimum price in each order is set by adding an amount
                        known as the class I differential to the M-W price from 2 months earlier.
                        Class I prices were set higher than class III prices to ensure an adequate
                        supply of fluid milk. The differentials were intended to give farmers
                        economic incentives to upgrade their operations to meet the higher sani-
                        tary standards required for fluid milk and to make it profitable to trans-
                        port milk from surplus milk-producing areas to deficit areas. Therefore,
                        when a national pricing system for milk used in fluid products was
                        established in the 19609, the smallest differential was established in the
                        Upper Midwest because that region was considered the nation’s major
                        source of surplus milk. Higher differentials were established elsewhere
                        to reflect the cost of transporting milk from the Upper Midwest.


                        The Subcommittee on Antitrust, Monopolies and Business Rights, Senate
Objectives, Scope,and   Committee on the Judiciary, and Senator Bill Bradley requested that we
Methodology             study several issues concerning the antitrust exemption provided to

                        4Elecausemost orders use three classes, we will refer to the class III price as the price for milk used
                        for manufacturing purposes,

                        6The M-W price calculation and use are described in Milk pricing: New Method for Setting Farm Milk
                        prices Needs to EleDeveloped (GAO/RCED-90-8,     Nov. 3,1989>.

                        “In orders with three classes, the class II price is determined by adjusting the latest available M-W
                        price with a formula based on dairy prod&t prices and then adding a differential that yields class II
                        prices that ln most orders are about 10 cents per hundredweight above the class III price. Ekxause of
                        the relatively small amount of mllk in class II and the closenessof the class II and class III p&es, in
                        this report we will focus on class I and class III prices.



                        Page 11                                   GAO/RCJD9@186        Capper-Volstead    Autitrust   Exemption
Chapter 1
Introduction




agricultural cooperatives under the Capper-Volstead Act. Even though
cooperatives are important in many agriculture sectors, at the subcom-
mittee’s and Senator Bradley’s request dairy cooperatives are the focus
of this study. First, this industry represents the largest segment of coop-
erative business volume. Also, because of the federal dairy price sup-
port program and the incentives provided by the federal milk marketing
order program, the government has incurred substantial costs in
purchasing surplus dairy products. Further, dairy industry data are
readily available. Because most aspects of our work were limited to
dairy cooperatives, any conclusions made cannot be assumed to apply to
all agricultural cooperatives and do not address more general questions
about the effects of Capper-Volstead.

Specifically, we were asked to identify (1) changes in the dairy industry
since the enactment of the Capper-Volstead exemption and the implica-
tions of these changes on farmers’ continued need for this exemption;
(2) whether dairy prices are being increased because of this exemption,
thus affecting consumer and government costs; and (3) the adequacy of
USDA’S oversight of the exemption.7 In addition, the requesters asked us
to examine an issue not directly related to the Capper-Volstead exemp-
tion-the effect of federal milk marketing orders on consumer dairy
product prices.

In addressing the first objective, we relied to a great extent on historical
data on the dairy industry presented in prior GAO reports. These reports
are listed at the end of this report under “Related GAO Products.” We
also obtained information from other sources such as the Agricultural
Cooperative Service, the National Agricultural Statistics Service, and
various dairy-related publications. The results of our work appear in
chapter 2.

In addressing the second objective, we performed a literature search to
identify theoretical and empirical analyses that have been performed to
address these concerns. Our work was limited to a brief conceptual anal-
ysis and a summarization of the results of the empirical studies. We per-
formed no original empirical analysis. The results of our work appear in
chapter 3.

In addressing the third objective, we identified changes that have been
made since we last reported on the Capper-Volstead oversight activities


70ur evaluation of the adequacy of USDA oversight applies to agricultural cooperatives in general.



Page 12                                 GAO/RCED-90-186     Capper-Volstead    Antitrust   Exemption
Chapter 1
Introduction




in a 1979 report8 through discussions with USDA, Department of Justice,
and Federal Trade Commission (FTC) officials. These changes are dis-
cussed in chapter 4.

Because our final objective is not directly related to Capper-Volstead, we
address it in Appendix 1II.OWe relied heavily on the report of the Amer-
ican Agricultural Economics Association’s Task Force on Dairy Mar-
keting Orders for both the theoretical analysis and the literature search
discussed in this appendix.1°

We were assisted in our review of the Capper-Volstead issue by two
agricultural economists: Dr. Edward Jesse and Dr. Ronald Knutson. Dr.
Jesse is Professor of Agricultural Economics and Chairman of the Agri-
cultural Economics Department at the University of Wisconsin-Madison,
and Agricultural Policy Specialist with the Cooperative Extension Ser-
vice, University of Wisconsin-Extension. Dr. Knutson is Professor of
Agricultural Economics, Extension Economist, and Director of the Agri-
cultural and Food Policy Center at Texas A&M University, formerly
Administrator of the Farmer Cooperative Service, and Chairman of the
1972 USDA Milk Pricing Advisory Committee. Their assistance should not
be interpreted as an indication that these economists necessarily concur
with all of the findings, conclusions, and recommendations contained in
this report.

We conducted our review from December 1989 to March 1990 in accor-
dance with generally accepted government auditing standards. We dis-
cussed the accuracy of the information presented in this report with
responsible USDA officials and have incorporated their views where
appropriate. However, as requested, we did not obtain official agency
comments.




“Family Farmers Need Cooperatives-But     Some Issues Need to be Resolved (CED-79-106, July 26,
1979).
“We addressed many issues concerning federal milk marketing orders in two earlier reports: -Milk
Marketing Orders: Options For Change (GAO/RCED-88-9, Mar. 21,1988) and Federal Dai Pro-
grams: Insights Into Their Past Provide Perspectives On Their Future (GAO/R -8,
1990).
“‘Federal Milk Marketing Orders: A Review of Research on Their Economic Consequences,Occasional
Paper No. 3, American Agricultural Economics Association Task Force on Dairy Marketing Orders
(June 1986).



Page 13                                 GAO/RCED-90-186     Capper-Volstead   Antitrust   Exemption
Chanter 2

Premise of Capper-VolsteadExemption for
Dairy Cooperatives May Remajn Despite
Industustry
         Changes
                        Since the passage of the Capper-Volstead Act, from the perspective of
                        dairy farmers, the dairy production industry has changed significantly.
                        Changes that have improved dairy farmers’ production efficiency,
                        increased their product transportation capabilities, and provided a
                        safety net for milk prices have helped increase dairy farmers’ relative
                        market strength. These factors have limited the ability of the firms that
                        would purchase milk from dairy farmers, in the absence of cooperatives,
                        to exert market power at the expense of dairy farmers.

                        Nonetheless, in general, dairy farms remain relatively small compared
                        to the processing and distribution firms that, in the absence of coopera-
                        tives, would purchase their products. Their relative smallness suggests
                        that, despite the limits to the ability of firms to exert market power,
                        many dairy farmers would continue to be in a relatively weak bar-
                        gaining position if required to act independently. Furthermore, those
                        firms that would purchase milk from dairy farmers in the absence of
                        cooperatives have become more concentrated, a situation which may
                        reduce competition among purchasers, thereby increasing the market
                        power of the remaining firms. This increase in firms’ relative market
                        power arising from increased concentration may offset any increase in
                        dairy farmers’ relative market strength due to wider marketing opportu-
                        nities and reduced price risk. To the extent that this offset occurs, the
                        premise that led to the Capper-Volstead Act, at least with respect to the
                        dairy industry, is as valid today as in 1922.


                        Technological improvements in areas such as transportation, refrigera-
SomeChangesHave         tion, and dairy animal feeding and breeding have allowed dairy opera-
Expanded Dairy          tions to grow in size and have offered dairy farmers expanded
Farmers’ Marketing      marketing opportunities. In addition, federal milk price intervention
                        through the federal dairy price support program and the federal milk
Opportunities and       marketing order program have reduced dairy farmers’ risks.
ReducedTheir Price
Risk

Technological Changes   Major technological changes in the dairy industry since the early part of
Have Expanded Dairy     the century have allowed dairy farmers to increase the size of their
                        operations and to ship milk to greater distances. Such changes poten-
Farmers’ Marketing      tially provide dairy farmers with increased marketing opportunities.
Opportunities           These increased opportunities can reduce the ability of milk handlers,




                        Page 14                      GAO/RCED-90-186   Capper-Volstead   Antitruet   Exemption
Chapter 2
Premise of Capper-Volstead Exemption for
Dairy Cooperatives  May Remain Despite
Industry Changes




processors, and manufacturers to exert market power at the expense of
individual dairy farmers. l

The availability of electricity and technological improvements in equip-
ment have contributed to the efficiency of milk production. This
increased efficiency has allowed farms to become larger and capable of
producing larger quantities of milk. In the 1930s and earlier, milking
was a manual operation because most farms did not have electricity.
Therefore, milk production was labor intensive and dairy herds were
generally small. With the introduction of electricity came the wide-
spread adoption of milking machines, which allowed an individual
farmer to milk cows faster than before and, thus, to maintain a some-
what larger herd. The increased size of the farming operation may
increase the potential market strength of farmers acting independently.

Other technological improvements, improved feeding and breeding of
cows, and better management have led to a dramatic increase in milk
production per cow in the past 60 years or so. In 1930, average annual
milk production per cow in the United States was about 4,500 pounds
per year. By 1989, production per cow had increased to about 14,200
pounds per year.

Extensive improvements also occurred in milk handling and transporta-
tion over the past 60 years. These milk handling and transportation
improvements allow dairy farmers to move their milk greater distances
to take advantage of better prices. In the 1920s and 1930s some milk
was used on the farm for butter and some was skimmed on the farm to
sell butterfat to creameries. If fluid milk was sold, it was placed in milk
cans and cooled by ice or cold water and hauled to a nearby plant where
it would be processed or consolidated for shipment to other plants. Long
distance hauling was dominated by the railroad. Refrigeration improved
the milk cooling and eventually bulk tanks largely replaced milk cans. In
the late 1940s long distance shipment of bulk milk shifted from the rail
to truck. With general use of farm bulk tanks and improved highway
systems, refrigerated tank trucks could haul milk directly from the farm
to the fluid milk processing, or manufacturing, plant. As a result, many
small plants consolidated or ceased business. Cooperatives took over
much more of the milk hauling when bulk handling became common.


’ In this report we refer to plants that process milk for the fluid milk market as fluid milk processing
plants. We refer to plants that manufacture milk into such products as cheese, butter, and nonfat dry
milk aa manufacturing plants.



Page 16                                  GAO/RCEDBO-1sB        Capper-Volstead    Antitrust   Exemption
                             Chapter 2
                             Preftlide of Capper-Volstead Exemption for
                             Dairy Cooperatives May Remain Despite
                             Industry Changes




The Increased Federal Role   The federal role in regulating milk pricing expanded greatly in the 1930s
in the Dairy Industry Has    and 1940s. In 1930 milk prices were not regulated by the federal or state
                             governments. By the 1980s the price of most milk produced in the
ReducedDairy Farmers’        United States was affected by federal or state regulation. Federal regu-
Price Risks                  lation took the form of the federal milk marketing order program and
                             the federal dairy price support program which were established in the
                             1930s and 1940s. These programs, designed to lend stability and orderli-
                             ness to milk markets, affect prices received by dairy farmers. These fed-
                             eral involvements in the industry reduce the price risk of dairy farmers
                             and limit the ability of handlers, processors, and manufacturers to use
                             their market power to lower the prices dairy farmers receive.

                             As discussed in chapter 1, federal milk marketing orders set minimum
                             prices that handlers must pay for milk. In addition, the federal dairy
                             price support program helps ensure dairy farmers a minimum price for
                             milk they produce. This program provides for dairy farmers a price
                             safety net that did not exist prior to the 1930s.

                             In the 193Os, the federal government purchased limited quantities of
                             dairy products to support milk prices. Through the Agricultural Act of
                              1949 (P.L. 81-439, Oct. 31, 1949), the Congress permanently adopted the
                             dairy price support programs it had created during World War II to pre-
                             serve higher milk prices and farm purchasing power. The purpose of
                             this program is to ensure an adequate supply of pure and wholesome
                             milk by recognizing cost-of-production changes and keeping farm income
                             high enough to maintain sufficient production capacity for meeting cur-
                             rent and future needs. Under the program, USDA, through the Com-
                             modity Credit Corporation, purchases, at specified prices, all quantities
                             of butter, cheese, or nonfat dry milk that are offered and meet USDA
                             specifications. Such purchases reduce the supply of dairy products on
                             the commercial market in times of surplus and help maintain the min-
                             imum milk price received by dairy farmers.


                             Many dairy herds remain relatively small, thereby limiting dairy
Relative Market              farmers’ bargaining strength. In addition, although technological
Strength of Dairy            changes and the increased federal role in the industry have limited the
Farmers Operating            ability of firms that, in the absence of cooperatives, would purchase
                             milk from dairy farmers to exert market power, those firms also have
Independently                changed in ways that may increase their bargaining strength. These
Remains Limited              firms have become larger and fewer and, thus, more concentrated. Also,
                             the role of the food retailer in the fluid milk processing industry has
                             grown. Because these changes in firms could offset the changes that


                             Page 16                              GAO/RCED-W186   Capper-Volstead   Antitrust   Exemption
                                   Clmpt.er 2
                                   Remiee of Cappe~Volstead  Rxemption for
                                   Dairy coopenrtlvee May Remain Deepite
                                   Industry Changes




                                   have limited their potential market power, the question about whether
                                   the relative market strength of dairy farmers operating independently
                                   has changed since the 1920s is left unanswered. This suggests that dairy
                                   farmers may still need the option to form cooperatives to attain an equal
                                   bargaining position.


Many Dairy Farms Remain            Despite the changes that have allowed farms to increase in size and
Relatively Small                   allowed farmers to gain some potential for increased market strength,
                                   dairy herds remain relatively small, thereby leaving the farmers in a
                                   relatively weak bargaining position. As shown in table 2.1, about 45 per-
                                   cent of dairy herds consisted of fewer than 30 dairy cows in 1988.
                                   According to USDA'S 1989 estimated average value of US. milk produc-
                                   tion per cow, a herd of 30 dairy cows would generate about $58,600 in
                                   annual gross income.
Table 2.1: Size of U.S. Milk Cow
Operations in 1998                 Number of milk cows                                                         Percent of herds
                                   l-29                                                                                       44.7
                                   30-49                                                                                       22.7
                                   50-99
                                   --                                                                                          23.2
                                   1oo+                                                                                         9.4

                                   Source: Cattle, USDA, (July 1989).



Firms That Would                   The declining number of fluid milk processing plants has resulted in
Purchase Milk From Dairy           increased concentration over the past 60 years or so. With fewer plants
                                   there may be less competition, and thus the market strength of these
Farmers Have Become                firms may have increased. Several large national fluid milk processing
More Concentrated                  companies were formed through a series of over 2,300 mergers and
                                   acquisitions, most of which occurred in the 1920s and 1930s. Since that
                                   time, most of the companies left the fluid milk processing business for
                                   various reasons, including the government antimerger policy. The fluid
                                   milk facilities were either abandoned or sold to local and regional
                                   companies.

                                   Table 2.2 shows that the total number of fluid milk processing plants
                                   (cooperatives and noncooperatives) in the United States dropped from
                                   9,600 in 1934 to 1,066 in 1980. USDA estimates that this number has
                                   declined to under 700 in 1988. An examination of noncooperative plants
                                   during the period for which data by type of plant are available shows
                                   that the number of noncooperative plants (national, regional, and local)



                                   Page 17                              GAO/RCED-90-186   Capper-Volstead   Antitrust   Exemption
                                         Chapter 2
                                         Premise of Capper-Volstead Exemption for
                                         Dairy Cooperatives  May Remain Despite
                                         Industry Changes




                                         decreased from 3,836 in 1964 to 964 in 1980. USDAestimates indicate
                                         this number could be about 600 in 1988. From 1934 to 1980, the percent
                                         of fluid milk sales made by noncooperative plants decreased from about
                                         96 percent to about 86 percent.

Table 2.2: Number of Fluid Milk
Processing Plants and Percentage of                                                                 Number of plants
Sales by Type of Firm (Selected Years)                                      1934        1950          1957      1964                1970             1960
                                         Nzt$xmt~lfirms and regional
                                                                                    a           a             a     335              253               173
                                         Local firms                                a           a             a   3,463            1,727               716
                                         Integrated supermarkets                3          12            21          38               51                65
                                         Subtotal                                   a         a       5.667       3.836            2.031               954
                                         Cooperatives                               a         a         520         267              185               112
                                         Total                              9,600       8,195         6,187       4,103            2,216             1,066
                                                                                                Percentage of salesb
                                                                            1934        1950         1957     1964                  1970             1960
                                         National firms and regional
                                            firms                              38          26            34              32               31               29
                                         Local firms                           58          67            58              55               49               39
                                         Integrated supermarkets                    c           c             c           3                9               17
                                         Subtotal                              96          93            92              90               89               85
                                         Coooeratives                           5           7             8              10               11               15
                                         %ata not available.
                                         bColumns may not add to 100 due to rounding.
                                         %cluded in the firms’ percentage.
                                         Source: Alden C. Manchester, The Public Role in the Dairy Economy-Why and How Governments Inter-
                                         vene in the Milk Business (Westvtew Press, Inc., 1983).

                                         The average size of the fluid milk processing plants has increased signif-
                                         icantly. In 1934, the average volume of fluid milk processed by commer-
                                         cial processing plants was about 1.9 million pounds. This had increased
                                         to 4.3 million pounds by 1950 and to 51.8 by 1981.

                                         Milk product manufacturing plants have also become more concen-
                                         trated. Both cooperative and proprietary plants that manufacture butter
                                         and cheese have declined in number because advanced technologies
                                         have increased average plant size and reduced labor cost. In comparing
                                         1944 and 1982 numbers, we found that butter plants declined from
                                         4,022 to 231, and cheese plants declined from 2,144 to 457. In 1977, the
                                         four largest companies manufacturing each product manufactured 30
                                         percent of butter and 38 percent of cheese. This concentration was
                                         higher at the subsequent handling stage in which some large companies



                                         Page 18                                GAO/RCElMO-186         Capper-Volstead        Antitrust        Exemption
Chapter 2
Prembe of Cappe~VoMead   ExemptIon for
Dairy Cwperativee May Remain Despite
Iudustry Changes




buy butter and cheese from other manufacturers to be cut, packaged,
and distributed.

The increased importance of food retailers in fluid milk processing and
distribution may expand their market power, particularly that of large
chainstores. During the past 60 years, home-delivered milk sales have
become nearly nonexistent. More recently, chain stores have gained an
increased importance in fluid milk distribution, and there has been a
trend toward chain-owned and -operated fluid milk-processing plants.
For example, as shown in table 2.2, information for the period for which
data by type of plant are available indicates that the number of inte-
grated supermarket fluid milk processing plants increased from 38 in
1964 to 66 in 1980. The percentage of sales by type of plant shows a
similar pattern. Integrated supermarkets show an increase in percentage
of sales from about 3 percent in 1964 to about 17 percent in 1980.




Page 19                           GAO/RCED-90-196   Capper-Volstead   Antitrust   Exemption
Chapter 3

Price Enhancing Effects of Capper-Volstead                                                                         2
Are Uncertain

               Since passage of the Capper-Volstead Act, many dairy cooperatives
               have grown very large. Such growth has raised the concern that dairy
               cooperatives can exercise market power to raise prices farmers receive
               and that higher farm-level prices may also lead to higher consumer
               prices. These cooperatives often charge and receive prices for their milk
               that exceed the minimums required by milk marketing orders. The dif-
               ferences between the prices charged and the marketing order minimums
               are known as over-order payments. The percentage of orders with over-
               order payments has tended to increase over time.

               Many factors may explain over-order payments. Portions of these pay-
               ments compensate for services that cooperatives provide while other
               portions may occur because minimum fluid milk prices may not accu-
               rately reflect transportation and production cost differences between
               production areas. A certain portion of these payments also may result
               from the exercise of market power by cooperatives. However, coopera-
               tive market power may be necessary to give dairy farmers bargaining
               strength equal to that of proprietary milk handlers, and may not lead to
               higher consumer prices unless the market power of the cooperatives
               exceeds that of other milk handlers.

               As discussed in chapter 1, the Capper-Volstead exemption allows
               farmers to jointly market their products through cooperatives, without
               fear of being in violation of antitrust laws. However, as described in Sec-
               tion 2 of Capper-Volstead, cooperatives can be found in violation of the
               Act if, through monopoly or restraint of trade, they unduly enhance
               prices. A strong positive correlation between cooperatives’ market share
               and the size of the over-order payments may indicate that by giving
               agricultural cooperatives a limited antitrust exemption, Capper-Volstead
               is partly responsible for higher prices.’ These higher prices may lead to
               higher production surpluses and therefore higher government costs
               through the purchase of those surpluses under the federal dairy price
               support program.

               Several university- and government-affiliated dairy economists who
               have studied over-order payments have attempted to determine the role
               that cooperatives’ market power plays in setting the level of over-order
               payments. Their analyses have focused on the relationship between
               over-order payment levels and cooperative market share, as a measure
               of potential market power. Mixed empirical evidence from studies we

               ‘As discussed in app. III, milk marketing orders, in addition to over-order payments, may contribute
               to higher prices.



               Page 20                                 GAO/RCED-90-186      Capper-Volstead    Antitrust   Exemption
                                           ChaPtAx    3
                                           Pries Enhancing   EfYecta of Capper4’olstead
                                           Are Uncertain




                                           reviewed makes it difficult to reach conclusions about the price
                                           enhancing effect of Capper-Volstead. Nonetheless, according to the
                                           results of a 1978 survey, both cooperatives and processors include the
                                           bargaining power of cooperatives and the percentage of milk volume
                                           they control among the most important determinants of the level of
                                           over-order payments.2


                                           Since the passage of the Capper-Volstead Act, dairy cooperatives have
Cooperatives Have                          played an increasingly important role in milk marketing. As shown in
Grown and Changed                          table 3.1, dairy cooperatives’ share of all milk delivered to other han-
Over Time                                  dlers, processors, and manufacturers grew substantially between 1957
                                           and 1973 but has remained relatively constant since then-76 percent
                                           in 1987.

Table 3.1: Cooperative Share of Milk
Delivered to Other Handlers, Processors,   Year                                                                          Percentage of share’
and Manufacturers                          1957                                                                                                59
                                           1964                                                                                                67
                                           1973                                                                                                76
                                           1980                                                                                                77
                                           1987                                                                                                76
                                           3hare includes milk handled by cooperatives serving only as bargaining agents
                                           Source: Marketing Operations of Dairy Cooperatives, USDA (Nov. 1989).

                                           The number of dairy cooperatives has decreased from 2,458 in 1930 to
                                           287 in 1988, in part due to mergers and consolidations. During the late
                                           1960s and early 197Os, for example, a period of major cooperative con-
                                           solidation occurred which led to several large regional cooperatives,
                                           such as the Associated Milk Producers, Inc., Dairymen, Inc., Mid-
                                           America Dairymen, Inc., and Milk Marketing, Inc. This pattern of
                                           mergers gave some cooperatives very high market shares in multiple
                                           markets. The development of large regional cooperatives reflects the
                                           expanding geographic scope of milk markets.

                                           The role of dairy cooperatives has also changed over time as they have
                                           become more involved in milk processing. Cooperatives’ share of fluid
                                           milk sales increased from about 5 percent in 1934 to about 15 percent in
                                           1980 and has held steady or declined slightly since then. As shown in


                                           ‘E.M. Babb and D.A. Bessler, Factors Affecting Over-Order Payments in Federal Milk Marketing
                                           Orders, 1966-80, Indiana Exp. Sta. Research Bulletin No. 977 (Purdue University, June 1983).



                                           Page 2 1                                 GAO/RCED-90-180    Capper-Volstead     Antitrust   Exemption
                                           Chapter 8
                                           Price Enhandng   EN%ctn of Chpper-Volstead
                                           Arc Uncertain




                                           table 3.2, the share of some dairy products manufactured by coopera-
                                           tives has also increased substantially. This increase in the cooperatives’
                                           share of milk processing and manufacturing adds to the potential for
                                           increased cooperative market power.

Table 3.2: Percentage of U.S. Production
of Selected Dairy Products                                                                                    Products
Manufactured by Cooperatives (Selected                                                                            Dry milk
Years)                                     Year                                                Butter            products                Cheese
                                           1957                                                     58                     57                  18
                                           1964                                                     65                     72                  21
                                           1973                                                     66                     85                  35
                                           1980                                                     64                     87                  47
                                           1987                                                     83                     91                  45
                                           Source: Marketing Operations of Dairy Cooperatives, USDA (Nov. 1989)

                                           Plants owned by supermarket chains and other proprietary firms have
                                           become specialized fluid milk plants. They contract with cooperatives to
                                           provide their milk supply. By doing so, the cooperatives perform the
                                           function of managing the raw milk supply by balancing the seasonal and
                                           day-to-day fluctuations in milk supply.


                                           Dairy economists who have studied over-order payments suggest that
Many Factors May                           the payments may be compensating cooperatives for costs of many ser-
Explain Over-Order                         vices that cooperatives, rather than other milk handlers, now often pro-
Payments Including                         vide. These services are associated with distributing milk among areas
                                           and class uses. These economists also point out, however, that some por-
Dairy Cooperatives’                        tion of payments may reflect the market power obtained by
Increased Market                           cooperatives.
Power

Percentageof Orders With                   Data for selected years presented in table 3.3 suggest that the per-
Over-Order Payments Has                    centage of marketing orders with over-order payments has been
                                           increasing over time. However, this trend may also reflect the consolida-
Increased                                  tion of orders over time which has reduced the number of orders from
                                           more than 70 in the late 1960s to only 41 in 1989. The data on payments
                                           as a percentage of minimum prices suggest that, following a period of
                                           federal order merger activity in the early 19709, the level of payments
                   *                       has generally been increasing.




                                           Page 22                                GAO/RCED-90-186        Capper-Volstead   Antitrust   Exemption
        .
                                           Chapter a
                                           Price Enhancing   J%fecta of CappercVolrrteaa
                                           Are Uncertain




Table 3.3: Frequency and Sire of Over-
Order Payments                                                           Percentage of orders with                Payment as a percentage of
                                           Year                                         payment8                       minimum class I price
                                           1966                                                     33.8                                        5.0
                                           1967                                                     41.1                                        5.6
                                           1968                                                     54.8                                        4.2
                                           1969                                                     59.7                                        4.3
                                           1970                                                     64.5                                        3.0
                                           1971                                                     61.3                                        3.2
                                           1972a                                                    35.5                                        1.8
                                           19738                                                    41.0                                        4.0
                                            1974                                                    75.4                                        7.1
                                            1975                                                    93.4                                        6.4
                                            1976                                                    92.3                                        2.8
                                            1977                                                    91.5                                        2.9
                                            1978                                                    93.6                                        2.7
                                            1979                                                    95.7                                        3.4
                                            1980                                                    93.6                                        3.9
                                            1981                                                    91.7                                        3.8
                                            1982                                                    93.9                                        3.6
                                            1983                                                    93.5                                        3.1
                                           i984                                                     93.3                                        3.3
                                            1985                                                    90.9                                        4.3
                                           1986                                                     93.2                                        4.1
                                           i987                                                     93.0                                        4.4
                                            1988                                                    95.2                                        5.7
                                            198gb                                                   97.6                                        5.3
                                           ‘The definition of over-order payments was changed temporarily for 1972-73,specifically to exclude
                                           reported service charges. Consequently, data for those years are not comparable with that of other
                                           years.
                                           ‘Preliminary figures.
                                           Source: Dairy Division, Agricultural Marketing Service, USDA



Payments as Responsesto                    Over-order payments can be compensation for some services now pro-
Changesin Costs of Milk                    vided by cooperatives that were previously provided by other milk han-
                                           dlers, including
Product Allocations
                                         . processor- and manufacturer-specific services such as performing
                                           quality control work, paying dairy farmers, guaranteeing a daily market
                                           outlet, providing insurance programs, and pricing milk at the location of
                                           the receiving plant, and




                                           Page 23                                  GAO/RCED-W-186         CappeNolstead   Antitrust   Exemption
                             chapter  3
                                                                                                                                I
                             Price Enhancing   Effecte   of CapperVolstead
                             Are Uncertain




                           . marketwide services such as finding outlets for milk in excess of fluid
                             uses (balancing), promoting fluid milk sales, and performing market
                             analysis.

                             Payments also can arise to facilitate the transfer of milk from surplus
                             uses or production areas to deficit markets. In such situations, the pay-
                             ments collected by cooperatives are compensation for

                           . charges manufacturing    plants require to compensate them for profits
                             foregone on manufactured products that are not produced when milk is
                             diverted by the cooperative from manufacturing to fluid uses, or
                           . charges dairy farmers in surplus production areas require to supply a
                             deficit area with additional milk because the current class I differential
                             may not accurately reflect the transportation cost and/or any produc-
                             tion cost differences between deficit and surplus production areas.

                             Payments also may arise as a compensation for imperfections in milk
                             pricing. For example, class I prices are set equal to the M-W price from 2
                             months earlier, plus the class I differential. Using a 2-month-old price as
                             a basis for current price is inherently imperfect since the current price
                             will not reflect current supply and demand conditions. Payments, how-
                             ever, are a mechanism by which current supply shortage conditions may
                             be incorporated into the class I price.


Payments Also May            With the assistance of Capper-Volstead, cooperatives are a vehicle for
                             organizing dairy farmers to increase the bargaining or market power of
Reflect Cooperatives’        individual dairy farmers relative to that of proprietary milk handlers.
Market Power With            Should the market power of either the dairy farmers or the handlers
Possible Consequencesfor     exceed that of the other, then the potential exists for the party with the
Consumers and the            greater power to exercise it and receive a disproportionate share of any
Government                   industry profits.3 Cooperatives, then, insofar as they provide a means of
                             obtaining market power, enable dairy farmers to deal with proprietary
                             milk handlers on a more equal basis. However, one consequence of a
                             shift in relative market power toward dairy farmers (cooperatives), may
                             be a relative loss of handlers’ market power reflected by the over-order
                             payments they make to cooperatives.




                             “At some level over-order payments or price increases that result from dairy farmers exercising
                             market power could be considered undue price enhancement and, consequently, a violation of anti-
                             trust laws, but only if they were enhanced as a result of monopoly or restraint of trade.



                             Page 24                                    GAO/RCRD-M-186   Capper-Volstead   Antitrust   Exemption
.
    Chapter 9
    Price Enhancing   FJfeeta of Capper-Volstead
    Arc Uncertain




    Evidence that cooperatives can take advantage of market power to
    obtain higher prices for farmers than the farmers could obtain indepen-
    dently does not necessarily imply that cooperatives are unduly
    enhancing prices. Cooperative market power may be necessary to bal-
    ance the market power of the firms that purchase milk to allow farmers
    to obtain prices based on equal bargaining strength, which would more
    closely approximate prices determined in a competitive market. Further-
    more, the prices cooperatives receive may represent, in part, payments
    for services cooperatives provide to other milk handlers and processors.

    Regarding over-order payments as reflections of the transfer of market
    power from processors to cooperatives, a 1978 survey asked coopera-
    tives and processors to rank the most important factors influencing the
    level of over-order payments4 Both cooperatives and processors ranked
    among the three most important factors the “bargaining power of coop-
    eratives and the percentage of milk volume they control,” an expression
    we interpret as cooperative market power. The two other highly-ranked
    factors were the supply-demand balance and the cost of milk from alter-
    native sources. Factors that were ranked lower in importance included
    the farm cost of milk production and any misalignment of federal order
    minimum prices to the extent that the minimum prices do not reflect
    production and transportation cost differences across orders.

    For consumers, the consequences of a shift in relative market power in
    favor of cooperatives depend, in part, on whether cooperatives, after
    the shift, are in a stronger bargaining position than proprietary han-
    dlers. If the bargaining position obtained by dairy farmers through
    cooperatives is not stronger than that of proprietary milk handlers, then
    cooperatives would be unlikely to obtain a level of over-order payments
    that might result in increases in consumer prices for milk products. In
    this case, over-order payments may serve only to reallocate industry
    profits between cooperatives and proprietary handlers with no conse-
    quences for retail markets. However, in the unlikely event that these
    handlers, prior to their loss of relative market power, had been passing
    along to the consumers some portion of the cost savings they achieved
    by virtue of their prior market power advantage over dairy farmers,
    then consumer prices might increase in response to over-order
    payments.

    If, on the other hand, cooperatives gain market power in excess of that
    of proprietary milk handlers, then the exercise of that power in the form

    4Babb and Bessler, pp.20-21.



    Page 28                                 GAO/RCED-90-186   Capper-Volstead   Antitrust   Exemption
                       Chapter 2
                       Price Enhancing   Effects   of Capper-Voletead
                       Are! uncertain




                       of payments could result in increasing consumer prices. In this situation,
                       the cooperatives would, through over-order payments, be attempting to
                       extract profits in addition to those previously available in the industry.
                       The necessary consequence of such profits would be to drive up con-
                       sumer prices. To sustain high payments, however, cooperatives would
                       find it necessary to somehow curtail the supply of fluid milk.

                       Compared to consequences for consumers, the consequences for govern-
                       ment of a shift in relative market power in favor of dairy farmers are
                       more straightforward. Government costs are likely to increase as dairy
                       farmers gain market power relative to proprietary handlers, irrespec-
                       tive of whether dairy farmers achieve more or less market power than
                       these handlers. As cooperatives gain and exercise market power in the
                       form of over-order payments, then, by definition, farmers will receive
                       higher average prices, which would most likely encourage them to
                       increase production.” Additional production may add to the milk product
                       surpluses that the government is obligated to purchase under the dairy
                       price support program, thus increasing government costs.


                       Some dairy economists have attempted to determine empirically
Relationship Between   whether cooperative market power has been responsible for at least
Cooperative Market     some portion of over-order payments. Their research has involved a
Share and Over-Order   variety of methodologies and has produced a variety of results.
                       Although this research has looked at the possible influence of coopera-
Payments Is Unclear    tive market power on over-order payments, it has not attempted to iden-
                       tify any portion of over-order payments as undue price enhancement or
                       as an abuse of market power on the part of cooperatives. On reviewing
                       this literature, we find that the results, to date, are mixed.

                       There are several important considerations in conducting an empirical
                       analysis of the relationship between cooperative market power and the
                       size of over-order payments. These include being able to (1) adequately
                       measure cooperative market power; (2) identify and measure other fac-
                       tors that may contribute to over-order payments, such as those
                       described above; and (3) select the appropriate type of data with which
                       to estimate relationships. In our review of the literature, we found that
                       the reported results were not sensitive to the measures of cooperative
                       market power used. However, the results may have been sensitive to

                       “This assumes that cooperatives paas on the higher prices to their member dairy farmers, and that
                       cooperatives are able to sustain higher average prices by restricting the supply of milk to the fluid
                       market. However, that portion of over-order payments which compensates cooperatives for services
                       they provide to other handlers would not provide incentives for increased production.



                       Page 26                                   GAO/RCED-90-186    Capper-Volstead    Antitrust   Exemption
Chapter 3
Price Enhancing   Effects   of Capper-Volstead
Are Uncertain




how the effects of other factors influencing over-order payments are
accounted for in the empirical analysis and the type and/or sample
period of data used to estimate relationships. Our review is summarized
below and presented in greater detail in appendix IV.

Different measures of cooperative market power were examined in sev-
eral of the studies we reviewed. In general, the studies concluded that
the results concerning any relationship between cooperative market
power and over-order payments were not sensitive to the particular
measure of cooperative market power used. Among the different mea-
sures of cooperative market power examined were the percentage of all
dairy farmer milk deliveries in a market (order) made by all coopera-
tives in that market, the percentage of dairy farmer milk deliveries in a
market by the four largest cooperatives, the percentage of dairy farmer
deliveries in the market by the largest cooperative, and the percentage
of all market dairy farmers who belong to the four largest cooperatives.
It is unclear, however, how adequately cooperative market power is rep-
resented by any of these measures. They do not, for example, account
for (1) whether different cooperatives within a market are competing or
acting in concert, although attempts were made to account for the exis-
tence of federations of cooperatives, or (2) whether there is competitive
pressure from dairy farmers outside the market area.

Attempts to estimate the effect on over-order payments of cooperative
market power should also account for the possible influence on pay-
ments of factors other than cooperative market power. The studies we
reviewed took into account a number of other factors, although no study
included all of the factors identified by the collection of studies we
examined. Specific factors accounted for in the reviewed analyses pri-
marily included those factors, described above, that are associated with
changes in costs of milk product allocations. Additional factors
accounted for included milk production cost, processor market power,
and a 1976 Department of Justice consent decree in which a major
regional cooperative agreed not to engage in exclusionary or predatory
acts or practices.

Data on payments and measures of cooperative market power and other
factors are available both across orders (markets) and over time. Dif-
ferent studies we examined attempted to estimate the relationship
between payments and cooperative market power from one or more of
the different perspectives of the data: across orders but for only one
time period at a time (cross-section analysis), across time but for only
one order at a time (time-series analysis), or across both time periods


Page 27                                   GAO/RCED-90-166   Capper-Volstead   Antitrust   Exemption
              Chapter 3
              Price Enhancing   Effecta   of Capper-Volstead
              Are Uncertain




              and orders all at once (pooled time-series and cross-section analysis). No
              one perspective of the data is clearly superior to the others. For
              example, although pooling maximizes the use of available information,
              there are many different pooling methodologies and consequently many
              different interpretations of pooled estimation results.

              The results for several different studies using cross-section analysis sug-
              gest no significant relationship between cooperative market power and
              over-order payments in most recent years. Nor was a significant rela-
              tionship consistently found in the one study that examines time-series
              data and accounts for factors that could affect over-order payments in
              addition to cooperative market power. However, recent studies using
              pooled time-series and cross-section analysis have produced mixed
              results. The most recent, and among the most thorough of the studies we
              examined, found a positive and statistically significant relationship
              between cooperative market power and over-order payments.” This
              result conflicts with results from an earlier study conducted using a sim-
              ilar methodology.7


              Since the studies we reviewed did not consistently find evidence of a
Conclusions   relationship between market share and over-order payments, we see no
              basis for reaching a definitive conclusion concerning the effect of
              Capper-Volstead on either consumer prices or government costs. Theo-
              retically, it is possible that cooperatives, with the assistance of Capper-
              Volstead, may obtain sufficient market power, relative to that of propri-
              etary milk handlers, to charge over-order payments. These payments
              may occur even if the market power of cooperatives is no greater than
              that of other handlers and may or may not result in increasing consumer
              prices for milk products. However, over-order payments that more than
              compensate for cooperative-provided services will most likely encourage
              dairy farmers to increase production with a possible consequence of
              increasing dairy surpluses and, thus, increasing government costs asso-
              ciated with the purchase of surplus milk under the dairy price support
              program.




              “E.M. Babb, Over-Order Payments in Federal Milk Marketing Orders, 1970-87, Staff Paper 371, Food
              and Resource Economics Department (University of Florida, Nov. 1989).

              7Babb and Bessler.



              Page 28                                    GAO/RCED-90-186   Capper-Volstead   Antitrust   Exemption
Chaptell 4

IGmited Federal Oversight of
Agriculture Cooperatives

                   Under Section 2 of the Capper-Volstead Act, the Secretary of Agricul-
                   ture is responsible for ensuring that cooperatives do not abuse their
                   antitrust exemption. More specifically, USDAis responsible for
                   restraining cooperatives when it believes they are “unduly enhancing”
                   (unjustifiably increasing) prices charged for their products. In 1979, we
                   reported that USDAhad not adequately carried out its Section 2 responsi-
                   bilities.’ For example, it was not actively monitoring cooperative pricing
                   activities. Further, we reported on concerns about whether USDA could at
                   the same time effectively regulate cooperatives and promote their
                   growth and development. Although USDA has since clarified the separa-
                   tion of its oversight and promotion activities, it has taken only limited
                   actions to improve its oversight of Capper-Volstead since our earlier
                   review. Although the Department of Justice and the Federal Trade Com-
                   mission have general responsibility for enforcing antitrust laws, the
                   Congress restricted FTC’Sauthority to review some issues relating to pos-
                   sible market abuses by cooperatives. Thus, many of the problems we
                   identified in 1979 remain.


                   Section 2 of the Capper-Volstead Act gives USDA the responsibility for
USDA’s Oversight   preventing cooperatives from exploiting the public through unwar-
Responsibilities   ranted price increases. Once USDAdetermines that Section 2 may have
                   been violated-that     a cooperative may have monopolized or restricted
                   trade to such an extent that its prices are unduly enhanced-USDA is
                   responsible for (1) informing the cooperative that it is suspected of vio-
                   lating Section 2, (2) holding a hearing during which the cooperative
                   states its point of view, and (3) reaching a conclusion on whether or not
                   the cooperative unduly enhanced prices. If USDA finds that the coopera-
                   tive has monopolized or restricted trade to such an extent that its prices
                   are unduly enhanced, USDAis to issue an order to the cooperative
                   directing it to stop the monopolization or restraint of trade. If the coop-
                   erative does not stop, USDA can then file in the relevant district court a
                   copy of the order together with a petition asking that the order be
                   enforced. If the court supports USDA,the case is given to the Department
                   of Justice for enforcement.




                   ‘Family Farmers Need Cooperatives-But    Some Issues Need to Be Resolved (CED-79-106, July 26,
                   1979%



                   Page 29                                 GAO/RCRD4O-186   Capper-Volstead   Antitrust   Exemption
                            Chapter 4
                            United Federal Oversight    of
                            Agricultural Cooperatives




                            In our 1979 report, we concluded that USDA had not done all that it
Past                        should to oversee cooperative activity and, as a result, provided little
Recommendationsfor          assurance that potentially powerful agricultural cooperatives were not
Improved Oversight of       abusing their Capper-Volstead exemption. Accordingly, we recom-
                            mended that USDA establish a more active oversight program, which
Cooperatives                would include (1) the active monitoring of cooperative pricing activities
                            and (2) the placement of the Capper-Volstead oversight and enforce-
                            ment responsibilities in an agency whose function was separate from
                            USDA'S responsibility to promote agricultural cooperatives.

                            In examining USDA'S oversight activities, our 1979 report concluded that
                            USDA had no active monitoring program. Instead, it relied solely on
                            outside complaints as a basis for starting each of its inquiries of possible
                            Section 2 violations. At the time of our 1979 review, we identified five
                            complaints that USDA had received, none of which was determined to be
                            an instance of undue price enhancement. We expressed concern that
                            USDA reached conclusions on these complaints without criteria that
                            would help it identify undue price enhancement. We noted that the need
                            for such criteria had been highlighted by the National Commission for
                            the Review of Antitrust Laws and Procedures (National Commission).2

                            Our past report also noted a potential conflict of interest between USDA'S
                            responsibilities under the Capper-Volstead Act and its responsibilities
                            under the Cooperative Marketing Act of 1926. Under the Capper-Vol-
                            stead Act, USDA is responsible for ensuring that cooperatives do not vio-
                            late the restraint of trade provisions of Section 2. Under the Cooperative
                            Marketing Act, USDA is tasked with promoting cooperatives and pro-
                            viding extensive services for them. We agreed with the National Com-
                            mission, which questioned whether USDA could both effectively regulate
                            and promote cooperatives, and recommended that the Secretary sepa-
                            rate the responsibilities.


                            USDA has made a few attempts to improve its oversight activities since
USDA Has Done Little        our 1979 report. These attempts, which are summarized below, have
to Improve Its              been short-lived or inadequate.
Oversight Activities    .   In 1980, the USDA Capper-Volstead Study Committee created a plan for
                            establishing a department within the Office of the Secretary which

                            “The National Commission for the Review of Antitrust Laws and Procedures was established in 1977
                            to study and make recommendations on (1) the resolution of antitrust cases and (2) the desirability of
                            retaining antitrust exemptions.



                            Page 30                                 GAO/RCED-90-180      Capper-Volstead   Antitrust   Exemption
    .
                    Chapter 4
                    Limited Federal Oversight   of
                    Agricultural Caoperativee




                  would monitor selected markets and investigate instances of potential
                  cooperative abuse. The committee also created broad criteria for deter-
                  mining when prices could be considered unduly enhanced. However,
                  according to present and former USDA officials, the incoming Reagan
                  administration did not wish to follow up on the committee’s plans.
                . In 1981, USDA placed responsibility for overseeing Capper-Volstead with
                  a contingency committee consisting of the Assistant Secretary for Eco-
                  nomics, the Office of General Counsel, and the Assistant Secretary for
                  Marketing and Inspection Services. However, to date USDA has not
                  actively monitored cooperative pricing activities. It continues to simply
                  investigate complaints as they are received.

                    Since our prior work, we found evidence of three additional complaints
                    related to Capper-Volstead, all of which were dismissed. Thus, in the 68
                    years since the law was passed, USDA has received and investigated eight
                    complaints of potential violations of Section 2 and has dismissed all of
                    them. USDA officials offered a number of reasons for the lack of incoming
                    complaints.

                l The public lacks awareness of Section 2. A senior USDAofficial stated
                  that low public awareness about Section 2 explains much of the lack of
                  Section 2 activity.
                . Other legal avenues can be used. People can and have used the court
                  system as an alternative for resolving concerns over possible abuses by
                  agricultural cooperatives. For example, since the passage of the Capper-
                  Volstead Act, the courts have reviewed more than 60 cases concerning
                  the rights and responsibilities of cooperatives in such areas as monopoli-
                  zation, organizational combinations, and cooperative size. People might
                  choose the court system because they face a lower burden of proof (it is
                  not necessary to determine that restraint of trade resulted in undue
                  price enhancement) and they may be awarded treble damages.
                . Few cases of market abuse exist. Senior USDA officials have suggested
                  that cooperatives have seldom had both the market power and the
                  opportunity to exploit the public by increasing prices. Consequently, the
                  small number of complaints may indicate that there are few cases of
                  market abuse.


                    At the time of our previous review, FTC monitored agricultural coopera-
FTC Oversight       tives as part of its overall responsibilities for monitoring levels of
Restrictions”       market competition in all business sectors. Since that time, however, its
                    role in overseeing cooperatives has been reduced. As a result, there now
                    may be even less oversight than when we made our previous review.


                    Page 31                          GAO/RCED-90-186   Capper-Volstead   Antitrust   Exemption
                       Chapter 4
                       Umlted Federal Oversight    oP
                       Agricultural cooperativea




                       Section 20 of the Federal Trade Commission Improvements Act of 1980
                       barred in: from examining cooperative conduct that is exempted under
                       the Capper-Volstead Act. The Congress added Section 20 to the Federal
                       Trade Commission Improvements Act to reaffirm USDA'S Section 2
                       responsibilities and eliminate perceived operational conflicts between
                       FIT and USDA.


                       USDA has done little to improve its oversight of cooperatives since our
Conclusions            1979 review. Further, FTC’Srole in overseeing agriculture cooperatives
                       has been reduced since our earlier work. Consequently, uncertainty
                       remains as to whether or not agricultural cooperatives are unduly
                       enhancing prices for their products.

                       We continue to believe in the need for more active oversight because of
                       the uncertainties surrounding pricing activities of agricultural coopera-
                       tives. However, USDA'S lack of progress toward active oversight raises
                       questions about the priority it places on Section 2 responsibility. There-
                       fore, we believe, as we did in 1979, that USDA should implement an active
                       oversight program. Further, we believe that the Congress should closely
                       monitor USDAactions and, if USDA does not initiate active monitoring of
                       cooperative activities, the Congress should consider assigning regulatory
                       responsibility for cooperative pricing activities to the ETC.


                       Given the uncertainties surrounding the pricing activities of agricultural
Recommendationto       cooperatives, it continues to be important to have an active oversight of
the Secretary of       agricultural cooperative pricing activities. Therefore, we recommend
Agriculture            that the Secretary of Agriculture direct his contingency committee that
                       oversees Capper-Volstead to actively monitor cooperative pricing
                       activities.


                       We believe that the role of monitoring cooperative pricing activities is
Matters for            very valuable. Therefore, we suggest that the Congress closely monitor
Consideration by the   USDA actions and, if USDA does not initiate active monitoring of coopera-
Congress               tive activities, the Congress should consider assigning regulatory
                       responsibility for cooperative pricing activities to the FTC. If the Con-
                       gress assigns this responsibility to the FTC,Section 20 should not be
                       extended for subsequent fiscal years.
           ”




                       Page 32                          GAO/RCED-90-186   Capper-Volstead   Antitrust   Exemption
                  Chapter 4
                  Lhbd       Federal Oversight   of
                  Agricnltural    Cooperatives




                  We discussed the accuracy of the information in this report with respon-
Views of Agency   sible USM officials. They disagreed with the need for active oversight of
Officials         agricultural cooperative pricing activities. They believe the most effi-
                  cient oversight method is to respond to complaints received. Further,
                  they believe there are adequate provisions in the form of antitrust law
                  enforcement by the Department of Justice and lawsuits initiated by pri-
                  vate individuals to ensure against impermissible activities by
                  cooperatives.

                  We continue to believe that it is important to initiate active oversight of
                  agricultural cooperative pricing activities because of the uncertainties
                  surrounding these pricing activities.




                  Page 33                             GAO/RCED-90-186   Capper-Volstead   Antitrust   Exemption
  Appendix I

,i Cooperatives’ Shzweof Agricultural Products ’
1 Marketed (SelectedYears)

                                                         Percentage of cooporativo81 aharo
                  Commoditv                           1951     1901      1971      1981                        1988
                  Grain and soybeans                    35         33              34               37               30
                  Milk and products                     46         58              70               72               76
                  Livestock oroducts                    13         13              11               12                7
                  Fruits and veaetables                 20         22              25               25               24
                  Cotton and products                   10         19              25               30               41
                  Sugar crops                           59         57              64               53                    a
                  Poultrv and eaas                       7          9              11                9                    a
                  Special crops                          12        13              21               20                    a

                 aData not available.
                 Sources: Growthand                                 USDA (Sept. 1984) and Farmer Coop
                 eratives, USDA (Mar. 1990).




                 Page 34                       GAO/RCED-90-186   Capper-Volstead        Antitrust        Exemption
Ppe   u

?Y6&mdives’ Share of Farm Supply Items
Purchased by Farmers (SelectedYears)

                                                               Percentage of cooperatives’ share
              Supplies                                      1951      1961     1971       1961                   1966
              Feed                                             18         18             17               18           18
              Fertilizer                                       16         26             30               36           40
              Petroleum                                        19         25             35               35           39
              Chemicals                                        12         16             20               34           28
              Equipment                                         4          5              6                6                a
              Field seeds                                      17         16             15               15           17
              General supplies                                  8          8             11               10             a

              aData not available.
              Sources: Growth and Trends in Cooperative Operations, 1951-81,USDA (Sept. 1984) and Farmer Coop-
              eratives, USDA (Mar. 1990).




              Page 35                               GAO/RCED-90-13fJ   Capper-Volstead        Antitrust    Exemption
Appendix III

Federal Milk Marketing Orders May Raise
Milk prices

                           Federal milk marketing orders, which apply only to milk eligible for
                           fluid use, set legally binding minimum prices that handlers must pay
                           dairy farmers and that, in turn, influence milk prices consumers pay for
                           fluid milk and manufactured dairy products.’ Although it is hard to
                           determine what prices would prevail without milk marketing orders,
                           conventional economic reasoning suggests that under the order system,
                           the average prices dairy farmers receive for their milk are higher than
                           they would likely be without marketing orders. Consumer prices for
                           fluid milk are likely to be higher than they would be without marketing
                           orders, but the prices consumers pay for manufactured dairy products
                           are likely to be lower. Several empirical studies suggest a similar conclu-
                           sion. In fact a recent USDA study suggests a larger effect of marketing
                           orders on prices than had been found in previous analyses.

                           The first section of this appendix provides background on key pricing
                           provisions of federal milk marketing orders. The second section dis-
                           cusses, from a theoretical perspective, whether orders are likely to
                           cause higher prices and whether cooperatives might be able to maintain
                           the existing price structure even without orders, The third section dis-
                           cusses the difficulties of quantifying the price effect of orders from
                           direct comparison of prices with and without orders, while the fourth
                           section discusses estimates of price effects obtained from economic
                           models.


                           In setting minimum prices for milk according to how it is used, federal
Pricing Provisions of      milk marketing orders assign the highest price to milk used for fluid
Milk Marketing Orders      consumption. Within an order, however, all dairy farmers or their coop-
                           eratives receive a uniform weighted average, or blend price.

                                                                                        .~~
Minimum Prices Are Based   As described in chapter 1, federal milk marketing orders use a system
on How Milk Is Used        known as classified pricing-setting   prices on the basis of how the milk
                           is used-to establish minimum prices that regulated handlers must pay
                           for milk. Minimum prices for milk used in manufacturing hard dairy
                           products (e.g., butter, cheese, and nonfat dry milk), class III milk, are
                           the same in all orders, but minimum prices for milk used for fluid con-
                           sumption, class I milk, vary. The class I minimum price in each order is
                           set by adding an amount known as the class I differential to the M-W


                           ‘We addressed many issues concerning milk marketing orders in an earlier report: Milk Marketing
                           Orders: Options For Change (GAO/RCED-88-9, Mar. 21,1988).



                           Page 36                                GAO/RCEIMW186       Capper-Volstead   Antitrust   Exemption
                          Appendix Ill
                          Federal Milk Marketing    Ordem May Raise
                          MUk Prices




                          price lagged 2 months. In general, each order’s differential depends on
                          the order’s distance from the Upper Midwest.


Dairy Farmers Receive a   Although the minimum prices handlers must pay are based on how the
Weighted Average Price    milk they buy is used, all dairy farmers or their cooperatives receive a
                          uniform weighted average or blend price for their milk.2 (Cooperatives,
                          however, need not pay their members the blend price.) The blend price
                          depends on the minimum price for each class and the proportion of milk
                          used in each class. If, for example, an order’s class III price was $10.00
                          per hundredweight (cwt) and its class I price was $12.00 per cwt, and 50
                          percent of the milk in that order was used for products in each class,
                          then the order’s blend price would be a weighted average of the class
                          prices, or $11.00 per cwt. For a given class I differential, the greater the
                          share of raw milk used for fluid consumption, the higher the blend price.
                          Similarly, for a given share used for fluid consumption, the higher the
                          class I differential, the higher the blend price.


                          Classified pricing yields higher average prices for dairy farmers than
How Milk Marketing        they would receive in a competitive market3 Compared to the prices
Orders Are Likely to      that would result from a competitive market, classified pricing also
Affect Milk Prices        results in higher consumer prices for fluid milk, but lower consumer
                          prices for manufactured dairy products. It is unlikely that cooperatives
                          would be able to enforce the same degree of classified pricing in all mar-
                          kets without milk marketing orders. This situation implies that, on
                          average, orders are likely to cause higher prices.




                          *Adjustments are made to this uniform price to account for butterfat content and the location of the
                          plant to which the milk is shipped.

                          “Even if classified pricing were eliminated, the dairy price support program would remain. Therefore,
                          in analyzing the effects of milk marketing orders, we are comparing current prices with those that
                          might exist without orders but with the continuation of price supports. In this context, a competitive
                          market refers to a market structure in which the support price provides a floor under market prices,
                          but above which level prices are determined by the interaction of supply and demand, with no one
                          seller or buyer being able to influence the market price.



                          Page 37                                  GAO/RCED-90-186     Capper-Volstead    Antitrust   Exemption
                           Appendix Ill
                           Federal Milk Marketing     Order8 May R&e
                           Milk Prices




Classified Pricing May     Classified pricing meets the economic definition of price discrimination
Raise Consumer Prices fo   because the price differences between classes do not reflect cost differ-
                           ences4 Conventional economic models of price discrimination show that
Fluid Milk but Lower       by charging fluid customers a price higher than they charge manufac-
Prices for Manufactured    turing customers, dairy farmers can receive a blend,price above the
Dairy Products             price that would prevail in a competitive market without discrimination,
                           thereby enhancing their returns. These higher prices and returns occur
                           because dairy farmers can effectively separate their market into two (or
                           more) groups of customers and because the demand for fluid milk is less
                           responsive to price changes than the demand for manufactured dairy
                           products. Furthermore, classified pricing not only makes the blend price
                           higher than the average price dairy farmers would receive in a competi-
                           tive market,5 but by definition makes the price in the highest class-the
                           price for milk used for fluid consumption-even    higher. On the other
                           hand, under classified pricing, farmers, despite higher average prices,
                           would receive lower prices for milk used for manufacturing purposes.

                           This analysis implies that marketing orders raise the prices handlers
                           pay for fluid milk, as long as the price that handlers would pay for milk
                           for fluid consumption in the absence of milk marketing orders (but with
                           price supports and the Capper-Volstead exemption unchanged) was
                           likely to be no higher than what it would be in a competitive market. If,
                           handlers pay higher prices, then consumer prices for fluid milk are also
                           likely to be higher, This analysis similarly implies that consumer prices
                           for manufactured dairy products are likely to be lower. However,
                           because of Capper-Volstead, cooperatives in some markets might be able
                           to maintain some form of classified pricing even without marketing
                           orders, If they can, then even without marketing orders, prices handlers
                           pay for milk used for fluid consumption might be above the competitive
                           level, while the prices handlers pay for milk used for manufacturing
                           purposes might be below the competitive level. In this case part (or all)
                           of the difference between actual prices and the prices that would prevail
                           in a competitive market would not be attributable to marketing orders.



                           4Different analysts include different cost elements in making this cost comparison. But even the
                           largest estimated difference between the cost of producing milk eligible for fluid use and the cost of
                           milk eligible only for producing manufactured dairy products is considerably less than the difference
                           between minimum class I and class III prices, according to the report of the American Agricultural
                           Economics Association Task Force on Dairy Marketing Orders.

                           “Strictly speaking, this is true in the long run only if, as is generally assumed, farmers in total cannot
                           increase milk production without increasing the cost of dairy inputs, such as feed, cows, and dairy
                           equipment.



                           Page 38                                   GAO/RCED-30-186       Capper-Volstead    Antitrust   Exemption
                             Appendix   III
                             zralcal          Marketing   Order0 May Raise




Cooperatives Probabl‘Y       Even when they are the dominant sellers in their markets, cooperatives
Need Milk Marketing          would probably be less successful without milk marketing orders in
                             enforcing in all markets the degree of classified pricing that exists
Orders to Enforce            today. Classified pricing existed before marketing orders were estab-
Classified Pricing           lished. However, analysts at that time were convinced that marketing
                             orders with legal authority to enforce agreements were necessaryto
                             maintain sufficient classified pricing needed for dairy farmers to receive
                             substantial long-term benefits. Without this authority, if the fluid price
                             were much higher than the price for milk used for manufacturing, then
                             some independent dairy farmers could undercut the cooperatives, or
                             cheaper milk might be imported from outside the market area. Further-
                             more, even a dominant seller’s ability to raise prices above the level that
                             would prevail if there were competitors may be constrained by the
                             potential entry into the market by new competitors.

                             Therefore, because classified pricing raises average milk prices farmers
                             receive and marketing orders are probably necessary to enforce the
                             degree of classified pricing that exists today, economic reasoning sug-
                             gests that average prices at the farm level under the order system are
                             higher than they otherwise would likely be.


                             Although economic reasoning suggests that milk marketing orders prob-
Quantifying the Price        ably cause higher milk prices, quantifying this effect is difficult.
Effect   of’ Orders   From   According to the report of the American Agricultural Economics Associ-
Direct Observation of        ation’s Task Force on Dairy Marketing Orders, a comprehensive study
                             that compared milk prices in the same locations before and after imple-
Prices Is Difficult          mentation of marketing orders would provide the best evidence of the
                             effects of orders.” However, such a study would encounter difficulties in
                             clearly separating the effects of introducing marketing orders in the late
                             1930s from the effects of the general economic recovery that began at
                             that time. In any event, in its review of research on milk marketing
                             orders the Task Force found no such study.

                             One study from the 1970s cited by the Task Force examined two cases in
                             which milk marketing orders were terminated and then reinstated.7
                             However, the Task Force concluded that these two cases were too short

                             “Federal Milk Marketing Orders: A Review of Research on Their Economic Consequences,Occasional
                             Paper No. 3 (June 1986).

                             7W.D. Dobson and Boyd M. Buxton, Analysis of the Effects of the Federal Milk Orders on the Eeo-
                             nomic Performance of U.S. Milk Markets, Research Bulletin R2897 (University of Wisconsin, Oct.
                             1077,.



                             Page 39                                  GAO/RCED-30-166   Capper-Volstead   Antitrust   Exemption
                     Appendix III                                                                                    ,
                     Federal Milk Marketing   Orders May Raise
                     Milk Prices




                     and too transitory to clearly indicate how milk markets would operate in
                     the absence of orders. A study from the 1960s compared prices between
                     unregulated markets and those with orders and found that prices were
                     higher under orders, but the difference was not statistically significant8
                     The Task Force suggested that more systematic extension of that type
                     of comparison might provide evidence about the effects of orders.


                     Because of the difficulties of estimating the price effects of milk mar-
Estimates From       keting orders from direct comparisons of situations with and without
Economic Models      orders, most empirical evidence comes from economic models of the
SuggestThat Milk     dairy sector of the economy. The bulk of this evidence suggests that
                     milk marketing orders have raised fluid milk prices. In fact, a 1988 USDA
Marketing Orders     study suggested larger effects than found by studies conducted in the
Have Raised Prices   1970s.

                     Several studies using economic models found similar results, despite dif-
                     ferences in their assumptions about (1) the extent to which dairy
                     farmers respond to higher prices by increasing production and (2) the
                     degree to which the demand for fluid milk

                     is less responsive to price changes than the demand for manufactured
                     dairy products. For example, several studies estimated that in the
                     197Os, milk marketing orders raised the average price dairy farmers
                     received by about 2 to 5 percent. None of the studies reviewed by the
                     Task Force estimated that orders raised that price by more than 10
                     percent.H

                     In general, however, these studies estimated larger effects on the prices
                     paid dairy farmers for milk used for fluid consumption. In relation to
                     the prices that would prevail without price discrimination, classified
                     pricing raises prices for milk used for fluid consumption and lowers
                     prices for milk used for manufacturing. For example, one study that
                     estimated a 4-percent increase in the average price paid to dairy
                     farmers, estimated a g-percent increase in the price paid for milk used
                     for fluid consumption (accompanied by a 6-percent decline in the price



                     “Reuben Kessel, “Economic Effects of Federal Regulation of Milk Markets,” Journal of Law and Eco-
                     nomics, Vol. 10 (1967), pp. 61-78.

                     ‘The Task Force report suggests that the effects of milk marketing orders on consumer prices are
                     likely to be fairly similar to the effects on prices received by dairy farmers.



                     Page 40                                 GAO/RCED-90-186     Capper-Volstead   Antitrust   Exemption
    ,
          Appendix III
          Federal Milk   Marketing Ordere May R&e
          Milk Prices




          paid for milk used for manufacturing).1° Another study, which estimated
          less than a l-percent change in average milk prices paid to dairy
          farmers due to milk marketing orders, estimated that orders increased
          the price paid for milk used for fluid consumption by 8 percent (while
          reducing the price paid for milk used for manufacturing by 9 percent).”

          A 1988 study by USDA estimated substantially larger national effects
          than previous research had suggested and also estimated the effects on
          prices in different regions. l2 In this study, USDA economists developed a
          simulation model of the dairy sector to estimate the long-term effects of
          various policy changes, including eliminating classified pricing. This
          study estimated that eliminating classified pricing through, for example,
          eliminating the pricing provisions of milk marketing orders, could
          reduce the national average price dairy farmers receive for their milk by
          as much as 13 percent and could reduce the price paid for milk used for
          fluid consumption by as much as 20 percent.13 In some regions the esti-
          mated effects were greater. For example, for the Northeast (New
          England, New York, and northern New Jersey), the corresponding esti-
          mated price reductions were as much as 17 percent for the average price
          and as much as 26 percent for the price for milk used for fluid
          consumption.


          Classified pricing-pricing   milk on the basis of its end use-enables
Summary   dairy farmers to receive higher milk prices. Cooperatives probably need
          federal milk marketing orders to maintain the same degree of classified
          pricing that exists today, Therefore, marketing orders are likely to
          increase average milk prices paid to dairy farmers and consumer prices
          for fluid milk but to lower consumer prices for manufactured dairy
          products. Results of some attempts to quantify the effects of marketing

          “‘R.A. Ippolito and Robert T. Masson, “The Social Cost of Government Regulation of Milk,” Journal of
          Law and Economics, Vol. 21 (1978), pp. 33-66.
          ’ ‘Roger A. Dahlgran, “Welfare Costs and Interregional Income Transfers Due to Regulation of Dairy
          Markets,” American Journal of Agricultural Economics, Vol. 62, No. 2 (May 1980), pp. 288-296.
          ’ zHoward McDowell, Ann M. Fleming, and Richard F. Fallert, Federal Milk Marketing Orders: An
          Analysis of Alternative Policies, USDA, Economic Research Service, Agricultural Economic Report
          Number 698 (Sept. 1988).
          ‘:‘USDA’s estimates are based on a key assumption about price variability and risk. That is, USDA
          assumes that eliminating classified pricing would not, in the long run, increase price variability so
          much that farmers would reduce their production because of an increase in the perceived risk level.
          But as USDA recognizes, if eliminating classified pricing increases price variability, and if dairy
          farmers are adverse to risk, then the production level might fall somewhat and thereby reduce the
          estimated decline in prices.



          Page 41                                  GAO/RCEWO-186         Capper-Volstead   Antitrust   Exemption
                                                                                      3
                                                                                           c

Federal Milk Marketing   Orders May Raise
MI& Prices




orders suggest that marketing orders raise prices, particularly                       for milk
used for fluid consumption.




Page 42                               GAO/RCED-90-186   Capper-Volstead   Antitrust       Exemption
Review of Empirical Analyses of the
Relationship Between Over-Order Payments
and Cooperative Market Power
                       The relationship between over-order payments and cooperative market
                       power has been examined by a number of dairy economists over the
                       past 16 years. We reviewed many of their studies, including both case
                       studies and empirical analyses. The studies we examined covered a
                       variety of different sample periods and used a variety of modeling and
                       empirical analysis methodologies.

                       For a number of possible reasons, the different studies do not reach a
                       consensus concerning the relationship between over-order payments and
                       cooperative market power. For example, the nature of the relationship
                       between over-order payments and cooperative market power may have
                       changed over time, in such a way that the relationship is significant
                       during the sample period of one study, but not during that of another.’
                       Further, the different studies generally have not been consistent in their
                       attempts to account for those factors, besides the cooperative market
                       power factor, that are considered important determinants of over-order
                       payments. This inconsistency may mean that some analyses inappropri-
                       ately attribute some portion of the size of over-order payments to coop-
                       erative market power rather than to factors not included in the
                       analyses. Also, the different studies are inconsistent in the manner in
                       which those factors included in their analyses are measured or approxi-
                       mated by the available data.

                       In this appendix we summarize the studies we reviewed according to the
                       order of their completion and evaluate what they suggest concerning the
                       relationship between over-order payments and cooperative market
                       power.


                       The literature we reviewed identified many reasons over-order pay-
Summaries of Studies   ments can occur. The primary objective of each study was to test
We Reviewed            whether these payments may reflect the exercise of monopoly power by
                       cooperatives. According to other explanations recognized in the studies,
                       payments can also be (1) for processor-specific services, such as quality
                       control work, now performed by the cooperative rather than the
                       processor; (2) for marketwide services, such as balancing, promotions,
                       and market analysis; (3) to obtain adequate supplies for the marketing
                       region on a supplemental or continuing basis; (4) to compensate manu-
                       facturing plants for profits lost when milk is diverted to fluid uses (give-

                       ‘We use the term “significant” here and throughout the appendix to refer to a statistically significant
                       relationship, at the Q&percent or better confidence level, which is positive in sign, as expected
                       according to economic theory.



                       Page 43                                  GAO/RCED-90-186      Capper-Volstead    Antitrust   Exemption
                           Appendix Iv                                                                                      ,
                           Review of Empirical Analyses of the
                           Relation8hip   Between Over-Order Payments
                           and Cooperative    Market Power




                           up costs); and (6) to correct for imperfections in the methodology used
                           to determine class I minimum prices, e.g., that the M-W price 2-months
                           lagged, rather than current, is used. Only in the more recent studies
                           were attempts made to account for nearly all of these factors in the
                           empirical analyses of the determinants of over-order payments.


Studies Completed in the   The earliest study we reviewed was a 1976 report by the Capper-Vol-
1970s                      stead Committee.2 Using regression analysis, the Committee concluded
                           that for each of the periods 1974,1974-76, 1976, and 1976-76, coopera-
                           tive market power was not significant in affecting over-order payments.
                           The Committee’s model of over-order payments also accounted for dis-
                           tance from Eau Claire, Wisconsin, (the class I price differential basing
                           point) and the extent to which local influences cause actual class I dif-
                           ferentials to deviate from what they should be, according to the general
                           formula (based on the M-W price and distance) used to establish class I
                           minimum prices. That these factors were found significant in affecting
                           over-order payments suggests that the payments serve to compensate
                           dairy farmers (cooperatives) for inaccuracies in the class I differentials
                           pertaining to transportation costs and any misalignments caused by
                           local influences.

                           The results of the Capper-Volstead Committee report were not consis-
                           tent with those of an unpublished 1977 Justice Department study.3 The
                           Justice study found that, for the years 1973-76, a positive and signifi-
                           cant correlation between the size of the over-order payments and one
                           measure of cooperative market power-the market share of the domi-
                           nant cooperative. This result implies that market power is an important
                           factor in determining the size of over-order payments.

                           The Justice Department study and the work of other dairy industry
                           experts were reviewed in a 1977 study edited by MacAvoy.4 The
                           MacAvoy study examined the relationship between over-order pay-
                           ments and market power of cooperatives from many viewpoints,

                           2The estion of Undue Price Enhancement by Milk Cooperatives, Capper-Volstead Committee,
                           t?SDf$.i.ic. 1976).

                           ““Statistical Analysis of Market Share and Over-Order Charges,” U.S. Department of Justice, Anti-
                           trust Division, Economic Policy Office (1977). Our review of this study is based on reviews by Jesse
                           and Johnson (1986) and MacAvoy (1977). Discussion of their studies, and citations, are presented
                           below.

                           4Paul MacAvoy, ed., Federal Milk Marketing Orders and Price Supports, American Enterprise Insti-
                           tute (Washington, DC., 1977).



                           Page 44                                 GAO/RCED-90-186      Capper-Volstead   Antitrust   Exemption
                          Appendix IV
                          Review of Empirical Analyses of the
                          Relationship   Between Over-Order Payments
                          and Cooperative    Mnrket Power




                          including those of economic theory, dairy industry experts, and pre-
                          vious empirical studies and available raw data. On the basis of available
                          evidence, MacAvoy concludes that, for the most part, over-order pay-
                          ments reflect the exercise of market power by cooperatives. MacAvoy
                          also points out, however, that the exercise of that market power
                          (attained with the assistance of Capper-Volstead) is made possible
                          largely because of the classified pricing system and associated restric-
                          tions placed on the movement of milk as instituted through the mar-
                          keting order system.

                          In suggesting that a significant relationship exists between over-order
                          payments and cooperatives’ market power, a later study by Masson and
                          Eisenstat (1980) also supported the conclusions of MacAvoy and the
                          Justice Department study results.6 The authors examined the conse-
                          quences of a 1976 consent decree of the Justice Department on pay-
                          ments in one market with a dominant cooperative. Using regression
                          analysis on data for this market over time, they found that the consent
                          decree was significant in reducing the size of over-order payments. This
                          result implies that, prior to the decree, the dominant cooperative was
                          exercising its market power in the form of higher payments. In their
                          analysis, Masson and Eisenstat control for the influence of many factors
                          (in addition to the consent decree) on the level of over-order payments,
                          including class I utilization and price, fuel and feed costs, and the status
                          of price controls.


Studies Completed After   In comparison to the studies summarized above, studies completed after
1980                      1980 present more extensive empirical analyses. Specifically, each of
                          the earlier studies that contain regression analyses examined only one
                          type of data, either time-series data or cross-section data.” Each of the
                          more recent empirical studies analyzes pooled (time-series and cross-sec-
                          tion) data in addition to separate time-series and/or cross-section data.




                          “R.T. Masson and P. M. Eisenstat, “Welfare Impacts of Milk Orders and the Antitrust Immunities for
                          Cooperatives,” American Journal of Agricultural Economics (1980), pp. 270-278.

                          “Time-series analysis examines data with observations over time, but data for each marketing order
                          must be analyzed separately. Cross-section analysis examines data with observations across mar-
                          keting orders, but data for each time period must be analyzed separately. It is possible to conduct
                          pooled time-series/cross-section analysis that examines data with observations across market orders
                          and over time simultaneously.



                          Page 45                                 GAO/RCEDSO-186      Capper-Volstead   Antitrust   Exemption
Appendix IV
Review of Empirical Analyses of the
RelationaNp    Between Over-Order Paymenta
and Cooperative    Market Power




Babb and Bessler’s 1983 study was the first to present analyses of
pooled data in addition to separate cross-section datam7Their data set
covered all federal marketing orders for the period 1966-80. They
modeled over-order payments as determined by the market power of
cooperatives (which was measured in several ways). Their model took
several factors into consideration: (1) the market power of proprietary
milk handlers (some cross-section analyses only), (2) class I price rela-
tionships among federal orders to reflect production and transportation
cost misalignments, (3) the percentage of milk in an order used for class
I purposes to reflect the production/consumption balance in each order,
(4) barriers to the movement of raw milk, and (5) return over cost of
milk production to reflect the status of the price-cost squeeze on dairy
farmers.

Using cross-section analysis, Babb and Bessler find a significant rela-
tionship between cooperative market power and the level of over-order
payments during the period 1966-72. In contrast to the earlier Justice
Department study, however, they do not find significance for the years
1973-75.R This inconsistency arises, in part, because the earlier Justice
Department study did not control for the effects on payments of all the
factors Babb and Bessler take into account.

Babb and Bessler’s pooled data analysis presents more of an overall per-
spective on the issue of a significant relationship between over-order
payments and cooperative market power. Their pooled data results sug-
gest the relationship between over-order payments and cooperative
market power is not significant9

Babb and Bessler also present results from a survey of cooperatives and
milk processors, in which each group was asked to rank, in order of
importance, seven different factors that influence the size of over-order
payments. Both cooperatives and processors ranked among the three
most important factors: (1) the bargaining power of cooperatives and
the percentage of milk volume they controlled, (2) the supply-demand

7E.M. Babb and D.A. Bessler, Factors Affecting Over-Order Payments in Federal Milk Marketing
Orders, 1966-80, Indiana Exp. Stg. Research Bulletin No. 977 (Purdue University, June 1983).
HBabb and Bessler also present results of a simple regression analysis in which cooperative market
power is the only explanatory variable of the level of over-order payments, This analysis shows
significance for the 1973-74 Period. These results are similar to those of the Justice Department
study.

gWe refer only to the portions of Babb and Bessler’s pooled analysis that use both time and order
intercept shifters because their analysis suggests both types of intercept shifters should be included
in the model.



Page 46                                  GAO/RCEDBO-186       Capper-Volstead    Antitrust   Exemption
.   Appendix IV
    l&dew of Emplrled Analyses of the
    Relation13hip Between Overorder Payment43
    and Cooperative   Market Power




    balance of milk, and (3) the cost of milk from alternative sources. In
    suggesting that cooperative market power is among the most significant
    determinants of the size of over-order payments, these survey results
    differ from those of Babb and Bessler’s empirical analysis.

    An empirical study similar to Babb and Bessler’s was completed in 1986
    by Jesse and Johnson, who analyze pooled data and separately analyze
    both cross-section and time-series data.lO Their data set contained
    monthly data from 1973-80 covering 38 federal marketing orders. Jesse
    and Johnson model over-order payments as determined by (1) coopera-
    tive market power (as measured by a variety of proxy variables), (2)
    market power of proprietary milk handlers, (3) cost of alternative milk
    supplies (similar to Babb and Bessler’s class I price relationships), (4)
    balancing costs (also measured with proxy variables), (6) change in
    direct milk production costs, (6) class I minimum price imperfections
    (two variables, one to cover price stickiness, the other to account for the
    fact that class I prices are determined according to a 2-month lag of the
    M-W price), and (7) the presence of a marketing federation of
    cooperatives.

    The results of Jesse and Johnson’s analyses of cross-section, time-series,
    and pooled data did not consistently suggest a significant relationship
    between over-order payments and cooperative market power. Specifi-
    cally, their cross-section analysis suggests that this relationship is sig-
    nificant only for several months of 1974 and for a few months during
    1979-80. Their time-series analysis suggests that over-order payments
    were significantly related to cooperative market power during 1974-80
    in only 4 of 24 market orders analyzed. Finally, their analysis of pooled
    data mirrors their analysis of cross-section and time-series data in sug-
    gesting that at different times or in different regions the relationship
    between over-order payments and cooperative market power could
    range from significant and positive, as expected, to not significant, or
    even significant but negative.

    The most recently completed empirical study we reviewed was Babb’s
    1989 update of the Babb and Bessler study.n For this update Babb
    changes the data set, from 1966-80 to 1970-87. He also changes the


    “‘Edward V. Jesse and Aaron C. Johnson, Jr., An Analysis of Cooperative Over-Order Pricing of Fluid
    Milk, Technical Bulletin 1708, USDA (1086).

    ’ ‘E.M. Babb, Over-order Payments in Federal Milk Marketing Orders, 1970-89, Staff Paper 371,Food
    and Resource Economics Department (University of Florida, Nov. 1989).



    Page 47                                GAO/RCRD-90-186     Capper-Volstead   Antitrust   Exemption
                        Appendix IV
                        Review of EmpirIcal Analyses of the
                        Relationship   Retween Over-Order Payments
                        and Cooperative    Market Power




                        model by adding two variables, one that reflects regional product con-
                        centration and one that replaces the return- over-cost variable with an
                        estimate of the costs of cooperative services. His cross-section analysis
                        shows a significant relationship between over-order payments and the
                        market power of cooperatives for only a few years during the 1980s.
                        Babb’s pooled data analysis, however, suggests a significant relationship
                        between over-order payments and cooperative market power. These
                        findings are not consistent with those of Babb and Bessler.

                        Also in 1989, Babb completed a case study covering 31 marketing orders
                        to determine the array of qualitative factors that may affect the size of
                        over-order payments. I2In general, he found that over-order payments in
                        most federal orders are more complex to interpret and administer now
                        than they were in the 1970s. Specifically, the use of competitive credits
                        (credits against over-order payments that processors can receive if com-
                        peting with other lower cost processors) may confuse the meaning of an
                        over-order payment. Also, over-order payments sometimes are set for
                        extended periods of time to enhance stability of milk prices and there-
                        fore are not as sensitive to factors such as supply and demand balance
                        as they once were.

                        Babb’s case study suggests that more recent data on over-order pay-
                        ments may not be comparable to data from the 1970s. This difference
                        may mean that empirical analyses of data from the 1980s are likely to
                        produce different results and require different interpretations than do
                        analyses of earlier data.


                        The weight of the evidence from the earlier studies suggests there is a
Overall Evaluation of   significant relationship between over-order payments and cooperative
the Results Presented   market power. Nonetheless, these early studies are less credible, in our
in the Literature       view, than the more recent studies. The earlier studies generally do not
                        account for many of the other factors besides cooperative market power
                        that are acknowledged in the literature as important determinants of
                        over-order payments.

                        The results of the more recent studies are mixed in suggesting a signifi-
                        cant relationship between over-order payments and cooperative market
                        power. Specifically, the results of Babb’s 1989 pooled data analysis are
                        the exact opposite of the results obtained from Babb and Bessler’s 1983

                        12E.M.Babb, Case Studies of Over-Order Payments in Federal Milk Marketing Orders, Staff Paper
                        667, Food and Resource Economics Department (University of Florida, May 1089).



                        Page 48                               GAO/RCED-99-186     Capper-Volstead   Antitrust   Exemption
Appendix N
Review of Empirical Analyses of the
Relationship   Between Over-Order Payments
and Cooperative    Market Power




pooled data analysis, although the methodologies of the two studies are
nearly identical (albeit for different sample periods). Further, the
results of the pooled analyses of both Jesse and Johnson, and Babb and
Bessler, suggest relatively few occasions (periods of time, and/or spe-
cific market orders) have occurred when a significant relationship
between over-order payments and cooperative market power existed.
Nonetheless, Babb and Bessler’s survey results show that processors
and cooperatives believe that cooperative market power is one of the
more important determinants of over-order payments.




Page 49                              GAO/RCED-99-186   Capper-Volstead   Antitrust   Exemption
Appendix V                                                                                        I

Major Contrtributorsto This Report


                        Jay R. Cherlow, Assistant Director
Resources,              Robert E. Robertson. Senior Evaluator
Community, and          John P. Rehberger, &aff Evaluator
                        Daren K. Sweeney, Staff Evaluator
Economic ” ’            Michael E. Schiefelbein, Writer-Editor
Development Division,
Washington, DC.
                        John T. McGrail, Senior Attorney
Office of the General
Counsel

Office of the Chief
Economist
                        Dale A Wolden, Regional Manager’s Representative
Chicago Regional        Verne J. Gilles, Evaluator-in-Charge
Office




                        Page SO                       GAO/RCED-BO-11   CapperVoLtead   Antltnut       Exemption
.




    Page 61   GAO/RCED-fKb-186   Capper-Volstead   Antitrust   Exemption
                                                                                              *

Related GAO Products                                                                                   .,



              Federal Dairy Programs: Insights Into Their Past Provide Perspectives
              on Their Future (GAO~RCED-~0-88,Feb. 28, 1990).

              Milk Pricing: New Method for Setting Farm Milk Prices Needs to Be
              Developed (GAOIRCED-90-8, Nov. 3, 1989).

              Dairv Termination Program: An Estimate of Its Imuact and Cost-Effec-
              tiveness (GAOIRCED-89-96, July 6, 1989).

              Dairy Termination Program: A Perspective on Its Participants and Milk
              Production (GAO/RCED-88-167, May 3 I, 1988).

              Milk Marketing Orders: Options for Change (GAOIRCED-88-9, Mar. 21,
              1988).

              Farm Programs: An Overview of Price and Income Support, and Storage
              Programs (GAO/RCED-88-84BR,Feb. 29, 1988).

              Federally Owned Dairy Products: Inventories and Distributions, Fiscal
              Years 1982-88 (GAOIRCED-88-108FS,Feb. 23, 1988).

              Surplus Commodities: Temporary Emergency Food Assistance Pro-
              @%nI'S OperatiOnS and COntinUanCe(GAO/RCED-88-11,OCt. 19, 1987).

              Food Inventories: Inventory Management of Federally Owned and
              Donated Surplus Foods (GAO/RCED-86-11, Dec. 5, 1986).

              Overview of the Dairy Surplus Issue -Policy Options for Congressional
              Consideration (GAO/RCED-86-132,Sept. 18, 1985).

              Effects and Administration    of the 1984 Milk Diversion Program (GAO/
              RCED86-126, July 29, 1985).

              Government-Owned Surplus Dairy Products Held in Inventory (GAO/
              RCED-86-43,Jan. 7,1986).

              Family Farmers Need Cooperatives-But             Some Issues Need to be
              Resolved (CED-79-106, July 26, 1979).




(160008)      Page 62                        GAO/RCED-PO-186    Capper-Volstead   Antitrust       Exemption
                                                                                                        _.._._
--,   .-I---   __..   ----._--..--.__--.-       ________   ~~.-_--                      -------




                                            Ortlt~rs may also be plactd   by cdling   (202) 275-6241.
                                                                                                                                                q
                                                                                                                                                ‘8,
I
                                                                                                                                                1
I~     I            _ ..__.._.._”
                               _._._ ____....l_____._...^_.._ .-__ _...-.--.._-.l   .._...---   ..-.-.^. ._ _...-- .I.. --1---1_   -~   ---.-




     I-.-.-.--.._                    ..-_   ~.-.-         __---   “-_l._L----.-