Federal Dairy Programs: Insights Into Past Provide Perspective for the Future

Published by the Government Accountability Office on 1990-03-07.

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

                   United States General Accounting    Office   / y b 7 7 $

GAO                Testimony’

For Release on     Federal   Dairy    Program&
Fxpected  at
10:00 am EDT       InsightG    Into     Pa&t Provide
March 7, 1990      Perspective      for   the Future

                   Statement for the Record by
                   John W. Harman, Director,
                   Food and Agriculture   Issues

                   ResourceS,   Community,       and Economic
                     Development   Division
                   Before the Committee on Agriculture,
                     Kutrition,  and Forestry
                   United States Senate

GAO/T-RCED-90-28                                                      GAO Form 160 W/87)

    Nr.      Chairman:

              We are pleased                  to submit               for      your       hearing        on dairy               programs
    for      the    199Os,         a statement                 for     the        record        on the         implications                     of
    current         dairy        policy.              As consideration                     begins        on the              1990 farm
    bill,      one needs            only         to reflect                 on changes           that        occurred              to the
    dairy      industry            in     the      1980s to understand                          the     dynamics              of    that
    industry          since        the       1930s --the              beginning            of    federal             efforts           to
    promote         stable         dairy         markets,             ensure          adequate          supplies,               stabilize
    prices,         and improve                 farmer         income.             The 1980s began with                            such
    excessive             milk     production                that      large          government             purchases              of dairy
    products          were       required,             costing              the    taxpayers            about          $17.2        billion
    during         that      decade.             In    fact,          the      inventory          of     these              products            was
    so large          that       the      federal            government               had difficulty                   giving          them
    away.          However,         as the            1980s ended and the                        1990s have begun,
    federal         dairy        surpluses             of cheese               and non-fat              dry     milk          have
    declined          to     such an extent                    that         traditional           donation                  programs            have
    little         or no dairy               products           for         donation.            In addition,                   while
    consumer         prices         for       retail          dairy          products           rose     an average                 of      2
    percent         annually            in    the      mid-          and late          1980s they              increased               by 6
    percent         in     1989.

              As you requested,                       this      statement              discusses              (1)      how the           dairy
    industry         has changed                 since         the     federal            government                first       enacted
    specific         dairy         legislation                during           the     193Os,          (2)     the          evolution            of
    federal         involvement               in      the      dairy         industry,           and (3)             how federal
    programs,             according           to our           analyses,             have       affected             milk       supplies.
         In summary,                the     dairy         industry            has changed                 significantly                 in
the    over      50 years            of        federal         involvement.                   For example,                 while        the
numbers        of      cows and farms                    have declined                 substantially,                  milk
production             has increased.                     These production                      increases            have
contributed             to changes               in      federal           involvement               in     the     industry.
Initially,             the    government                 became involved                     when low milk                 prices
appeared        to threaten                 the       adequacy             of the       nation's             milk      supply.
Federal        actions          were        therefore               intended           to     stabilize             milk      prices
and encourage                milk     production.                     Over time,              the        federal       milk
progra:.ls --milk             marketing               orders          and price              supports--contributed                           to
market       distortions:                 creating             incentives              for      periodic            surpluses            by
encouraging             more milk               to be produced                  than         could        be marketed              at
resulting           prices.           Consequently,                       government            actions            during       the
198Os,        including             price        support            reductions,               were directed                  at curbing
milk     production.                 However,             those           actions       that         paid         farmers       to
reduce       production              or stop             dairy        farming       have achieved                     only
temporary           success.              Accordingly,                    we have       continued                to encourage
changes        that,         over      the       long         term,        would    provide               more permanent
solutions           to periodic                 surplus          problems,          make dairy                   programs          more
market-oriented,                    and reduce                the     federal          role         in    the      dairy      industry.


         The objectives                   of     the      federal           dairy       policy            over      the      years       have
been to        support          farmers'              prices          and incomes,               expand            consumption,
ensure       an adequate               supply            of    good quality                  milk,        and stabilize                 dairy

prices       and-markets.                The policy               is     carried             out      principally            through
two program --the                 milk      marketing                 order          program,          created         in    1937,
and a price           support          program,            created             in      1949.

           To meet the          objectives              of promoting                    stable         markets,         ensuring
adequate       supplies,              stabilizing                prices,             and improving              farmer           income,
marketing         orders        set      forth       marketing                 practices,              terms      and
conditions          of    sale,        minimum prices                    that         must be paid              by dairy
plants,       and the          distribution              of       financial              returns          among farmers.

          Under     the    price         support         program,                the     U.S.         Department            of
Agriculture           purchases,            at designated                      prices,          all     quantities               of
butter,       cheese,          and nonfat            dry         milk         that      cannot         be used
comr;lercially.            The program               stabilizes                  milk        prices       by,     in    effect,
guaranteeing             a minimum price                   for        any amount              of dairy          product           that
can be produced.                  Federal           outlays             for      the program              are     dependent
upon the       extent          to which          milk       production                  exceeds         commercial               use and
the   support         price.           The more that                    production              exceeds         use,        the       more
surplus       products          the      government               buys         and the         greater          the     cost          to
the   government.


          I would        now like         to     focus        my testimony                    on changes            that         have
occurred       over       the     last      60 years              in     the         dairy      industry,           federal

efforts         to.legislatively                  manage milk              production,                   and our past
analyses           of how federal                programs          affected            dairy         surpluses.

Dairy       Industry          Has Changed

           While      the     basic        legislation             has remained                 relatively               unchanged,
the      efficiency           of milk           production          has increased.                        Annual         milk
production            per     cow has grown               from      about        4,500         pounds            in     1930 to
about       14,200        pounds        in      1988.       These      gains        have            largely            been a
result       of     advances          in     technology,            better        management,                    and improved

           These      gains         in production            have more than                     compensated                  for
decreases           in both          the     number of dairy                 cows and farms.                           Between           1930
and 1988,           the     number         of    cows declined               from        22.2        million            to    10.2
million,           and the          number       of dairy          farms        decreased                from      about           4.5
million        to about             220,000.         The average                herd         size        in     that     period
increased           from      5 to 46.

           The Upper Midwest                    continues          to be the            major            milk      producing
area,       representing              about       28 percent           of U.S.               milk        production                in
1988.        Although          its     share        of total         milk        production                   has not         changed
significantly               since       1970,       the     shares         of    some other                   regions         have.

The Southwest,                for     example,          has increased                  its     percentage                of U.S.
milk       production          by 60 percent,                to     14.9        percent             of    the      1988 national

milk  production,
            _.                     while      the        Corn Belt's               share        has declined                    by about
20 percent.

Changes        in     Focus        of    Federal          Involvement

          Federal          involvement              in    the      dairy          industry            began        in     the        1930s
when low milk                prices        were perceived                   to threaten                the     nation's               milk

suPPlY*         Both         the    marketing             order         and price              support         programs               were
created        to stabilize                prices         for      the      farmer          and help           ensure            an
adequate        supply          of milk.             From the              1930s through                the        197Os,            the     two
programs        were         changed        generally              to      support          incomes          for        the      farmer
by increasing                the    price      support             level          and establishing                      a national
pricing        system.

          During       the      late       1970s and early                       198Os,        farmers         began            to
produce        milk     at      unprecedented                   levels.            Because        the        market             was
unable       to absorb             the     additional             production,                annual          purchases                under
the    price        support         program          dramatically                  increased            from        $251 million
in     1979 to        $2.6     billion         in        1983.          This       led    to actions                in         1981 and
1983 that           were      intended         to control                  the     surplus,            in part,                through
the    price        support         program.             Another            program,            the     Milk        Diversion
Program,        in     1984,        paid      farmers            to reduce            the       amount         of milk               they
marketed        for     a 15-month             period.                In    1985,        the     Congress                (1)
instituted            a "supply/demand                    adjuster,"               which--for            a limited                   number
of years*-automatically                        reduced            price          supports         if     surpluses                   were
projected           to exceed            certain          levels,           and (2)          authorized                 the      Dairy

Terr,\ination               Program,         which      paid     farmers              to slaughter          or export
their       entire           herds      and leave           dairying            for     5 years.           Because           the
198S drought                 increased           feed     prices,         the         Congress      passed         legislation
to      suspend         use of        the       automatic        supply/demand                  adjuster          in    1989.

GAO Analyses                 Support         Less Federal            Involvement                in Dairy          Programs

          Over        the     last      10 years,           we have         reported            (see      attached           list     of
related         products)             that       the    milk    marketing               order     and price             support
prograr.ls           have     contributed              to periodic              surpluses         by creating
incentives             to produce             more milk         than       can be marketed.                      We found
that      the        guaranteed          purchase           of all        production             and the          consistent
increases             in price          supports          during         the     1970s--from              $9.00        per
hundredweight                 of milk           in    1977 to       $13.10            per    hundredweight              of milk
in      1980 --created               incentives           for   farmers               to continue          to increase
milk      production             despite             accumulating          dairy            surpluses.

          The pricing                policies          established              by milk         marketing          orders           were
intended             to encourage             and maintain               a locally            produced          supply         of
milk.        These policies                   can no longer               be justified              for     this        reason
because             grade     A milk         is produced            in    all         regions     of      the     country           and
technologies                 are available              to transfer              it     between        regions          as
needed.              As such,         milk       marketing          orders            provide     incentives,                in
addition             to those         provided          by the       price            support     program,             to produce
milk.           *

             PIilk     marketing              orders           created            incentives                  for        excessive
production                because         the         fluid          milk        prices         under          certain              orders         were
artificially                   high.          Under           marketing             orders,            the          grade       A
differential                   is higher              than       the        added cost                of producing                   grade         A
milk         (only        grade        A can be used                    for       fluid         consumption)                    instead            of
grade         B milk           (used      only         for       manufacturing                       dairy          products).                  About
88 percent                of all        milk         produced               in    this         country              is    grade       A, far
more than              is      needed         for      fluid          milk        markets.

            Other         marketing            order           provisions                 (called            down allocations                          and
col,lpensatory                 payments)              are      designed             to economically                         discourage                 the
shipment             of      reconstituted                  milk,           which         is    a more efficient                           means for
moving          milk         between       distant               locations.

            In addition,                marketing                order           distance             differentials                    that        were
originally                intended            to make it               profitable                    to transport                   milk        into
deficit            areas        have,         in      fact,          created         regional                inequities.
Distance             differentials                   provide           production                    incentives                in all           regions
of     the      country,              except          the      Upper            Midwest.              The greater                   these
differentials,                    the     greater              the production                        incentives.                    These
incentives                have been partly                       responsible                   for     the          increase           in milk
production                in    some regions                   of     the        county.

            Further,            as production                    increases               nationally,                     the    more likely
it     is     that        surpluses            will           rise     high         enough            to cause              the      support
price         to     fall,       if     the         supply/demand                   adjuster             is         retained.               A

combination              of higher            differentials                  and lower            support          prices          can
have       a particularly                  adverse         impact           upon the         traditional               milk-
producing            region         of     the    Upper Midwest,                   which         receives          little          or no
benefit           from       the    differentials                but     which         would        be hurt           by declines
in    the     support          price.

           Efforts           to reduce           milk      surpluses,              under         the     milk      diversion             and
dairy        termination             programs,            have        achieved            only      temporary               success.
For example,              we estimated                  that     the     milk       diversion             program            reduced
production             by about            4 billion            pounds        in    1984 and could                    have      saved
up to        $664 million.                  We also            estimated           that     from         1986 through               1990,
the       dairy      termination             progran            would        reduce        milk         production            by 39.4
billion           pounds       and save           the      government              about         $2.4     billion.              While
these        figures          may sound           impressive,               the     estimates             of annual             milk
reductions             attributable               to the         dairy        termination                program            declined
each year            after         1987,      indicating              the     program            would         have    no lasting
effect        on milk          production.                However,            unlike        the         temporary            impact       of
these       programs,              price-support                reductions            have        a permanent                impact.


           While       short-term            solutions            have        addressed             the        periodic
surpluses,             we believe            that        a long-term,               permanent             solution            is
needed.            We have          recommended                to the       Congress             that     it      adopt       changes
in dairy           programs          that        would         make them more market-oriented,

reducing       the    federal      role       in     the       dairy      industry.1              Accordingly,           in
regard       to the    price      support          program,            we recommended             that      the
Congress       continue         to use a supply/demand                       adjuster,          tied      to a
relatively        low level        of expected                 surpluses,         to set        price       support
levels.        In regard         to milk       marketing               orders,       we recommended               that
the   Congress        gradually       decrease             the     federal        role     in milk         pricing
through       a series      of    steps       that     better           reflect        regional          cost-of-
production       differences,             allow       freer        movement of milk                between
regions,       and eliminate          features             of milk         pricing       that      distort
regional       production         patterns.

lFedera1     Dairy Programs:     Insights   Into Their                                 Past Provide
Perspectives      on Their Future     (GAO/RCED-90-88,                                 Feb 28, 1990).
               __                     RELATED GAO PRODUCTS
Federal    Dairy Programs:    Insights    Into Their Past Provide
Perspectives     on Their Future      (GAO/RCED-90-88, Feb. 28, 1990).
Dairy Imports:           Issues       Related     to Chocolate         Products         (GAO/RCED-8%
159BR, July 18,          1989)    l

Milk Pricinq:      New Method            for Setting  Farm Milk                Prices        Needs to Be
Developed     (GAO/RCED-90-8,            Nov. 3, 1989).
Dairy Termination     Proqrarn:   An Estimate                   of Its        Impact      and Cost-
Etfectiveness     (GAO/RCED-89-96,   July 6,                   1989) .
California  Dairy:             Production,        Sales,      and Product        Disposition
lGAO/RCED-88-180FS,             June 15,        1988).
Dairy Termination          Program:   A Perspective                  on Its Participants                  and
Milk Production          (GAO/RCED-88-151,   May 31,                 1988) .
Milk   Marketinq   Orders:             Options      for     Change     (GAO/RCED-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 (GAO/RCED-88-108FS,      Feb. 23, 1988) .
Surplus    Commodities:            Temporary Emerqency Food Assistance
Proqrarn's   Operations           and Continuance  (GAO/RCED-88-11,  Oct.                           19,
Food Inventories:            Inventory Management of Federally   Owned and
Donated Surplus          Foods (GAO/RCED-86-11,  Dec. 3, 1985) .
Overview of the Dairy Surplus   Issue--Policy   Options                                for
Congressional  Consideration  (GAO/RCED-85-132,   Sept.                                18,    1985).
Effects and Administration   of the 1984 Milk                          Diversion          Proqram
(GAO/RCED-85-126,   July 29, 1985) .
Government-Owned          Surplus Dairy Products                Held     in    Inventory
TGAO/RCED-85-43,          Jan. 7, 1985) .
Improved Administration              of Special Surplus   Dairy Product
Distribution  Program             Needed (GAOIRCED-84-58,   Mar. 14, 1984).
SavingswAre         Possible      Throuqh Better            Management of Government-
Owned Dairy         Products      (GAO/CED-82-79,            May 18, 1982) .
Alternatives         to Reduce Dairy            Surpluses      (CED-80-88,         July       21,    1980).