Bailey, Kenneth W.

English

Research Papers in Economics

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               Staff Paper # 375                                       June 2005 
   
 
 
Implications of European Policy Reforms  
on the U.S. Dairy Industry 
  
 
Kenneth Bailey 
Associate Professor of Agricultural Economics 
 
 
 
 
Department of Agricultural Economics and Rural Sociology 
College of Agricultural Sciences 
The Pennsylvania State University 
210-A Armsby Building 
University Park, PA  16802-5600 
 
 
 
 
 
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Implications of European Policy Reforms  
on the U.S. Dairy Industry 
 
 
The U.S. has contended for years now that European Union (EU) agricultural policy is 
inherently unfair and negatively impacts world markets.  This issue was highlighted recently by 
U.S. dairy farmers at the U.S. International Trade Commission hearing (December 2003) on milk 
protein imports.  It was contended that EU casein subsidies and export restitution payments 
provided the EU with an unfair trade advantage that resulted in increased U.S. imports of milk 
protein concentrate (MPC).  This theme was the cornerstone of the U.S. position at the Uruguay 
Round Agreement that created the World Trade Organization (WTO).  The U.S. and other 
countries argued that the Common Agriculture Policy (CAP) adversely affected global market 
prices for dairy products such as butter, cheese, and skim milk powder. 
Since the WTO agreement the U.S. has had its share of expensive agricultural programs.   
The 2002 Farm Bill introduced new income support programs including direct payments and 
counter-cyclical payments for major program crops.  For dairy, the Milk Income Loss Contract 
Program was created.  This program provides targeted counter cyclical payments to small dairy 
farms.  And the dairy price support program continues even though it represents an Amber Box 
policy under the WTO.  Amber Box programs adversely affect markets and are subject to cuts 
under the current WTO negotiation.  In addition, the U.S. used foreign donation programs and 
casein production subsidies in order to reduce excessive stocks of surplus skim milk powder. 
The fact is the EU has made significant reforms to the CAP.  In the case of dairy 
programs, this will mean the EU will be far ahead of the U.S. in the current round of negotiations 
of the WTO, the so-called Doha Round.  These changes and their implications for the U.S. dairy 
industry will be explored below. 
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EU Dairy Programs 
The EU dairy program consists of a production quota for milk, import protection, an 
intervention program that supports the price of skim milk powder and butter, and export refunds 
which are used to market surplus dairy products.   
The milk quota was created in the early 1980s in response to a growing milk supply.  
Each EU country received a quota on milk production and butterfat.  The quota year begins April 
1 and ends March 31 of the following year.  In addition to production quotas, the EU has import 
quotas that limit the volume of dairy products that can enter the EU.  These import quotas are 
mainly country specific and allow a limited amount of imports at relatively low tariffs.  Import 
quotas are also available under the Market Access Agreement of the GATT (non country 
specific). Any quantity over the quota levels faces stiff tariffs that were negotiated in the last 
WTO. 
The EU also has a number of domestic or internal programs designed to support farm 
milk prices.  Domestic support begins with the intervention system. This program was designed 
to provide a safety net for minimum prices of skim milk powder and butter.  Because of growing 
purchases of excess inventory, the EU limited the amount of product that could enter 
intervention as well as the months of the year that product can enter.  Only 109,000 mt of skim 
milk powder and 60,000 mt of butter can enter into the EU intervention program during the 
months March through September (to be reduced annually by 10,000 tons to just 30,000 mt by 
2008).  In addition to the intervention program, the EU has an array of consumption subsidies on 
products such as butter used in pastry and ice cream, and skim milk for calf feed.  The EU also 
has a subsidy on casein production (which will likely face continued reductions in the future). 
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The EU has surprisingly few direct regulations on milk pricing. It can be argued that 
minimum pricing for butter and skim milk powder can indirectly affect all EU prices at the farm, 
processing, and retail levels.  But with the exception of the intervention prices, most prices for 
dairy products in the EU are not regulated and are allowed to “float” with internal market 
conditions.  Thus market prices for products like yogurt and cheese, for example, don’t face 
regulated minimum prices for milk ingredient costs or for wholesale market prices.  As a result, 
farmers are paid a formula price that is based on how their milk company markets their products.  
Each milk company looks at the portfolio of products they sell and estimates what they can 
afford to pay farmers.  Of course these companies must compete with each other for milk 
supplies and the milk quotas available from each producer.  Thus there is no minimum 
manufacturing price or regulated blend price as in the U.S. 
One of the problems with the EU system is that it has created a surplus of butter and skim 
milk powder.  The most pressing problem is excess butterfat production in the EU.  Demand for 
butterfat has declined in the EU due to consumer preferences for low fat products.  The EU has 
used export subsidies to direct surpluses onto the world market.  They use an export refund 
system to bridge the gap between high internal prices and lower world market prices.  This 
created much discord during the Uruguay Round because export subsidies act to depress world 
market prices and made them more volatile. 
 
CAP Reform 
The dairy portion of the CAP cost roughly $2 billion euros in 2003.  Due to decoupling 
the overall cost of the dairy portion of the CAP will fall to $1 billion euros.  But major reforms in 
the EU are underway to reduce the cost of the CAP even further.  While it appears that the EU is 
mending its ways with regard to trade distorting policies, there are a number of logical factors   5
that are forcing the EU to make significant reforms to the CAP.  First, agriculture today 
contributes very little to EU employment.  That of course wasn’t the case after World War II 
when agricultural employment was important.  Second, the cost of the CAP has become 
burdensome, particularly since 10 new countries have now joined the EU.  These new countries, 
all in Eastern Europe, are expected to be net recipients of CAP payments which will further 
create a budget crisis.  And finally, the EU is attempting to better position itself in the current 
WTO round.  Their strategy is to make major reforms on export refunds and domestic spending.  
In this way they may hope to avoid major concessions on import protection issues (called market 
access) since they are obviously having less adverse effects on global markets.  It is in effect a 
well thought out strategy. 
The EU has already phased in major reductions in both the amount of product that can 
enter the intervention system and the intervention prices themselves (see Table 1).  This is 
intended to directly lower internal market prices for all dairy products.  It is shocking to think 
that lower internal prices for dairy products has now become a major goal of CAP reform.  
Casein production subsidies will also likely be phased out over time.  These subsidies were 
$1500 per mt just a few years ago and are now $450 per mt.  And the EU has agreed in the WTO 
negotiations to eventually eliminate all export refunds.  If domestic prices for dairy products 
declines there will be less need for export refunds.   
These changes will cause economic hardships for EU dairy farmers.  EU politicians have 
made the decision to create new direct payments to help offset some of the price reductions.  
These payments are decoupled and linked to environmental programs.  That means they are 
outside Amber Box spending programs and have no direct relation to the level of milk 
production.  In addition, these new payments will be off the EU books and placed on individual 
national budgets.  Thus this strategy will likely be viewed positively in the current WTO   6
negotiations.  Estimates are that for the current year these direct payments will only offset 55 
percent of the reduction in EU farm milk prices.  In addition, under these changes, the cost of EU 
dairy programs will actually grow from $1-$2 billion euros a year to $6 billion euros.  While it 
will cost EU taxpayers more, the nature of the payments will be more amenable to WTO 
watchers.   
 
Implications of CAP Reform 
There are a number of implications of CAP reform: 
•  Domestic EU prices for dairy products will fall 
•  EU processors will focus more on value-added processing in order to offset lower market 
prices 
•  EU dairy farmers will become fewer and larger over time 
•  The EU dairy industry will become more globally efficient  
•  Exports of surplus dairy products will disappear, creating less EU presence in global 
markets 
EU CAP reform is startling in its degree of change.  Market prices will be lower, there will be 
fewer dairy farmers, and export refunds and production subsidies will disappear.  The EU will be 
in an excellent position to argue in the current WTO that they are making real commitments 
towards lower spending on domestic programs and export subsidies.  They will use this 
argument effectively to avoid major commitments to increasing EU market access.  Currently the 
EU has greater import protection than does the U.S. when it comes to dairy products.   
While the EU has taken an aggressive well thought out strategy towards the WTO, the 
U.S. dairy industry in contrast is completely unprepared.  The MILC payment program and the 
price support program are clearly areas where the U.S. will likely have to make significant   7
reductions in the WTO since these programs represent Amber Box spending.  The U.S. may 
trade off the MILC payment program in the upcoming Farm Bill because of budget pressures and 
because it is controversial among dairy producers.  But the U.S. dairy industry is committed to 
continuing the price support program and is even discussing production subsidies for the 
production of dried milk proteins (including casein and milk protein concentrates).   
In addition to these programs, the U.S. is being criticized for the use of expanded export 
subsidy programs.  The U.S. government used foreign donation programs in order to remove 
surplus skim milk production from storage under the dairy price support program and export 
these products abroad.  These “free” exports likely competed with commercial sales from 
countries like New Zealand who rely on unsubsidized exports.  In addition, the USDA has 
accepted some limited offers to sell surplus skim milk powder to domestic U.S. processors 
willing to produce casein.  This clearly represents a production subsidy since the purchase price 
is lower than the domestic market price of skim milk. 
 
Conclusions     
It is likely that the U.S. dairy industry will face significant criticism and will have major 
changes forced upon her if an agreement is reached in the Doha Round.  The EU has already 
made significant market reforms and will be viewed favorably as a leader of market reform.  
Since implementation of the Uruguay Round the U.S. has only increased spending on 
agricultural programs and has made no efforts to reform or phase out the dairy price support 
program.  Unless some significant reforms are made in the upcoming Farm Bill, the U.S. dairy 
industry may find itself outmaneuvered by the EU on issues of domestic market reform and 
elimination of export refunds. 
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Table 1.  Proposed Reductions in the European Union Dairy Intervention Program 
 
 
Marketing 
Year 
 
Skim Milk Powder 
 
Butter 
  % drop in price  MT  % drop in price  MT 
    
2004 -5  109,000  -7  60,000 
2005 -5  109,000  -7  50,000 
2006 -5  109,000  -7  40,000 
2007 0  109,000  -4  30,000 
 
 

IMPLICATIONS OF EUROPEAN POLICY REFORMS ON THE U.S. DAIRY INDUSTRY

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