Recently there has been much media buzz about “free trade agreements.” Free trade agreements cover many products, but this article will focus on dairy products. Certainly these free trade agreements will impact U.S. dairy pricing, and this article will review some of the factors and trends that free trade agreements are influencing.
The North American Free Trade Agreement (NAFTA) is an old trade agreement, and in 2012, new trade agreements were finalized with South Korea, Panama and Columbia. From 2010 through 2014, U.S. dairy exports expanded significantly, and with this new demand, producer milk prices were generally very good. During 2015 and 2016, exports tumbled and milk prices tumbled as well.
Many additional trade agreements are under consideration. There is no doubt that free trade agreements will increase volatility in milk prices and bring new competitive pressures. Competition will likely bring lower consumer prices, but they will also bring pressure on producer prices. In addition to all the domestic factors that can impact prices, international factors also now impact prices. New free trade agreements will accelerate these trends.
While trade agreements can expand exports as they did for dairy products in the early part of this decade, they can also decrease exports and increase imports. For the American consumer, they provide more low-cost buying opportunities. However, for U.S. producers, they can provide a strong price-competitive environment with demand volatility.
As an example, when China reduces imports of dairy products from New Zealand, New Zealand must find a new home for these products. When Russia bans imports of European dairy products, European producers must find a new home for these products. Finding a new home typically means reducing prices to gain new markets. With more free trade agreements, these actions can happen faster.
The U.S. has 14 trade agreements in place today, which cover 20 different countries. There are nearly another 20 free trade agreements in negotiations. Two of the most discussed agreements under negotiation are the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP).
The details of these are still in negotiation, but they are major in terms of potential impact. The TPP includes Canada and Japan, both of which currently have high import tariffs on dairy products.
Turning the calendar back, dairy was always geographically contained in a local area. Production, processing, marketing and sales were restricted. This was necessary because the majority of the market was fluid milk, and transportation of a product that is 87 percent water was costly. The short shelf life of fluid milk also limited geographical boundaries and the need for refrigeration further complicated logistics.
Over time, the geographical limitations were overcome and markets developed in new ways. Technology improved shelf life and shelf-stable products were developed. Tastes changed and low-water dairy products became the market leaders. Improved logistics reduced transportation costs.
Today, it is possible to use milk from any location and convert it to products that can be economically shipped anywhere in the world. Trade agreements have further lowered barriers to international shipments.
Trade agreements are not a new thing, but they are bringing new dynamics to the dairy industry. NAFTA was one of the first agreements to impact the U.S. dairy business. In 1990, over a quarter of a century ago, negotiations began with Mexico and the U.S. on an open trade agreement. It was signed in 1992.
Since then, the export of dairy products from the U.S. to Mexico has expanded tremendously. But the flow is now in two directions. Almost as much butter is imported from Mexico to the U.S. as is exported from the U.S. to Mexico.
By the terms of the trade agreement, Mexico cannot pass through imports from another country to the U.S., but they can use low-cost imports to fill their domestic demand while exporting domestically produced dairy products. Initially, when the trade agreements were executed, the Mexican dairy industry was far behind the U.S. dairy industry.
However, by 2015, major dairy companies were emerging in Mexico. As an example, the Mexican dairy company LALA bought Borden, a major U.S. dairy brand, and National Dairy from DFA. With the acquisition of these U.S. companies, LALA has expertise and roots in both Mexico and the U.S.
While Canada is included in NAFTA, they have excluded their dairy operations except for a few high-protein niche items. Canada has a closed dairy system, which protects its producers and keeps producer prices very high. But this also leaves them with inefficiencies that do not allow them to compete in the global arena. With those limitations, Canada could not entertain free trade agreements for dairy products.
As mentioned above, the TTIP agreement could possibly change Canada’s dairy exclusion. If TTIP is signed into being, and Canada’s dairy industry is not excluded, the change would be very difficult for producers. Changes of this magnitude are usually carried out in increments over 10 to 15 years.
The umbrella organization for trade agreements is the World Trade Organization (WTO). The WTO has its headquarters in Geneva, Switzerland, and the U.S. is a member.
Most all trade agreements are negotiated, formed and revised within the WTO framework. As with any large international organization, parties will try to find ways to bring favor to their country’s interests.
As an example, exports of certain U.S. dairy products can be blocked from Europe for many reasons. For instance, Europe uses a process for limiting the maximum somatic cell count (SCC) allowed in milk that is different from the U.S. process. Europe uses a system that is analytically stricter than the U.S. standard, but the enforcement method is more forgiving.
However, the difference can be used as a tool to limit U.S. imports of dairy products into Europe and the many other countries that have adapted the European system. Should the same logic be used to limit imports of European dairy products into the U.S.? Should the U.S. standard be revised to match the European standard?
Another example is the difference between non-fat dry milk (NDM) and skimmed milk powder (SMP). In reality, these products are identical, but the standards for SMP require a minimum protein level to be labeled as SMP. SMP is the European standard and other countries generally accept that standard. Issues of this nature are the basis for extensive negotiations on trade agreements.
A part of trade agreements include standards to protect the quality of incoming products. In the dairy arena, this includes requirements for health, safety, environmental analysis and product standards. The receiving country can reject any products that do not meet the “current standards” of that country.
Now back to the real question. How do free trade agreements impact U.S. dairy pricing? Through 2014, free trade agreements significantly improved exports and with increased demand, producer prices surged. Beginning in 2015 and continuing through 2016, exports plunged and so have producer prices.
Competing in a world with multiple free trade agreements increases the competitive environment. Many countries have competitive advantages. New Zealand has a very low-cost forage system for milk production. Mexico has a lower labor cost structure. Many countries have more lenient environmental standards and animal rights standards.
Many countries have government polices of financial support for developing industries. And, very importantly, exchange rates constantly vary and create a constantly changing competitive structure. Increased competition typically brings lower prices.
The above illustrates the difficulty of competing in the dairy business in a world of free trade agreements. Pricing volatility will be a major factor. Maintaining a competitive low cost structure is essential, but that cannot always make up for some of the factors mentioned above. With increased competition, long-term lower prices are likely.
Properly negotiated trade agreements are very important, and the dairy industry must have significant participation in these negotiations. While significant participation is necessary, there will be a cost for the dairy industry. Counting on government participation to represent the dairy industry will not be sufficient. There will also be a cost for the dairy industry to keep the playing field level as other countries try to define and interpret rules to their advantage.
Trade agreements may be good for consumers as lower cost opportunities occur. However, the U.S. dairy industry will have to work hard to make sure the international playing field remains fair and will need to continue to improve productivity while lowering costs. PD
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John Geuss
- John Geuss Consulting
- Email John Geuss
