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The US-Canada fight over NAFTA and dairy exposes an inconvenient truth about free markets


The bizarre US-Canada dairy trade spat is about way more than just milk.

As black markets go, Canada has a pretty weird one. Every so often, authorities bust “cheese barons” and “mozzarella mafias”—smugglers bent on turning a profit on bricks of cheap foreign cheese.

Other Canadian behaviors concerning dairy are legal, but just as strange. Around Christmas every year, Newfoundlanders are known to hoard something called Fussell’s Thick Cream, an obscure imported tinned cream traditionally slapped atop pies and into cherry cake batter. And let’s not forget the great butter panic of winter 2015, when the Canadian government authorized the importing of nearly 8.8 million pounds of “emergency” foreign butter. In the frenzy of yuletide baking, Canadians had simply eaten the domestic supply up.

These are some of the many downsides of a regulatory system in which the government tightly controls an industry. The Canadian government limits the amount of dairy that farmers produce, sets the prices, and blocks most imports. There’s a big upside to Canada’s cow-based command economy, however: The stable dairy prices keep the industry consistently profitable and allow small farmers to thrive.

America does things differently. Whereas Canada limits supply, the US encourages a bounty of dairy. It’s a land of milky excess: fried butter balls, $0.99 milkshakes, four-cheese pizzas, and iced mocha Frappuccinos. A place where the people of certain Midwestern states competitively sculpt butter. Though US consumers clearly relish dairy, for farmers and processors, the dairy surplus has its drawbacks. For instance, right now, the US makes so much milk that farmers have poured forth lakes of the unwanted stuff (paywall). Bankruptcies—and increasingly, suicides—among dairy farmers are on the rise.

These vastly different systems existed alongside each other in relative harmony for decades. Until recently, that is. Since taking office, Donald Trump has fanned the issue of dairy—and trade with Canada more broadly—into a 10-alarm firestorm.

In June, the US slapped import tariffs on Canadian steel and aluminum, in part in retaliation against Canada’s super-high dairy tariffs, which on average are around 250%. Canada responded by hiking tariffs on $3 million worth of American yogurt. Now Trump is threatening to leave Canada out of a new NAFTA deal with Mexico. Dairy is one of the main contentious trade issues that now threaten to break down North America’s most strategically and economically important alliance, with the White House positioning it as a sticking point for any potential deal.

But the bizarre US-Canada dairy trade spat is about way more than just milk. The dispute reveals the defining conflict of this new era—the role of governments, markets, and free-trade agreements in creating thriving societies.

The world order built on pushing free trade NAFTA, the WTO, and other transnational institutions pushed globalization too far. A backlash is underway, evident in populist upsurges like Trump’s victory and Brexit.

Nation-states are filling the void as they claw back authority from global organizations. The question is what form the restoring of national sovereignty will take. Can countries wrest back control of their economic policies while preserving the mutually beneficial elements of open markets? Or will this impulse give way to corrosive nationalism that wields trade threats like a cudgel?

The answers will determine global prosperity for generations. And so far, what can be divined from the great North American milk fight offers some ominous clues to that outcome.

The age of hyperglobalization

A useful framework for thinking about trade’s connection to national economies comes from the work of Dani Rodrik, an economist at Harvard University. The current global trade regime, established just after World War II, ushered in an unprecedented spread of prosperity across the planet, evident in brisk global GDP growth and surging stock markets. But globalization took a bad turn in the 1990s, argues Rodrik—morphing into what he calls “hyperglobalization.”

The turning point, according to Rodrik, came as international pacts and the creation of the WTO prioritized the free flow of trade and investment over individual countries’ domestic policies. This has made it harder for governments to pass policies to support domestic social contracts that might impinge on the access of multinational companies to its consumers. At the same time, the ideology that free trade was the ticket to prosperity encouraged leaders to shirk social contracts altogether, leaving it to corporate largesse and the cheapening of consumer goods improve their citizens’ wellbeing.

The nationalist backlash

Eventually, something had to give. As Rodrik sees it, the rise of nationalism signified by the election of Donald Trump in the US and Brexit in the UK is just that.

“What’s been dangerous in the past is we’ve pursued a narrative where the nation-state is irrelevant, and that essentially helped the winners of hyperglobalization to disengage from local and domestic stakeholders,” says Rodrik. “And the populist reaction is very much a reflection of that.”

The recent populist convulsions in the US and Europe push back against the mistaken assumptions that underlay the embrace of globalization: that the best way to organize an economy is around markets freed from government intervention.

This doctrine is frequently attributed to Scottish economist Adam Smith, one of the forefathers of modern economic thought. In his magisterial tome written in 1776, Wealth of Nations, Smith explained that each businessman was “led by an invisible hand to promote an end which was no part of his intentions.” Smith’s now-famous invisible hand promoted social good by spreading wealth, he argued.

“By pursuing his own interest, [the businessman] frequently promotes that of the society more effectually than when he really intends to promote it,” wrote Smith. “I have never known much good done by those who affected to trade for the public good.”

 
Adam Smith, c/o Library of Congress

According to Smith, markets aggregate the behavior of individuals—specifically, what price consumers are willing to pay for goods and services, and what amount producers are willing to supply in exchange—into one big, pulsing mechanism that spits out prices. That information spurs businesses focus on making what people want, bringing markets into equilibrium in which supply equals demand. Following these cues discourages waste in a way that government planning simply can’t.

Smith nonetheless cited plenty of exceptions about when governments should regulate markets, as renowned Canadian economist Jacob Viner pointed out in a 1928 essay (paywall). But starting in the 1960s, Smith’s theories had calcified into an ideology that damned state intervention of any sort. According to this doctrine, free markets were supremely efficient at allocating resources, while government intervention encourages waste. In the business of improving people’s lives, markets and national governments were implicitly at odds with each other. And since “harmonizing” laws and regulations among countries curb the power of national governments, it stood to reason too that the deeper the globalization, the better off humanity would be.

That’s the seldom-dissected logic behind the free-market legal regime that governs much of global trade. In practice, however, market failure is a frequent problem—take, for example, the 2008 global financial crisis, or the pollution that has given rise to climate change.

As it happens, markets for dairy fail us constantly—and in particularly spectacular ways.

The udder and the invisible hand

To nourish calves, Nature created milk. To delight his palate, man created milk products. Fresh burrata, Greek yogurt, salted caramel gelato, crème fraiche, cappuccino foam—hardly any of our dairy indulgences of today are in the same form that flows from the udder. Instead, our beloved dairy products come from a concentration of one or the other of milk’s basic components—protein and fat.

Condensing milk protein to make, say, skim milk in school lunches or Starbucks’ Cold Foam creates extra fat as a byproduct. Conversely, when dairy processors concentrate fat to make butter, ice cream, and other creamy delicacies, protein is left over. So to produce more fat, a farmer also must make more protein, and vice versa.

The invisible hand can squeeze the udder, but it’s still milk that fills the pail.

Now, in a free market, the law of supply and demand sets prices—the all-powerful nugget of information that tells businesses how much of a good to make. This mechanism ensures that they don’t hurt consumers by producing too little, or creating too much of the good to sell, driving them out of business.

But even in a totally free and open dairy market, farmers only have so much say in the amount of milk fat and protein they produce. The rest comes down to bovine biology. After all, the invisible hand can squeeze the udder, but it’s still milk—in a fairly set ratio of fat to protein—that fills the pail.

If consumer demand mirrored the same ratio of fat and protein that flows out of the cow as milk, the market might work as planned. Unfortunately for farmers, however, when the public demands dairy products that are high in protein, they tend to steer very clear of ones that are high in fat—and vice versa.

From pro-fat to low-fat and back again

Consider the extremes the US has boomeranged between in the last 70 or so years.

Back in the 1940s, the New York Times observed that skim milk had “little commercial value” due to its unpopularity. This, after all, was the heyday of Julia Child, whose recipes called for globs of butter and cream.

Then dawned the Lipitor era.

Since the 1950s, doctors had been recommending low-fat diets for patients at risk of heart attacks. Then in 1977, that push went mainstream. The US federal government issued its first-ever dietary guidelines (pdf) urging people to “substitute non-fat milk for whole milk” and “decrease consumption of butterfat.” And lo’, the low-fat industrial complex was born. Skim milk abounded. Low-fat frozen yogurt took off. Cool Whip replaced whipped cream. Butter was elbowed aside by margarines like Country Crock and Parkay (“The label says Parkay, the flavor says butter”). This sharp swivel in demand tilted the worth of milk’s component parts. Protein’s value rose. Butterfat was passé—and therefore, relatively cheap.

In the late 1990s, the tide began turning once again. By the early 2000s, low-carb mania popularized by the Atkins and South Beach diets chipping steadily away at the low-fat obsession, according to Ann La Berge, a scholar of public health history, in a 2008 article in the Journal of the History of Medicine and Allied Sciences. That coincided with a growing chorus of scientific researchers whose findings challenged the notion that milk fat was intrinsically unhealthy, says Mike Von Massow, economics professor at the University of Guelph—as well as with the ascendancy of butter-loving cultural forces.

“With the rise of the celebrity chef and the Food Network and other [TV shows], everyone began recognizing that food tastes better when you cook with butter,” says Von Massow. “People have historically liked butter because, let’s face it: butter tastes good. So when science began saying it was good for you, people started eating more.”

Suddenly, whole milk appeared alongside skim in coffee shops, cheese plates populated menus, yogurt went full-fat, and Paula Deen urged the masses to deep-fry cheesecakes.

All the while, a steady drop in US liquid milk demand underway since the 1970s continued.

What happened as a result illustrates why the dairy industry defies the free-market faithful—and is almost always ruinously out of whack.

Land o’ milk lakes

In the decade or so since butterfat’s triumphal, farmers in the US and other dairy powerhouse countries reacted to surging consumer demand for butterfat exactly the way economic textbooks might predict: they cranked up milk production. But again, meeting consumer demand for more fat necessarily means making more protein too—it’s a cow’s package deal. That’s created a glut of skim milk that no one wants.

This classic boom-and-bust cycle has buffeted dairy farmers for the last century or so. It starts with a sudden jump in demand that spurs industry-wide investment to boost milk output. Within a few years, a glut follows. Prices crash. Farmers go out of business or dramatically cut output to cover production costs. Soon they’re producing too little milk to meet demand, forcing consumers to pay exorbitant prices or go without this crucial source of nutrition.

And as has often been the case in the last century or so, global trade has amplified the swings between scarcity and excess.

The dairy industry defies the free-market faithful—and is almost always ruinously out of whack.

In 2008, deliberately adulterated infant formula killed six children in China and sickened more than 300,000. By 2013, steadily rising wages and fears about the safety of dairy products—in particular, domestic baby formula—converged in a Chinese buying frenzy of foreign milk products (which were presumed to be safely produced). China Customs reported legal imports of 120,000 tonnes of baby formula in 2014, up from just 40,000 in 2008. To capitalize on the rising prices stoked by that demand, American farmers invested on expanding their output.

Then, suddenly, prices reversed course. In the last couple years, an unfortunate sequence of global events collided with the US’s increased capacity, leaving the world awash in unwanted milk. In 2014, Russia invaded Ukraine, prompting Western sanctions. In retaliation, president Vladimir Putin banned US and European Union dairy.

By mid-2015, Russia was cracking down on smuggling rings sneaking in Western cheese, complete with the propagandist flourish of a nationally televised bulldozing of black-market cheese. On top of that, in 2015, the European Union officially ended its milk quota system. That’s left European farmers adding to the excess milk sloshing around the world dairy market.

American consumption trends—notably, the fading of the Greek yogurt mania and the almond milk craze—aren’t helping offset these supply woes.

The resulting glut crushed US prices. The farm-gate price for raw milk has plunged nearly 40% since its April 2014 peak.

Farmers are now producing vast reservoirs of skim milk with no one to drink it. A rash of bankruptcies have swept rural communities in Wisconsin and elsewhere in the US. Three members of Agri-Mark, a US dairy cooperative with around 1,000 members, killed themselves in the last three years, reports Harvest Public Media. Now the collective includes a list of suicide hotlines in the market forecasts it sends to members.

The outlook isn’t any rosier. While global dairy demand is growing at a rate of about 1.5% annually, milk production in the US, EU, New Zealand, Australia, and Argentina has been rising at about twice that rate.

Boosting demand—or limiting supply?

Governments, too, are notorious for causing market failures—and that certainly the case for the dairy industry. Throughout most of the last century and well into the current one, governments of nearly every major dairy producing nation have tried to insulate farmers from brutal price swings. Mostly they’ve done that by offering them subsidies, price supports, and buying programs—essentially, creating a price floor by boosting demand.

Ironically, though, this state protection spurred global trade, according to Bruce Muirhead, history professor at the University of Waterloo, in his 2014 analysis of dairy history (pdf), since export markets were inevitable outlets for the chronic overproduction that subsidies encouraged.

The cost of these policies has mostly proven unsustainably expensive for taxpayers, spurring governments to cut back dairy supports. But in times of price collapse, governments often roll out emergency aid.

“It has been death by a thousand cuts for Wisconsin family-scale dairy farms over the past few decades.”

Take, for instance, the cheese-buying initiative and other programs the US government has launched in the last couple years to save farmers hit by slumping prices. As of last year, authorities had 800 million pounds of American cheese languishing in reserves, more than any time since 1984, reported the WSJ (paywall). Meanwhile, the 272 million pounds of butter bought by the federal government is the biggest since 1994.

By artificially boosting demand, these policies have invited farms to expand production, leading to savage price wars ever decade or so. Unable to exploit scale, small farmers struggled to compete, says Mark Kastel, head of The Cornucopia Institute, a farming watchdog group.

“It has been death by a thousand cuts for Wisconsin family-scale dairy farms over the past few decades,” Kastel told the Milwaukee Journal Sentinel last year. “An unfair and uneven playing field has allowed factory farms to muscle out” smaller operations. Yet Wisconsin farms continue to pump out more milk than ever.

This is a pattern across the US. Back in 1999, farms with 2,000 or more cows produced just under a tenth of US milk output; by 2009, the last year for which there are data, that share had ballooned to more than 30%.

Conversely, in 1999, the two-thirds share of US milk that came from smaller farms—those with fewer than 500 cows—had slipped to just 41% a decade later, according to USDA data (pdfs).

Canada used to struggle with costly subsidies and chronic oversupply too. Now it doesn’t. In the 1970s, its politicians and dairy industry leaders took a wholly different tack. Instead of creating demand, they limited supply.

Canada’s controversial—but highly effective—system

To attack the dairy industry’s chronic instability and overproduction, in the early 1970s, Canada established a comprehensive nationwide system to set dairy prices and limits farmers’ output. Known as “supply management,” this is the system stoking controversy today. In addition to production quotas and price controls, those 270% tariffs that so enrage Trump are the crucial third element of that system. Canada allows only a small volume of duty-free imports, walling off the rest of its market behind those ultra-high tariffs. It has to; without a way to shield Canadian farmers from foreign competition, the guarantee of relatively high, stable prices for farmers would break down.

Of course, one obvious downside of this system is that consumers, not taxpayers, pay the premium required to keep the dairy market stable. Canada also periodically runs out of certain types of cheese. And of late, residents have faced the aforementioned butter panics during the holiday season, inviting outraged analogies to Soviet breadlines. Limiting supply also inevitably creates a cartel-like industry structure in which high barriers to entry keep would-be dairy farmers from getting into the industry. (This might help explain a burgeoning interest in goats among younger Canadian farmers.)

Canadians don’t seem that upset about the downsides, though. As of April 2018, three in four Canadians thought their government should defend their dairy system in the face of US pressure in NAFTA renegotiations. This probably has something to do with what they gain as a result of their milky sacrifices.

Canadian farmers—and, therefore, rural communities—have far less to fear from the market’s violent whims. They might not get the upside of good times. But they also don’t get bashed anywhere near as hard by the bad times. Canadian farmers earn a higher price, on average, than those in the US do. In 2016, they pocketed around 60% more per liter of milk, reports the Guardian.

This has helped smaller farmers stay afloat. While small family farms in America have mostly folded, in Canada, many are still around. For instance, while there are more and more dairy farms of more than 10,000 cows in the US, in Canada, they don’t exist, Maurice Doyon, an economist at Quebec’s Laval University, told NPR last year.

America’s open market and Canada’s virtual autarky work well enough in parallel. When they interact, though, there’s trouble. And the reason they’ve been interacting is that unforeseen consequences of NAFTA are corroding Canada’s supply management system—and with it, in a sense, Canada’s sovereignty.

The sneaky NAFTA loophole

Canada’s dairy supply management system was spared in the NAFTA negotiations. Under its obligations to NAFTA and the WTO, it was still allowed to protect its dairy market from most imports. In return, Canada agreed to export very few dairy products. (For what it’s worth, NAFTA also exempted a slew of US agricultural products (pdf, p.6)—including dairy.)

But the high walls Canada built to shield its system can only protect dairy commodities carved out in NAFTA—and not products developed after NAFTA went into effect in 1994.

A few years later, dairy processors perfected a new way of separating and concentrating milk proteins retained in the process of extracting milk fat to make creamy dairy delicacies like yogurt, ice cream and, of course, butter. Known in the industry as “milk protein concentrates,” the protein-dense gunk had a use: it presented a cheaper, more efficient ingredient in making cheese than the usual procedure, which required processors to buy—and transport—liquid milk and then skim out the necessary proteins themselves.

This post-NAFTA development meant milk protein concentrates had be traded duty-free among the North American signatories. By importing the substance from US processors, Canadian cheesemakers could make cheese much more profitably than if they had to buy higher-priced proteins or heavy raw milk domestically.

So for the last decade or so, American dairy processors have profited from near-exclusive access to Canada’s market for this otherwise insignificant butterfat byproduct. Shut out of the domestic market for protein products, Canadian farmers began dumping skim milk in 2015.

For US dairy processors, the timing couldn’t have been better. As surging milk output in response to rising demand for butter has left the world awash in unwanted milk protein, they could count on Canadian cheesemakers as a captive outlet for their dairy excess. Driven by this niche trade, America’s dairy trade deficit exploded, more than doubling between 2006 and 2014.

Until, that is, last year.

The US case against Canada’s sovereignty

In 2017, Canada’s government-backed dairy agency slashed the price of milk protein concentrate to encourage domestic cheesemakers to buy the stuff locally. At the same time, the agency boosted milk production quotas to meet consumer demand for butterfat.

No longer able to compete on price, US dairy processors lost out. A handful of processors in Wisconsin and New York that had thrived in recent years on sales to Canadian cheesemakers dissolved milk-buying contracts with local farmers, some of whom had expanded their farms to meet booming demand from their northern neighbor.

Due to inconsistent use of trade codes, it’s hard to say how much it cost the US. US government researchers estimated that around $100 million in American exports was at risk (pdf), while an industry group put the figure closer to $150 million (paywall). Indeed, Canadian imports of US milk protein concentrates have since nosedived, according to Canada’s official data—falling by more than half between 2016 and 2017.

At the same time, Canadian processors turned the tables on the US and began exploiting the NAFTA loophole, exporting milk protein products abroad, mainly to Mexico and Egypt—undercutting US exporters at a time when milk protein is already devastatingly cheap. This may well count as dumping—that is, selling a good abroad at a lower price than you charge at home.

So is Canada in the wrong? Trump obviously thinks so. “What they’ve done to our dairy farm workers is a disgrace,” he said in April 2017. He added:

“I spent time with some of the farmers in Wisconsin, and, as you know, rules, regulations, different things have changed. And our farmers in Wisconsin and New York State are being put out of business, our dairy farmers…. The fact is, NAFTA—whether it’s Mexico or Canada—is a disaster for our country. It’s a disaster. It’s a trading disaster…. We can’t let Canada or anybody else take advantage and do what they did to our workers and to our farmers.”

Andrew Novakovic, professor of agricultural economics at Cornell University, disagrees. The pressure US officials are putting on Canada to dismantle their supply management system is a “challenge to their sovereignty,” he says. Trump’s pushback on Canada’s dairy tariffs “puts us in the position of telling them what their domestic policies should be, not just their trade policies.”

The debate over dairy and NAFTA is also about how the US and Canada should respect each other as nation-states.

His argument echoes Rodrik’s broader critique of hyperglobalization—that prioritizing free trade as an end unto itself can undermine the authority of democratic governments to fulfill their own social contracts. US leaders’ blazing anti-Canada rhetoric also distracts the American public from their failure to create domestic policies that might foster a more sustainable dairy industry.

And so the debate over dairy and NAFTA isn’t simply about the rules that govern the US-Canada trade. It’s also about how the US and Canada should respect each other as nation-states. Does democracy claim primacy in setting domestic economic policy, as Canada’s position implies? Or does precedent go to the regime of deep integration of national markets? It cuts to deep confusion among the American public and its leaders—and, for that matter, those of many other Western countries—about the role of trade in a nation’s economic strategy, and deeper still, about whom that economic strategy is built to serve.

A fork in the road for reviving nation-states

With the backlash against globalization finally underway, it seems there are two ways this disagreement of political philosophy could shake out.

We could see an orderly retreat from aggressive integration of trade and financial regimes. As they negotiate new ground rules for international trade and finance, nation-states can reclaim authority over domestic policy while respecting each other’s democratic will. Americans can make their country great again with stable, responsive domestic economic policies; Canadians can keep doing so, too. As a result, trade and finance transaction costs might be a tad pricier than in the past. This would presumably be a cost worth bearing if those systems let democracy thrive again.

This approach should be a no-brainer for the man who swept into the White House on a sea of “Make America Great Again” hats. Indeed, Trump’s rise is Exhibit A in the backlash against hyperglobalization.

It’s therefore highly weird that, in the US-Canada dairy dispute, the president is effectively arguing in favor of hyperglobalization. By condemning Canada’s domestic policies and strong-arming its neighbor into buying US dairy exports, Trump is endorsing the mercantilist practices and pro-corporate world trade regime that he railed against so relentlessly on the campaign trail.

This brings us to the much scarier alternative path of globalization’s unraveling—one in which international relations devolve into a push and pull of nationalistic agendas, with trade a source of mercantilist enrichment.

Which will it be? Trump’s confusing position on Canada’s dairy policy is an ominous hint to that answer. As he excoriates Canada for its domestic policies, he’s articulated no domestic plan of his own for building a stabler dairy industry—let alone, for rewriting America’s long-lapsed social contract.

Indeed, Trump’s incoherence suggests no vision at all for an alternative way of structuring world trade. His anti-Canada rants offer no guiding principles on how countries should cooperate on trade. They center not on fairness, but on the politics of personal slight.

The US-Canada dairy face-off makes increasingly clear the disquieting possibility that Trump’s vision of world order is a lens through which only grievance is refracted—and trade policy, in turn, a tool for exacting payback for those perceived national insults. If tariff grudge matches and scrapping of trade agreements become badges of nationalist honor, Trump could easily drag the world down with him into a mercantilist vortex. America First, at the expense of everyone else—and ultimately, at the expense of Americans too.

Source: qz.com


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