A Regional Economic Analysis of Dairy Compacts:
Implications for Missouri Dairy Producers

The purpose of this study was to examine the economic impact of Missouri joining a Southern dairy compact. Since Missouri cannot form her own compact and since compacts affect national supply and demand for dairy commodities, a national perspective was taken in this analysis. Thus the economics of dairy compacts on individual federal orders, on select states and on the total United States was evaluated.

The results of this study show economic tradeoffs. If a dairy compact is imposed on a region of the United States, dairy producers in the region will receive higher farm-gate milk prices depending on the level of the compact price and resulting premium.

In this study, a $2 compact premium was used. Thus, if Missouri were to join a Southern Dairy Compact and the Mid-Atlantic and Northeast states were to also have a compact, farm prices in these regions would rise. If the compact commissions in these regions imposed a compact price which resulted in an effective $2 compact premium (the difference between the compact price and the Class 1 price in each federal order), and market over-order premiums in these regions were maintained, then the farm-gate milk price would rise $0.97 per cwt in the Southeast order and $0.88 per cwt in Missouri.

Such a compact would result in higher effective farm prices for federal orders within compact regions. Those orders with higher percent Class 1 use will get a greater response in terms of higher effective farm prices due to the Compact(s).

• Northeast order: up $0.54 per cwt
• Appalachain order up $1.13 per cwt
• Florida order up $1.11 per cwt

The benefits of dairy compacts to farm milk prices and sales in select compact states can be illustrated below in Table 6.1.

Table 6.1 Farm Impacts of a Northern, Mid-Atlantic and Southern Dairy Compact on Select States using a $2 per cwt Compact Premium

Source: Appendix Table 2.

The effectiveness of a dairy compact in raising farm-gate milk prices in compact states depends on three factors: 1) the size of the compact premium, 2) the percent Class 1 sales in the market and 3) changes in national class prices. Thus, farmers in Southeast states where Class 1 sales are up to 90 percent of milk marketings will benefit more from a compact premium than say farmers in New England where Class 1 sales are just 50 percent of marketings. Also, the more states that form compacts, the more milk will be marketed and the more dairy commodity production will be increased. This will depress national dairy commodity prices and will lower national class prices (i.e. the Class 1 price mover). Thus compact premiums will be offset to some extent by lower class prices.

These concepts are illustrated in Table 6.1. Take the case of New York. Class 1 sales in New York are about 42.8 percent. Thus, at the most, a $2 compact premium on Class 1 milk sales will translate into an average $0.86 cents per cwt. Under the compact scenario, Class 1 sales falls to 41.5 percent of milk marketings. Thus the $2 compact premium falls to just $0.83 per cwt. The Class 1 mover falls $0.23 per cwt nationally due to the compact. And, assume that the cost of administering the compact is roughly $0.10 per cwt. Thus a $2 compact premium is now $1.67 per cwt ($2 - $0.10 - $0.23). Apply that to all milk sales and the benefit of the $2 compact price falls to $0.69. Include lower class prices for Class 2, 3 and 4 milk and it is obvious why the effective farm price in New York only rises $0.54 per cwt.

Thus one economic conclusion regarding dairy compacts can be reached: farmers in the compact region will receive a higher effective milk price.

Dairy compacts raise the farm-level price of milk for dairy producers in compact states. Dairy compacts, however, also have other affects in compact states. This study concludes that a compact premium on fluid milk sales raises the cost of milk to fluid milk processors. Those costs are then passed on to retailers and ultimately to consumers.²¹ Higher retail milk prices reduces fluid milk consumption and raises retail fluid milk expenditures in compact states. Thus retail consumers bear a substantial portion of the higher farm milk sales generated by the compact. In addition, based on the assumption of a fixed dollar farm-to-retail mark up, processors and retailers also bear some of the cost of a compact by facing a reduced mark up on a percentage basis and lower fluid milk sales.

To illustrate these concepts, state-level impacts for select compact states under a combined Northern, Mid-Atlantic and Southeast Dairy Compact scenario are summarized in Table 6.2. These impacts are presented as changes from the baseline.

Table 6.2 Consumer Impacts of a Combined Northern, Mid-Atlantic and Southeast Dairy Compact on Select States using a $2 per cwt Compact Premium

Source: Appendix Table 2.

The results are consistent across each of the dairy compact states. The Class 1 price for milk used for fluid purposes will fall $0.23 per cwt in all federal orders. Other class prices will fall as well due to increases in dairy commodity production brought on by the compact. As a result, the federal order blend prices (which does not include any premiums) will fall $0.24-$0.30 per cwt in each of the select compact states, depending on differences in Class 1 percent use.

The $2 compact premium increases the cost of Class 1 milk to processors by $0.15 per gallon (the $2 per cwt compact premium is offset by a $0.23 reduction in the Class 1 price mover). That higher Class 1 cost is then passed on to consumers who pay at least $0.15 per gallon more for milk due to the compact. The farm-to-retail margin does not change since a fixed dollar mark up was assumed in this study.

The higher retail fluid milk price reduces per capita fluid milk consumption by 3.23-3.77 pounds. Lower fluid milk consumption is offset by higher retail fluid milk prices. Thus consumers in these select compact states will pay more for fluid milk relative to the baseline during the course of a year: $13.4 million in Missouri; $44.5 million in New York; $19.1 million in Georgia; and $9.70 million in Kentucky.

If a fixed percentage farm-to-retail mark up is assumed, consumers will pay much more. Retail fluid milk prices under a combined compact will rise by $0.31 per gallon. Thus, fluid milk expenditures will rise by $26.8 million in Missouri, $83.3 million in New York, $39.7 million in Georgia and $18.1 million in Kentucky.

Thus a second conclusion regarding dairy compacts can be reached: consumers in the compact region will pay more for fluid milk.

The impacts of dairy compacts are not localized within the dairy compact region. The results of this study show that farmers in Compact states respond rationally to higher milk prices by producing more milk. In addition, higher Class 1 costs reduces the amount of milk used for Class 1 purposes. As a result, more milk is used for Class 3 and 4 purposes, resulting in an increase in the production of butter, nonfat dry milk and cheese. In this way, the compact "sells" some of its excess production in the form of greater supplies of dairy commodities to the national market. That in turn affects non-compact states.

An increase in the production of dairy commodities results in lower class prices in federal and state orders. For farmers in the compact region, these lower class prices are offset by compact premiums. Thus compact farmers face a higher net milk price. However, farmers in non-compact regions and states face the full impact of lower class prices. Thus dairy compacts result in lower farm gate milk prices for farmers that are outside the compact region.

These effects are illustrated in Table 6.3 for select non-compact states. Again, the model results from the combined Northern, Mid-Atlantic and Southeast Dairy Compact scenario was used.

Table 6.3 Farm Impacts of a Northern, Mid-Atlantic and Southern Dairy Compact on Select States Outside the Compact Region using a $2 per cwt Compact Premium

Source: Appendix Table 2.

These results show that farmers outside compact borders will face lower farm-gate milk prices and lower farm milk sales. California will lose $67.3 million and Wisconsin $63.8 million in annual milk sales relative to the baseline if a Northern, Mid-Atlantic and Southeast Dairy Compact were to exist. In a nutshell, compact farmers export their surplus milk onto the U.S. market, resulting in lower farm-gate milk prices for non-compact farmers.

Thus a third conclusion regarding dairy compacts can be reached: compacts result in an increase in manufactured dairy products, which result in lower farm prices for non-compact farmers.

Should Missouri join the proposed Southern Dairy Compact? The analysis in this report illustrates how such a decision will impact both farmers and consumers.

Missouri dairy farmers will benefit economically from joining a Southern Dairy Compact. The impact of a combined Northern, Mid-Atlantic and Southeast Dairy Compact will raise Missouri farm-gate milk prices by $0.88 per cwt and will raise farm milk sales by $26.6 million. Consumers, however, will end up paying more. Missouri retail milk prices will rise $0.15-$0.31 cents per gallon²²and retail fluid milk expenditures will rise $13.4-$26.8 million²³ if a combined dairy compact is created. The annual additional costs of a dairy compact on a Missouri family of four is presented in Table 6.4 below.

Table 6.4 Annual Cost of a Dairy Compact to a Missouri Family of Four¹