The Price of Milk

It's important for politicians to know the retail price of a pint of milk - it's 49p in the supermarkets, or 29.5p per pint if you buy a four-pint (plastic) bottle.  That's equivalent to 86p and 52p per litre.

However, the producer price is substantially less.  Marks & Spencer, Waitrose, Sainsbury's, and Tesco sign up farmers to medium-term contracts which link the price they pay for milk to production costs: this gives prices currently in the range 29-32p per litre.  Otherwise prices are below that: the average in May was 27p per litre.  Dairy farmers complain that at prices below about 30p they are making a loss.

So what's going on?  Tim Worstall is ready as ever with a neo-liberal analysis:

This is how the system is supposed to work. Too many dairy farmers producing too much milk? Some should go produce something else: that loss is the stick with which to beat them into it. It's not the supermarkets causing these losses. It's not us being mean when considering the price of a bowl of cornflakes either. It's that dairy farming has become more efficient:

The latest provisional figures from Defra show a 4.7 per cent (331 litres per cow) increase in the average yield per cow from 2009/10, to 7,406 litres per cow in 2010/11.

Is this a one off, a single year's blip? No:

The average yield in 2010 was 22.4 per cent (1,336 litres per cow per annum) higher than ten years previously when the average stood at 5,979 litres per cow per annum.

Assume that milk demand stayed static: a 22 per cent rise in output per cow means that we need 22 per cent fewer cows...

I don't know whether Worstall is being careless or disingenuous, because he's skipped past a table (on the page he links to) which shows that total UK milk production fell by 5% in the nine years to 2010.  To be fair, we should include the change in 2000-1, which according to this document (which gives similar but not identical data) was a 2% increase, so the fall over the full 10-year period would be 3%.  The increased yield and falling production implies a decline by 20% of the number of dairy cows (percentages don't work quite as simply as Worstall guesses, a 20% fall in one factor cancels a 25% increase in another, 0.8*1.25 = 1).  (This page reports a decline in dairy cow numbers of 7.2% in the last five years.)  And the number of dairy farms has fallen by about 35% over the eight and a half years - production has concentrated in larger, presumably more efficient, farms.

What these figures show is that whereas yields have risen, falling numbers of cows and farmers have more than compensated for it.  The system has already worked as Worstall says it is supposed to.  Low producer prices are not as he claims due to rising milk yields.

Are British farmers being outcompeted by the rest of the EU?  No.  UK producer prices are lower than in any country we could plausible import fresh milk from.

Are producer prices falling because consumers are getting a great deal?  No, over the last ten years the Consumer Prices Index has gone up by 28%.  The price of a pint of milk has risen by the same 28%.

What about demand for milk?  Liquid milk consumption per person fell by 17% over the ten years.  The UK population rose by 6%, implying a 12% fall in liquid milk consumption.  However, there was increased consumption of yoghurt, cheese, and butter.  I can't be precise about the amount of milk that went into making those products, but I estimate it would compensate for about half the fall in demand, implying a net fall in demand of 6%.

So it does seem that over a decade, demand has fallen slightly more than supply.  Is that the cause of falling producer prices?  If it is, the market must be rather unstable.  Why?

I suggest that the explanation lies in the structure of the milk market, and that it's possible for producer prices to fall below production costs even if there is no oversupply.  First, fresh milk is a perishable product - you have to sell it almost as soon as you produce it, you can't hold out for the best price.  And if a farmer fails to sell his milk he loses its entire value.  Second, while overseas supplies are more expensive, they're not ruinously expensive, even including transport costs, compared with retail prices.  So if a retailer fails to buy milk from a UK farmer, he has viable alternative, it costs him just a few pence more per litre.  Third, retailers have diversified businesses and are not dependent on profits from milk sales, unlike dairy farmers.  And fourth, you can't turn dairy production off and on at will.

The effect of these factors is that all the bargaining power is in the hands of the retailers - they can drive prices down to levels at or below production costs, and farmers have no choice but to accept.  And retailers, who operate in a competitive market, have every reason to cut their costs when they can.

So where are we heading?  If dairy farmers aren't exaggerating their problems, several - more than 3% - will go out of business soon.  Producer prices will then rise, and retailers will have to import some of the milk they sell.  The cost to the retailer will go up, and very likely they'll pass that on to consumers.  Everyone will lose, except for the continental farmers who get a higher price for their product, and the providers of refrigerated transport who bring it here.

The fundamental point is that markets do not always produce efficient outcomes, at least not on a time-scale we care about.

Which brings us back to the supermarkets mentioned above who pay contracted farmers relatively generously.  I doubt that that's just because they're caring human beings, or because they think it good public relations.  My guess is that they are concerned about a collapse in UK production, and they think it worth paying a modest premium now to secure cheap supplies in the future.  Perhaps former dairy farmers would manage half a smile at the sight of the Asda paying up for imported milk while Tescos get the stuff cheap from the farmers they've kept in business.