Deregulation
A Speech To The 1999 DRC Ruakura Dairy Farmers’
Conference
Delivered at Hamilton on 5th May 1999
Since 1993, New Zealand has progressively lost the plot by reverting
to the ‘do nothing’ approach. The Government has let New Zealand slip backward
relative to other countries that maintained a reform agenda. A massive spending
programme ($6 billion+) killed the goose that was laying the golden eggs.
The outcome - A massive balance of payments
blow-out
- A credit downgrade
- A reversal in the fall of unemployment
- A recession in 1998
As a result, investors marked the New Zealand dollar down and while the
outlook for the export sector is now better, at least temporarily, the
agricultural industry is still in dire straits, despite the fact that the real
exchange rate has been below its long-run average.
The Dairy, Apple and Pear and Kiwifruit Boards have powers to control,
acquire and market all of the produce from within the country and to trade
internationally as well. They have built sophisticated marketing structures
involving withheld returns that require up to 50% of the market price in the
Dairy Board’s case to service. Dairy farmers have as much invested off farm as
they do on farm through their co-operative processing companies and the Dairy
Board’s offshore assets.
Although proponents of the status quo can often claim increased export
receipts or even improved "returns" i.e. the unit price, the deciding issue must
be individual profitability and the misuse of resources.
The main arguments in favour of deregulation are as follows:
1.
Monopolies are too inflexible to manage the urgently needed shift to added
value, sophisticated, consumer demanded products that can improve farmer
profitability.
Despite the hype, even the Dairy Board with its very large resources has only moved around 20% of its products into the branded, high value end of the market. The vast bulk of exports are exposed to the declining commodity market.
New capital and ideas, access to entrepreneurial flair with smarter ownership structures and an ability for consumers and producers to work together in strategic alliances to achieve a high level of warranty on food safety issues are all urgently needed. The present structures are counter-productive in this regard as they act as a deterrent to new investors.
Deregulation will not mean the end of the present structures. Indeed they are most likely to continue as strongly as ever but at least new players will be able to enter.
The question is why should we prevent anyone from doing business with anyone else at home or abroad on any terms they choose? Why do we treat the marketing of dairy products differently from other industries in the economy including forestry, fishing and wine?
Single seller arrangements stifle entrepreneurship and innovation by preventing people with other ideas finding better ways to do business.
2.
Monopolies are bureaucratic and expensive
The evidence emerging from the greater level of accountability has revealed the extent of the overhead margins taken by the Boards. My understanding is that the marketing Boards absorb between 30% and 50% of market receipts in running their business, well in excess of comparable deregulated operations. Why do we tolerate this when New Zealand’s experience is that we have yet to see a monopoly whose performance did not improve dramatically when opened up to competition. Foreign investment and through it, the development of new linkages with markets is blocked or discouraged.
3.
Marketing objectives are wrong when they focus on maximising farm gate returns
rather than profitability
The huge increase in dairy production in recent years has been rewarded at the average price when the industry knows that the marginal return under present arrangements is likely to be significantly less than the average. This distortion has led to the increase in production and export receipts but a continuing decline in farmer profitability.
This one-size-fits-all strategy exposes whole industries to mistakes like the recent foreign exchange disasters or the customs issue in the UK.
4.
Farm gate prices are "bundled" - various returns from various activities
paid in one price
In order to do business, dairy farmers are compelled to invest heavily in offshore processing and marketing operations. They are unable to diversify their risks efficiently.
A dairy farmer has an on-farm investment plus a considerable sum tied up in a processing plant and an unknown amount in some 60 different offshore marketing, storage and processing companies, research facilities, brand names, quota market premiums etc. This bundle of investments pays out one farm gate price creating anomalies that lead to even more distortions. The increased production, especially from converted sheep and beef properties, is proving difficult and expensive to manage, utilising precious capital that should be invested in added value, branded products.
Despite the fact that this anomaly was identified as a hindrance to profitability over 14 years ago, little has been done to rectify the situation.
This distortion of price signals to farmers, which I discussed with the Dairy Board 14 years ago, is a real tragedy for the industry - land prices are artificially inflated as a result.
5.
The averaging ethic is penalising the best performers
While the co-operative approach may have served the farming industry
reasonably well in past decades, the time to look at moving from a co-operative
to a corporate structure with fully tradeable shares has long since past. It is
now a matter of urgency, with the increasing capital requirements of the
industry, farmers are less willing and able to assume the required risk.
The problem that members have in monitoring the industry’s performance
increases as co-operatives amalgamate and accumulate more members - this means
that lack of transferability of ownership rights becomes increasingly untenable
as the assets of the co-operative grow. The averaging of returns has been a
severe impediment to improving performance.
Boards are morally bound to acquire all produce irrespective of the
need to properly incentivise activity and concentrate on only the best.
6.
Mixed political and commercial structures rarely achieve the
best outcomes.
There has always been evidence that political considerations have interfered with the process of fundamental commercial decision making. It is said by some in the industry that the efforts of the early innovators in the dairy industry were swamped by the block voting of the bigger companies intent on maintaining their political influence. Many useful developments from individual companies and some urgently needed changes to eliminate costs and distortions were voted down by those wanting to continue in office.
It is clear that over the years, all of the Producer Boards have made inferior decisions through political compromise. Too often, sound commercial decisions have been traded off for political purposes. The fact is that the existence of the Boards and their regulations means the agricultural industries are bedevilled by politics, both industry and national politics.
This means an enormous amount of the time of industry leaders, managers and farmers, is diverted from commercial priorities.
7.
International trading developments will put pressure on State Trading
Enterprises
Although the particular type of State Trading Enterprise New Zealand has is not distortionary of international trade it offends GATT articles 1 and 17. These weaknesses in our bargaining position are used against us, even if unfairly and make it difficult for our negotiators to achieve outcomes favourable for our exporters.
My understanding is that the US Department of Commerce has stated publicly that the NZ Dairy Board is enemy No. 2 behind the Canadian Wheat Board. In these circumstances, New Zealand will find it impossible to withstand that pressure. Are we going to control the deregulation process or let outsiders dictate the terms?
However, the potential for New Zealand to gain access to the lucrative North American market for a greater range of goods at lower tariffs clearly offsets any advantage that a Board may bring. Access will most certainly not be achieved without disbanding the regulatory regime currently in place. There is growing evidence that a bilateral agreement is possible and could be established with few restrictions. By any measure this would represent a useful ‘trade off’.
The Arguments raised against deregulation.
1.
Deregulation is ideological and theoretical.
New Zealand is almost the only remaining country in the world with producer boards of the kind we persist with. Regulating markets is now considered ideological and counter productive. If the device was useful we would have regulated markets for other products and other countries would be putting them in place not disbanding them.
2.
Weak selling would result
This position demonstrates a lack of understanding of the international market. New Zealand rarely dictates the price of its goods. It is already selling in a highly competitive marketplace. Whether New Zealand farmers are represented by one seller or ten will have little effect in a cut-throat situation where there may be more than 50 agents operating. Most of the present arrangements and bodies will remain. The Dairy Board in similar form will remain a large and dominant marketer. Enza will still market most apples. However, those who want to risk going on their own and new players with new capital and ideas will be able to proceed unhindered by regulation.
3.
There is no level playing field in the marketplace
There is no logical or valid argument for New Zealand to resort to protectionism just because others do, in fact, to the contrary, it is more likely we will succeed best if we are free from such distractions. It is a classic situation of "two wrongs do not make a right". There is no advantage for New Zealand farmers to have protection just to compete against someone who has.
The few remaining single buying countries do not constitute a valid basis for having regulation. Other industries without producer boards cope well enough.
4.
Producer control is necessary to prevent peasantry
New Zealand farming is well down the road of peasantry because it remains regulated. Amalgamations and "silent" forced sales abound as once solid performing farming families are put under increased pressure. It is a fallacy to propose that typically, small players are exploited by larger players. If there is a competitive market where small players can move freely there are more advantages than disadvantages.
No single farmer is going to be left to market his or her own produce. Groups of like minded producers with the same commitments to quality and with a homogeneous product are likely to work together to obtain a strong relationship with consumer interests to ensure they meet their specifications.
5.
Scale is critical to success
Larger organisations do have advantages in some situations but with the future of food marketing being in a range of sophisticated, branded, added value products, then size is less of an issue. In fact, the ability to market variety is enhanced by flexibility and quickfootedness. Where scale is an issue to provide the muscle and resources in combating the power of the grocery multiples for example, the private sector has demonstrated an ability to achieve a combined approach.
6. The
single desk Dairy Board has out performed the free enterprise meat industry
The question is, has it? The evidence over the long term is that meat producers are no worse off than dairy farmers despite dairying having been more profitable in the last few years. The net positions are almost identical and one could argue, even worse for dairy farmers considering the amount of off-farm investment they have.
7. Why
change something that is not broken?
The declining net incomes of farmers is not just an unacceptable position for them but the overall effect on the economy of poor performing resources is no longer tenable. If we want an expanding economy and a growing standard of living with high quality privately provided social services we must deal with the regulated industries that still make up such a large part of the economy.
It is incongruous to have farmers complaining about being in debt and having insufficient income while they march on the streets to retain expensive out of date monopolies.
8.
Where is the researched case proving deregulation will deliver improved
outcomes?
Farmers and growers have been demanding the Government prove that the deregulated environment will deliver greater profitability than the status quo. This ignores a basic tenet of deregulation that no one can second guess the market and say with certainty what will emerge. What is known for sure is that most markets improve dramatically following the removal of a state-established monopoly.
Summary
At long last the industry is recognising the need for massive change. The Dairy Board’s monopoly and the co-operative structures have caused inefficiencies and distortions that have cost farmers and the country massive amounts - probably several hundreds of millions of dollars annually.
The key solutions are twofold:
·
the government’s task is to remove the monopoly and
probably to license exports to the EU butter market if retaining the quota
premium could not be handled by industry Cupertino; and
·
the industry should decide to demutalise - move from
co-operative to corporate structures with fully tradeable shares. This is
necessary to remove the bundling distortions (resulting from returns from raw
milk and from off-farm investment being combined in one payout price), permit
diversification (into non-dairy products and non-New Zealand dairy products),
remove limitations on capital raising and strengthen corporate governance.
Recent mergers may make sense but the idea of folding the whole industry into a mega-co-operative is crazy. The industry should opt for two or more companies:
·
these would already be huge organisations, perfectly
capable of obtaining competitive returns in world markets (like our forestry
companies) - weak selling arguments are not credible. They would co-operate
where this was advantageous;
·
by creating a monopoly, farmers would close off all
options for competitive processing and marketing of their milk - short of new
entrants coming in. This would make them very vulnerable to inefficiency and
exploitation;
·
analysis will no doubt show the usual cost savings from a
merger (management numbers etc) but the inefficiencies inevitably associated
with a monopoly will be huge and unquantifiable. A monopoly that has performed
efficiently in the long term has yet to be discovered; and
·
farmers will lose all the potential of competition
between rival companies for new ideas and better ways of doing things, and for
checks on mistakes - they will take years to show up. Farmers would be reverting
to a situation where all their ‘eggs’ were in one basket (their recent
experience with the Dairy Board’s foreign exchange losses underlines the risks).
The government is in a strong position to influence the outcome, as it has to approve changes to the Dairy Board’s legislation. Also the disciplines of the Commerce Act should apply. Given past policy decisions to promote competition and break up monopolies, it would be outrageous for the government to sanction the proposal.