Dairy Industry: Estimated Economic Impacts of Dairy Compacts
Released: 2001-09-14T00:00:00

Letter

Background

Of the approximately 167.7 billion pounds of raw milk produced in the United States in 2000, about 55.5 billion pounds were processed into fluid milk products—such as whole, 2-percent, 1-percent, and skim milk; flavored milks; and buttermilk—that yielded approximately $22 billion in retail sales. The rest of the raw milk was used to produce manufactured products, such as butter, cheese, ice cream, powdered milk, and yogurt. In the United States, a complex pricing system has evolved that affects prices paid for raw milk used to produce processed milk (fluid drinking milk) and manufactured dairy products, such as cheese and butter. Various milk regulators—USDA, some states, and the Northeast Dairy Compact— establish minimum prices that must be paid for raw milk to help stabilize the milk supply. In addition to USDA, the states, and the NEDC, other entities affect milk prices, including cooperatives, which may provide services to farmers such as collecting farmers’ milk; milk processors, which convert raw milk to fluid milk; manufacturers of dairy products; and retailers, which stock and sell dairy products to consumers. Each of these groups contributes to the value of fluid milk and dairy products sold at the retail level, and each receives a portion of the difference between the prices that farmers receive and the retail price.

Federal and State Dairy Programs

USDA's milk marketing and milk price support programs, as well as some states' dairy programs, are intended to ensure an adequate supply of milk by establishing milk prices and other milk marketing rules, which, in turn, are intended to stabilize milk marketing conditions and thus assist individual farmers as well as consumers. In effect, these programs ensure that farm prices do not fall below a minimum level and provide a safety net for individual farmers who lack the market power of other entities, such as wholesale milk processors.

Currently, about 70 percent of the milk produced in the United States is regulated under the federal milk marketing order program created in 1937 and administered by USDA. Under this program, on the basis of national dairy market information, USDA sets the minimum prices that must be paid by processors for raw fluid grade milk in specified marketing areas, or orders. These prices vary by the type of dairy product for which the milk is used; the minimum price for raw milk used for fluid drinking purposes also varies by location. Even though USDA sets minimum prices for raw milk, buyers of milk can and sometimes do pay farmers prices in excess of the established minimums—prices known as “over-order premiums.” Market forces play a role in determining any such premiums.

Under the federal milk marketing order program, USDA has a classified pricing system for setting minimum prices, on a monthly basis, for milk that is based upon its intended use, as shown in table 2. Federal milk marketing order class prices are determined by using product price formulas that compute milk component values based on wholesale dairy product prices. For example, Class III formulas use monthly average butter, cheese, and dry whey prices to determine values for butterfat, protein, and other solids, respectively. Class IV formulas use monthly average butter and nonfat dry milk prices to determine values for butterfat and nonfat solids, respectively. The Class II price is determined by adding an amount—a Class II differential—to the Class IV price, while the Class I price is determined by adding a Class I differential to the higher of the Class III or IV price. Class I prices can vary from one milk marketing order to another.

Dairy farmers selling raw milk within a federal milk marketing order receive an average, or “blend,” price that is the weighted average of the prices of Class I through IV milk, with the weights determined by the amount of milk sold for each class of use in each marketing order. The average price farmers receive, therefore, depends in part on the extent to which the total raw milk supply in a specific order is used to make fluid milk as opposed to the three classes of manufactured products.

Dairy farmers located in one milk marketing order sometimes ship their milk to another order to obtain a higher price. Depending on the amount of milk shipped, a producer may qualify for a receiving order’s blend price. If the producer meets the receiving milk marketing order's blend price requirements, not only can the milk shipped qualify for the blend price— all of that producer's milk can qualify for the blend price. However, farmers must consider whether the cost of transporting a sufficient amount of milk to qualify for the receiving order's blend price outweighs the benefit of receiving a higher blend price.

Some states, such as California, Maine, Nevada, New York, Pennsylvania, and Virginia, have established their own minimum farm-level milk pricing programs that cover all or portions of their states. These states have established commissions or boards to perform functions similar to those of USDA. For example, Virginia’s milk commission, created in 1934, establishes monthly producer prices to ensure dairy farmers an adequate return on their investment and to preserve market stability. Similarly, Nevada’s dairy commission, established in 1955, sets minimum prices for raw milk sold to processing facilities located within that state.

The federal milk price support program, established in 1949, also influences farm-level prices. This program supports farm-level prices by providing a standing offer from USDA to purchase butter, cheese, and nonfat dry milk at specified prices. The prices offered for these dairy products are intended to provide sufficient revenue so that dairy product manufacturers can pay farmers, on average, a legislatively mandated support price. This program is intended to make the support price a floor price for raw milk used for manufacturing purposes, and it is unlikely that manufactured product prices will fall below the floor for very long. Because the price for raw milk used for fluid purposes is based, in part, on the price of raw milk used for manufacturing purposes, the price support program influences the price that farmers receive for raw milk used for fluid purposes as well.

Dairy Compacts

In addition to the federal and state milk marketing order programs that set minimum milk prices, in 1996, the Congress authorized the Northeast Interstate Dairy Compact for the six New England states. The Compact supplements the federal milk marketing order and state programs by setting the monthly minimum price to be paid for raw milk used for fluid milk marketed in the six-state area. In July 1997, the Compact set a minimum price of $16.94 per hundredweight for raw milk used for Class I, or fluid milk, and that minimum price has not changed. In months when the federally set minimum price for Class I milk for the Northeast Milk Marketing Order falls below the Compact price, the Compact price takes effect. In other months, when the federally set Class I price is higher than the Compact Class I price, the federally set Class I price takes effect. Since the Compact was established, federally set minimum prices for the area of the Compact that is subject to federal milk marketing regulation have ranged from $13.50 to $20.50 per hundredweight but have usually been below the Compact price of $16.94 per hundredweight.

In those months when the Compact Class I price is higher than the federally set Class I price, processors having sales of fluid milk in the six NEDC states are required to pay a monthly over-order obligation per hundredweight equal to the difference between $16.94 and the federally set Class I price. Processors multiply the monthly over-order obligation by the volume of their total fluid milk sales in the six NEDC states in hundredweight by this difference and pay this amount to the commission that administers the Compact. After deducting administrative fees and other expenses, the commission distributes the balance of the proceeds in accordance with the amount of milk produced that was actually used for fluid milk, as opposed to cheese or other manufactured products. The commission makes disbursements to farmer cooperatives and milk handlers, located both within and outside the NEDC states, who then make individual payments to farmers based on their production. Thus, dairy farmers from other states, such as New York, that supply raw milk used to make fluid milk that is sold in the Compact states also benefit from the Compact’s minimum prices.

The 1996 farm bill provided the Compact with considerable flexibility to establish regulations to carry out its intended purpose. The legislation authorized the establishment of a commission composed of delegates from the six NEDC states to administer the Compact. The state delegates are appointed by each of their respective states and include farmer, milk processor, and consumer representatives. In addition to being empowered to establish Compact prices, the commission may investigate costs associated with producing and selling milk; examine the economic forces affecting producers, including trends in production, consumption, and the financial conditions of dairy farmers; and prepare and provide periodic reports to the states regarding its efforts. While the commission is required to report annually to USDA, USDA is not required to investigate or report on the commission’s efforts.

States in other regions of the country, including some southern states, are considering the adoption of similar compact arrangements. The proposed Dairy Consumers and Producers Protection Act, a bill that was introduced in the Congress in May 2001, if enacted, would reauthorize the NEDC. The bill would also allow additional states to enter the NEDC. In addition, it would establish a southern dairy compact consisting of 17 states, as well as a Pacific Northwest dairy compact and an Intermountain dairy compact, each consisting of 3 states. The proposed bill, like the 1996 farm bill, would provide the compact commissions with broad flexibility to carry out their objective of ensuring the continued viability of the dairy industry in their states. Therefore, it cannot be known in advance whether commissions for these new compacts would regulate milk pricing in their respective states in a manner similar to the way that the NEDC commission has regulated milk pricing.

Other Factors Affecting Milk Prices

In addition to federal and state programs and the NEDC, other entities affect prices paid for milk at the wholesale and retail levels. For example, about 83 percent of all raw milk produced in the United States is marketed through dairy cooperatives that are owned by farmer-members. Cooperatives perform services for their members and buyers of milk such as (1) transporting milk among different milk producing areas, (2) scheduling milk deliveries, (3) testing milk, and (4) paying members for their marketings. Costs for these services are paid by processors and dairy product manufacturers that purchase milk from the cooperatives at prices above federally specified minimum prices and then process or manufacture, package, and distribute fluid milk and manufactured dairy products to retailers. The costs that processors and manufacturers incur in purchasing raw milk from farmers or cooperatives and in processing or manufacturing, packaging, and distributing fluid milk and manufactured dairy products are included in prices charged to retailers for these products. Finally, the prices that retailers set for selling milk and dairy products are affected by the retailers’ operating costs, such as labor, rent, and utilities; their strategies for pricing milk and manufactured dairy products; and the demand for those products.

Isolating the Intraregional Impacts of the NEDC Is Difficult

Although dairy sector indicators that we examined changed after the NEDC’s milk pricing regulations took effect in July 1997, it is difficult to determine how much of the change is attributable to the Compact. Such a determination is difficult because the Compact’s impact on these indicators cannot be easily isolated from the effects of other factors. For example, while retail milk prices increased by 15 to 20 cents per gallon in July 1997, and there is general agreement that the Compact contributed to these increases, the lack of an economic model that fully accounts for the influences of other factors, such as costs for processing fluid milk, makes it difficult to determine how much of that price increase can be attributed to the NEDC. Similarly, while the Compact has resulted in payments being made to dairy farmers that reflect the difference between USDA’s marketing order minimum prices and the NEDC’s minimum price, it is difficult to determine whether some portion or all of these payments would have been made to dairy farmers anyway, depending on market conditions. Although economic reasoning suggests that the Compact would be likely to cause increased milk production and reduced fluid milk consumption in the six NEDC states, analyses of relevant data on dairy farm structure, milk production, and milk consumption show little change in historic trends after the Compact’s implementation.

Retail milk prices increased by as much as 20 cents per gallon immediately following the NEDC’s establishment—which is an amount comparable to the immediate increase in the minimum farm-level price for raw milk to be used for and sold as fluid milk in the six New England states when the NEDC’s price regulations became effective. For example, the NEDC minimum price of $1.46 per gallon was 18 cents higher than USDA’s June 1997 Class I price for Boston of $1.28 per gallon and 26 cents higher than USDA’s July 1997 Class I price of $1.20 per gallon. While this might appear to be a substantial increase, when compared with USDA’s average Class I price of $1.41 per gallon during the prior year, the NEDC price did not actually represent such a large increase. However, without a model of farm-to-retail price transmission that accounts for how quickly and how fully farm-level price changes are passed on to wholesale and retail levels, we cannot estimate how much of the retail price change was due to the Compact.

Furthermore, while retail milk prices in Boston and other selected cities in the NEDC states remain at the higher levels experienced since the Compact took effect, national average retail prices have also increased, but at rates lower than in the NEDC states. Even so, it is not certain what portion of the retail price increase in the NEDC states is attributable to the Compact, given that both the retail and farm-level prices for milk have fluctuated since July 1997. Some portion of the price increase could also be due to other factors, such as changes in the costs for processing or retailing milk, marketing strategies, or consumer demand. In addition, it is difficult to estimate the extent to which fluid milk processors would have paid more than the minimum farm-level price for milk without the NEDC; that is, we do not know the extent to which the NEDC price substituted for market-driven over-order premiums. Several studies analyzing the NEDC’s impact on retail milk prices concluded that the NEDC has increased prices. However, the amount of the increase attributed to the NEDC varies from study to study, depending on assumptions made by the different researchers and the time periods that they examined. For example, estimates ranged from a low of 2.7 cents to as much as 20 cents per gallon.

Data on farm income are limited, and while dairy farmers have received NEDC payments, it is unclear to what extent these payments replaced market-driven over-order premiums that farmers might have been paid in the absence of the Compact. We estimate that through calendar year 2000, the NEDC payments made to dairy farmers in the six NEDC states totaled about $99 million, assuming that all dairy farmers located in these states had their milk processed at fully regulated NEDC plants. The NEDC payments that an average dairy farmer in one of the six states would have received would have fluctuated widely from month to month and from year to year, however, depending on the difference between USDA’s Class I price and the Compact price of $16.94 per hundredweight and the percentage of milk used for fluid milk in the NEDC states. For example, in 1998 the average NEDC over-order producer price payment was 67 cents per hundredweight. This would have provided dairy farmers supplying raw milk used to produce fluid milk sold in the NEDC states about 25 cents per hundredweight, based on the percentage of raw milk used for fluid milk. We estimate that these payments provided the average dairy farmer in the six NEDC states about $3,892 above the minimum amount that the farmer would have received in 1998 had USDA’s Class I price of $16.78 been in effect. In 2000, the average NEDC over-order producer price payment was $2.14 per hundredweight. This amount would have provided a farmer supplying raw milk used to produce fluid milk sold in the NEDC states about 91 cents per hundredweight, based on the percentage of raw milk used for fluid milk. These payments provided an average dairy farmer in the six NEDC states about $15,301 above the minimum amount that the farmer would have received in 2000 had USDA’s Class I price of $14.80 been in effect. These estimates are comparable to data developed by the Compact commission, which indicate that dairy farmers in the six NEDC states and New York received over-order payments totaling about $146 million from July 1997 through June 2001. In particular, the NEDC data indicate that about 4,200 dairy farmers, including 1,300 in New York, received average annual payments of about $9,800. Whether these payments were sufficient to alter the financial health of dairy farmers supplying raw milk used to produce fluid milk sold in the NEDC states is difficult to determine, however. USDA data are inconclusive as to whether the Compact had a positive impact on NEDC dairy farmer income, while NEDC analyses conclude that the Compact stabilized and enhanced farmer income.

A limited number of studies have been conducted on the Compact’s impact on farm income. In its 1998 report, the Office of Management and Budget (OMB) estimated a 6- to 8-percent increase in farm income from July through December 1997. In addition, an economist at the University of Vermont modeled the effect on Vermont dairy farmers of establishing a floor for Class I prices and concluded that stabilizing prices by having a price floor could have a positive impact on dairy farmer income.

The NEDC’s impact on farm structure is unclear. The number of dairy farms decreased, and the average size of herds increased, both prior to and following the NEDC’s establishment in both the Compact states and the rest of the country. For example, the number of licensed dairy farms in the six NEDC states decreased by 32 percent between 1992 and 2000, from 4,079 to 2,772, while the number of licensed dairy farms in the rest of the country decreased by 37 percent during the same period, from 127,456 to 80,253. Regarding herd size, the average herd in the six NEDC states increased 36 percent, from 58 to 79 milk cows, between 1992 and 2000. In the rest of the United States, the average herd increased 57 percent during the same period, from 56 to 88 milk cows. According to USDA, this decline in the number of farms, along with the increase in herd size, most likely reflects fundamental changes in dairy farming caused by such factors as technological and genetic advances.

Although economic reasoning suggests that higher farm-level milk prices would result in increased raw milk production, we have no basis on which to estimate the specific impact that the Compact has had on milk production in the six NEDC states. Data on milk production show an increase in total milk produced and milk produced per dairy cow, but these trends began prior to the Compact’s establishment, making it difficult to estimate the specific impact of the NEDC. Farmers in the NEDC states increased their total milk production by 2.9 percent, from 4.5 billion pounds in 1993 to 4.7 billion pounds in 2000, while farmers in the rest of the nation increased production by 10.3 percent, from 148 billion pounds to 163.3 billion pounds during the same period. The average amount of milk produced per cow in the NEDC states increased by about 11.6 percent during the same period, from 15,633 pounds to 17,440 pounds. Milk production per cow in the rest of the United States increased by about 15.9 percent during this period, from 15,726 pounds to 18,226 pounds. Studies of the NEDC’s impact on milk production, including OMB’s study and an analysis by researchers at the University of Vermont, estimated that the Compact has resulted in a slight increase in milk production in the NEDC states.

We cannot estimate the specific impact that the Compact has had on fluid milk consumption in the six NEDC states, in part because we cannot estimate how much of the retail price change since July 1997 has been due to the Compact. Data on fluid milk consumption show a decrease in per capita milk consumption, which reflects trends both within the NEDC states and in the rest of the country that began prior to the NEDC’s establishment. Per capita consumption of fluid milk was higher in USDA’s New England Milk Marketing Order than in some other USDA marketing orders prior to the Compact. Even so, consumption of fluid milk had been slowly declining, both in that marketing order and in the rest of the country, as the consumption of other fluid beverages increased and as the population aged. For example, annual per capita milk consumption for the New England Milk Marketing Order declined by 4 percent from 1993 to 1999, or from about 233 to 223 pounds. Similarly, annual per capita milk consumption for all the other USDA marketing orders declined 6 percent from 1993 to 1999, or from about 214 to 202 pounds. In its 1998 study, OMB’s analysis of the NEDC’s impact on fluid milk consumption during the last half of calendar year 1997 showed a 0.5-percent decline; while in a July 2000 study, an economist at Pennsylvania State University estimated that the NEDC had no appreciable impact from mid-1997 through 1999.

Additional details about the intraregional impacts of the NEDC are included in appendix III.

The NEDC Has Not Increased Net Federal Costs for the Milk Price Support Program, but Its Impact on a Major Nutrition Assistance Program Is Less Certain

According to USDA, the NEDC has not resulted in a net increase in the federal government’s costs for its milk price support program, while it is not certain whether it has affected federal costs for one of its major nutrition assistance programs. The Compact commission must, by law, compensate USDA for any estimated increase in costs to its price support program that are caused by the Compact, and the NEDC commission has done so. Regarding its nutrition assistance programs, USDA estimates that federal costs to its largest nutrition assistance program—the Food Stamp Program—could have increased but federal costs for its other nutrition assistance programs have likely not increased.

As required by the 1996 farm bill, when the rate of increase in milk production in the NEDC states exceeds the rate of increase in national milk production, the Compact commission must compensate USDA for any additional costs to the milk price support program that result, and the commission has done so. According to USDA officials, the NEDC did not result in a rate of increase in production greater than the national rate of increase in 1997, during the first 6 months of the Compact. USDA calculated that in 1998, milk production in the NEDC states was 1.8 percent greater than the average of the prior 2 years, compared with a national increase of 1.3 percent. The NEDC compensated USDA $1.8 million for this higher rate of increase in production. USDA calculated that in 1999, milk production in the six states was 3.6 percent greater than the average of the prior 2 years, compared with a national increase of 3.2 percent. The NEDC compensated USDA $1.4 million for this higher rate of increase in production. USDA calculated that milk production in the six NEDC states increased by 0.1 percent in 2000, compared with a national increase of 5.1 percent. Thus, compensation was not required.

USDA is not certain whether the Compact has affected federal costs for the Food Stamp Program, which is USDA’s largest nutrition assistance program. According to USDA, if (1) retail milk prices in the NEDC states increased sufficiently to increase national average retail milk prices, and (2) the Compact was the cause of the full amount of the price increases in the NEDC states, then the Compact might have increased federal Food Stamp Program costs because program benefits are sensitive to the national average retail milk price. Benefit levels and federal Food Stamp Program funding have increased since July 1997, because of, among other things, increased national average retail milk prices. However, according to USDA, it is difficult to establish the Compact’s impact on retail milk prices in the six NEDC states, and thus it is difficult to establish the Compact's role in affecting national average retail milk prices. If the Compact would have caused benefit levels to increase to the next dollar, USDA estimates that the Compact increased annual federal program costs by about $60 million. If the Compact did not cause benefit levels to increase to the next dollar, any increased retail milk prices caused by the Compact would have been absorbed by program participants in the NEDC states.

Regarding USDA’s other major nutrition assistance programs, such as the Special Supplemental Nutrition Program for Women, Infants, and Children (WIC), and the National School Breakfast and Lunch Programs, USDA has concluded that federal costs have not increased as a result of the NEDC. Federal WIC program costs have not increased because WIC is a discretionary grant program. Federal school breakfast and lunch program costs have not increased because the level of federal reimbursements is based on the average price of a large variety of food items, which is relatively insensitive to changes in the retail price of milk. Because federal funding for WIC and school breakfast and lunch programs have not increased, those state or local agencies or organizations that provide program benefits or program participants have had to absorb any increase in retail milk prices caused by the NEDC. Although the 1996 farm bill does not require the Compact to do so, the commission compensates the six states for the increased milk costs incurred by the WIC and school programs that are estimated to be attributable to the NEDC. Through December 2000, the NEDC provided state WIC programs a total of $3.8 million, and the schools a total of $662,606.

Should compacts be expanded to include additional states, smaller increases in retail milk prices within the compact states would be necessary to increase the national average retail milk price and, hence the level of Food Stamp Program benefits and federal funding. For example, USDA estimates that should retail milk prices increase by about 20 cents per gallon—an amount similar to the immediate increase in the NEDC states when the commission established an NEDC price—within a compact of states that represents 50 percent of the nation’s fluid milk sales, monthly food stamp allotments would be forced up by, on average, $1 to $2. USDA estimates that these increases in monthly food stamp allotments would increase annual Food Stamp Program costs by $60 to $120 million. Nonfederal costs to its other major nutrition assistance programs, including WIC and the school programs, could also increase should compacts be expanded. While two studies analyzed the NEDC’s impact on USDA’s nutrition assistance programs, the studies relied on a limited amount of data on retail milk prices in the six NEDC states, and their results are inconclusive.

Additional details about the NEDC’s impact on USDA’s milk price support and nutrition assistance programs are included in appendix IV.

Estimated 1999 Interregional Impacts of Various Compact Alternatives Increased as Compacts Grew in Size

Our estimates of the interregional impacts of dairy compacts in 1999 on such measures as farm-level prices, milk production, and farm revenue range from minimal to somewhat larger, depending on the size of the compact and the assumptions that we used to run the economic model. The NEDC states account for only about 3 percent of the milk produced in the nation, and we estimate that in 1999 it had little to no impact in other regions of the country on farm-level prices or milk production and, hence, on farm revenue. An expanded NEDC would account for approximately 18 percent of the milk produced in the nation, and we estimate that in 1999 it would have had a larger but still relatively small impact on farm-level prices, milk production, and farm revenue in other regions of the country. An expanded NEDC, in conjunction with a southern compact, would account for approximately 27 percent of the quantity of milk produced in the nation, and we estimate that in 1999 it would have had a somewhat larger impact on farm-level prices, milk production, and revenue in other regions of the country. These estimates are comparable to other economists’ estimates of the interregional impacts of dairy compacts of different sizes.

In general, if dairy farmers located within a compact region received higher farm-level milk prices than they would otherwise have received, they would respond by increasing their raw milk production. Moreover, these higher farm-level milk prices would likely lead to higher fluid milk retail prices in the compact region—prices that would lower consumer purchases of fluid milk in that region. These two effects in the compact region—greater raw milk production and lower consumer fluid milk purchases—would increase the national supply of raw milk that was available for the manufacture of other dairy products, such as cheese, butter, and nonfat dry milk. In turn, this increase in the national supply of milk for manufacturing purposes would result in lower farm-level prices for raw milk to be used for manufacturing purposes. Because minimum Class I prices are based on the prices paid for raw milk to be used for manufacturing purposes, farmers in noncompact regions would receive lower farm-level prices for all classes of milk and, thus, lower blend prices. Other things being equal, dairy farmers in noncompact regions would respond to lower farm-level prices by reducing their milk production.These two effects in noncompact regions—lower farm-level prices and reduced production—would cause farm revenue there to fall. This impact would be particularly significant for dairy farmers in regions such as the Upper Midwest, where most milk is used for manufacturing purposes. Farmers in noncompact regions who ship their milk to compact regions may be eligible to receive the compact region’s farm-level price for that milk, which could offset the loss in revenue associated with lower farm- level prices for milk. If the compact price is sufficiently high, any increased transportation or shipping costs could be offset.

To assess the likely interregional impacts of each compact alternative or scenario, we derived an initial set of estimates that represents the impact of that alternative in 1999, given an initial set of assumptions. We then changed key assumptions to analyze how sensitive our initial estimates were to such changes. In general, these sensitivity analyses demonstrated that our initial estimates were not very sensitive to changes in the key assumptions. (For a more detailed description of our initial and subsequent sets of assumptions, see app. II.) Accordingly, we present our estimates of the impacts of the different compact scenarios as ranges that include our initial set of estimates and the results of our sensitivity analyses. In addition, we present these estimates as changes from our 1999 baseline estimates, which represent the estimated values of farm-level and wholesale-level dairy indicators in that year in the absence of any dairy compact—our “no-compact scenario.”

Our estimates apply only to 1999, and they may not represent the interregional impacts of compacts in all years. In particular, these estimates are based on data for the period prior to USDA’s milk marketing order regulatory reforms in January 2000, which have affected some dairy sector indicators, such as farm-level milk prices. Furthermore, farm-level milk prices in 1999 were higher than they were in some other years, and we anticipate that, other things being equal, compacts have less of an impact in years when farm-level prices are relatively high. In addition, although our estimated impacts of compacts on noncompact regions for both 1999 and 2000 are relatively small, the impacts on some individual dairy farmers, such as small producers with marginal profitability, in noncompact regions could be significant.

Finally, as in any modeling effort, there is some uncertainty about a model's structure and the data and assumptions used. In addition, the model that we used was limited in its ability to distinguish between shipments of bulk raw milk and packaged fluid milk into regions that import milk to meet their demand because the model is an annual model, and such shipments are frequently seasonal. (See app. II for a discussion of this as well as other modeling limitations.) Despite this uncertainty and limitation, we believe that the process for developing our estimates was rigorous and that the model is comprehensive and sound. Given these conditions, our estimates should be interpreted as indicative of the order of magnitude of changes in farm and wholesale economic values, rather than as precise estimates.

Appendix V provides more detailed information about our estimates of the impacts of the three compact alternatives on 1999 farm-level prices, production, and revenue in noncompact regions, as well as on national average wholesale-level prices and national wholesale-level production and expenditures.

Interregional Impacts of the NEDC in 1999 Were Small

We estimate that the NEDC resulted in small economic impacts in noncompact regions in 1999. Specifically, we estimate that the largest reductions in farm-level revenue under the NEDC compared with the no- compact scenario occurred in California and the Upper Midwest region: from $4 million to $11 million and from $4 million to $9 million, respectively. Table 3 provides our estimates of the extent to which the NEDC reduced farm-level revenue—that is, the value of all milk sold by dairy farmers—in these two regions and in all noncompact regions combined.

These estimated impacts on farm-level revenue were small because dairy farmers in the NEDC states produced only about 3 percent of the nation’s milk supply. As a result, any increased supply of milk that was available for manufacturing purposes in 1999 from NEDC farmers was small compared with the nation’s total milk supply for manufacturing purposes. Therefore, the impact on farm-level prices and milk production, and hence on farm revenue, for producers outside the compact region was also small. For example, we estimate that, as a result of the NEDC, farm-level prices in all noncompact regions remained unchanged or fell by no more than 2 cents per hundredweight, or less than 0.20 percent, while milk production for all noncompact regions combined fell by less than 0.06 percent.

We estimate that, in 1999, the NEDC’s impact on the national average wholesale prices of manufactured dairy products was also minimal. For example, we estimate that the wholesale prices per hundredweight for American cheese were 3 to 9 cents lower and for butter about 3 to 23 cents lower than they would have been under the no-compact scenario. These estimated differences, even at the upper ends of these ranges, represent about 0.06 and 0.19 percent, respectively, of our estimated 1999 wholesale American cheese and butter prices under the no- compact scenario.

Interregional Impacts of an Expanded NEDC in 1999 Would Also Have Been Relatively Small

We estimate that, in 1999, the interregional impacts of an expanded NEDC that included five additional states would have been a little larger than the impacts of the NEDC, but still small. Specifically, we estimate that, compared with our analyses using the no-compact scenario, dairy farm revenue in 1999 would have been reduced the most in the Upper Midwest region—by $13 million to $24 million. Table 4 provides our estimates of the extent to which an expanded Northeast Compact would have reduced farm-level revenue in the Upper Midwest and in all noncompact regions combined.

As under the NEDC scenario, we estimate that the impact of an expanded NEDC would have been relatively small because dairy farmers in the 11 states included in the expanded Compact produced only about 18 percent of the nation’s milk supply. As a result, any increased supply of milk that would have been available for manufacturing in 1999 from those farmers, although a little larger than with the NEDC, would have still been small compared with the nation’s total milk supply for manufacturing. Therefore, the impact on farm-level prices and milk production, and hence on farm revenues, for producers outside the expanded Compact region would have been small. For example, under the expanded NEDC scenario we estimate that, compared with our no-compact scenario, farm-level prices in noncompact regions would have fallen by no more than 6 cents per hundredweight or less than 0.5 percent, while milk production for all noncompact regions combined would have been lower by about 0.21 percent or less.

We estimate that, in 1999, the impact of an expanded NEDC on the national average wholesale prices of manufactured dairy products would have been a little larger than the impact of the NEDC, but still relatively small. For example, we estimate that the wholesale prices per hundredweight for American cheese would have been about 18 to 41 cents lower and for butter 46 to 88 cents lower than under our no-compact scenario. These differences, even at the upper ends of these ranges, represent less than 0.3 and 0.7 percent, respectively, of our estimated 1999 wholesale American cheese and butter prices under the no-compact scenario.

Interregional Impacts of an Expanded NEDC Combined With a Southern Compact in 1999 Would Have Been Somewhat Larger

We estimate that, in 1999, the interregional impacts of an expanded NEDC in conjunction with a southern compact—a total of 23 states—would have been somewhat larger than the impact of our other compact scenarios. Specifically, under this scenario and using the same assumption about fluid milk trade between regions as used in the previous scenarios, compared with our no-compact scenario we estimate that dairy farm revenue in 1999 would have been reduced the most in California and in the Upper Midwest and Mideast regions: $26 million to $118 million, $26 million to $63 million, and $21 to $43 million, respectively.Table 5 provides our estimates of the extent to which an expanded NEDC in conjunction with a southern compact would have reduced farm-level revenue for milk in these regions and for all noncompact regions combined, in 1999.

The estimated impact of the expanded NEDC in conjunction with a southern compact is relatively larger because dairy farmers in the states included in these compacts produced about 27 percent of the nation’s milk supply. As a result, any increased supply of milk that would have been available for manufacturing purposes in 1999 from farmers in these states would have been somewhat larger than under the previous scenarios. Therefore, the impact on farm-level prices and milk production, and hence on farm revenues, for producers outside the compact regions would have been somewhat larger. For example, we estimate that farm-level prices in noncompact regions could have fallen by as much as 36 cents per hundredweight or about 2.6 percent compared with our no-compact scenario, while milk production for all noncompact regions combined could have fallen by as much as 0.75 percent.

We estimate that, in 1999, the impacts of an expanded NEDC in conjunction with a southern compact on the national average wholesale prices of manufactured dairy products would have been somewhat larger than the impacts of our other scenarios. For example, compared with the estimated wholesale prices under our no-compact scenario, we estimate that the prices per hundredweight would have been about 62 cents to $1.41 lower for American cheese and between 21 cents higher and $6.53 lower for butter. At the upper end of these ranges, these differences represent about 1.0 percent and 5.5 percent, respectively, of our estimated 1999 wholesale American cheese and butter prices under our no-compact scenario.

For the expanded NEDC plus a southern compact scenario, we found that our estimates of interregional impacts were sensitive to our assumption about how much milk can be shipped between noncompact and compact regions. In particular, our estimated impacts for 1999 of an expanded NEDC in conjunction with a southern compact on noncompact regions would have been greater if we had used a more restrictive assumption that limits the amount of milk that can be shipped from noncompact into compact regions. Specifically, we estimate that using a more restrictive assumption increases our estimate of how much farm-level prices, milk production, and farm revenues in noncompact regions would have fallen in 1999 under this scenario compared with under our no-compact scenario. Table 6 shows our estimated reductions in farm revenues for raw milk in California and the Upper Midwest and Mideast regions, and all noncompact regions combined under our restricted fluid milk trade assumption compared with under our no-compact scenario.

We also estimate that the impact in 1999 of an expanded NEDC in conjunction with a southern compact on the national average wholesale prices of some manufactured dairy products would have been greater under the more restrictive fluid milk trade assumption than without that restrictive trade assumption. For example, under the more restrictive trade assumption, we estimate that the price per hundredweight for American cheese would have been about $1.27 to $1.86 lower than under our no-compact scenario. However, for butter we estimate that the impact with the restrictive trade assumption would have been smaller than the estimated impact without the restrictive trade assumption. Under the restrictive trade assumption, we estimate that the price per hundredweight for butter would have changed from 7 cents higher to $2.80 lower than under our no-compact scenario. At the upper end of these ranges, these differences represent about 1.3 and 2.3 percent, respectively, of our estimated 1999 wholesale prices for American cheese and butter under our no-compact scenario.

Using Farm-Level Prices for 2000 as Opposed to 1999 Has a Limited Influence on the Estimated Impacts of Compacts

As noted previously, the farm-level prices that we used in our model can affect our estimates of the impacts of compacts on dairy sector indicators such as farm-level revenue. In 1999, the national average blend price was $14.09 per hundredweight of milk; in 2000, the national average blend price was $12.11 per hundredweight of milk. With lower farm-level prices in 2000 than in 1999, the difference between a compact price in our model and the federal milk marketing order Class I minimum price was larger in 2000 than in 1999. As a result, the increase in milk production and decrease in fluid milk purchases that would have likely occurred within a compact region in 2000 would be expected to be greater than when farm- level prices were higher, as they were in 1999. This situation, in turn, would imply a greater increase in the supply of milk available for manufacturing dairy products in 2000, which, other things being equal, would lead to lower farm-level prices, reduced milk production, and lower farm-level revenue in noncompact regions.

However, on the basis of preliminary data for 2000, we estimate that the impacts of our three compact scenarios, which are based on our initial set of assumptions, are generally similar to our initial estimates for each scenario in 1999. Even though our estimates are generally similar, when we impose our more restrictive fluid milk trade assumption on our scenario of an expanded NEDC in conjunction with a southern compact, our estimates of the impact on the Upper Midwest are slightly greater for 2000 than for 1999. The similarities between our 2000 and 1999 estimates suggest that other factors may be affecting our estimates for 2000.

In those years when noncompact farm-level prices are lower than compact farm-level prices, a factor offsetting the potentially larger interregional impacts of compacts is the ability to market noncompact region milk in compact regions for use as fluid milk. Farmers in noncompact regions whose milk is marketed in compact regions for use as fluid milk may be eligible to receive the compact regions’ farm-level blend price for that milk. When noncompact region farm-level blend prices are low, the gain to farmers from shipping milk to compact regions is greater than when noncompact region prices are high. This gain can partially offset the larger negative impact that compacts can have on revenue in noncompact regions when farm-level prices are low because of the increased supply of milk available for manufacturing purposes. Table 7 provides our estimates of the impacts of the compact scenarios on 2000 farm-level revenue in the Upper Midwest region and all noncompact regions.

Appendix VI contains our estimates of the interregional impacts of compacts on 2000 farm-level and wholesale-level dairy sector indicators.

Other Economic Analyses of Interregional Dairy Compacts Have Produced Similar Estimates

We reviewed other studies of the interregional impacts of the NEDC and larger dairy compacts and found that the results are comparable with ours, even though they used different methodologies. In a 1999 analysis, USDA estimated that the impact of the NEDC on farm-level prices and dairy farm revenue in noncompact regions during the years 2000 through 2005 would have been minimal. For example, USDA estimated that in 2000 the NEDC would either have no impact on producer prices in noncompact regions or reduce producer prices by about 1 cent per hundredweight of milk, or by about 0.07 percent, depending on the noncompact region of the country. An analysis conducted by researchers at the University of California, Davis, also estimated that the NEDC reduced producer prices in noncompact regions by about 2 cents per hundredweight of milk, or by about 0.15 percent, on the basis of 1999 data. The researchers concluded that the NEDC had such a small impact because the NEDC states produced such a small portion of the nation’s milk supply. They also estimated that if the Compact had been expanded to include additional states that produced 9 percent of the nation’s milk supply, producer prices in noncompact regions would have fallen by about 5 cents per hundredweight, or by about 0.35 percent. An analysis conducted by a researcher at Pennsylvania State University of an expanded NEDC in conjunction with a southern compact that produced 27 percent of the U.S. milk supply also concluded that compacts have a relatively small impact.Using a range of assumptions about milk prices and data for 1997, the researcher projected that in 2000, the compact would decrease producer prices in noncompact regions by 4 to 14 cents per hundredweight, or by about 0.3 to 1 percent. Researchers at the University of Wisconsin- Madison, using a 1997 version of the Interregional Dairy Competition Model that we used in our analysis, also estimated that the NEDC had a small impact on producer prices. This analysis estimated that farm-level prices would fall from 5 to 10 cents per hundredweight under an expanded NEDC scenario; 13 to 15 cents per hundredweight under a southern compact scenario; and 14 to 28 cents per hundredweight under a combined expanded NEDC and southern compact scenario. In an analysis of the impact of compacts prepared for the International Dairy Foods Association, one researcher estimated that the NEDC reduced farm-level revenue in noncompact regions in 2000 by about $29 million, while an expanded 29-state compact would reduce farm-level revenue in noncompact regions by about $374 million.

A more detailed discussion of these studies is included in appendix VII.

Concluding Observations

By affecting the minimum prices that dairy farmers within the Compact region receive for their raw milk, the NEDC may have enhanced dairy farmer income in the six NEDC states, and other states such as New York, that supply raw milk used for and sold as fluid milk in the NEDC states. It is not certain, however, whether the NEDC will help ensure the continued vitality of dairy farming in the New England dairy region. Data indicate that the number of dairy farms in the six states continued to decrease following the NEDC's establishment in July 1997. With regard to retail prices, the NEDC contributed to increased retail fluid milk prices within the six states, although the extent of its contribution is uncertain. Even so, available evidence and analyses indicate that the NEDC has had little impact on dairy farmers or consumers in noncompact regions.

Proposals are pending before the Congress for larger compacts. Our analysis shows that as the share of the U.S. milk supply covered by compacts increases, the estimated interregional impacts on farm-level prices and revenue increase as well. Furthermore, these estimated impacts could be different under new marketing conditions. Our estimates of the interregional impacts of compacts are based primarily on data from before January 2000, when USDA’s regulatory reforms took effect. Data since January 2000 indicate that the dairy industry is in the process of adjusting to these substantial changes. Equally as important, our estimates of the interregional impacts are based on three compact scenarios, the largest of which includes fewer than the number of states currently being considered for inclusion in dairy compacts. A thorough understanding of the impacts of these other potential compacts on dairy sector indicators cannot be developed until sufficient data become available following the dairy industry’s adjustment to regulatory reform.

Agency Comments and Our Response

We provided USDA and the Executive Director of the NEDC with a draft of this report for review and comment. On September 5, 2001, we met with USDA's Chief Economist, Dairy Programs, Agricultural Marketing Service, and other officials from USDA's Agricultural Marketing Service, Economic Research Service, Farm Service Agency, Food and Nutrition Service, National Agricultural Statistics Service, and the Department's Office of the Chief Economist to obtain their oral comments. USDA officials stated that they recognized the difficulty of undertaking a study of this nature and said that our work represents a reasonable effort to estimate the intraregional and interregional impacts of dairy compacts. They provided a number of technical corrections and suggestions, which we incorporated as appropriate.

We also discussed the draft report with the NEDC Executive Director, who stated that we had dealt with the issues in a constructive and comprehensive manner. The NEDC Executive Director also provided us with written comments. While concurring with our estimate of the interregional impacts of the NEDC, the Executive Director expressed concern that the University of Wisconsin-Madison dairy model did not measure the benefits that New York dairy farmers receive when they supply milk to the NEDC states. We concur that the model does not measure the impacts of compacts on noncompact states that are within the same region as compact states. As the model is designed, New York and the NEDC states, as well as several other states, are included in the same (Northeast) region. The NEDC Executive Director's written comments and our detailed responses appear in appendix VIII.

We performed our work between September 2000 and September 2001 in accordance with generally accepted government auditing standards. Appendix I contains a detailed description of our scope and methodology.

We are sending copies of this report to the Senate Committee on Agriculture, Nutrition, and Forestry; the House Committee on Agriculture; other appropriate congressional committees; the Secretary of Agriculture; the Executive Director of the NEDC; the Director, OMB; and other interested parties. We will also make copies available to others upon request.

Please contact me at (202) 512-3841 if you or your staff have any questions about this report. Another GAO contact and key contributors to this report are listed in appendix IX.

Appendix I: Objectives, Scope, and Methodology

In May 2000, Senator Herbert Kohl requested that we examine the economic impacts of the Northeast Interstate Dairy Compact (NEDC) and other potential compacts on a variety of dairy sector indicators. Specifically, because legislation authorizing the Compact is to expire on September 30, 2001, and the Congress is considering legislative alternatives for reauthorizing the NEDC and authorizing other states to enter into such compact arrangements, Senator Kohl asked us to provide information on the intraregional impacts of the NEDC (that is, within the six NEDC states of Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, and Vermont) on dairy sector indicators such as (1) retail milk prices, (2) milk producer income, (3) dairy farm structure, (4) milk production, and (5) milk consumption; the impact of the NEDC on the costs to the federal government of its milk price support and nutrition assistance programs; and the interregional impacts of the NEDC, an expanded NEDC, and an expanded NEDC in conjunction with a southern compact (that is, on noncompact milk-producing regions) on selected indicators such as farm- level and wholesale-level indicators such as prices, production, and revenue.

NEDC’s Intraregional Impacts

To determine the intraregional impacts of the NEDC, we sought, but did not find, a readily usable economic model that comprehensively estimates these impacts while holding constant other factors that also affect the selected dairy sector indicators. Further, due to time and resource constraints, we were not able to develop a model or series of models to estimate these impacts. As a result, we analyzed federal, state, and other data on these indicators, for a period of time before and after the NEDC’s minimum pricing regulations became effective, to determine any changes in historic trends in the NEDC states. In each case, we also obtained these data for the rest of the United States so that we could compare trends in New England with those in the rest of the country. We also reviewed available studies on the NEDC’s potential impacts on the indicators.

Specifically, to determine the impacts on retail milk prices, we obtained and analyzed retail milk price data from (1) A.C. Nielsen, a private data collection and analysis company, for the Boston market as well as for other major U.S. cities for November 1996 through September 2000; (2) the departments of agriculture in Connecticut, Maine, and New Hampshire for November 1996 through October 2000; and (3) the International Association of Milk Control Agencies for those states that have independent milk pricing agencies for January 1994 through November 2000. We also reviewed available economic analyses of the NEDC’s impact on retail milk prices and interviewed USDA’s Agricultural Marketing Service and NEDC officials to obtain their views on the NEDC’s impact on retail milk prices.

To examine the intraregional impacts of the NEDC on milk producer income, we compared USDA’s Economic Research Service balance sheet and income statement data from 1991 through 1999 for a representative composite dairy farmer in the Service’s northeastern region with data for a farmer located outside the northeastern region. The Economic Research Service’s northeastern region includes Connecticut, Delaware, Massachusetts, Maryland, Maine, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont. States outside the northeastern region include all states with the exception of these 11 states and Alaska and Hawaii. The Service was not able to provide data for a representative composite farmer in the six NEDC states alone because the sample size was not sufficiently large to produce reliable balance sheet and income data. The Economic Research Service develops these data through surveys of sampled farm operations. It collects data on operating costs—such as feed, equipment purchases, and product distribution—as well as data on returns, such as income received from sales of field crops and livestock. The Service uses information obtained from sampled farms to estimate the average costs of milk production in the United States and in various regions in the country. Costs can vary significantly from farm to farm because of differences in farm location, size, and production practices. As a result, the costs and returns for an individual farm can vary considerably from the average. In addition to using Economic Research Service data to estimate the impact of the NEDC on farm income, we also estimated the average payment a licensed dairy farmer in one of the six NEDC states may have received between July 1997 and the end of calendar year 2000 as a result of the NEDC. To do this, we used (1) monthly NEDC balance sheets that reflect the total amount of milk eligible for the NEDC milk price and NEDC over-order producer price payment amounts available for dairy farmers, (2) USDA’s National Agricultural Statistics Service milk production data for the six NEDC states, and (3) American Farm Bureau Federation data on the number of licensed dairies in the six states. To determine the average payment, we estimated what proportion of the milk eligible for the NEDC milk price could be attributed to a licensed NEDC dairy farmer’s milk. We also reviewed available economic analyses of the potential impacts of the NEDC on dairy farmer income. Last, we obtained data developed by the NEDC commission on amounts distributed to farmers as a result of the Compact, and its assessment of the Compact's impact on farmer income.

To determine the intraregional impacts of the NEDC on dairy farm structure, we obtained National Agricultural Statistics Service data on the total number of cows in the NEDC and the rest of the United States, as well as state-by-state data on the number of farms having at least one milk cow between 1992 and 2000. We obtained data from the American Farm Bureau Federation on the number of licensed dairies in the United States, by state, between 1992 and 2000. We also reviewed information on factors that affect the structure of dairy farms, and interviewed officials from the Agricultural Marketing Service, the Economic Research Service, the National Agricultural Statistics Service, and the NEDC commission to obtain their views of the Compact’s impacts on farm structure.

To determine the intraregional impacts of the NEDC on milk production, we reviewed National Agricultural Statistics Service data on the average amount of milk produced by state and the average amount of milk produced per dairy cow between 1993 and 2000. We also reviewed available economic analyses of the impacts that the NEDC may have had on milk production. In addition, we interviewed officials from the Agricultural Marketing Service, the National Agricultural Statistics Service, and the NEDC to obtain their views on the NEDC’s impact on milk production.

To examine the intraregional impacts of the NEDC on milk consumption, we reviewed Agricultural Marketing Service data on the total amount of sales of packaged fluid milk products in federal milk marketing orders and California between 1996 and 1999. Such sales are representative of the consumption of fluid milk products and account for about 93 percent of fluid milk sales in the United States. In addition, we reviewed data on factors affecting milk consumption and available economic studies of the NEDC’s impact on milk consumption.

NEDC’s Impacts on Federal Programs

To examine the impacts of the NEDC on the costs of the federal government’s milk price support program, we reviewed USDA Farm Service Agency analyses of estimated amounts of milk production in the six NEDC states compared with the rest of the United States. We also reviewed USDA and Compact data on payments made to USDA by the NEDC. In addition, we interviewed Farm Service Agency and NEDC officials to obtain information on payments made by the NEDC. To examine the intraregional impacts on nutrition assistance programs, we interviewed USDA Food and Nutrition Service officials and obtained that agency’s analyses of the potential impact of the NEDC on its programs. We also interviewed officials responsible for each of the six states’ Special Supplemental Nutrition Program for Women, Infants and Children and school nutrition programs. Finally, we reviewed available economic analyses of the estimated impact of the NEDC on nutrition assistance programs.

Compacts’ Interregional Impacts

To examine the interregional impacts—that is, the economic impacts in other regions of the country—of the NEDC, an expanded NEDC, and an expanded NEDC in conjunction with a southern compact, we conducted policy simulations using the University of Wisconsin-Madison’s Dairy Sector Interregional Competition Model calibrated to reflect the dairy industry in 1999 (IRCM99). We contracted with the University to have Dr. Thomas L. Cox, Professor of Agricultural and Applied Economics and a primary developer of the model, conduct the policy simulations. Working with Dr. Cox and consulting with other prominent dairy economists from different regions of the country, we developed a set of parameters for use in simulating different compacts’ impacts on dairy sector indicators.

We modeled three different compacts—the NEDC, an expanded NEDC, and an expanded NEDC in conjunction with a southern compact— consisting of an increasing number of states. The states in the NEDC are Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, and Vermont. The states that we assumed to be included in the expanded NEDC are these six states and Delaware, Maryland, New Jersey, New York, and Pennsylvania. The states that we assumed to be included in the expanded NEDC in conjunction with a southern compact are the above 11 states and Alabama, Arkansas, Georgia, Kansas, Kentucky, Louisiana, Missouri, Mississippi, North Carolina, South Carolina, Tennessee, and Virginia. The above states included in an expanded NEDC and a southern compact were selected because they had enacted legislation, as of the end of February 2001, that authorized their entry into a dairy compact should the Congress establish one. While West Virginia had also enacted such legislation as of the end of February 2001, we did not include that state in a southern compact for the purposes of our analysis because of the difficulties associated with accounting for that state’s milk production in compact versus noncompact regions of the country. Furthermore, because West Virginia produces a relatively small amount of milk in comparison with other states included in compact regions, the effect of excluding West Virginia is negligible.

The agricultural economists and other dairy experts with whom we consulted concerning model specifications and assumptions include the following: Kenneth W. Bailey, Associate Professor, Department of Agricultural Economics and Rural Sociology, the Pennsylvania State University; Joseph V. Balagtas, Research Assistant, Department of Agricultural and Resource Economics, University of California, Davis; Scott Brown, Research Assistant Professor, Food and Agricultural Policy Research Institute, the University of Missouri; Harold M. Harris, Jr., Professor, Department of Agricultural and Applied Economics, Clemson University; Harry Kaiser, Professor, Department of Applied Economics and Management, Cornell University; Richard L. Kilmer, Professor, Food and Resource Economics, the Leigh Maynard, Assistant Professor, Department of Agricultural Economics, the University of Kentucky; Neil Pelsue, Extension Associate Professor, Department of Community Development and Applied Economics, the University of Vermont; William A. Schiek, Economist, Dairy Institute of California; Mark Stephenson, Senior Extension Associate, Department of Applied Economics and Management, Cornell University; Daniel Sumner, Professor, Agricultural and Resource Economics Department, University of California at Davis; Cameron S. Thraen, Associate Professor, Agricultural, Environmental, and Development Economics, the Ohio State University; and Christopher Wolf, Assistant Professor, Department of Agricultural Economics, Michigan State University.

In addition, we consulted with several agricultural economists at USDA, including economists in the Office of the Chief Economist and the Economic Research Service.

Our process for developing the assumptions that we used to model the interregional impacts of dairy compacts included reviewing economic literature to identify estimates of (1) regional supply elasticities, (2) wholesale demand elasticities, (3) and transportation costs. We also obtained data on market over-order premiums and compact over-order producer prices. Finally, we interviewed USDA and other officials to obtain information on regulations governing milk shipments among federal marketing orders and noncompact and compact regions.

After identifying assumptions for modeling the three different compact scenarios, we developed an initial estimate of the economic impacts of the different compacts. We then conducted sensitivity analyses by varying the values of our key assumptions. We provided our preliminary estimates to several agricultural economists to obtain their views, and incorporated many of their comments in subsequent modeling before developing our final range of estimates. Our final estimates of the impacts of the different compact scenarios are presented as ranges that include our initial estimates as well as estimates from our sensitivity analyses. (A detailed discussion of the model and assumptions, data, and data sources used is included in app. II.)

In addition to modeling the interregional impacts of the different compact scenarios, we reviewed economic analyses that have been conducted on the potential interregional impacts of dairy compacts. We present these reviews in appendix VII.

Appendix II: Methodology for Estimating the Interregional Impacts of Dairy Compacts

This appendix describes our methodology for estimating the interregional impacts of three compact scenarios: the six-state NEDC, an expanded NEDC, and an expanded NEDC in conjunction with a southern compact. To estimate the interregional impacts, we contracted with the University of Wisconsin-Madison to use the Dairy Sector Interregional Competition Model (IRCM), which is an interregional spatial market equilibrium model of the U.S. dairy sector. This model is useful in estimating the impacts of different dairy policy options, such as dairy compacts. Dr. Thomas L. Cox, Professor of Agricultural and Applied Economics at the university and a primary developer of the model, conducted the policy simulations for us. This appendix describes the structure of the IRCM and how it estimates the interregional impacts of dairy compacts, data and data sources used for conducting policy simulations of different how we calibrated a baseline for 1999, details of each scenario that we modeled, parameter values for our baseline and initial estimates, how we varied key assumptions to test the sensitivity of our initial estimates, and the limitations of the model.

The results of our different policy simulations and sensitivity analyses are presented in appendixes V and VI.

IRCM Structure

The IRCM is a hedonic spatial equilibrium model of the U.S. dairy sector that can be used to estimate the impacts of policy or program changes, such as the establishment of compacts. The model allocates the production and consumption of raw milk and nine other different dairy commodities among 12 regions of the country and solves for the trade flows of these commodities among those regions to achieve a spatial equilibrium. Using nonlinear programming techniques, the model solves to ensure an efficient regional distribution of the different dairy commodity resources, given the demand for and supply of those resources at various prices.

On a more technical basis, the model solution maximizes the sum of producer and consumer welfare minus processing, transportation, and U.S. Department of Treasury costs. The model defines aggregate wholesale dairy product demand and farm-level milk supply functions as follows: (1a) D = (1b) where pregion, with ∂p/∂w > 0, i = 1, …, J, and pik (w) is the price-dependent supply function for milk in the i-th (zik) is the price-dependent demand function for the k-th dairy product consumed in the i-th region, /∂zik < 0, i = 1, …, J, k = 1, …, K. Equation (1a) is the sum of the areas under the K demand curves in the i-th region. This can be interpreted as a measure of consumer benefits generated by the K commodities in the i-th region. Equation (1b) is the area under the supply curve, a measure of milk production cost in the i-th region. The term (D – S), consumer benefits minus total production costs in the i-th region, minus transportation costs, is a measure of net social benefits to farmers and consumers in each region. Federal government costs are then subtracted.Two steps are used to create an IRCM that models the impact of compacts in 1999: IRCM99. First, the model is calibrated to 1999 data so that baseline estimates of key dairy sector measures of prices, production, consumption, and trade flows can be obtained on a regional basis. Second, simulation analyses are performed to estimate the impacts of the different compact scenarios.

In the IRCM99, milk production and dairy product consumption in the country are divided into 12 regions that are based on the current 11 USDA federal milk marketing orders and California. In addition, the IRCM99 accounts for net private stocks, net government stocks/removals, and U.S. imports and exports. Table 8 compares the IRCM99 regions, the corresponding USDA marketing orders or states before January 2000, states included in the IRCM99 regions, and states that had enacted legislation as of February 2001 authorizing entry into any congressionally authorized dairy compact.

Figure 1 shows USDA’s marketing orders, the corresponding IRCM99 regions, the corresponding states included in the IRCM 99 regions, and states that had enacted legislation authorizing entry into a compact as of February 2001. With respect to modeling the impact of compacts, the states that have enacted legislation are part of four different federal milk marketing orders and their corresponding IRCM99 regions. Because of this, both compact and noncompact states are included in some IRCM99 regions when modeling some compact alternatives. This can influence the interpretation of modeled results. For example, some states that have enacted legislation authorizing entry into a dairy compact, such as West Virginia, which is part of the Mideast Marketing Order, produce only a small portion of the milk produced by dairy farmers in that marketing order and hence, estimating the effect of West Virginia’s participation in a compact, would be difficult.

IRCM99 solves for regional prices and production levels for farm-level raw milk on the basis of three milk components: milk fat, protein, and carbohydrates (primarily lactose). The model also solves for regional wholesale-level price, supply, demand, and trade flows for the following dairy products: (1) fluid milk, (2) soft dairy products, (3) American cheese, (4) Italian cheese, (5) other cheese, (6) butter, (7) frozen dairy products, (8) other manufactured dairy products (a residual product category), and (9) nonfat dry milk. The model uses a fixed component composition that converts farm milk into fluid milk and different types of manufactured dairy commodities, as shown in table 9.

The regional supply of milk components (milk fat, protein, and carbohydrates) must be greater than or equal to the regional utilization of these milk components by the processing sector to ensure regional component supply/demand balance. The marginal value of this restriction (given by the corresponding Lagrange multiplier) measures the shadow value of each milk component in each region. The model subsequently generates empirical estimates of regional shadow prices for each milk component. The model also generates market prices that are consistent with milk component pricing for each commodity in each region.

Modeling Classified Pricing

The basic structure of the IRCM99 is consistent with a competitive market equilibrium, where, at the optimum, the market price equals the marginal cost of each commodity. However, USDA and California use a system of classified pricing for milk that influences pricing in ways that differ from the competitive outcome. Therefore, to incorporate the classified pricing system, price wedges are used in the model to represent the difference between the minimum price of milk in a particular class and the minimum price of milk in a reference class. In the model, the reference class for USDA’s milk marketing orders is Class III, and the reference class for California is 4b. For example, the price wedge for raw milk used for fluid milk is the difference between the price for milk used for Class I (fluid) and the price for milk used for Class III (cheese), plus potential over-order premiums. For USDA’s milk marketing orders in 1999, we calculated the price of raw milk used for manufacturing (Classes II, III, and IV) as the implicit price of milk used for Class II and Class III in the Upper Midwest Milk Marketing Order (portions of Illinois, Iowa, Michigan, Minnesota, North Dakota, South Dakota, and Wisconsin). USDA milk marketing order prices for nonfat dry milk and butterfat differentials are computed by using USDA formulas and wholesale commodity prices. California milk prices are calculated for milk used in fluid products (Class 1); milk used for heavy cream, cottage cheese, yogurt, and sterilized products (Class 2); milk used in ice cream and other frozen dairy products (Class 3); milk used in butter and nonfat dry milk (Class 4a); and milk used in cheese other than cottage cheese (Class 4b). We computed California price wedges by using administered formulas for the fat and solids-not-fat component prices by class. These component prices are computed from wholesale commodity prices for butter, nonfat dry milk, and cheese that are endogenous to the model. Because Class 4a prices were lower than Class 4b prices in 1999, this method implies a negative price wedge in California for Class 4a. Finally, because dairy farmers are paid blend prices based on USDA and California’s classified pricing systems, we incorporated price wedges that represent these blend prices in each of the respective modeled regions.

Modeling Producer Settlement Pools

We took into account pooling regulations for both USDA and the NEDC in modeling “producer settlement pools.” The first step in this calculation is to compute total revenues from regional milk production under the assumption that all raw milk is pooled in the region where it is produced. This is done in each region by multiplying the price wedge for each commodity by the quantity of raw milk used to produce that commodity. However, by shipping some of their milk to another order, producers can sometimes become eligible to receive the minimum prices in the destination order for their milk, which might be higher than the minimum prices in their "home" order. As a result, in estimating how the proceeds from raw milk sales are distributed to producers, through producer settlement pools, the model can adjust its initial estimate to take into account that not all raw milk is pooled in the order where it is produced.

When we estimated the impacts of the compact scenarios, no such adjustments were necessary because the model's solutions did not yield any pooling of raw milk outside any home order. As a result, before taking into account further adjustments described below, the revenue received from milk sales from farmers in any order were the same as they would have been had no adjustment been made and all producers' receipts from milk sales were based on the prices in their home order. We recognize that some milk is pooled outside the order in which it is produced. However, we did not have data on shipments of raw milk by individual farmers or shipments of fluid milk or other dairy commodities by individual processing plants, which limited the model's ability to estimate raw milk movements across orders. Instead, the model solution includes substantial movement of packaged fluid milk to balance supply and demand across orders. If enough packaged fluid milk moves out of an order, the model's structure allows for further adjustments to be made in the producer settlement pools, but there was no region affected in this way.

However, the producer settlement pools were adjusted for the movement of packaged fluid milk into compact regions under the various scenarios that we analyzed. These adjustments were made because processors in exporting regions shipping packaged fluid milk into compact regions are required to pay a compact premium on this milk. Similarly, these processors can return to their producers an amount equal to the compact premium multiplied by the percentage of the compact region's raw milk that is sold for Class I use.

Data Used in the Model

We obtained data for our analysis from several sources, including USDA, the state of California, academia, and research institutes. We obtained most of the price and production data from USDA and the California Department of Food and Agriculture. In particular, we obtained farm-level milk data from USDA’s Milk Production, Disposition and Income—1999 Summary, and commodity production data from USDA’s Dairy Products— 1999 Summary. We obtained commodity price, stock, import, export, and government utilization data from monthly USDA Economic Research Service “Livestock, Dairy, and Poultry” reports. We obtained federal milk marketing order data from USDA’s Agricultural Marketing Service Federal Market Order Milk Statistics—1999 Annual Summary. In addition, we obtained data on price support levels from USDA’s Commodity Credit Corporation.

We obtained regional projections of wholesale dairy product demand by using aggregate wholesale demand functions for the United States and regional population data. We obtained component yields—the amount of milk fat, protein, and carbohydrates per unit of milk and wholesale dairy product—from a component accounting exercise that fully allocates 1999 aggregate milk and dairy product production. We obtained regional farm- level milk supply elasticities from the Food and Agricultural Policy Research Institute and product demand elasticities from research conducted by Cox et al. and USDA’s Economic Research Service. These demand elasticities were estimated using USDA aggregate national time series data on commercial disappearance and wholesale prices. The estimates are consistent with a complete demand system specification covering all major food groups and products. We obtained data on refrigerated and nonrefrigerated transportation and assembly costs for farm milk from dairy researchers at Cornell University. We used USDA estimates of dairy manufacturing costs to incorporate processing costs into our analysis.

1999 Baseline Calibration

We calibrated the model to yield solutions that are close to the observed 1999 data for farm-level and wholesale-level measures of prices and production and to link key regional prices to commodity reference prices used by USDA and California, such as those reported by the Chicago Mercantile Exchange and USDA’s National Agricultural Statistics Service. Tables 10 through 13 compare the 1999 model solutions with actual 1999 data for farm-level prices, farm-level production, wholesale commodity prices, and wholesale commodity production, respectively. At the farm level, the simulated values calibrate closely with the actual data—all discrepancies are 0.5 percent or less, except for the farm-level price in California, for which the discrepancy is about 1 percent. At the wholesale level, the price discrepancies for major products (fluid milk, American and Italian cheeses, butter, and nonfat dry milk) are less than about 3 percent, while production discrepancies are 3.5 percent or less.

Because our baseline was calibrated to actual 1999 data, our original baseline values represented estimates for a time when the Compact was in place. As a result, we used the IRCM99 to estimate the impact of the NEDC by simulating the year 1999 without the NEDC and comparing those results with those obtained in our original baseline. That is, the estimated impacts of removing the Compact from our original baseline are interpreted as the estimated impacts of adding the Compact to a no- compact baseline, with the signs reversed. For each subsequent compact scenario, we used the IRCM99 to estimate the interregional impact of compacts. That is, we compared our estimates of farm-level and wholesale-level prices, production, and revenue in 1999 under each compact scenario with our estimates of what they would have been in that year without any compact. In effect, the no-compact scenario became our new baseline for comparison.

Compact Scenarios

We developed three compact scenarios: the NEDC, which includes Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, and Vermont; an expanded NEDC that also includes Delaware, Maryland, New Jersey, New York, and Pennsylvania; and an expanded NEDC in conjunction with a southern compact that includes Alabama, Arkansas, Georgia, Kansas, Kentucky, Louisiana, Missouri, Mississippi, North Carolina, South Carolina, Tennessee, and Virginia. These states were included in the expanded NEDC and the southern compact on the basis that they had enacted legislation as of the end of February 2001 that would allow them to enter into a dairy compact, should the Congress enact legislation allowing them to do so. While West Virginia had also enacted such legislation as of the end of February 2001, we did not include it in our analysis of an expanded NEDC in conjunction with a southern compact because of the difficulty of modeling West Virginia as part of a southern compact, given that it would have been the only state in USDA’s Mideast Marketing Order whose milk would fall under compact regulation. Since West Virginia produced less than 0.2 percent of the nation’s milk supply in 2000, we do not believe that its omission significantly affects our estimates of the impact of the southern compact.

The IRCM99, as discussed previously, models different regions of the country based, in part, on USDA's milk marketing orders and California. Because of this, the states in the NEDC are incorporated as part of the IRCM99 Northeast region. This region encompasses the following states: Connecticut, Delaware, Maine, Massachusetts, Maryland, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, and Vermont (and the District of Columbia). To account for the NEDC, we calculated the amount of milk produced by the six NEDC states as a percentage of the total amount of milk produced within the Northeast Milk Marketing Order. Therefore, while we are able to estimate the impact of the NEDC on other noncompact regions of the country that do not contain any compact states, we could not estimate the NEDC's impacts on other noncompact states within the Northeast region. Further, because we defined the impacts of the NEDC scenario to be based on the amount of milk produced by the six NEDC states, the impacts of this scenario do not account for milk that noncompact states, such as New York, may ship into the NEDC states. Further, reductions in revenue in noncompact states are also not accounted for. Thus, our estimate of the NEDC's impact on noncompact regions is a little smaller than would be expected had we been able to isolate the effects of noncompact and compact states within the same region.

Similarly, in our scenario of an expanded NEDC in conjunction with a southern compact, the IRCM99 has the compact region extending into four regions: the Appalachian, Central, Northeast, and Southeast. While this compact scenario fully includes the majority or all of the states encompassed by three of the four regions, one region—the Central—is not fully encompassed. The Central region includes the following seven states: Colorado, Illinois, Kansas, Missouri, Nebraska, Oklahoma, and South Dakota. However, only two of these states—Kansas and Missouri—are assumed as part of a compact. As with our modeling of the NEDC, we calculated the amount of milk produced by the two states as a percentage of the total amount of milk produced within the Central region. Therefore, while we are able to estimate the impact of the expanded NEDC in conjunction with a southern compact on noncompact regions of the country that do not contain any compact states, we could not estimate this compact scenario's impact on the Central region. Similarly, under this compact scenario, we do not take into account the amount of milk that may be shipped into the compact states by bordering noncompact states in the Central region. Further, reductions in noncompact producer revenue in these noncompact states was also not accounted for. Thus, our estimate of the expanded NEDC in conjunction with a southern compact's impact on all noncompact regions combined is a little smaller than would be expected had we been able to isolate the effects of noncompact and compact states within the Central region.

Parameter Values for Our Baseline and Initial Estimates

We used specific parameter values to arrive at our baseline, or no- compact, scenario and initial estimates of the impacts of the different compact scenarios. We also used key assumptions regarding the amount of market-driven over-order premiums, compact producer price payment levels, and transportation costs, and the ability of milk to move from region to region.

Specifically, we used a milk price support payment amount, or price floor, of $9.90 per hundredweight of milk, which equates to $1.10 per pound for American cheese, 65 cents per pound for butter, and $1.01 per pound for nonfat dry milk. In addition, we assumed medium-term, or 5-year, wholesale demand elasticities for fluid milk and other dairy products, as shown in table 14.

We also assumed medium-term regional supply elasticities as shown in table 15.

We also assumed that within a compact region, there was no market- driven over-order premium above the compact minimum price. This initial assumption represents a lower bound, and assumes that compact over- order producer price payments may have replaced, or become a substitute for, much of the market-driven over-order premiums in the compact region. We also assumed that the Class I price in a compact region, or the compact price, was $16.94 per hundredweight of milk.

To better model the effect of pooling and to account for milk shipments from region to region and from noncompact to compact regions, we assumed that no more than 40 percent of any one region’s packaged fluid milk could be shipped to another region without being pooled in the receiving region. We also assumed that a processor had to pay the compact over-order producer price into a compact pool for milk shipped into a compact region in order to receive a compact blend price for these fluid shipments. With these assumptions, we did not restrict milk flows from region to region or from noncompact to compact regions. We also used transportation costs as developed by researchers at Cornell University, with no adjustment.

Sensitivity Analyses

Following our initial analyses, we conducted additional analyses of the impacts of compacts by varying our initial parameter values or assumptions to determine how sensitive our initial estimates were to changes in key values or assumptions. Specifically, with respect to wholesale demand elasticities, we changed the medium-term elasticities used in our initial analyses to long-term, as shown in table 16, to determine what impact higher elasticities would have on our initial estimates.

In a separate analysis, we changed our regional supply elasticities to long- term, as shown in table 17, to determine if changes in long-term supply elasticities would affect our initial estimates.

In a separate analysis, we changed our assumption regarding the lack of any market-driven over-order premium within compact regions and added a 50-cent-per-hundredweight over-order premium above the compact's minimum price to determine what impact this would have on our initial estimates. We then simultaneously used long-term supply and demand elasticities in conjunction with the 50-cent over-order premium in compact regions to determine what combined effect these three changes taken together would have on our initial estimates.

In a separate analysis, we inflated transportation costs that we obtained from Cornell University by 25 percent within each of the IRCM99 regions to determine what effect increased transportation costs would have on our initial estimates.

In addition, we conducted a separate sensitivity analysis specific to the expanded Northeast Compact in conjunction with a southern compact scenario. In this analysis, we varied the assumption regarding the Class I minimum price, or compact price, in the compact region. We increased the minimum price from $16.94 to $18.00 per hundredweight in the southern compact but retained the $16.94 minimum price in the expanded Northeast Compact. We conducted this analysis because data on cooperative pay prices in selected cities in USDA’s Appalachia, Southeast, and Central milk marketing orders were about a dollar higher in 1999 than in the Northeast Milk Marketing Order.

We also analyzed how sensitive the model was to trade limitations across regions. Our initial estimates and previous sensitivity analyses assumed that milk flowed relatively freely between noncompact and compact regions. We revised this assumption by limiting the amount of milk that could flow into a compact region from a noncompact region to that amount of milk produced within 100 miles of a compact region’s border. Although we recognize that there are no regulations establishing such a limit, we performed this particular analysis to reflect the fact that the IRCM99 uses average transportation costs, on a regional basis, because of the lack of specific data on the location of processing plants for 1999. This limitation may lead to a model solution with unrealistically high interregional milk trade. We then compared the estimated impacts of the different compact scenarios with the impacts of the no-compact scenario using this revised trade assumption. We also conducted the same sensitivity analyses discussed above to determine how sensitive these new estimates were to changes in key values and assumptions.

We also conducted an analysis of how sensitive our initial estimates were to the magnitude of the difference between USDA and compact prices. We derived our initial estimates and our sensitivity analyses using 1999 pricing data because 1999 was the most recent year for which complete data were available. During 1999, the national average blend price of milk, or the average weighted minimum farm-level price, was $14.09 per hundredweight, which was higher than the prices observed in some other years, including 2000. For example, the national average blend price of milk in 2000 was $12.11 per hundredweight. To determine how sensitive our 1999 estimates were, we used preliminary milk pricing data for 2000 to determine what impact this difference may have had. This required a new baseline for assessing the magnitude of change that compacts made, given the relative magnitude of change in compact and USDA prices. We did not, however, conduct a full range of sensitivity analyses regarding this change in assumptions because of the preliminary nature of the 2000 pricing data. Further, the 2000 pricing data reflected regulatory reform measures implemented by USDA in January 2000, which posed potential data reliability concerns.

We calibrated the model using dairy sector data for 2000 to simulate the impact of compacts during that year. The method used to develop the IRCM00 was similar to the method used to develop the IRCM99, with two exceptions: We used data on 2000 regional farm production and milk prices; aggregate commodity supply/demand balance (commodity production, imports, exports, and stocks) and prices; and component balance (using 2000 disaggregate commodity production data) to develop the base model.

We incorporated revised January 2000 USDA milk marketing order pricing regulations into the model. These revisions include a methodology for computing (1) classified prices based on USDA’s “Final Rule” multiple component pricing, (2) Class I prices based on the higher of the Class III or Class IV multiple component price, and (3) minimum Class II prices based on adding a 70-cent-per-hundredweight premium to Class IV prices.

As in the IRCM99, all classified pricing commodity wedges are computed relative to Class III prices, so that if Class IV prices are higher than Class III prices, additional classified pricing premiums are added to Class I, II, and IV prices. Tables 18 and 19 summarize the additional classified pricing premiums for USDA and California.

USDA’s revised pricing regulations result in larger Class I and II premiums over Class III milk than occur under California’s pricing regulations, as shown in table 20.

USDA Class I and II premiums are also higher in 2000 than in 1999 because of lower Class III prices in 2000 relative to 1999, and the impact that Class IV prices had on Class I and II. Also, in modeling the impacts of compacts in 2000, we computed commodity premiums in producer price settlement pools on the basis of fat and skim-not-fat commodity components, using revised classified fat and skim-not-fat prices.

IRCM Limitations

As with any modeling exercise, the IRCM has certain limitations. These limitations include: (1) the model cannot identify individual shipments of raw milk from one milk marketing order to another because we do not have data on shipments of raw milk and packaged fluid milk by individual farmers and processors, respectively, (2) the model is static and does not take into account dynamic adjustments, (3) the model ignores some institutional and/or historical rigidities and capacity constraints (other than for the milk marketing orders and component flow constraints), (4) the model assumes the absence of farmer, processor, and/or retailer market power, and (5) the model takes exports and imports as being exogenous to the model.

Appendix III: NEDC’s Intraregional Impacts

The intraregional impacts of the NEDC on (1) retail milk prices, (2) milk producer income, (3) dairy farm structure, (4) milk production, and (5) milk consumption are difficult to determine. Data indicate that retail milk prices increased when the NEDC’s alternative minimum pricing requirement took effect in July 1997, and prices continue to remain relatively high compared with retail milk prices in the rest of the country. However, because many factors affect retail milk prices, we were unable to determine what portion of the retail price increases in the NEDC states was due to the NEDC as opposed to other factors. With regard to milk producer income, when the NEDC price has been higher than the Class I price, dairy farmers have received payments that reflect the NEDC price— that is, the Class I price plus the difference between the Class I price and the NEDC price. (This difference is called an over-order payment.) However, it is likely that farmers would have received some portion of the difference even without the Compact in the form of market-driven over- order premiums. Data on the structure of dairy farms, milk production, and fluid milk consumption in the six NEDC states and data for the rest of the United States show similar trends, suggesting little or no change in the NEDC states following the Compact’s establishment.

Retail Milk Prices Increased in the NEDC States, but It Is Difficult to Determine the Amount Attributable to the Compact

Retail milk prices increased in the NEDC states in July 1997, when the Compact’s alternative minimum price for raw milk to be used for and sold as fluid milk in the six states took effect, but not in the rest of the country. Data indicate that since July 1997, retail prices in Boston and other selected cities and towns in New England have remained relatively high, compared with prices in other major cities in the country. It is difficult to determine, however, what portion of the retail price increase can be attributed to the NEDC’s alternative minimum price as opposed to other factors that affect retail milk prices. Economic analyses of the NEDC’s impact on retail milk prices have concluded that retail milk prices increased following the Compact’s establishment, but the estimated amount attributable to the Compact’s higher alternative minimum price varies among the different studies.

Retail Milk Prices Increased in July 1997 in New England but Not in the Rest of the Country

The retail price of milk in the New England states increased sharply during July 1997, when the NEDC began setting minimum prices that processors must pay for raw milk used for and sold as fluid milk—milk used for drinking purposes—in the NEDC states, but comparable increases did not occur in most other locations in the United States. In that month, the NEDC price—$1.46 per gallon—was 26 cents higher than USDA’s milk marketing order Class I price of $1.20 per gallon. This 26-cent per gallon (or 22 percent) price increase appears to have been passed on to consumers at the retail level on fluid milk prices during the same month. Table 21 shows the increase in retail prices according to data collected by the departments of agriculture in Connecticut, Maine, and New Hampshire; the International Association of Milk Control Agencies; and A.C. Nielsen.

Data from the International Association of Milk Control Agencies indicate that between June and July 1997, the average retail price of a gallon of milk increased by about an average of 7 percent in nine cities in Maine, Massachusetts, and Vermont. A.C. Nielsen data for Boston indicate that retail milk prices increased by an average of about 8 percent during the same period.

Our review of data for the rest of the United States indicates few increases in the retail price of milk in July 1997 that were comparable to what occurred in the New England states. For example, data from the International Association of Milk Control Agencies for 42 cities and regions outside the NEDC states indicate that only two of those cities or regions experienced retail price increases comparable to or larger than those observed in selected cities in Maine, Massachusetts, and Vermont in July 1997: Eastern Virginia had a 31-cent increase and Reno, Nevada had a 10-cent increase between June and July 1997. Moreover, data from A.C. Nielsen for 13 major cities outside the NEDC states show an increase in retail milk prices in only one city between June and July 1997: in Seattle, the price of milk rose from $2.91 to $3.01 a gallon. Elsewhere, retail milk prices declined, for example, in Cincinnati, from $1.43 to $1.35 per gallon between June and July 1997 and in Washington, D.C., from $2.47 to $2.44 per gallon.

From July 1997 to September 2000, Retail Milk Prices in the Rest of the Country Have Increased Less Than in the NEDC

In the longer term, between July 1997 and September 2000, retail milk prices in most of the United States did not increase as much as they did in the NEDC states, according to A.C. Nielsen data, as shown in figure 2. The average retail milk price in Boston increased by 18 percent between June 1997 and September 2000, from $2.40 to $2.84 per gallon. The national average retail price of milk increased by 8 percent during the same period, from $2.49 to $2.68 per gallon.

A.C. Nielsen data for 13 major cities outside the NEDC indicate that retail milk prices increased between June 1997 and September 2000 in 10 of those cities as well. For example, retail prices increased by 3 percent in Phoenix, or from $2.21 to $2.27 per gallon; by 12 percent in Seattle, or from $2.91 to $3.26 per gallon; by 17 percent in New Orleans, from $2.58 to $3.03 per gallon. Data for one city—Cincinnati—show a greater price increase than in Boston: prices increased by 80 percent, from $1.43 to $2.57 per gallon, between June 1997 and September 2000. However, data for Cincinnati indicate that between March 1997 and May 1998, retail milk prices were considerably lower than those in other major cities. In contrast to retail milk prices in cities such as Boston and Cincinnati, prices fell in Dallas, Denver, and San Diego.

Data from the International Association of Milk Control Agencies also indicate that retail milk prices increased from June 1997 to November 2000 in the NEDC states and the rest of the country. For example, retail prices increased by 17 percent, from $2.59 to $3.04 in Burlington, Vermont; and by 10 percent, from $2.18 to $2.39 in Augusta, Maine, from June 1997 to November 2000. In the rest of the country, of the 29 cities or regions for which the Association had June 1997 and November 2000 data, retail milk prices increased in 21 of them. For example, retail milk prices increased by 4 percent, from $2.76 to $2.88 per gallon in Philadelphia, Pennsylvania; and by 20 percent, from $2.55 to $3.05, in Salem, Oregon.

Even though it is likely that the Compact caused some portion of the retail milk price increase in the NEDC states, it is difficult to determine the size of that portion. In part, this is because retail milk prices vary considerably in relation to the minimum farm-level price for raw milk. For example, after retail prices increased by about 20 cents per gallon in July 1997, they fell by about 5 to 7 cents per gallon for a period of several months. In addition, even though the NEDC price remained stable at $1.46 per gallon between July 1997 and August 1998, data on retail milk prices for Boston indicate that retail prices fluctuated during that period from a high of $2.60 to a low of $2.53 per gallon. Figure 3 shows the relationship between the Class I or NEDC price and the average retail price of milk sold in Boston.

Between July 1997 and September 2000, the retail price in Boston varied between $2.53 and $2.90 per gallon. In September 1998 when the NEDC price increased by 9 cents, from $1.46 to $1.55 per gallon, the retail price increased by only 1 cent, from $2.55 to $2.56. As figure 3 shows, retail prices increased in early calendar year 1999 and again in late calendar year 1999. In November 1999, the retail price of milk reached a high of $2.90, when the NEDC price was $1.68 per gallon.

One of the reasons that there is not a close relationship between the NEDC price for milk and the retail price is that many factors affect the retail price of milk, including wholesalers’ costs, state regulations, consumer demand, and retailers’ pricing strategies. More specifically, the retail price of milk is affected by wholesalers’ costs of acquiring and processing raw milk and packaging and distributing processed fluid milk to retail outlets. The retail price can also be affected by state regulations that, for example, dictate how and where milk can be distributed. Another factor is consumers’ shrinking demand for milk products, as opposed to other beverages. This shrinking demand has created a need to advertise and improve products, which has increased retail costs. Finally, retail milk prices are affected by retail pricing strategies involving such factors as retail costs, competitor pricing, if and how milk prices are used to attract customers, shopping convenience, the image a store may want to project regarding quality or low prices, and the extent to which retailers exercise market power.

Other Studies Estimate That the NEDC Has Increased Retail Prices

Four studies have estimated the Compact’s impact on retail milk prices, and each has concluded that the NEDC has resulted in increased retail prices. Each study provides a different estimate of the amount that the NEDC has caused retail prices to increase, however, largely because of the different methodologies used and the time frames analyzed. The Office of Management and Budget (OMB) issued a study in 1998 that analyzed retail milk price data for the first 6 months that the NEDC was in effect. OMB estimated that the Compact could have had a small impact (an increase of 5 to 10 cents per gallon), a medium impact (an increase of 10 to 15 cents per gallon), or a large impact (an increase of 15 to 20 cents per gallon) on retail prices, depending on the extent to which costs were passed on from the farm to the retail level, and the extent to which wholesalers and retailers absorbed or passed on any increased costs. However, OMB cautioned that its study was completed too soon after the Compact began operating in July 1997 to determine its economic impacts and implications with confidence or precision. OMB further cautioned that U.S. dairy industry economics are complex, and that producer, wholesale, and retail prices are affected by numerous proprietary, regional, and national factors. OMB concluded that retail price patterns have fluctuated in recent years and provide no definitive indication of the retail price levels that would have occurred without the Compact.

In 2000, economists (Lass et al.) at the University of Massachusetts issued a study that analyzed the NEDC’s impact on retail milk prices during the first year of the Compact. For this study, which was conducted for the NEDC, Lass et al. used data from January 1982 through June 1996 to develop a model of farm-to-retail price behavior in two markets: Boston and Hartford. They then used data from an 18-month period—July 1996 through December 1997—to predict what the retail price for milk would have been without the Compact and to compare those predicted effects with the effects that actually occurred in New England. Lass et al. concluded that the NEDC caused an average retail milk price increase of about 7 cents per gallon in the Boston market and about 6 cents per gallon in the Hartford market. They also concluded that because this estimated retail price increase was less than the NEDC increase in costs to fluid milk processors (the over-order amount due to the NEDC), an amount less than the NEDC over-order amount was being passed on to consumers. The authors cautioned, however, that the model did not capture changes that may have occurred in the farm-to-retail price relationship from July through December 1997.

A third study, issued in 2000 by an economist (Bailey) at Pennsylvania State University, analyzed the farm-to-retail markup for fluid milk over the period January 1996 through December 1999. Using a simple but direct markup model to evaluate the impact of the NEDC on retail fluid milk prices in Boston and Hartford, Bailey concluded that the retail price of milk increased after the Compact established its minimum price in July 1997. Specifically, Bailey concluded that the retail price of milk rose 24 cents per gallon from July 1997 to December 1999 over the average price in effect from January 1996 to June 1997. According to Bailey, the majority of this 24-cent per gallon increase—17 cents per gallon—was attributable to the Compact, while the rest was attributable to other factors. Finally, studies issued in 2001 by economists (Cotterill and Franklin) at the University of Connecticut examined specific factors that may have increased retail milk prices in four New England marketing areas—Boston, Providence, Hartford/Springfield, and Northern New England—following the Compact’s establishment in July 1997. Cotterill and Franklin compared retail price data from February 1996 through early July 1997 with retail price data from July 1997 through August 1998. The authors separated out retail price increases as caused by four factors: (1) the increased farm price of milk caused by the NEDC; (2) the increased farm price of milk caused by strong raw milk markets when the farm price spiked above the NEDC price; (3) nonmilk costs, such as increased processing costs other than costs for purchasing raw milk and increased distribution costs; and (4) changes in pricing at the wholesale and retail levels. Using this methodology, Cotterill and Franklin concluded that of the 29-cent increase in the retail price of a gallon of milk, on average, 2.7 cents per gallon were caused by the NEDC and 6.5 cents per gallon were caused by strong milk markets.

Limited Data Are Available to Estimate the Potential Impacts of the Compact on Producer Income

While it is likely that the NEDC has stabilized producer income, it is difficult to determine how large of an impact it has had on producer income because of uncertainty about what dairy farmers in the six NEDC states would have been paid for their milk in the absence of the Compact. This uncertainty arises because NEDC payments made to dairy farmers may be, in part, substitutes for market-driven over-order premium payments. Even so, the NEDC commission has concluded that the Compact has had a positive effect on the financial status of dairy farmers in the six NEDC states and New York. USDA data on dairy farm income do not clearly indicate whether the improved financial status of an average dairy farmer in the NEDC states resulted from the NEDC. Finally, while two studies of the NEDC’s impact on farm income concluded that the NEDC could have a positive impact on farm income, they provide no definitive estimate of the size of this impact.

NEDC Payments May Be, in Part, Substitutes for Market-Driven Premium Payments

We cannot determine how much impact the NEDC has had on dairy farmer income because we do not know what dairy farmers’ incomes would have been from July 1997 to the present in the absence of the NEDC. While farmers would have received at least the minimum federal marketing order or state prices, in some cases it is likely that they would have received an amount greater than these prices even in the absence of the NEDC. According to USDA officials, dairy farmers in the NEDC states had received some market-driven over-order premiums prior to the NEDC’s establishment. For example, in 1996, the over-order Class I premium in the New England order averaged 76 cents per hundredweight. Research conducted by economists at Cornell University indicates that after the compact began, producers receiving NEDC payments received no over-order premiums above the amount needed to compensate them for cooperative services. In one survey conducted in August 2000, dairy farmers in New York who received NEDC payments were receiving no market-driven over order premiums, while producers not shipping milk into the NEDC states received about 60 cents per hundredweight in market-driven over-order premiums. USDA officials concurred with this assessment. According to one USDA official, over- order charges decreased about 50 cents per hundredweight after the NEDC began setting its price for Class I milk, and were at levels indicative of the costs of services provided by cooperatives for handlers.

We estimate, however, that dairy farmers supplying raw milk for use as fluid milk sold in the NEDC states have received revenue as a result of the Compact. We estimate that an average licensed dairy farmer located in one of the six NEDC states received annual payments of between $3,892 and $15,301 since the NEDC regulations took effect in July 1997 through December 2000, as shown in table 22.

As table 22 shows, the dairy farm payment resulting from the difference between the USDA Class I price and the NEDC price (the over-order producer price payment) increased significantly in 2000, when the USDA Class I price was low—$14.80 per hundredweightative to the NEDC price of $16.94.

Although we are unable to determine how much of an impact the NEDC has had on dairy farmer income in the six NEDC states, dairy farmers supplying milk and receiving over-order producer price payments have likely benefited from the NEDC. At a minimum, the NEDC has had a stabilizing impact on the prices paid to farmers for milk, irrespective of the amount of additional income it may have generated, because the $16.94 NEDC price per hundredweight has protected dairy farmer income when the minimum federal marketing order price has fallen below the NEDC price. This occurred in 35 of the 46 months between July 1997 and March 2001.

NEDC Data Indicate a Positive Impact on Net Farm Income, but USDA Data Are Less Clear

NEDC commission data indicate that the difference between the Compact Class I price and the USDA minimum Class I price from July 1997 through June 2001, minus fees for administering the NEDC, totaled about $146 million. This amount was provided to 4,217 farms supplying the New England market, of which 1,300 are estimated to be located in New York. According to the NEDC, between July 1997 and June 2001, the NEDC resulted in annual payments of between $3,900 and $14,700, to these farms, depending on herd size. The average annual payment was $9,812 per farm. According to the NEDC commission, this additional income helped stabilize and enhance farm-level prices for farmers in the six NEDC states as well as New York, some of whom have historically been part of the New England milk shed.

Similarly, NEDC data indicate that net farm earnings improved as a result of the Compact. For example, the NEDC commission estimated that in 1997, the Compact increased net farm earnings of those supplying the New England milk shed by about $6,800, from about $11,000 to about $17,800. The NEDC commission estimated that in 2000, the Compact increased net earnings by about $15,200, from about $8,100 to about $23,300. The NEDC commission also estimated that in 2000, the percentage of dairy farms that experienced financial stress was 20 percent lower than it would have been in the absence of the Compact: About 50 percent of farms experienced some degree of financial stress, compared with 70 percent that would have experienced some degree of financial stress without the NEDC. These figures led the NEDC commission to conclude that the overall reduction in financial stress resulted in a significant reduction in the likely net loss of dairy operations in the Northeast.

While USDA data indicate that the net farm income of an average dairy farmer in the northeastern region has increased slightly more than the net income of an average farmer in other regions between 1991 and 1999, the data also indicate that net farm income in the northeastern region was lower than that of farmers in other regions during the same time period.Figure 4 shows that the net farm income of average dairy farmers in the northeastern region and other regions in the country has increased between 1991 and 1999, but that the trend increased at a lower rate in the northeastern region than in other regions in the country. Regarding the northeastern region, the data indicate that an average dairy farmer’s net farm income increased by 36 percent, from $34,064 in 1996 to $46,415 in 1999. In the rest of the United States, an average dairy farmer’s net farm income increased by 61 percent, from $45,650 in 1996 to $73,486 in 1999. It is difficult to determine, however, the specific impact of the NEDC, because many factors influence dairy farm income, and USDA’s northeastern region includes other states in addition to the six NEDC states.

USDA data also indicate that between 1991 and 1999, the percentage of northeastern dairy farms having favorable solvency grew more than the percentage of dairy farms with favorable solvency in other regions of the country. Figure 5 shows that the percentage of dairy farms having favorable solvency in other regions of the country remained relatively constant.

About 61 percent of the dairy farms in the northeastern region had favorable solvency in 1991, in comparison with about 69 percent of the dairy farms in the rest of the U.S. regions. About 82 percent of the dairy farms in the northeastern region had favorable solvency in 1999, in comparison with about 73 percent of the dairy farms in the rest of the U.S. regions. Whether the NEDC caused the percentage of dairy farms in the northeastern region having a favorable solvency to grow faster is difficult to determine because, as noted previously, the six NEDC states form only a portion of the northeastern region.

Two Studies Provide Limited Information on the NEDC’s Impact on Income

Two studies have analyzed the NEDC’s impact on dairy farmer income and concluded that the Compact has the potential to improve farmer finances. OMB’s 1998 analysis was limited by the fact that the Compact had been in effect for only about 6 months when OMB conducted its study. To estimate the NEDC’s impact on farm income, OMB developed two alternative scenarios of what milk prices would have been had the Compact not been established. Under the first scenario, OMB assumed that the Class I price would have averaged $15.92 per hundredweight in 1997; under the second scenario, OMB assumed that the Class I price would have been $16.10 per hundredweight, taking into account the decline in the market-driven over-order premium when the NEDC took effect. OMB then compared these prices with a minimum NEDC price of $16.94 per hundredweight. Using $16.94 as a basis for calculating a blend price, OMB estimated that in 1997, the NEDC generated an average increase in gross farm income of $5,650 under the first scenario and $4,770 under the second scenario. Regarding the NEDC's overall impact on dairy farmers' income, OMB concluded that, if other factors affecting dairy farmers were held constant, higher milk prices would not be expected to greatly alter the long-term trend toward fewer, but larger and more efficient dairy operations in New England.

In 1998, an economist (Wackernagel) at the University of Vermont issued a study on the potential impact of the dairy Compact that used computer models to simulate characteristics of Vermont dairy farms under different milk pricing policies. The models varied with respect to factors such as farm size, farm profitability, productivity growth rate, and milk prices. Although no one model specifically simulated the impact of the NEDC, Wackernagel concluded that using his compact scenarios, the impact of stabilizing prices could increase farmer cash reserves and net worth, but he estimated that such gains would be more limited than those that would be achieved by having a higher farm-level price that varied from month to month. Wackernagel also concluded that gains associated with price stabilization would be limited unless a Compact’s policies recognized the impact of inflation as well as the variability and level of milk prices.

The NEDC’s Impacts on Farm Structure, Milk Production, and Milk Consumption Are Difficult to Determine

The Number of Farms Has Continued to Decline as Herd Size Has Increased

Data on the number of farms and herd size show similar trends in the NEDC and other states before and after the NEDC was established, suggesting little or no change in the NEDC states due to the Compact. Moreover, the data suggest that the trends are caused by other factors, such as major technological advancements in dairy farming.

The number of dairy farms in the NEDC and the rest of the United States has been decreasing, as measured by both the number of farms having at least one dairy cow and the number of licensed dairies. In the NEDC states, the number of farms having at least one milk cow decreased by 33 percent between 1992 and 2000, from 5,050 to 3,370. In the rest of the United States, the number of farms having at least one milk cow decreased by 39 percent in that same period, from 166,510 to 101,880. Given that some of the farms with at least one milk cow may not produce milk for sale to dairy processors, we also looked at the number of farms licensed to sell milk to dairy processors. Between 1992 and 2000, the number of licensed dairy farms in the six NEDC states decreased by 32 percent, or from 4,079 to 2,772, while the number of licensed dairy farms in the rest of the country decreased by 37 percent during that same time period, or from 127,456 to 80,253 (see fig. 6). From 1992 to 1998, the percentage decrease in the number of licensed dairy farms in the NEDC states was greater each year than in the rest of the United States; in 1998, the percentage decrease in the rest of the United States became greater each year. With respect to the change from 1997 to 2000, the number of licensed dairy farms decreased by 14 percent in the NEDC states, or from 3,237 to 2,772 farms; while the number of licensed dairy farms decreased by 17 percent in the rest of the country, or from 96,176 to 80,253 farms. It is not known whether this change in trends was caused by the NEDC or some other factors.

Between 1992 and 2000, the average herd size in the NEDC states increased by 36 percent, from 58 to 79 milk cows, while in the rest of the United States, average herd size increased by 57 percent, from 56 to 88 milk cows. As shown in figure 7, although average herd size has increased in the NEDC states, this increase consistently lagged behind the increases in the rest of the United States.

One of the reasons for the declines in herd size is that over the past 50 years, technological developments have significantly altered both dairy farming itself and the way farm products are processed and distributed. Farming has changed from an operation that was historically dependent on human and animal labor to one in which most operations are mechanized. As a result, at every level, economies of scale (the lower cost of large-scale versus small-scale operations) have led to fewer and larger farms. The number of farms in general, and dairy farms in particular, has been shrinking since the Depression. While dairy farms with 100 cows were considered large in 1950, today dairy farms as large as 1,500 to 3,000 are emerging in the western, northwestern, and midwestern regions of the country. This trend, along with the pressure to convert land used for agriculture into land used for nonagricultural purposes, will likely result in a continued increase in the size of farms with a commensurate decline in the total number of farms in the Northeast.

Production Has Continued to Increase

Milk production increased in the six NEDC states and the rest of the country both before and after the NEDC was established. This trend toward greater milk production has occurred at the same time as the total number of milk cows has declined, reflecting a greater amount of milk produced per cow. These trends make it difficult to determine what impact, if any, the Compact has had on milk production. Two studies have analyzed the NEDC’s impact on milk production and concluded that while the NEDC may have caused an increase in production, any increase was small in relation to the total amount of milk produced in the NEDC states.

Milk production has increased in the NEDC states and the rest of the country, as measured by both total milk produced and milk produced per cow. From 1993 to 2000, total milk produced in the NEDC states increased 2.9 percent, from 4.545 billion pounds to 4.678 billion pounds, while production in the rest of the country increased 10.3 percent from 146.091 to 163.274 billion pounds. With respect to the change from 1997 to 2000, production increased by 2.5 percent in the NEDC states, or from about 4.6 billion pounds to 4.7 billion pounds; while production increased 7.8 percent in the rest of the country, or from about 151.5 billion pounds to 163.3 billion pounds. Much of this growth reflected an increase in milk production per cow. Figure 8 shows that from 1993 to 2000 the average amount of milk produced per cow in the NEDC states increased by 11.6 percent, from 15,633 pounds to 17,440 pounds, while production per cow in the rest of the United States increased 15.9 percent, or from 15,726 pounds to 18,226 pounds.

Whether the increase in milk production per cow was dramatically influenced by the NEDC, however, is not clear. The data on milk production per cow do not show a large difference in upward trend between the NEDC states and states in the rest of the country between 1997 and 2000. Specifically, during this period production per cow increased by 6.6 percent in the NEDC states, or from 16,360 pounds to 17,440 pounds; while production per cow increased by 7.9 percent in the rest of the country, or from 16,887 pounds to 18,226 pounds. Increases in production per cow, and increased efficiency in all of the states, has more likely resulted from fundamental changes in the structure of dairy farming throughout the country, such as the increased cost of labor; new improved machinery; artificial breeding services; better feed and forage; adoption of different strains of livestock; and careful use of fertilizer, irrigation, and chemicals. The overall impact drastically increased production per cow, which has led to the need for fewer cows to supply the market.

Both of the studies that analyzed the NEDC’s impact on milk production were based on a limited amount of data. OMB’s 1998 study found that from July through December 1997, New England milk production was up 3 percent from the same period in the previous year, while national milk production was up 2 percent during the same period. Given this increase in New England milk production and using USDA’s dairy economic model, OMB estimated that the Compact commission’s price of $16.94 per hundredweight for raw milk used for and sold as fluid milk would have caused milk marketings to increase from 5.38 billion pounds to 5.40 billion pounds, or by about 0.4 percent , between July and December 1998. OMB cautioned, however, that the analysis addressed only the first 6 months of the NEDC.

At the request of the NEDC, economists (Nicholson et al.) at the University of Vermont also used a model to estimate the impact of higher Compact prices on milk production. Their study, issued in 2000, used state quarterly all-milk prices for each of the six Compact states as a basis to estimate what milk prices would have been without a Compact. In Vermont, these prices ranged from $12.85 to $15.09 per hundredweight. On the basis of their analysis of milk production data for the period July 1997 to June 1998, Nicholson et al. concluded that the NEDC caused milk production to increase by 45 million pounds, or about 1 percent. Nicholson et al. estimated that the Compact resulted in increased production in each of the six NEDC states, with the largest increase occurring in Vermont. Nicholson et al. postulated that without the NEDC milk production in that state would have declined.

Milk Consumption Has Continued to Decrease

The impact of the NEDC on milk consumption in the six NEDC states is difficult to determine because even though the data indicate that per capita consumption of fluid milk was higher in the NEDC states than in much of the rest of the United States between 1993 and 1999, consumption slowly declined during that period, both within the NEDC states and throughout much of the rest of the country, suggesting little or no change as a result of the NEDC. On the other hand, one study that analyzed the impact of the NEDC on milk consumption concluded that the Compact could have caused a slight reduction in milk consumption in the NEDC states in the latter part of 1997.

As figure 9 shows, from 1993 to 1999 annual per capita milk consumption in the New England Milk Marketing Order declined by about 4 percent, from about 233 pounds to about 223 pounds. This decline is equivalent to a reduction from about 27 gallons to 26 gallons. Similarly, annual per capita milk consumption in the rest of the milk marketing orders in the United States for the same time period declined by about 6 percent, from about 214 pounds to about 202 pounds. This is equivalent to a reduction from about 25 gallons to 23 gallons.

This slow decline in milk consumption began in the late 1970s, probably as the result of such factors as increasing consumption of other beverages, such as fruit beverages, bottled water, and carbonated soft drinks; growing dietary concerns about fat and cholesterol; and an aging U.S. population. USDA estimated that without marketing efforts undertaken by the milk industry, such as advertising and product innovation, milk consumption would have been lower than it was by as much as 1.4 percent from 1996 to 1999.

OMB’s 1998 study found that from July to December 1997, fluid milk sales in New England totaled 1.3 billion pounds, which was down 0.7 percent from the same period 1 year earlier. Nationally, fluid milk sales increased by 0.2 percent in the last half of calendar year 1997. OMB noted that studies on the relationship between retail prices and consumption suggest that a 10-percent increase in retail fluid milk prices reduces consumption by 1 to 2 percent. Using USDA’s model, OMB estimated that the average retail price in the Compact states would have been $2.46 per gallon without the NEDC price regulations, and that with the NEDC price regulations retail prices increased by 3.7 percent to $2.55 per gallon. Given the retail price and consumption relationship found in other studies, and the NEDC’s impact on retail milk prices, OMB concluded that the NEDC’s price regulations reduced fluid milk consumption in the NEDC states by about 10 million pounds, or about 0.5 percent, between July and December 1997.

Bailey’s July 2000 study also analyzed the NEDC’s impact on retail fluid milk consumption. Bailey examined Class I sales in the New England Marketing Milk Marketing Order from 1996 through 1999 and observed a retail milk price increase of 24 cents per gallon in the Hartford and Boston markets over that period. He attributed this increase to an average 10-cent- per-gallon Compact obligation and a general rise in the farm-to-retail markup. Even though retail prices increased, Bailey concluded that total fluid milk consumption did not change appreciably after introduction of the Compact: He estimated that the amount of milk consumed decreased by less than 0.3 percent in 1998 and 1999.

Appendix IV: NEDC’s Impacts on Federal Program Costs

According to USDA, the NEDC has not increased the net federal costs of the milk price support program, and the agency is not certain whether the Compact has increased costs of the nutrition assistance programs administered by USDA. Net costs for USDA's milk price support program have not increased because the 1996 farm bill requires that the NEDC commission compensate USDA for any additional dairy commodity purchases to the extent that the percentage change in milk production in the NEDC states exceeds the national average. Regarding nutrition assistance programs, according to USDA, federal costs for its Food Stamp Program may have increased as a result of the NEDC, but federal costs for its other nutrition assistance programs have not increased because of how these programs are funded or because of how federal program benefits are calculated for them. According to USDA officials, regardless of whether federal costs for its other nutrition assistance programs have increased, increased retail milk prices caused by the Compact have been borne by agencies or organizations that provide program benefits or by program participants in the NEDC states. The NEDC commission directly reimburses the NEDC states for increased costs incurred by selected nutrition assistance programs. While two studies assessed the NEDC’s impacts on selected nutrition assistance programs, study results are inconclusive as to whether the NEDC has impacted these programs.

Federal Net Costs for the Milk Price Support Program Have Not Increased

Even though USDA estimates that the NEDC states’ rates of increase in milk production have exceeded the national rates of increase in 2 of the 4 years since the Compact began setting the price of milk used for and sold as fluid milk in the NEDC states in July 1997, net federal milk price support program costs have not increased. The price support program, created in 1949, supports farm-level prices by providing a standing offer from the government to purchase butter, cheese, and nonfat dry milk at specified prices. The 1996 farm bill requires that the Compact commission compensate USDA when the estimated rate of increase in milk production in the six NEDC states is greater than the estimated rate of increase in national milk production. The NEDC commission is required to compensate USDA before the end of any fiscal year in which the NEDC states’ estimated rate of increase in production is greater than the national rate of increase for the preceding fiscal year. Neither the NEDC nor USDA must determine whether the greater rate of increase, or what portion of the greater rate of increase, is attributable to the NEDC.

According to USDA officials, milk production in the NEDC states did not increase at a greater rate than the national rate of increase between July and September 1997. However, in 1998, USDA estimated that milk production in the NEDC states increased 1.8 percent, based on its analysis of the average amount of milk produced in the six states during 1997 and 1998, as compared to a national average increase in production of 1.3 percent. On the basis of these two rates, USDA estimated that it purchased about $1.8 million of nonfat dry milk that was attributable to the NEDC’s greater rate of increase in production. In 1999, USDA estimated that milk production in the NEDC states increased 3.6 percent, based on its analysis of the states’ average milk production in 1998 and 1999, compared with a national average rate of increase of 3.2 percent. On the basis of these two rates, USDA estimated that it purchased about $1.4 million of nonfat dry milk that was attributable to the NEDC’s greater rate of increase in production. The NEDC commission compensated the federal government these amounts for these 2 fiscal years. The Compact commission was not required to compensate USDA for fiscal year 2000 because USDA concluded that the average rate of increase in milk production in the NEDC states (0.1 percent) was less than the average national rate (5.1 percent).

It Is Unclear Whether Federal Net Costs for Nutrition Assistance Programs Have Increased

USDA analyzed the Compact’s impact on federal nutrition assistance program costs and concluded that it is uncertain whether the federal costs of one of its major programs—the Food Stamp Program—have increased, while federal costs of its other programs most likely have not. Food Stamp Program costs may have increased to the extent that the NEDC caused retail milk prices to increase nationally and to the extent that the agencies or organizations that provide or receive program benefits are not reimbursed. USDA’s Food and Nutrition Service is responsible for nutrition assistance programs, which include the Food Stamp Program; the Special Supplemental Nutrition Program for Women, Infants and Children (WIC); school programs such as the National School Breakfast and Lunch Programs and the Special Milk Program; the Child and Adult Care Food Program; and several small food distribution programs for Indian reservations, the elderly, pregnant women, and children. These programs are carried out at the state and local level by state and local agencies and organizations, such as day care centers or schools.

Regarding the Food Stamp Program, USDA officials said that federal costs may have increased as a result of the NEDC, but they do not know because it is difficult to determine (1) how much of the increased retail milk price in the NEDC states was caused by the Compact, and (2) to what extent that portion of the increased retail milk price caused an increase in the national average cost of food items used to determine program benefits. The Food Stamp Program is operated by state and local welfare offices. Under the program, food stamp recipients spend their benefits (in the form of paper coupons or electronic benefits on debit cards), to buy eligible food in authorized retail food stores. Program benefits under this program are indexed to the cost of a selected group of foods, which is sensitive to the changes in the national average retail price of milk.Benefit levels have increased since July 1997, because of, among other things, increased national average retail milk prices. USDA officials said that the retail milk price increases in the six NEDC states caused by the Compact had the potential to increase the index used to set benefit levels and, thus, federal costs, but it is not certain whether they did so. Further, it is difficult to determine what portion of the retail milk price increases was attributable to the Compact. USDA estimates that if the NEDC caused a 16-cent per gallon increase in the national average retail milk price, there is a 50 percent chance that Food Stamp Program benefits increased by $1 per program participant per month and annual federal Food Stamp Program costs increased by about $60 million. USDA officials also noted that even if the increased price of milk attributable to the NEDC was enough to increase national food stamp benefit levels, some portion of the increased retail milk costs have been borne by participants located in the six NEDC states.

Regarding WIC, USDA officials said that the Compact has not increased federal costs to the program because of the discretionary nature of its funding. Even so, because approximately 30 percent of the funds spent on WIC foods are used to buy fluid milk, any increase in retail milk prices can significantly affect the food package cost per participant and these higher costs, unless offset, would reduce the potential number of participants. WIC is administered by state agencies, most of whom provide WIC participants checks or food instruments to purchase specific foods each month at authorized retailers. While the 1996 farm bill does not require the Compact commission to reimburse the WIC program, NEDC regulations specify that the Compact commission is to compensate New England state agencies that administer WIC for any increased costs due to the Compact. The amount of compensation equals the over-order producer price payment multiplied by the volume of milk used by program participants in a given month. For example, in January of 1998 when the Vermont WIC program purchased 52,403 gallons of milk, the difference between the NEDC Class I milk price and the minimum USDA Class I price was 74 cents per hundredweight. Given that a hundredweight is equivalent to about 11.6 gallons of milk, the Compact commission compensated Vermont about $3,343 for that month. In total, the Compact commission compensated the six states’ WIC programs $3.8 million from 1997 through 2000 for increased milk costs due to the NEDC.

According to state WIC officials, the programs used to administer WIC are being held harmless by the NEDC. These officials said that the NEDC has not resulted in increased WIC program costs or reduced program participation. One state WIC official said that the NEDC has done everything it can to ensure that the WIC programs in the six states remain unharmed by reimbursing the states the full difference between the NEDC’s minimum Class I producer price and the milk marketing order minimum Class I price on all WIC milk purchases.

Regarding school programs, according to USDA officials, it is likely that federal costs to these programs have not increased as a result of the NEDC because program benefits are based on a broad index of food prices that is relatively insensitive to changes in the price of milk in the six NEDC states. Thus, any increases in milk prices caused by the Compact would either have to be absorbed by the schools or passed on to paying students. Programs such as the School Lunch Program are usually administered by state education agencies, which operate the program through agreements with local school districts. NEDC regulations specify that the Compact will reimburse schools for any Compact-related increased costs of fluid milk sold in 8-ounce containers by schools in the six NEDC states. This commitment applies to all milk served in 8-ounce containers by schools, including milk provided under such child nutrition programs as the school lunch and breakfast programs and the Special Milk Program. The NEDC commission requires that school food authorities submit claim forms at the end of each school year that identify the number of 8-oz. cartons of milk purchased during the school year on these forms. School authorities document whether part of the price for the 8-ounce milk containers is attributable to the NEDC over-order premium and, if so, how much on the basis of milk vendor submissions. Our review of school food authority claim data indicates that the portion of the contract price that milk vendors have attributed to the NEDC varies. For example, Connecticut school food authorities attributed from .2 cents to 1.37 cents per 8-ounce container to the NEDC over-order premium during the 1999-2000 school year.

The NEDC commission then verifies that amounts claimed do not exceed the NEDC’s average over-order premium for the school year and compensates school food authorities either the average over-order premium or the amount vendors attributed to the NEDC over-order premium, whichever is less. Thus, the amounts paid to school food authorities vary depending on the amount that they attributed to the NEDC and the amount of milk purchased. For example, one school food authority in Massachusetts was compensated $308.35 for 146,835 cartons of milk purchased during the 1999-2000 school year, while another school food authority in that state was compensated $316.33 for 31,633 cartons of milk purchased for the same year. In total, the NEDC commission reimbursed the states $662,606 for the 1998-1999 and 1999-2000 school years.

Although the amounts paid varied from school to school, officials in the six states’ departments of education generally said that schools claiming and receiving compensation were not, in the end, spending additional funds for milk or having to charge higher prices for milk sold to students. However, these officials also said that many school food authorities have chosen not to seek compensation because some school food authorities view the claim process as burdensome and not worth the effort given the relatively small amounts of money that they would receive.

As is the case with the school programs, according to USDA officials it is likely that federal costs of the Child and Adult Care Food Program also have not increased as a result of the NEDC because program benefits are based on a broad index of retail food prices that is relatively insensitive to changes in the price of milk. State education or health departments administer the program, with independent centers and sponsoring organizations entering into agreements with these departments to operate the program. Under the program, USDA provides eligible centers and sponsoring organizations, such as family day care homes and child-care centers, reimbursements for meals served. According to USDA, it has no data on the amount of milk purchased under the program, and it would be prohibitively labor-intensive for the NEDC to establish a method for compensating thousands of individual homes and centers for any increased retail milk prices.

Regarding USDA’s food distribution programs, according to USDA officials, USDA has not estimated the potential NEDC-related increased costs to these programs. USDA officials said, however, that any increased costs would be relatively small, given the small size of these programs compared with programs such as WIC. Furthermore, because most of these programs are not entitlement programs and thus federal funding is not mandatory, any increased costs due to the NEDC would have to be borne by program providers and could result in fewer participants being served.

If Compacts Are Expanded, Federal Food Stamp Program Costs Could Increase, as Could Nonfederal Costs for Other Nutrition Assistance Programs

According to USDA, if the NEDC is expanded to include additional states or if a southern compact is also created, it is more likely that federal costs for the Food Stamp Program would increase than with the existing NEDC: The likely increase in retail milk prices in more states would have a more direct impact on the index used to set program benefits.

USDA estimated that if retail milk prices in the states of an expanded NEDC and a southern compact increased by about 20 cents per gallon—an amount that USDA noted is possible given the NEDC experience—food stamp participants in compact states would spend about $93 million a year more to purchase milk. If this price increase did not cause the national price increase to rise sufficiently to increase program benefits, Food Stamp Program participants would have to absorb this cost. However, if the 20-cent-per-gallon price increase resulted in a sufficiently large national average retail milk price increase to cause a $1- to $2-per- participant increase in Food Stamp Program benefits, USDA estimated that federal Food Stamp Program costs could increase by as much as $60 to $120 million per year—an amount that would have to be federally funded. Moreover, if the NEDC is expanded and a southern compact is established, and if the NEDC does not provide reimbursements, increased retail milk costs could result in fewer participants being served by state WIC programs. Given these assumptions, it is also likely that costs to school programs would have to be absorbed by school food authorities and program participants because of the index used to establish benefits under these programs. Table 23 summarizes the additional costs that USDA estimated could be incurred under the above assumptions in fiscal year 2000 by food stamp, WIC, and school program providers or participants in compact states if the NEDC is expanded and a southern compact is established, and if retail milk prices increase in the compact states.

Two Studies of the NEDC’s Impact on Nutrition Assistance Programs Provide Inconclusive Results

Two studies—one prepared by the Office of Management and Budget (OMB) and the other by University of Vermont researchers—offer inconclusive results on the NEDC’s potential impacts on USDA’s nutrition assistance programs. Both studies were conducted early in the Compact’s existence and relied on limited retail milk price data. For example, OMB’s 1998 study began before the NEDC commission and the states entered into agreements for compensating states’ WIC and school programs and relied on only 6 months of retail price data—from July through December 1997.Because of this, the study projected either a low (5- to 10-cent), medium (10- to 15-cent), or high (15- to 20-cent) impact on retail milk prices, as reflected in an increased price for a gallon of milk. Assuming no NEDC reimbursements and a medium impact on retail milk prices, OMB estimated that a 15-cent increase in the retail price of milk in the first 6 months of the NEDC would increase state WIC program costs by about $721,300, which would require a reduction in program participation of about 3,000 people if the states did not spend the additional money. OMB also estimated that school lunch and breakfast program costs would increase by $1.2 million during the first 6 months of the NEDC—an increase that would have to be absorbed by schools or passed on to families who pay for meals and snacks. For the same period, OMB also estimated that participants in USDA’s Food Stamp Program who reside in the NEDC states would pay an additional estimated $2.4 million because of increased retail milk prices—an amount that the federal government would not be required to pay because it is likely that national average milk prices would not have increased sufficiently to warrant an increase in benefits. Even if the price increase were large enough to trigger an increase in the index used to establish program benefits, only a small portion of the additional program benefits would go to food stamp recipients in the NEDC states, because all recipients nationwide would receive the increase.

Researchers at the University of Vermont, who were asked by the NEDC commission to conduct the study, also relied on limited data. Wang et al. focused on the NEDC’s potential impact on the WIC program and analyzed retail milk price and program participation data for the period between June 1997 and February 1998. They accounted for NEDC reimbursements to the states’ WIC programs and examined retail milk prices in Boston and Hartford. Their analysis concluded that WIC program participation had not been significantly affected by the NEDC during the time frame analyzed. The study also concluded that retail milk prices in Hartford increased significantly more than in Boston, an increase that might be explained by differences in market concentration and competition. However, the authors concluded that their study results had two principal limitations: (1) their analysis was limited to Boston and Hartford and (2) the NEDC had been in effect only since July 1997, thus providing a small amount of data for the analysis.

Appendix V: Interregional Impacts of Three Compact Alternatives in 1999

This appendix provides our 1999 estimates of the interregional farm- and wholesale-level impacts of the NEDC, an expanded NEDC, and an expanded NEDC combined with a southern compact on various dairy sector indicators. To develop our estimates, we first estimated the impact of each compact scenario on the basis of certain assumptions, such as transportation costs and supply and demand elasticities. We then varied these assumptions to test the sensitivity of our initial estimates. (See app. II for a detailed discussion of our methodology; a description of the IRCM; a list of the states included in the different compact scenarios; values for parameters used, such as the responsiveness of consumers to changing commodity prices; and a summary of the data used and sources for these data.)

We present the data in a series of tables that summarize (1) the range of estimates that we obtained using our initial and subsequent sets of assumptions across the various compact scenarios for each of the dairy sector indicators that we analyzed; (2) our initial estimates of farm-level and wholesale-level impacts of the NEDC scenario, and the results of our sensitivity analyses for that scenario; (3) our initial estimates of farm-level and wholesale-level impacts of the expanded NEDC scenario, and the results of our sensitivity analyses for that scenario; (4) our initial estimates of farm-level and wholesale-level impacts of the expanded NEDC scenario combined with a southern compact, and the results of our sensitivity analyses for that scenario; and (5) the results of our sensitivity analysis for the expanded NEDC scenario combined with a southern compact using a more restrictive trade assumption. In all instances, we present the estimated impacts of the various compact scenarios as changes to our no- compact baseline values for 1999.

The Economic Impacts of the NEDC in 1999

To obtain our initial estimates of the effects of the NEDC in 1999, we used the following assumptions (our no-compact baseline includes the first three assumptions): No more than 40 percent of any one region’s milk may be shipped to another region without being subject to the receiving region’s pricing requirements. This assumption is used to simulate USDA milk marketing order regulations regarding minimum pricing requirements for milk shipped between marketing orders. This threshold was chosen as a proxy for the requirement that an adjustment be made if a plurality of an order's packaged milk was sold in another region.

Supply elasticities are medium-term (that is, 5 years). Demand elasticities are medium-term. The Class I minimum price in the Compact region is the higher of the Compact price of $16.94 per hundredweight of milk, or the USDA milk marketing order price.

Market-driven over-order premiums are zero in the Compact region. This initial assumption represents a lower bound, and assumes that all market- driven over-order premiums in NEDC states are replaced by Compact over-order producer price payments.

A handler must pay the compact over-order producer price into the Compact pool for milk shipped into the Compact region in order to receive the compact price.

We then performed a series of sensitivity analyses by varying key assumptions to test the “robustness” of these initial estimates—that is, whether, and if so by how much, our initial estimates would change when we used different assumptions. Tables 30 through 39 present our initial and subsequent estimates of the impacts of the NEDC in 1999 compared to a no-compact scenario on farm- and wholesale-level indicators.

Sensitivity Analyses for the NEDC Scenario

Tables 32 through 37 display the results of our sensitivity analyses for 1999 farm- and wholesale-level indicators. In comparison with our initial estimates, we used (1) 10-year regional supply elasticities as opposed to 5- year; (2) long-term (i.e., higher), as opposed to medium-term, commodity demand elasticities, (3) higher market-driven over-order premiums as opposed to zero; (4) a combination of the previous three assumptions; and (5) an overall 25-percent increase in transportation costs.

Summary of the Estimated Impacts of the NEDC

Tables 38 and 39 summarize the results of our initial estimates and sensitivity analyses by presenting the range of estimates of the changes from our no-compact scenario that we obtained from our various analyses.

The Economic Impacts of an Expanded NEDC in 1999

To obtain our initial estimates of the impacts of an expanded NEDC in 1999, we used the same set of assumptions that we used under our no- compact scenario. We also used the same assumptions that we used in developing our initial estimates of the impacts of the NEDC. We then performed the same series of sensitivity analyses as under the NEDC scenario. Tables 40 through 49 present our initial and subsequent estimates of the impacts of an expanded NEDC in 1999 compared with a no-compact scenario.

Summary of the Estimated Impacts of the Expanded NEDC

Tables 48 and 49 summarize the results of our initial estimates and sensitivity analyses by presenting a range of estimates of the changes from our no-compact scenario that we obtained in our various analyses.

The Economic Impacts of an Expanded NEDC in Conjunction With a Southern Compact in 1999

As with the other compact scenarios, we developed initial estimates of the effects of an expanded NEDC in conjunction with a southern compact in 1999 by using a set of key assumptions and conducting subsequent sensitivity analyses. In addition to conducting the same sensitivity analyses that we conducted under the previous two compact scenarios, we also varied the assumption regarding the Class I minimum price, or compact price, in the compact region. For that analysis, we increased the minimum price from $16.94 to $18.00 per hundredweight in the southern compact but retained the $16.94 minimum price in the expanded NEDC. We used this higher minimum southern compact price because cooperative pay prices in selected cities in USDA’s Appalachian, Southern, and Central milk marketing orders averaged about a dollar higher than in the Northeast Marketing Order in 1999. Under this scenario we conducted an additional analysis in which we assume that fluid trade movements into compact regions are limited to the amount of milk that is produced within a 100-mile radius surrounding a compact region. Because this analysis represents a variation of the model, we also conducted a separate set of sensitivity analyses.

We modified the model for each of the three compact scenarios to account for this additional fluid milk trade restriction. The model results under the NEDC and the expanded NEDC scenarios did not change when this restriction was added, but results were different for the expanded NEDC in conjunction with a southern compact scenario. Therefore, we are including the results of this additional modeling effort only for the expanded NEDC in conjunction with a southern compact scenario.

We performed this analysis because our data are at the regional level as opposed to the milk plant or dairy farm level. Therefore, our transportation cost data are average cost data and do not apply to individual shipments. As a result, our initial results may reflect more movement of milk between regions than would actually occur.

Sensitivity Analyses for the Expanded NEDC in Conjunction With a Southern Compact Scenario

Tables 52 through 57 present the results of our sensitivity analyses for 1999 farm and wholesale-level economic variables.

Summary of the Estimated Impacts of the Expanded NEDC in Conjunction With a Southern Compact

Tables 58 and 59 summarize the results of our initial estimates and sensitivity analyses by presenting the range of estimates of the changes from our no-compact scenario that we obtained from our various analyses.

The Economic Impacts of an Expanded NEDC in Conjunction With a Southern Compact Using a More Restrictive Fluid Milk Trade Assumption

Tables 60 and 61 provide our initial estimates obtained by modifying the IRCM to include a more restrictive trade assumption about fluid milk.

Tables 62 through 67 present the results of our sensitivity analyses using a more restrictive fluid trade assumption.

Tables 68 and 69 summarize the results of our initial estimates and sensitivity analyses by presenting the range of estimates of the changes from our no-compact scenario that we obtained from our various analyses using a more restrictive trade assumption.

Appendix VI: Interregional Impacts of Three Compact Alternatives in 2000

We present our estimates of the three compact scenarios’ impacts on 2000 farm-level and wholesale-level indicators when compared with a no- compact scenario in the following tables. As with our 1999 analysis, we calibrated the Interregional Dairy Sector Competition Model (IRCM) using 2000 data to develop a baseline—an IRCM00. However, we did not conduct a series of sensitivity analyses for the 2000 estimates for several reasons: The data for 2000 were preliminary when we conducted these analyses in July 2001.

The dairy industry was undergoing a period of adjustment following USDA’s regulatory changes to its milk marketing order program in January 2000. Because the IRCM is a spatial equilibrium model, and the dairy markets appeared to be in disequilibrium in 2000, we questioned whether 2000 could be used to accurately estimate the impacts of dairy compacts.

The sensitivity analyses performed for the 1999 estimates indicated that the IRCM99 model was robust—that is, the estimates that we obtained when we used different assumptions were similar to the initial estimates that we obtained using our initial set of assumptions. As a result, we did not think that another series of sensitivity analyses would provide much additional information.

The following tables provide baseline estimates of the dairy sector indicators under our no-compact scenario and the estimates of the impacts of the three different compact alternatives. As with our 1999 estimates, we present estimates under both less restrictive and more restrictive fluid trade assumptions for the expanded NEDC in conjunction with a southern compact scenario. Our baseline estimates for 2000 also include the effects that USDA’s milk marketing order regulatory reforms had on farm-level and wholesale-level dairy sector indicators. As a result, the baseline estimates for 2000 are not comparable to those for 1999.

We used the same set of assumptions to develop our 2000 estimates as we did to develop our 1999 baseline and initial estimates: No more than 40 percent of any one region’s milk may be shipped to another region without being subject to the receiving region’s pricing requirements. This assumption is used to simulate USDA milk marketing order regulations regarding minimum pricing requirements for milk shipped between marketing orders. This threshold was chosen as a proxy for the requirement that an adjustment be made if a plurality of an order's packaged milk was sold in another region.

Supply elasticities are medium-term (that is, 5 years).

Demand elasticities are medium-term. The Class I minimum price in the compact region, or the compact price, is $16.94 per hundredweight of milk.

Market-driven over-order premiums are zero in the compact region. This initial assumption represents a lower bound, and assumes that all market- driven over-order premiums in NEDC states are replaced by Compact over-order producer price payments.

A handler must pay the compact over-order producer price into the compact pool for milk shipped into the compact region in order to receive the compact price.

Using these assumptions, tables 70 through 75 compare our no-compact baseline scenario with our estimated changes in farm-level and wholesale- level indicators across different compact scenarios for 2000.

Appendix VII: Studies of the Interregional Economic Impacts of Various Dairy Compact Alternatives

We reviewed and analyzed five studies that provide estimates of the interregional economic impacts of various compact alternatives. These studies used a variety of economic models, assumptions about model parameters such as demand elasticities, and data sets. The compact alternatives that they examined also varied. Despite these differences, the results of these studies on the impacts of relatively small compacts, such as the NEDC, on dairy farmers in noncompact regions were generally comparable to ours. In addition, these studies agree with ours that, as compacts expand in size, the economic impacts on dairy farmers in noncompact regions increase.

USDA (1999)—A Study Using an Annual, Time-Series Dairy Sector Model

A study issued in 1999 by USDA estimated the interregional impacts that the NEDC would have on noncompact regions. USDA used a model derived, in part, from a national dairy sector model developed by USDA’s Economic Research Service and dairy sector data from 1999 to forecast the impact of the NEDC from 2000 through 2005. The parameters used in the analysis were not directly estimated, but instead, were drawn from the Economic Research Service model. The Service’s national dairy sector model is an annual, time-series dairy model that is estimated as a system of equations using a three-stage, least squares regression analysis. USDA modified the Service’s model to allow for a multiregional analysis. The modified model used to estimate the interregional impacts of the NEDC consisted of five sections: (1) milk supply, (2) dairy product supply, (3) dairy product demand, (4) market equilibrium conditions, and (5) regional market utilization and pricing. The major features of USDA’s analysis and model included the following: The model used an iterative process to solve a system of simultaneous dairy demand and supply equations.

The model used 36 regions, including the former 32 federal milk marketing orders; California; and three other nonfederally regulated regions.

The model did not provide for milk movements between regions.

USDA adjusted parameters developed for the Economic Research Service model to reflect regional differences in the dairy industry.

USDA used 1999 data to project the NEDC’s impacts in each of 6 years— 2000 through 2005—and the average annual impact over the same period.

USDA used two different scenarios to estimate the NEDC’s impacts: (1) the NEDC price of $16.94 per hundredweight of milk would remain constant during the years 2000 through 2005 and (2) the NEDC price of $16.94 per hundredweight would remain in effect only in 2000, after which time the NEDC price would change to the USDA federal milk marketing order Class I price for Boston plus $1.30 per hundredweight.

Table 76 summarizes USDA’s estimates of the 6-year average annual impact of the NEDC in (1) noncompact regions of the country affected the most by the NEDC, (2) all 32 marketing orders combined, (3) California, and (4) the country as a whole. These estimated impacts are expressed as changes to average production levels, farm-level prices, and farm-level revenue from levels that would be expected in the absence of the NEDC.

USDA also reported on the interregional impacts in each of its then- existing 32 milk marketing orders and in all noncompact regions combined. For example, under the first scenario, for which it used a $16.94 NEDC price for each of the 6 years, USDA estimated that the average all- milk price in all noncompact regions would decline by less than 1 cent per hundredweight during the years 2000 through 2005. With regard to its individual marketing orders, such as the Upper Midwest Marketing Order, USDA estimated that the all-milk price would decline by 1 cent per hundredweight in 2000, 2001, 2004, and 2005.

Cox et al. (1999)–A Study Using a Spatial Market Equilibrium Model

A study issued by Cox, Cropp, and Hughes in 1999 estimated the impacts of an expanded NEDC and an expanded NEDC in conjunction with a southern compact on noncompact regions. Cox et al. used a spatial market equilibrium model and dairy sector data for 1997 to estimate the potential impacts of compacts in that year. For purposes of the analysis, the expanded NEDC included the six New England states, New Jersey, New York, Maryland, and Pennsylvania. The southern compact consisted of 10 states.

The spatial market equilibrium model also incorporated two additional modeling features: It simulated the processing of dairy commodities in a vertical marketing sector and used price wedges, or mark-ups, for each dairy commodity to simulate USDA’s classified pricing system and compacts. To generate a competitive spatial market equilibrium, the model maximized producer and consumer surpluses in each region, minus transportation costs, for the different commodities, subject to certain trade-flow and other constraints. In addition, the model allowed for classified pricing so that raw milk used for fluid milk attracted a higher price than raw milk used for manufactured dairy commodities. Using an iterative technique, the model solved for regional farm-level milk prices and production, wholesale-level dairy prices and production, and interregional trade flows. This model—the IRCM97—is an earlier version of the model that we used for our analysis of interregional impacts.

The model assumed intermediate-run (3- to 5-year) supply and demand functions for 12 geographic regions of the country (the current 11 USDA milk marketing orders and California), representing different milk and dairy product supply and demand regions. In addition, Cox et al. used component yield data from other researchers. Features of their analysis follow: The model was an interregional, spatial equilibrium model. The model prohibited fluid milk trade between compact and noncompact regions.

Twelve demand relationships for dairy products were developed for the 12 regions in the model; these demand relationships were based on consumer demand for nine distinct dairy products using national estimates of per capita wholesale demand.

To link prices among the 12 regions, the model used 1995 transportation cost estimates provided by researchers at Cornell University.

The model used 1997 price and production data obtained from USDA for developing a 1997 base year.

The model added a price wedge of $2 per hundredweight to the 1997 Class I differentials in each compact region.

All scenarios assumed no Commodity Credit Corporation milk price supports because these were set to expire in 2000.

Under the model assumptions used, the researchers estimated the impacts of dairy compacts on farm-level prices and revenue, and commodity prices and expenditures. Tables 77 and 78 provide the study’s results.

Bailey (2000)–A Study Using a Regional Economic Simulation Model

In 2000, Kenneth Bailey, an agricultural economist at Pennsylvania State University, issued a study that estimated the interregional economic impacts of a large compact on noncompact states. Bailey used a static equilibrium model, similar in structure to the constant elasticity functional form policy models developed by Gardner. In his 2000 study, Bailey relied on 1997 data to forecast the impact of compacts in 2000. The compact simulation included those states in USDA’s Appalachian, Florida, Northeast, and Southeast milk marketing orders. The model was multiregional to reflect milk supply, allocation, and class prices in federal milk marketing orders. However, overall supply and demand for dairy products were modeled at the national level, as opposed to on a marketing order basis. The model also relied on medium-run supply and demand elasticities as reported in agricultural economics literature. The data sources for the model included USDA’s Agricultural Marketing Service, federal milk marketing order administrators, and the California Department of Agriculture.

The model incorporated several significant aspects of USDA’s milk marketing order reform that were adopted in January 2000, including component pricing. As specified in milk marketing order reform, the model based the Class I price on the higher of the Class III or IV price. The model posited 13 regions: 11 federal marketing orders, California, and an “unregulated” region representing all areas of the country that did not fall under federal marketing orders or California’s milk pricing plan.

Bailey analyzed the impacts of a large multiregional dairy compact accounting for about 27 percent of all milk marketed in the model. This compact scenario was evaluated relative to a no-compact baseline. Bailey also conducted additional analyses by varying retail fluid milk demand elasticities (from –0.32 to –0.23) and by using a fixed-percentage farm-to- retail milk markup instead of a fixed-dollar markup. The major features of Bailey’s analysis and model follow: The model did not allow for trade between regions. The model estimated supply, price, and demand for fluid milk and three dairy commodities: butter, cheese, and nonfat dry milk.

Both a $1 and a $2 fixed amount per hundredweight were used to model an effective compact over-order producer price payment.

The assumption about the amount of the market-driven over-order premium was varied to reflect either the full amount of the market-driven over-order premium as that in the no-compact baseline or half the amount in the no-compact baseline.

The model estimated demand for fluid milk at the retail level and demand for manufactured dairy products at the wholesale level. In addition, the model used various farm-to-retail markup assumptions.

Table 79 summarizes Bailey’s estimates of the multiregion compact on farm-level milk prices, revenue, and production in 2000.

In addition to estimating the multiregional compact’s impact on farm-level milk prices, revenue, and production, Bailey also estimated changes within the compact region, and the impact that these changes would have on all noncompact regions. Bailey estimated that milk production within the compact region would increase by 0.4 to 1.4 percent, causing lower wholesale prices for butter (by 0.3 to 1.0 percent), cheese (by 0.5 to 1.7 percent), and nonfat dry milk (by 0.3 to 0.8 percent) in all federal milk marketing orders.

Balagtas and Sumner (2001)–A Study Using a Price Discrimination Framework

A study conducted in 2001 by Balagtas and Sumner estimated the interregional effects of the NEDC and an expanded NEDC on noncompact regions. Balagtas and Sumner used an annual, national-level supply and demand simulation model to estimate the effects of the Compact on the U.S. dairy sector, based on 1999 data. For purposes of this analysis, the expanded NEDC included the NEDC states and New Jersey and New York.

The model simulated class and blend prices that would be announced by USDA’s milk marketing orders in the absence of any compact. The model's parameters were established by using milk marketing order and Compact commission data and intermediate-run (3- to 6-year) supply and demand elasticities. The model also used national-level, as opposed to regional- level, supply elasticities.

The major features of the model follow: The model included two aggregate milk categories—fluid milk and manufactured dairy products—as opposed to four milk classes.

The model estimated the interregional impacts of the two different compacts in four noncompact regions: California, Wisconsin, Minnesota, and a combined rest of the United States that excluded the NEDC states.

The model calculated the elasticity of demand for manufactured dairy products in the New England region.

Table 80 summarizes the results of Balagtas and Sumner’s estimates of the interregional impacts of the NEDC and an expanded NEDC on farm-level milk prices and production in noncompact regions.

Balagtas and Sumner also estimated the interregional impacts on the price of milk used for manufactured dairy commodities and farm-level revenue. They estimated that in 1999, the price of milk used for manufactured dairy commodities would fall in noncompact regions by about 2 cents per hundredweight, which would have translated into producer surplus losses for noncompact producers of about $34 million in 1999.

Rosenfeld (2001)–A Study Using an Economic Model of Classified Pricing

A study issued by Allen Rosenfeld in 2001 estimated the interregional impacts of the NEDC and a larger compact on noncompact states.Rosenfeld used a classified pricing model and dairy sector data from 2000 to predict potential impacts in that year. For purposes of the analysis, the larger compact included a total of 29 states located in the Northeast and the South. These 29 states accounted for about 62 percent of Class I milk consumption in 2000.

The model used supply and demand analysis within the context of traditional modeling of classified pricing. Rosenfeld used supply and demand elasticities from the dairy economics literature to estimate the increase in milk production and the decrease in milk consumption in the compact regions caused by a higher compact minimum price for milk used for and sold as fluid milk. Rosenfeld then used these elasticities to estimate the decrease in the price of milk used for manufacturing purposes, which he then used to estimate the decline in dairy farm revenue in noncompact states.

The major features of Rosenfeld’s analysis and model follow: The model used a compact Class I over-order premium for both compact scenarios of 18.5 cents per gallon of milk.

The model used a supply elasticity of 0.227 to estimate the impact of a higher blend price within the compact region on milk production. The model subsequently used a higher elasticity (0.35) in a sensitivity analysis.

The model used a wholesale demand elasticity of –0.144 for Class I milk and a wholesale demand elasticity of –0.261 for all other classes of milk to estimate the impact of price changes on consumption.

The model did not allow for decreased production by farmers in noncompact states in response to lower prices.

The study did not discuss interregional trade.

Table 81 summarizes Rosenfeld’s estimates of the interregional impacts of the NEDC and a larger compact on dairy farm revenue in noncompact states for 2000.

Rosenfeld noted that his use of 2000 data may have overstated the estimates of the impact of the NEDC and an expanded compact because, in 2000, the difference between the Class 1 milk marketing order price and the NEDC price of $16.94 was larger than in other years since the NEDC has been in effect. To account for this, he performed a sensitivity analysis by adjusting the compact Class I price to simulate the average amount of the NEDC over-order payment during the first 44 months of NEDC operations. The result was that the 29-state compact had a smaller impact on dairy farm revenue in noncompact states ($228 million as opposed to $374 million).

Comparison of Studies Reviewed

The five studies we reviewed and analyzed used a variety of models, assumptions, and data sets. They also varied in terms of the dairy compact alternatives they examined. To allow a comparison, table 82 summarizes the key features of these studies.

Appendix VIII: Comments From the Executive Director, NEDC

The following are GAO's comments on the NEDC's written response dated September 7, 2001, to our draft report.

GAO Comments

1. We recognize that the National Agricultural Statistics Service revised its estimates of New England's milk production for 2000. However, our estimates of the impacts of the NEDC are based primarily on 1999 data. While we also used preliminary data for 2000 to estimate the impacts for that year, we note that these data are preliminary and as a result, we did not conduct sensitivity analyses for that year. Further, a 2-percent adjustment in New England's milk production would be unlikely to affect our estimates of the NEDC's impact on noncompact regions in the country. 2. We recognize that before USDA's milk marketing order regulatory reforms took effect in January 2000, New York was in a different milk marketing order than were the New England states. However, we do not model New York as being in a different milk marketing order. Rather, the dairy model that we used to estimate the impact of compacts aggregates states on a regional basis. As discussed in appendix II, the states included in the model's Northeast region include the six NEDC states, Delaware, the District of Columbia, Maryland, New Jersey, New York, and Pennsylvania. Because the model is a regional model, the NEDC is represented as being part of the Northeast region. As a result, the model is unable to estimate the impact of compact states on noncompact states within the same region. 3. We disagree that the report misrepresents the regulation's design and function. We state that all raw milk used for and sold as fluid milk in the six NEDC states is subject to the NEDC's regulations, not just milk produced by dairy farmers in the six NEDC states. We have revised the report to explicitly state that farmers in New York may receive NEDC payments. However, the impact of the NEDC on dairy farmers in New York was beyond the scope of work that we agreed to perform for Senator Kohl. 4. We concur that New York dairy farmers have received NEDC payments, based on data developed by the NEDC commission. The report, however, does not state that $50 million has been provided to New York dairy farmers. We have revised the report to include data published by the NEDC that indicates that about 1,300 New York dairy farmers have received NEDC payments that have averaged, on an annual basis, $9,812 since the NEDC began in July 1997.5. We disagree that the model omits from consideration the regulatory treatment of plants located outside New England that sell packaged milk in New England—partially regulated plants. The model provides for shipments of packaged milk between compact and noncompact regions. A discussion of how this is modeled is included in appendix II. 6. USDA officials and other dairy economists who have analyzed the NEDC's impact on the premium structure in New England told us that the NEDC has had the effect of eroding much of the market-driven over-order premium that processors had been paying prior to the NEDC's establishment, as opposed to premiums that cover services provided by cooperatives or handlers. This effect would vary, however, depending upon market forces. Such market forces could fluctuate from month to month and year to year. Much of the data needed to determine the specific impact that the NEDC has had on the premium structure in New England are proprietary in nature, and thus we do not have access to this data. 7. The report states that the trends regarding farm attrition rates and production in the NEDC states and the rest of the country were similar, both before and after the compact. This is not to say that the percentage change in the NEDC states was identical to the percentage change in the rest of the country. Regarding attrition, the number of farms has been steadily declining both within the NEDC states and in the rest of the country, but at a slightly different rate. 8. We disagree that the report concludes that the NEDC had no impact on farm attrition. We note that the percentage reduction declined slightly following the NEDC's establishment but conclude that it is difficult to determine the extent to which the NEDC, relative to other factors, may have changed farm attrition. 9. We disagree that the herd size discussion is less helpful. We believe that providing a longer-term perspective that includes national trends provides a useful context for discussing dairy policy options. 10. We agree that the NEDC's impact on retail milk prices is a complex question. Our report states that many factors affect retail prices, in addition to the farm-level price of milk. We revised the report to recognize that retail milk prices, after increasing by about 20 cents per gallon in July 1997, subsequently fell by as much as 5 to 7 cents per gallon for several months. 11. We relied on USDA's Food and Nutrition Service's analysis of the NEDC's impact on the Food Stamp Program. On the basis of its analysis, USDA was unable to determine if the NEDC increased program benefit levels. According to USDA, if the NEDC's impact on retail milk prices in the NEDC states had caused a $1 increase in national benefit levels, this would have resulted in an additional $60 million in federal funding per year. Aside from the issue of whether the NEDC has increased federal costs, USDA indicated that the NEDC has increased Food Stamp Program participant costs.

Appendix IX: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

In addition to those named above, M. Shawn Arbogast, Venkareddy Chennareddy, Jay R. Cherlow, Nancy L. Crothers, Oliver H. Easterwood, Barbara J. El Osta, and Marcia B. McWreath made key contributions to this report.

Related GAO Products

Dairy Industry: Information on Milk Prices and Changing Market Structure (GAO-01-561, June 15, 2001).

Fluid Milk: Farm and Retail Prices and the Factors That Influence Them (GAO-01-730T, May 14, 2001).

Dairy Products: Imports, Domestic Production, and Regulation of Ultra- filtered Milk (GAO-01-326, Mar. 5, 2001).

Dairy Industry: Information on Prices for Fluid Milk and the Factors That Influence Them (GAO/RCED-99-4, Oct. 8, 1998).

Dairy Industry: Information on Marketing Channels and Prices for Fluid Milk (GAO/RCED-98-70, Mar. 16, 1998).