AFPC Policy Issue Paper 96-2

Ronald D. Knutson
Joe L. Outlaw

Agricultural and Food Policy Center
Department of Agricultural Economics
Texas Agricultural Experiment Station
Texas Agricultural Extension Service
Texas A&M University

August 1996

College Station, Texas 77843-2124
Telephone: (409) 845-5913
Fax: (409) 845-3140


The statutory objectives of federal dairy policy have not changed since the enactment of the milk price support program in 1949 and the enabling legislation for federal milk marketing orders in 1937. Officially, price support objectives remain as specified in the 1949 Act, including:

Likewise, the statutory federal order objectives are officially as specified in the 1937 authorizing legislation, including:

Dairy policy has not been nearly as stable as these underlying unchanging objectives. Changes in policy have been a reaction to:

Partially in reaction to structural changes, dairy program philosophy evolved in the 1960s into a uniform national policy on milk pricing. This policy involved the establishment of specific relationships among class prices, and between federal order and support prices. Building on previous studies by Gaumnitz and Reed; Trelogan and Herman; and Harris, this uniform policy on milk pricing was most extensively studied, debated, developed, and explained in the Nourse Report. This report was the product of a USDA secretarial committee composed of many of the most knowledgeable dairy intellects ever assembled. It subsequently and most recently was summarized, restated, and reconfirmed in the 1972 Report of the Milk Pricing Advisory Committee, USDA.

During the 1980s and the 1990s, there appears to have been a marked departure from, and challenges to, the milk pricing policy and philosophy that developed in the decades of the '60s and '70s. Ironically, national study committees assembled during the 1980s continued to express views and recommendations on dairy policy that were consistent with those laid down in the 1960s, while reflecting the contemporaneous philosophy regarding the role of government and the prevailing budget constraints.

The purpose of this leaflet is to restate underlying principles of milk pricing that developed during this formative period, to evaluate apparent departures from those philosophies, and to explain their potential impacts. The leaflet is written on the premise that public and private institutions perform most effectively and smoothly if their decisions are guided by a common set of principles and philosophical underpinnings.

These principles and the related policies may be changed or adjusted as industry changes, but this should be done within the context of and consistent with the remaining existing policies. The emphasis in this leaflet is on dairy price support and marketing order policy.

Evolution of Dairy Policy Objectives

The objectives and institutions of dairy policy pre-date and transcend both the enactment of federal order enabling legislation and the milk price support program. Cooperatives formed during the 19th Century to bargain were subsequently legitimized by the Capper-Volstead Act. Their leaders and economic advisors developed the first milestone in milk pricing philosophy that subsequently evolved to benefit the entire industry. The core concept involved classified pricing of milk. This concept was implemented in the early 1900s by cooperatives as a means of enhancing producer returns and rewarding producers for quality. Geographic alignment of prices from a local basing point located at population centers recognized the economics of moving milk over distances. The deterioration of cooperative classified pricing systems during the Great Depression led to their codification initially into state law. However, conflicts between states in pricing provisions, resulting from the constitutional mandate not to impede the movement of goods in interstate commerce, led to the enactment of the 1937 Act. Subsequently, a system of federal milk marketing orders developed across the United States. Correspondingly, the role of state orders declined, except in states such as California.

After World War II, it was found that orderliness was difficult, if not impossible, to accomplish in an environment of surplus production and in the absence of a support floor on milk prices. The result was the enactment of the 1949 permanent legislation establishing the price support program.

The subsequent development of surplus conditions led to the appointment by the National Milk Producers Federation (NMPF), in 1959, of a committee of land grant university economists to consider methods of stabilizing prices and incomes to dairy farmers. As the first in a series of producer proposals to control production, the NMPF committee suggested that producers give careful study to a program to limit supplies. The committee recommended a program that included negotiable bases with a tax on excess production to cover the cost of surplus product disposal. In addition to the status quo and production controls, alternatives of direct payments, a self-help dairy board, and marketing restrictions on low quality products were considered as policy options. Even though the subsequently elected Kennedy administration espoused a production control philosophy, it was never implemented.

Rapid improvement in transportation and refrigeration technology adapted to the dairy industry in the post-World War II economy resulted in increased interaction across markets and conflict over the appropriate federal order pricing instruments (pay prices vs. formulas) and basing points (local vs. regional vs. national). The result was the Nourse report which enunciated the following paraphrased and abbreviated federal milk marketing order objectives:

A decade later, when framed in the context of both the price support program and federal orders, the 1972 interagency Milk Pricing Advisory Committee boiled down U.S. dairy policy to having three objectives:

In attempting to rationalize, specify, and recommend policies designed to achieve these objectives, both the Nourse report and the Milk Pricing Advisory Committee spent considerable time evaluating appropriate relationships among federal order class prices and the milk price support program. These relationships, which have evolved and withstood the test of time, could legitimately be thought of as basic milk pricing principles. They include:

These principles of federal order prices created an orderly and consistent milk pricing system because changes in either national supply or demand were reflected throughout the system. That is, when the price of milk used for manufacturing (Class III) changed, all other minimum class prices adjusted upward or downward in a consistent manner. Moreover, when policymakers adjusted the level of the support price, all other class prices and the blend price paid producers moved in the same direction.

The central purpose of the 1972 Milk Pricing Advisory Committee was to determine whether the M-W price series, as the basic formula price, was still a reliable indicator of prices of milk used for manufacturing and to determine an appropriate substitute mover of milk prices. While the study concluded that the M-W was still reliable, it recommended that USDA proceed to develop and be ready to implement a substitute. The Committee determined that product formulas offer the best alternative to the M-W price series. It took over two decades for the M-W series to be modified. While it still considers only Grade B prices for milk that is used for manufacturing, it now updates the M-W for changes in product prices.

About a decade passed before the NMPF commissioned an autonomous Dairy Policy Study Committee to analyze federal dairy price programs and to advance recommendations for adjusting programs to better serve their public purposes. The majority of its membership were land grant university economists. The Study Committee's purpose was In its first and only report concentrating on price support issues, the Study Committee recommended a market-oriented safety-net dairy policy.

The Study Committee specified a rationale for government involvement in dairy that was consistent with the earlier Nourse and Milk Pricing Advisory Committee Reports. This rationale reflected contemporary thinking regarding the role of government in agriculture and was designed to be more consistent with the approach taken on other commodities, including:

In so recommending, the Study Committee determined the use of the price support program to enhance price and income as being inappropriate. This conclusion was based upon the resulting resource misallocations, excessive costs, arbitrary price determinations, and negative consumption impacts. It likewise rejected supply controls because they reduce competitiveness, impose market access costs, impede economically justified adjustments, and involve too high a level of regulation that is difficult or impossible to eliminate.

Arguably, the results of the Study Committee became the basis for successive reductions in the milk price support level and the adoption of a CCC purchase trigger for reducing price support levels. Clearly, the milk price support level has been at safety net levels since the completion of the work of the Study Committee.

The National Commission on Dairy Policy was established by the 1985 farm bill to study the milk price support program and the future of U.S. milk production. The Commission was composed of a cross-section of leading U.S. milk producers. In an environment of increased concern about regional divisions in dairy policy, the thrust of the Commission's report recognized the need for a national dairy policy. It rejected regional differences in policy such as the higher California make allowance. In doing so, it rejected the use of price supports to protect certain producers.

The Commission was critical of disruptive short-run adjustments in dairy policy, opting for policy to be established on a long-run basis without substantial change. It suggested that price support policy should:

As a result, it recognized that parity was outdated as a standard for milk pricing. It stated that historical average pricing used in other commodities has appeal. However, the Commission departed from the NMPF Study Committee Report by recommending a standby two-tier pricing system to accomplish production adjustment. Except for this last recommendation, the Commission report was quite consistent with the policies that had developed for the milk industry over the past three decades.

Principle Modification

Beginning in the 1970s, the milk pricing system and its underlying principles were increasingly challenged. Incremental policy changes were advocated and sometimes made apparently without consideration of how they fit into the historically accepted philosophy of milk pricing. Was there a new set of principles being developed in reaction to fundamental change within the industry or was a system being created that had no underlying principles? Some of the principle events that led to this challenge included:

Concluding Remarks

Changes in the principles of milk pricing are appropriate as the economic forces underlying the dairy industry change or as the statutes themselves are changed to reflect new or different policy objectives. For example, changes in the milk price support program may be required if market access and related GATT provisions effectively undermine the operation of the program.

Policy changes made incrementally without evaluation of their implications for the underlying principles of milk pricing almost certainly lead to inefficiencies. More significantly, they run the risk of undermining the federal order and price support programs. It seems unlikely that is what the dairy industry is seeking.