1. Economic Implications of the AUS-FTA for U.S. Dairy Markets and Policy Presentation by Joseph Balagtas at the Silverado Symposium on Agricultural Policy Reform Napa, California December 19, 2004 Based on a Preliminary Report prepared by Daniel Sumner, Julian Alston, Joseph Balagtas, Henrich Brunke for Dairy Australia

2. Issues Proposed AUS-FTA may include key agricultural commodities, including dairy Proposed AUS-FTA may include key agricultural commodities, including dairy Dairy has been left out of CUSTA, NAFTA. Dairy has been left out of CUSTA, NAFTA. What’s the likely impact on U.S. dairy markets? What’s the likely impact on U.S. dairy markets? Quantity of imports Quantity of imports Prices of milk components Prices of milk components Prices and quantity of milk produced Prices and quantity of milk produced Domestic dairy farm policy Domestic dairy farm policy

3. Approach: Overview Develop a simulation model of world dairy trade Develop a simulation model of world dairy trade Model underlying supply and demand relationships Model underlying supply and demand relationships Allow for trade-distorting policies around the world Allow for trade-distorting policies around the world Simulate the effects of the AUS-FTA relative to a baseline Simulate the effects of the AUS-FTA relative to a baseline

4. Modeling Approach: Country Groups Principal idea is to represent the facts that Principal idea is to represent the facts that Trade barriers limit movement of dairy products across borders in many parts of the world Trade barriers limit movement of dairy products across borders in many parts of the world Local sanitation and product quality limits the movement of dairy products across borders Local sanitation and product quality limits the movement of dairy products across borders It is impossible to specify the details of these arrangements and limitations in an empirically tractable way, so some approximations and simplifications are necessary It is impossible to specify the details of these arrangements and limitations in an empirically tractable way, so some approximations and simplifications are necessary We approximate the trade barriers and sanitary limits on trade by dividing the world into several aggregates: We approximate the trade barriers and sanitary limits on trade by dividing the world into several aggregates: Represented in the model as quantities or shares of milk that had particular trade openness for Australian dairy products. Represented in the model as quantities or shares of milk that had particular trade openness for Australian dairy products.

5. 5 Country Groups Defined (A) Australia (U) United States (Z) Suppliers that are open to market trade and export directly in competition with Australia in relevant markets (NZ data represents the milk quantity for this aggregate). (R) Milk markets and suppliers that participate in global market driven trade, but their internal prices are only partially open to influences outside their borders (Southeast Asia, Latin American, etc.) (O) Milk markets that export and import mainly on non-market basis with trade barriers or export subsidies or who do not trade in markets in competition with Australian dairy products (e.g., India, Japan, and EU) We do not specify countries in R and O We do not specify countries in R and O

6. Modeling Approach: Trade in Milk Components Manufacturing capacity is not fixed to specific products over the 5-10 year horizon for AUS-FTA implementation Manufacturing capacity is not fixed to specific products over the 5-10 year horizon for AUS-FTA implementation We model derived demand and supply for milk components We model derived demand and supply for milk components Fat Fat Solids-not-fat (SNF) Solids-not-fat (SNF) Other aggregations possible (protein) Other aggregations possible (protein)

7. Key Information Requirements Elasticities of supply and demand Elasticities of supply and demand Baseline U.S.-Australia price wedge Baseline U.S.-Australia price wedge Depends on world supply and demand projections, and also policy projections Depends on world supply and demand projections, and also policy projections Measure of international price transmission Measure of international price transmission Depends on the size of each region, as well as domestic and border policies in each region Depends on the size of each region, as well as domestic and border policies in each region

8. Baseline Alternatives Status quo policies Status quo policies Liberalization following Doha round Liberalization following Doha round We model Doha’s effects as a rise in world market prices due to tariff cuts and TRQ expansion in the U.S., Europe, and elsewhere We model Doha’s effects as a rise in world market prices due to tariff cuts and TRQ expansion in the U.S., Europe, and elsewhere FTAA FTAA

9. AUS-FTA Scenarios Gradual elimination of trade-distorting policies Gradual elimination of trade-distorting policies Expansion of quota Expansion of quota Reduction of TRQ Reduction of TRQ Moderate trade liberalization Moderate trade liberalization Free trade by 2009 Free trade by 2009 Slow trade liberalization Slow trade liberalization Expansion of Australian quota, price wedge remains Expansion of Australian quota, price wedge remains Free trade by 2014 Free trade by 2014 With and without Doha trade liberalization With and without Doha trade liberalization

10. Preliminary Results: Production and Trade 20092014 Changes in: SlowModerate Without WTO With WTO U.S. Fat Production (million pounds) -17-135-160-18 U.S. Snf Production (million pounds) -40-318-376-43 U.S. Fat Imports (million pounds) 4321024828 U.S. Snf Imports (million pounds) 2339446654

11. Preliminary Results: Production and Trade 20092014 Percentage Changes in: SlowModerate Without WTO With WTO U.S. Fat Production (percentage of base) -0.3-2.0-2.3-0.3 U.S. Snf Production (percentage of base) -0.3-2.0-2.3-0.3 U.S. Fat Imports (percentage of base) 0.63.03.40.4 U.S. Snf Imports (percentage of base) 0.22.62.90.3

12. Preliminary Results: Prices and Quantity of Milk 20092014 Changes in: SlowModerate Without WTO With WTO U.S. Fat Price (cents per pound) -5.0-7.4-8.8-1.1 U.S. Snf Price (cents per pound) 1.30.00.1-0.03 U.S. Milk Quantity (billion pounds) -0.46-3.7-4.3-0.50 U.S. Milk Price ($/cwt)-0.03-0.24-0.28-0.04

13. Preliminary Results: Prices and Quantity of Milk 20092014 Percentage Changes in: SlowModerate Without WTO With WTO U.S. Fat Price (percent)-3.0-5.7-6.5-0.7 U.S. Snf Price (percent)1.60.10.1-0.03 U.S. Milk Quantity (percent)-0.3-2.0-2.3-0.3 U.S. Milk Price (percent)-0.3-2.0-2.3-0.3

14. Summary of Preliminary Results AUS-FTA would have very small to moderate effects on U.S. dairy sector, depending on AUS-FTA would have very small to moderate effects on U.S. dairy sector, depending on Pace of implementation Pace of implementation Contingent possibility of lower pre-existing price wedges resulting from WTO Contingent possibility of lower pre-existing price wedges resulting from WTO By 2009, as a result of the AUS-FTA By 2009, as a result of the AUS-FTA Slow scenario => 0.3 percent reduction in U.S. price and quantity of milk (3% decrease in price of fat offset by 1.6 increase in price of snf) Slow scenario => 0.3 percent reduction in U.S. price and quantity of milk (3% decrease in price of fat offset by 1.6 increase in price of snf) Moderate scenario => 2.0 percent reduction in U.S. price and quantity of milk (5.7 percent decrease in price of fat and 1.0 percent decrease in price for snf) Moderate scenario => 2.0 percent reduction in U.S. price and quantity of milk (5.7 percent decrease in price of fat and 1.0 percent decrease in price for snf)

15. Summary of Preliminary Results By 2014, without a WTO agreement in force By 2014, without a WTO agreement in force Impacts of free bilateral trade similar to those in 2009 (the moderate scenario), but slightly larger Impacts of free bilateral trade similar to those in 2009 (the moderate scenario), but slightly larger 2.3 percent reduction in U.S. price and quantity of milk 2.3 percent reduction in U.S. price and quantity of milk A WTO agreement would pre-empt most of those effects by eliminating most of the Australia-U.S. price wedge A WTO agreement would pre-empt most of those effects by eliminating most of the Australia-U.S. price wedge Price and quantity effects of AUS-FTA all less than 1 percent Price and quantity effects of AUS-FTA all less than 1 percent

16. Implications for U.S. Dairy Farm Policy U.S. dairy programs potentially affected by the AUS-FTA U.S. dairy programs potentially affected by the AUS-FTA Dairy price support Dairy price support Milk Income Loss Contract (MILC) Milk Income Loss Contract (MILC) Dairy Compacts Dairy Compacts Milk Marketing Orders Milk Marketing Orders

17. AUS-FTA and U.S. Dairy Price Support U.S. government supports a target milk price with purchases of butter, cheese, NFDM. U.S. government supports a target milk price with purchases of butter, cheese, NFDM. Purchase prices are set by formula intended to ensure a minimum farm price of milk. Purchase prices are set by formula intended to ensure a minimum farm price of milk. The target price has fallen over the last 20 years. The target price has fallen over the last 20 years. Purchase prices adjusted periodically Purchase prices adjusted periodically Baseline projections indicate market prices above purchase prices. Baseline projections indicate market prices above purchase prices. Small effects of AUS-FTA do not induce additional purchases and increased outlays. Small effects of AUS-FTA do not induce additional purchases and increased outlays.

18. AUS-FTA and MILC MILC is a deficiency payment that pays MILC is a deficiency payment that pays 0.45 x ($13.69 – Class 1 Mover) per cwt up to 2.4 mil. lbs of milk per farm per year (output of about 110 cows) MILC may cushion the impact of AUS-FTA on producer revenue. MILC may cushion the impact of AUS-FTA on producer revenue. In that case, AUS-FTA also increases taxpayer cost of MILC. In that case, AUS-FTA also increases taxpayer cost of MILC.

19. AUS-FTA and Dairy Compacts Compacts are currently not a part of U.S. dairy policy, but continue to be considered as a potential policy tool. Compacts are currently not a part of U.S. dairy policy, but continue to be considered as a potential policy tool. Similar to MILC, but the target price is legislated as a minimum pay price, so consumers pay, not taxpayers. Similar to MILC, but the target price is legislated as a minimum pay price, so consumers pay, not taxpayers. Dairy Compacts could cushion the impact of AUS-FTA on U.S. milk revenue. Dairy Compacts could cushion the impact of AUS-FTA on U.S. milk revenue. The cost born by consumers, with no additional government outlays. The cost born by consumers, with no additional government outlays.

20. AUS-FTA and Marketing Orders Marketing orders transfer income from consumers to producers by price discriminating against fluid consumers and pooling milk revenue. Marketing orders transfer income from consumers to producers by price discriminating against fluid consumers and pooling milk revenue. Fluid price set as a fixed differential above the manufacturing price. Fluid price set as a fixed differential above the manufacturing price. Any change in the manufacturing milk price (from the AUS-FTA) is matched with a change of equal magnitude in the fluid milk price, and thus in the average milk price. Any change in the manufacturing milk price (from the AUS-FTA) is matched with a change of equal magnitude in the fluid milk price, and thus in the average milk price. Our model captures the effect on the average milk price. Our model captures the effect on the average milk price.