One Decade After the Dairy Compact: The Response of Retail Fluid Milk Prices in New England

The Northeast Dairy Compact, a brief experiment in regional regulation, was an agreement between New England states from 1997 to 2001 that sought to maintain the cultural and economic welfare of dairy farmers, rural communities, and promote regional development in New England. Nationally, the market share of New England farmers had diminished in comparison to that of Midwestern and Western farmers. The Compact was instituted to protect less productive but historically important New England dairy farmers from national competition. In effect, the Compact created a price floor below which the farm price for fluid milk could not fall. The base rate established by the Compact sought to promote economic security for dairy farmers at the expense of the full determination of prices by competitive supply and demand. However, retailers of milk in New England took note. Prior to and during the implementation of the Compact, research addressed the impact of the Northeast Dairy Compact on the relationship between farm and retail fluid milk prices. Evidence has shown that after the implementation of the Northeast Dairy Compact, retailers responded to increases in the production price of milk by quickly increasing retail prices at each instance of farm price increase, often in proportions far above the percentage increase in farm price, and by slowly, and incompletely, lowering retail prices after each instance of farm price decrease. Several studies suggest that New England retailers responded to the expected rise in wholesale milk prices by tacitly colluding to raise the retail price of fluid milk (Cotterill and Franklin, 2001; Chidmi, et al., 2004; Lass, et al., 2001; Lass, 2005). The objective of this paper is to determine to what extent the absence of the Compact during the past decade impacted farm-to-retail price asymmetries. If asymmetry diminishes, either in large part or at least to the levels of the immediate pre-Compact period, then we can conclude that the Compact truly served as a focal point event for price collusion by retailers. If it appears that asymmetry has been maintained, or even grown, in the decade since the Compact, then it remains open as to what extent the Compact truly caused a shift in pricing behavior in the New England dairy industry. Such results would beg the question of whether or not the divergence of retail and farm price over the late 1990s and 2000s was the result of factors other than the Compact, such as long-run processes of structural change within the dairy industry. We use monthly time-series data for the New England region for the time immediately following the end of the Northeast Dairy Compact in October 2001 through October 2011. The data set mirrors that used by Lass, Adanu, and Allen (2001) and by Lass (2005) to facilitate comparison. Retail fluid whole milk prices for Boston, Massachusetts and Hartford, Connecticut and the Class I farm price of milk for the Northeast Marketing Area were retrieved from the USDA Agricultural Marketing Service (AMS) online database (2012a) (Lass, 2005). We use the same modified Heien markup price model of fluid milk farm price-to-retail price transmission employed by Lass, Adanu, and Allen (2001) and Lass (2005). We model farm-to-retail price transmission as a dynamic distributed lag time-series model, reflecting the “notion that store managers may wish to use a ‘smoothed’ value of [wholesale price] to avoid changing prices [or at least to spread price changes out over the course of several months]” (Heien, 1980; Kinnucan and Forker, 1987). The model is partitioned into rising and falling farm prices with the intention of isolating their partial effects on retail price. The effect, or lack thereof, of the Dairy Compact on retail prices has significant implications for policy, particularly in light of the recent resurgence of regional efforts to bolster the economic security of culturally important regional agricultural markets. A reevaluation of the Compact may assist policy makers in determining whether it did, in fact, create a focal point for tacit collusion, as was suggested by empirical research at the time. If we cannot say with certainty that it did, then perhaps such regional price floors have the capacity to maintain the cultural and economic welfare of dairy farmers, rural communities, and promote regional development without consumer welfare loss. This question is both relevant to current discussions and has the potential to generate discussion among agricultural economists