Agricultural Marketing Regulation
The ACIL Report Twelve Months On
Prepared for
The New Zealand Business Roundtable
By
Denis Hussey
Director
ACIL Economics and Policy Pty Ltd
November 1993
A year ago the New Zealand Business Roundtable published the ACIL report Agricultural Marketing Regulation: Reality versus Doctrine. Since then its conclusions have been widely debated and there have been developments in each of the five major industries studied.
Most of these changes have, either explicitly or in their practical effect, been deregulatory in nature. Given the potential benefits for New Zealand of a more competitive environment, this is a welcome trend. Only a minority of the changes could be considered backward steps. Moves to partially exempt some producer boards from the Commerce Act come into this category.
There is a rising tide of questioning and deregulatory sentiment in all New Zealand's major agricultural industries. Discussion is becoming more focused on the important issues. Awareness of regulatory costs, and the benefits of competition and choice, is spreading.
However, there is ample scope for improving the quality of the debate and accelerating the pace of change.
This paper reviews developments over the past year in the context of ACIL's conclusions and recommendations. It begins with a brief recapitulation of ACIL's principal findings. The rationale and implications of some of the major changes which have since been made are then discussed. The concluding sections highlight what remains to be achieved, emphasising the wisdom of moving quickly to a more comprehensive programme of reform to replace what has been a piecemeal and ad hoc approach to date.
The principal objective for New Zealand agriculture must be maintaining internationally competitive industries. This means large and continuous improvements in cost structures, quality and innovation. The task has to be undertaken in an international environment where competition is fierce and mobile ideas and capital go where the commercial opportunities are most attractive.
ACIL's research led to two major conclusions in respect of this objective.
• Restricting competitive exporting incurs tangible costs and reaps virtually no benefits. New Zealand has minimal exploitable market power internationally and hence - with the exception of specific and unusual quota markets - there are no monopoly benefits for the taking. Regulations predicated on the unreal assumption that market power does exist incur high costs by suppressing competitive choice, the testing of ideas, innovation and commercial diversity. They form a major barrier to beneficial links with international expertise, market outlets and money.
• Producer boards and cooperatives are presently structured so as to bundle product prices and investment dividends. The consequences are distorted producer returns, leading to production at the margin which is unwittingly sold at a loss. New Zealand farmers effectively subsidise overseas consumers. The costs are greatest in the single seller industries. Moreover, the existing structures make it impossible to monitor investment performance and lack effective sanctions when performance is unsatisfactory.
ACIL did not recommend a wholesale dismantling of existing marketing structures. In fact, this would be counter-productive. Instead, two main recommendations for unleashing the benefits of competition and removing the bundling distortions were made:
• remove all the regulations (with some minor exceptions) preventing competition and choice in agricultural processing and marketing; and
• corporatise all the statutory and cooperative businesses, issue the shares to producers, and allow the shares to be traded freely.
Until these changes are introduced in full and across the board, New Zealand agriculture will fail to achieve its full potential. Unfortunately, the rest of the world is not standing still - delay is increasing the costs of changes which are inevitable.
One obstacle to substantial regulatory reform is a continuing belief in some of the old myths and shibboleths. In particular, major misconceptions about producer ownership and control remain, and spurious arguments supporting the need for regulated exporting are still widespread. However, the logic of the case for reform has gained support in policy making circles and with some farming leaders.
Shortly after the release of the ACIL report, the Director-General of the Ministry of Agriculture and Fisheries - the government's principal adviser on agricultural policy - stated in a report that he was "in general agreement with the thrust of the ACIL report, especially with respect to the assessment that New Zealand is a price taker on world markets for most, if not all, of its agricultural products, and to the need to 'unbundle' returns to farmers."
The minister of agriculture, addressing the Meat and Wool Boards' new electoral committee earlier this year, said:
"It's fine to have the protection of a levy or market allocation systems. But, just as we became dependent on subsidies, we must not become dependent on a form of regulation that comes from Parliament.
"Ultimately, I'm certain that if New Zealand society keeps going the way it is going along, and gets more self-reliant, it will say, if industries want to cooperate let them do so. Let them function on the basis of them wanting to do it rather than us having to pass laws to make it happen."
The President of Federated Farmers, Owen Jennings, in his valedictory address in July this year, imagined he was speaking in the year 2005. His remarks were 'reflections' on what had occurred, and why, over the 'previous' twelve years. He had the following to say about marketing regulation:
"The Producer Boards themselves, as well as Federated Farmers, defended the then position in the belief that not only was it successful, but that it ensured that farmers' interests were best protected by such statutory bodies. However, several major changes led to a rethink.
"Firstly, the value of deregulation and competition in the rest of the economy drove many farmers to conclude that there were gains to be had in an atmosphere where efficiency and effectiveness were driven by competitive forces.
"Secondly, the rapid growth from a dependence on commodity products, where price was the only issue that could be haggled over in the market place towards a more sophisticated range of added value consumer oriented products, meant that the perceived dangers of multiple selling were lessened considerably.
"Thirdly, the same stimulating competitive conditions that drove efficiency were also recognised as the ideal breeding ground for maximising diversification in product lines, marketing and structure.
"Fourthly, there was a growing realisation that political and commercial imperatives could not be pursued effectively under the same umbrella.
" ...a government dominated by those who believed that the market place was the best arbiter in resource allocation saw a number of moves aimed at substantially changing the nature of statutory boards. A progressive fast-track policy of removing commercial activities from the boards' control was instituted. A withdrawal of the boards' licensing and control powers followed.
"By the late 1990's the industry was generally driven by a range of large and small corporations, with substantial joint venture involvement from off-shore, competing in all product areas except a few remaining bulk commodities."
This scenario did not meet with universal acclaim from producers not used to farming leaders being this explicit in saying what they think. However, Jennings' status and experience in New Zealand agriculture and its politics mean the comments carry considerable authority.
The retiring President of the Waikato Provincial District of Federated Farmers reminded his annual conference in May 1993 of earlier advice he had given dairy farmers:
"Statutory protection of a single seller and cooperatives are aberrations in a free market economy. They will be constantly challenged by those outside the industry wanting a slice of the action and from within the industry by those wishing to expand their opportunities."
The Chairman of Parliament's Primary Production Select Committee was quoted in April as saying that:
"...a growing number of 'new breed' politicians are questioning whether producer boards are the best mechanism to deliver returns to farmers. And they are increasingly frustrated by lack of answers to their questions from the boards and by the boards' 'outmoded' public relations."
In an interview for a Canadian publication, The Taxpayer, the then Deputy Chief Executive of Federated Farmers was asked what he thought might happen to New Zealand's marketing boards. His reply was:
"Our marketing boards will be reformed if not totally eliminated. The boards have monopolistic powers which have acted against the interests of farmers in quite a lot of places."
Philippa Stevenson reflected the growing pressures for change in a 'Point of View' column in Straight Furrow:
"The winds of change are certainly in the air when the 70 year old meat and wool boards' electoral committee gets turned on its head and a Federated Farmers leader predicts the demise of producer boards.
"The Meat Industry Association is also moving things along with its contentious strategic report."
An editorial in the Herald in July commented:
"The rest of the productive economy has been liberated long since from the nostrum that all marketing wisdom can reside in a protected sectoral conglomerate. It may take another descent in the commodity cycle to cause most farmers to question the confines they have placed on their products' potential. But others, with corporate or national welfare in mind, are challenging the statutory restrictions."
In late August a columnist in New Zealand Farmer pointed out that it was somewhat ironic that farmers, having been "a driving force behind the change to an open, competitive economy based on sound money, individual choice and responsibility", were now unprepared for the consequences of these changes in their own backyard. He went on to point out that farmers were not unique in having to adjust their approach and attitudes. "Unions, vested interests, protected sectors and all those who relied on the benevolence of an all powerful state have the same problem."
He also made the following comments about farming and farming politics:
"Twenty years ago, farmers wanting to make a contribution to their own and the industry's future were drawn inexorably into farmer politics. Today the ambitious and capable are abandoning politics for business or specific issues which they feel strongly about.
"Farmer politics, especially the producer boards, is being sidelined. The real action has shifted to the doers and movers and, let's face it, this is a thoroughly healthy trend.
"Increasing numbers of farmers see the boards and farmer politics as a sideshow at best and irrelevant or even counter-productive at worst."
These comments reflect a growing view in favour of regulatory reform. However, it is far from universal. There is still widespread misunderstanding of the consequences of regulation, particularly the costs producers and the wider New Zealand economy incur while it remains so pervasive in agricultural marketing.
Shortly after his election, the new President of Federated Farmers was quoted as saying:
"...monopolies are not good when we have to buy from them. When they represent us, it's a good form of commercial vehicle."
This superficially reasonable statement encapsulates misconceptions many producers still harbour about the benefits and costs of marketing regulation. There are two reasons why it is wrong in its implication that regulation which restricts export competition benefits farmers.
First, there is no evidence that New Zealand has exploitable monopoly power in export markets - the regulations deliver monopoly costs in return for few, if any, benefits.
Even where there is only one exporter from New Zealand, it is not a monopoly in any practical sense when operating in the international market. To be a successful monopoly a producer has to be able to exercise effective monopoly power - by restricting supplies and forcing prices up in a sustainable way. By definition, monopoly power does not exist when there are others producing the same products or adequate substitutes.
Competitive advantage derived from branding or product differentiation - and a reputation for being a reliable marketer is a brand - is not monopoly power and does not require a single seller, or lesser forms of regulation, to be commercially successful.
Achieving some level of critical mass is also not a justification for regulating exporters. The dairy industry frequently points out how small the Dairy Board is relative to those with whom it competes overseas. This is even more the case with the Kiwifruit and Apple and Pear Marketing Boards. A New Zealand meat company chief executive commented on this point recently in the following terms:
"Size doesn't matter. It's personal relations, customer relations. The more people you have selling (more businesses) the more they are involving others and the wider you spread it. You have control as you have the major importers each with their own niche."
The second mistake in the statement by the President of Federated Farmers is the failure to recognise that producers, in a very real sense, do currently buy from the regulated monopolies (single sellers). They buy marketing services.
The Dairy Board, for example, takes the producer's output, markets it, deducts all the costs, and returns what is left to the farmer. The amount the Board deducts is the price the dairy farmer has paid to have output marketed. That it is deducted rather than charged is immaterial to the fact that it is a cost for a service the farmer buys - in this case is compelled to buy.
When a single seller is the only source of marketing services, the farmer has no ability to use competition to minimise this cost (the price of the service). Unwittingly, the President has hit the nail on the head when he says "monopolies are not good when we have to buy from them".
In summary, single sellers have no effective monopoly powers when selling overseas, but can and do exercise effective monopoly power when selling services to the New Zealand farmers who own them. Farmers have got the reasoning they use to support export marketing regulation precisely the wrong way round.
Branding and product differentiation are the keys to value adding, competitive market positioning and better profitability. This is not a disputed proposition. The major boards are proud of their achievements in this area and producers are continuously exhorted to be more market focused, and to support the efforts of their marketers in developing brands.
These sources of competitive advantage do not require regulation for their survival or success. In fact, restricting competition only serves to limit the scope for New Zealander marketers to upgrade their competitive position. Monopolies mean there is only one source of ideas and one set of judgments about what is best.
Branding and product differentiation are features of the marketing activities of all the single sellers. For branded products and consumer markets, the case for deregulation is overwhelming.
Producer boards and cooperatives have structures which expose their supplier shareholders to financial risks over which they have limited individual control. The problem stems from the way these bodies raise capital and deduct capital servicing costs from producers.
Cooperatives' only source of equity capital is their suppliers. They can only raise capital by reducing payouts to producers. This is slightly less of a problem for monopoly boards because producers have no choice, although it is becoming an issue in the dairy and apple industries as discussed later. It is often a severe problem for cooperatives who risk losing suppliers if returns are not competitive.
As a consequence, these bodies rely heavily on debt funding and are highly geared. Financiers have traditionally not considered this gearing risky because producers are effectively locked into servicing and repaying the debt. In situations where this has been in doubt (wool, meat, kiwifruit) financiers have found both producer boards and governments 'helpful' in ensuring producers do not escape their 'obligations'.
This is set to change in the future. During the funding crisis in the kiwifruit industry earlier this year, the minister of agriculture said:
"Up to now the banks have looked at producer boards as government-owned banks and I think in future you're going to see some requirements for capital and better collateral coming into play."
However, this will not necessarily reduce risks for producers who are locked into the system by regulatory fiat.
There have been many instances where this structural fault in boards and cooperatives has cost producers dearly. Ironically, the structures which producers believed were there to benefit them have been the reason why they could not avoid paying in full for costly mistakes over which they had limited control.
The following are examples in three of New Zealand's five main agricultural industries of producers picking up the tab:
• The wool industry's scheme to accumulate stocks and support market prices collapsed over two years ago. Had individual farmers been asked to store wool on their farm and fund this by personal borrowings secured against their assets, many would have chosen not to do so. For others, it would not have been possible.
The Wool Board, supposedly representing woolgrower interests, decided it was a good idea. Many farmers probably took little notice because it was all fairly remote from the farm business. Besides, the most immediate impression was that it stopped their incomes being even lower. It was only possible to escape involvement by leaving the wool industry.
What happened is history. Woolgrowers are still repaying the debt. They cannot even escape this obligation by selling the farm because the new owner must factor the outstanding industry liability into the purchase price.
• The meat industry has been painfully restructuring for at least a decade. The Meat Producers Board has been heavily involved and has maintained a strong advocacy of producer ownership and control in justifying this involvement. It is now very evident that what producers principally 'own and control' are large debts, and that they have incurred capital losses.
Producer cooperatives have also figured prominently in the process. At least producers have been able to choose whether or not to belong to a cooperative. The strategies adopted by financiers during the restructuring agony, which is not yet over, should be highly instructive to producers. Financiers continue to 'watch over' the industry as evidenced in the beef quota debate discussed later.
• In the case of the kiwifruit industry, the regulations, with some help from the government by way of extension and tightening, have ensured that the only escape route for growers is to clear fell their vines and use the land for something else. Growers are reminded of the financial liability incurred on their behalf every time they pick a kiwifruit - part of the return has to go towards repaying the debts.
The international kiwifruit market, now mature, is very competitive and price sensitive. The lack of effective monopoly power is unarguable in this industry. Because of the existence of a monopoly exporter, individual growers who may have preferred to adopt different marketing strategies were unable to do so. However, they still have to pay their share of the cost of wrong decisions by the marketing board.
A common feature of these examples is that the risks and rewards of marketing strategies were not commercially distributed. The issue is not that commercial mistakes were made. All businesses make mistakes from time to time. However, in unregulated markets not everyone makes the same mistake at the same time and not every industry participant is compelled to be involved. When mistakes do occur, the financial and other consequences are spread between the investors, lenders and managers who choose to be involved.
Producers need to ask themselves whether competitive markets, which they sometimes emotionally liken to the law of the jungle, would not in fact leave them better off individually. Producers in the dairy and apple industries who think it could never happen to them should be looking carefully at their personal balance sheets, particularly those items which are not under their direct control.
Today's major industries are becoming global in their scope. National borders are becoming less and less significant. Expertise and capital are moving to where the prospective returns look best. Dynamic countries are encouraging these flows, or certainly not trying - Canute-like - to stop them. New Zealand now has considerable evidence of how international competition in the economy can lift the performance of domestic industries. Why would it be any different in agriculture?
In agriculture the only resource international entrepreneurs cannot shift is the land - but there is no shortage of that in the world. The marketing regulations in New Zealand either block international involvement totally or make investors nervous about the sovereign risks. They are able to take their expertise, capital and market connections elsewhere - to South America or Australia, for example.
The consequence is that instead of becoming part of the international trading environment, New Zealand ends up competing against resources that have chosen to go elsewhere. The idea that New Zealand is better off by going it alone is both anachronistic and naive.
As Professor Hughes from Waikato University put it:
"... scepticism of producers about the value of marketing ... and a desire to keep returns to marketers to a minimum have retarded our export efforts to date;"
and:
"It is essential that New Zealand producers ... cooperate with marketers to develop and service worldwide markets with many related products rather than insisting that a single organisation or producer board handle each commodity separately."
John Robertson, a member of Parliament's Foreign Affairs and Defence Select Committee, pointed to the importance of the international dimension:
"One cannot discuss trade linkages without acknowledging the importance of investment linkages in the process of trade. Here again we have an institutional block - the producer board.
"Overseas investors with strong marketing structures abroad who wish to vertically integrate back into New Zealand are effectively shut out from our main agricultural industries. It is ironic that our ministers fly around the world singing the praises of investment in New Zealand while we preclude such investment from our largest industries."
The Heinz investment in Watties is a vote of confidence in New Zealand as a base from which to push into Asian markets. The move has been positively received because the company has a good performance record. A representative of the Vegetable Growers Federation pointed out that "the Heinz brand is well recognised internationally and there is potential under this and other labels for more value-added product to be exported from New Zealand."
Why wouldn't greater involvement by companies like Nestlé and Kraft bring similar benefits to the dairy industry, Chiquita and Dole benefits to horticulture, and ConAgra - as it has in Australia - benefits to the meat industry?
There is well-founded optimism about growth prospects in Asia. It is necessary only to contemplate China, and its vast and rapidly growing market, to appreciate the potential and what is at stake for New Zealand.
All the main international food companies are active in China. The consequence of their competitive activities is to accelerate growth in a market which is only just taking off. They are seeking out opportunities which suit them best, and building bilateral and joint venture arrangements with local entrepreneurs - an important aspect of doing business in Asia. Many are seeking one-to-one relationships, not the one-to-many relationships of single seller or single buyer structures. The result is a growing number of international food processing and marketing companies that need agricultural products to service the market.
In these circumstances, New Zealand faces the prospect of being left behind because of regulations which confine participation to a single player. How can one organisation hope to cover the field? What opportunities are being missed? What about the resulting limitations on capital, expertise and ideas for developing these markets?
There can be no doubt that New Zealand's interests are best served by maximising the resources - human and capital - devoted to benefiting from growth prospects in Asia. Any regulations restricting exporting from New Zealand is akin to leaving lead in the saddle bags just as the race of the century is beginning.
In 1992 the wool industry produced a strategic plan. In 1993 the meat industry produced two strategic plans - one by the Meat Industry Association (MIA) and one by the Meat Producers Board.
It is pleasing to see industries attempting to develop shared strategic objectives and means of achieving them for the benefit of their members. However, there are also dangers with industry strategic plans which need to be avoided if the plans are to be beneficial.
First, there is often a tendency for industry strategic plans to be so general and consensus-based that they are of little value or influence. This reflects the practical difficulties of achieving industry-wide agreement on issues which might differentially influence the competitive position of participants. The wool industry's plan had a blancmange character for this reason.
Debate in the meat industry gave rise to two plans, which led to vigorously expressed differences of view. The MIA plan did not consider the deficiencies of cooperative structures despite their relevance to achieving the primary objective of sustained profitability. Presumably this reflected the difficulties of reaching consensus in an industry where the cooperative structure dominates and there are some difficult problems yet to be sorted out.
The second danger is that industry strategic plans become vehicles for new or additional regulation and market interference. The wool plan led to the establishment of a marketing company owned by the Wool Board to compete with existing private operators. At the same time it delivered little effective deregulation. For example, it did not question the place of price intervention and acquisition powers in the statutes.
Both meat industry plans were half-hearted in their deregulatory recommendations. The MIA plan did advocate significant reduction in intervention by the Board but suggested most activities be transferred, at least initially, to the Meat Planning Council (MPC) - also a statutory body only differentiated from the Board by having a wider range of interests. Its domination by major interests was evident in the recent United States beef quota debate which is discussed later. The Meat Board's plan envisaged only limited changes.
The main value of the planning in both industries has been the resulting focus on some of the major policy issues. There is now greater questioning of the wisdom of leaving unused regulation in place. Notwithstanding costly collapses, market intervention has a history of re-emerging phoenix-like from the ashes. Producers are starting to recognise that removing the ability and temptation to regulate would be good insurance for the future.
It is no longer relevant to ask what good works statutory bodies can undertake. The contemporary question is why are they needed. While the organisations exist - that is, while the regulations remain in place - they can be counted on to find things to do. It is part of human nature.
The meat industry should recall the E-grade lamb saga if it needs any convincing. This was a textbook example of regulators poking their nose into the industry's business where it was not needed. The Meat Board reacted strongly to a suggestion by a New Zealand Business Roundtable representative, Alan Gibbs, that the proposed standard was an unwarranted interference. The Board was most insistent that it was an exercise in cooperation for the benefit of all. Clearly, the industry thought differently and within days the proposed interference was quietly dropped. What about the occasions when this does not happen?
The Wool Board says its functions are now concentrated on promotion, research and product and market development. It says it is also enhancing market information services and practical advice on such things as shearing, wool growing and handling. The Meat Board talks of focusing on market development, research and development, and education and training.
In all of these areas there needs to be rigorous examination of why competitive markets could not do the job satisfactorily if left to do so unhindered. Why are regulations and statutory bodies required?
Structural changes in the transport industry will follow the Meat Industry Freight Council's decision to open meat exporting to Europe to competition. Marketing costs will also fall as a result of removing the shipping monopoly.
A British-led shipping conference has had a monopoly on this trade for many years. The Meat Board used to negotiate rates with the conference each year. Now individual meat exporters will be able to deal directly with designated carriers.
While the Meat Board has stepped back from the negotiating role, it will continue to designate the carriers and monitor their performance. It will also programme shipping to Europe to ensure a phased flow of the annual quota. There is no need for this continuing regulation. It is another illustration of the inability of statutory bodies to let go residual functions.
The MIA said the decision to end the monopoly was "the biggest breath of fresh air to hit the industry for over 30 years." The move follows the opening up of trade to North America four years ago, which led to dramatic falls in costs. Already this competition is estimated to have saved the New Zealand meat industry $230 million. Why did the European route have to wait so long when the benefits of competition were so apparent?
At the beginning of this wool selling season, the Wool Board introduced compulsory certification for commercial wool exports. All consignments must now have documentation detailing their characteristics such as colour, clean fibre content and fibre diameter. New Zealand is the first country in the world to introduce this requirement.
As the Board has pointed out, this is not a regulation setting minimum standards since exporters will still be free to export whatever consignments or blends they like. But it is still a regulation which involves compulsion. If, as the Board Chairman has said, it is a very small additional investment which "will allow customers to buy an enhanced New Zealand brand", why not let market participants make the investment decision?
It would be easy for the industry to operate an accreditation system where exporters opted for the service, were allowed to use the 'brand' and were subjected to effective sanctions if they broke the rules. Better still, why not let the seller/buyer relationship sort out what is required? Why does the Board have to be involved at all?
The introduction of additional commercially provided wool tests will be driven by commercial imperatives. The length test for scoured wool was developed by the Wool Research Organisation with funds from the Board. The business that will be undertaking the tests has indicated that scouring companies will need to invest in $50,000 worth of equipment to be able to use them. As a company executive said, "customers will dictate the demand for this test". That is how it should be.
The Apple and Pear Marketing Board is presently a monopoly marketer on the domestic and export markets. It administers marketing regulations which restrict competition to a greater extent than in any other agricultural industry.
The Producer Board Acts Amendment Act has introduced changes which will result in more competition and structural reform in the apple and pear industry. The pace at which change will now occur could be rapid, notwithstanding the exemption the Board has been given from sections of the Commerce Act.
The two legislative changes which will have most influence on future developments in the industry are:
• deregulation of the domestic market by removing the Board's monopoly at the beginning of 1994; and
• a requirement for the Board to establish guidelines which it must use to consider applications for export licences and the obligation to provide written reasons when applications are refused.
The implications of these changes are likely, over time, to be profound because they will provide more comparative information about the commercial performance of the Board, and because they raise questions about who owns the existing marketing assets and who should bear costs and be entitled to 'profits'.
The Producer Board Acts Amendment Act introduced audits of the Board's performance. This is now a requirement for a number of producer boards. As discussed later, these audits are of very limited value in helping shareholders assess commercial performance, and they may even be counter-productive by providing reassuring answers to the wrong questions.
Practical experience with the performance of other marketers is far more useful in assessing the Board's performance. Such information should be available when others begin to export and the domestic market becomes competitive.
This will be the case provided the Board continues to participate in the domestic market. There are some suggestions that it will not be able to compete profitably and will have difficulty 'hiding' losses under the new arrangements. The Board has said it will remain a major participant in the domestic market, but acknowledges that competition will be fierce and it will have to lower its overheads. It reduced staff numbers in New Zealand earlier this year. This suggests that competitors may be able to offer lower costs and/or higher quality services for export marketing as well.
The prospects for others being given permission to export are enhanced by the general nature of the legislation. It is not as specific as similar provisions in the dairy industry. As the guidelines are developed and applications to export assessed, it will be important that the spirit of Parliament's intention - which was clearly to provide others with an opportunity to demonstrate their skills - is not obstructed.
There is potential for litigation if the provisions are not applied in the spirit intended. It is clear from recent events in the apple and kiwifruit industries that litigation is paid for by growers and ultimately does little other than delay inevitable change at high and unnecessary cost.
It is also difficult to see why the same provisions should not immediately be included in the kiwifruit industry's legislation.
The emerging changes in marketing arrangements will have significant implications for the structure and ownership of the industry's marketing assets and how shareholders receive the profits. It is now widely acknowledged in the industry that unbundling product and investment returns will have to occur. Consideration of how this will be done has already commenced.
Enza Fresh is a company recently formed by the Board to handle its domestic marketing. Who will own it and how will its profits be distributed? At the moment all growers have 'equity' in it.
More generally, the major consideration necessitating unbundling will be the fact that individual growers will be selling differing proportions of their crop on the domestic and export markets and, therefore, to and through the Board. Some growers will also be doing their own exporting under licence. Growers not using the Board may not wish to hold equity in its assets. These growers will need a means of withdrawing their capital.
In these circumstances, anything short of complete corporatisation of the Board, with freely tradeable shares and conventional dividends, will result in very complex, inefficient and inequitable organisational arrangements. It is in the interests of all growers to have the changes made cleanly and quickly. In the past, trying to get everyone on-side politically before changes were made cost growers dearly.
As the Board recently won an exporter of the year award, it might seem reasonable to conclude that it is a better than average marketer. Why, therefore, does the Board require an export monopoly to protect it from competition?
The answer is that it does not. Either it is a commercially successful marketer not requiring an export monopoly to deliver benefits to growers, or it is not performing satisfactorily, in which case growers would be better off if it did not have a monopoly and they were able to exercise choice. In either case the answer is the same: compulsion should be removed.
Evidence presented by Robert Auerbach to the Primary Production Select Committee when it was considering the Producer Board Acts Amendment Bill is pertinent. Auerbach is a former United States lobbyist and specialist in regulatory law now living in Auckland. He said that many of the arguments used by the Board in support of its monopoly exporter status were similar to those used by American Telephone and Telegraph (AT&T) when it was opposing deregulation in the United States. He was reported as follows:
"Using words such as 'smoothing, pooling and stabilisation' gives the impression the board is making production decisions based on a well thought out strategy. If we peeled the onion, I am sure the lack of substance supporting its strategies would shock us.
"Monopolies have no one to challenge their assumptions. In a competitive market, anyone who disagreed with the board's policies could test their own. The market would then determine who is right and who is wrong.
"Loss of the monopoly would not affect future success of the board because past success rested on its marketing ability not the monopoly. It simply does not control enough of the world's apple production to be able to influence either the supply or the price of apples. The present situation is truly the worst of both worlds. New Zealand apple growers do not earn a 'monopolist premium' for their apples. Yet they incur higher costs than might otherwise exist in a freely competitive environment.
"In the long run, I believe the Apple and Pear Marketing Board will be grateful for losing its monopolist power. AT&T fought tooth and nail to preserve its monopoly. With the benefit of hindsight, its loss is the best thing that ever happened to it."
When defending the Board against suggestions that it would not be able to compete on the domestic market, the Chief Executive said:
"...we have nearly 40% by volume of the Southern Hemisphere markets - we are used to competition. It is not such a big test for us."
Might this suggest the Board would not be overly concerned if it also lost its export monopoly? Is reality starting to break in?
In a ballot 70 percent of growers voted in favour of deregulating the domestic market. The President of the Fruitgrowers Federation was reported as saying that "it was not in our interests to continue to fight for local market regulation when we needed to focus on export markets."
For years the industry's leadership argued that a domestic monopoly was crucial to managing the export market. Change is emerging, if slowly.
Other reasons still being used to justify the export monopoly have been rendered equally irrelevant by changing circumstances. For example, the Board now has strong brand recognition through its reputation and that of Enza. It is widely accepted that brands provide protection against the alleged 'evils' of competitive exporting. In these circumstances, why incur the costs of a monopoly when there are few, if any, offsetting benefits?
Finally, as these changes unfold, and the vigour and stimulus of commercial diversity emerges, maybe New Zealand will see a resurgence in the pear industry.
Deregulation of the town milk market has resulted in aggressive competition for market share and some decline in retail prices. There have been concerns expressed by dairy farmers that their cooperatives are fighting each other to buy market share at dairy farmers' expense.
The Chairman of Federated Farmers' Dairy Section, commenting on appropriate strategies in the town milk market, said that producer returns would fall "unless cooperative dairy companies discipline themselves for the long-term advantage rather than short-term gains". But how can companies adopt long-term strategies when dairy farmers insist on arrangements which would disadvantage the companies if they did?
The problem is that a cooperative dairy company has only one objective: maximum payout to suppliers each season. Everyone knows what happens to dairy companies that cannot deliver competitive payouts. To achieve this objective the company will sell milk into the domestic market whenever the return from that milk is higher than the next best alternative. That alternative return could be quite low - butter sales to Russia, perhaps.
It could be concluded that two immediate benefits of town milk deregulation are lower milk prices for consumers - quite possibly below farmers' cost of production - and another source of pressure on the industry to address the bundling problem.
A further issue which dairy farmers should consider is that while bundling exists it makes it difficult for new entrants into milk processing and distribution to compete for supplies. New entrants are essentially being asked to match a bundled payout when their commercial structure correctly separates the price paid for milk from investment returns. The existing arrangements are blocking new businesses which could be a source of added buying competition for raw milk. Who is benefiting from that?
One of the popular myths behind the case for statutory protection, particularly in the dairy industry, is that "New Zealand Incorporated has to sell into world markets that are corrupted by subsidies and protection." You cannot, it is said, be better off by having a so-called level playing field at home - that is, competitive exporting - while the world is so distorted, unfair and cruel.
Many importing countries and countries whose exports compete with New Zealand's do have intervention policies which influence international demand and prices, and make profitable exporting more difficult for New Zealand. However, this fact does not mean New Zealand or its producers will be better off by constraining competitive exporting in response.
The international market distortions commonly discussed are of three types - tariffs, subsidies and quotas. These three types of distortions to trade need to be examined to see whether they provide any logical justification for controlling competitive exporting.
Using the dairy industry as an example, the examination should start with the benchmark proposition, which the Dairy Board has acknowledged as valid, that if dairy trade was not distorted by these measures there would be no justification for controlling New Zealand exporting.
Tariffs are the most common intervention measure. They only affect prices and they do this in the same way as normal market influences. Essentially, tariffs raise prices in the importing country, change the domestic supply and demand balance, and lower imports.
If, as is generally accepted, regulations are not needed when governments do not interfere with markets, then the same conclusion applies in the case of tariffs. Tariffs make profitable exporting more difficult. So, for example, does a market-induced devaluation of an importer's currency, or a seasonal surge in United States milk production. Tariffs carry no particular implications for export regulation because they are just another price influence, however distasteful.
Statistics obtained from the Ministry of Foreign Affairs and Trade show that approximately 70 percent of New Zealand's dairy exports are to markets protected only by tariffs. What, therefore, is the logical justification for regulating exports to these markets?
In the case of export subsidies, the conclusions are identical. Subsidised exports alter prices in importing country markets. As is the case with tariffs, this is not a valid justification for controls over New Zealand exporting.
This leaves quotas, which can be different in some cases. The key issue with quotas is whether New Zealand can obtain any or all of the premiums or economic rents that quotas generate. As ACIL's report explains in detail, the answer depends on the precise nature of the quota. Many quotas are designed to make sure the exporter cannot get the rents.
Moreover, even where some or all of the rents are available to exporters, it does not necessarily follow that statutory controls are needed to capture them. Many markets for industrial products - like steel and cars - are subject to quotas and voluntary restraint agreements and exporter rents are often captured by voluntary industry cooperation.
Statutory control over exporters will only be required in exceptional circumstances where there are large benefits and where controls are the only way to capture them. Only under these conditions is there a case for forgoing the normal efficiency and innovation benefits associated with competitive marketing. In ACIL's view only the United Kingdom butter market, the United States beef market (for the time being) and, possibly, the EC lamb market, meet this test.
Should the Uruguay Round succeed and these and other quantitative restrictions be replaced by tariffs, the case for any controls would fall to the ground.
In summary, there is general agreement that if overseas governments did not interfere with trade there would be no justification for controlling New Zealand dairy (and other) exports. The industry would not need regulations to compete successfully in a market influenced only by normal market forces.
The presence of tariffs and subsidies, which are price mechanisms and akin in their effects to normal market forces, does not alter this conclusion. In the dairy industry only the United Kingdom butter quota provides a defensible justification for controlling exporting.
It is therefore patently incorrect to assert that wall-to-wall controls over exporting are needed just to harvest the United Kingdom quota rents. The gains from competition are too large to sacrifice on a general basis. This conclusion is reinforced by the extent of branding and product differentiation in the New Zealand dairy industry and the proportion of New Zealand's dairy exports that go to tariff-only markets.
Therefore, the argument that "the rest of the world is distorted and not a level playing field" collapses as a justification for current export regulation. To conclude otherwise is erroneously to believe that distortions which make profitable exporting more difficult can be countered by controlling exporting. This logic was eventually accepted, by most farmers among others, as reality in the policy debate over New Zealand's import controls. It was concluded that the existence of trade restrictions in other countries was not a sound reason for New Zealand to maintain protectionist policies.
There is an urgent need for one of two things to happen in the dairy industry. Either the industry convincingly rebuts this logic - which it has not even attempted to debate over the past twelve months - or most controls over dairy exporting should go.
The meat industry recently debated, but then rejected, a Meat Planning Council proposal for determining exporter allocations to the United States beef market which requires New Zealand to stay within an annual but variable import quota. The proposal also applied to the EC lamb and goat meat quota markets.
The central feature of the MPC proposal was to allocate most of the quota to existing exporters (at least 60 percent of throughput had to be exported to qualify) on the basis of one season's export performance. A small proportion was to be reserved for new entrants to the industry. Owners of the quota asset would then be free to use, lease or sell their entitlement in the same way as any other asset. They were not to be permitted to leave the entitlement idle.
The proposal was supported by the banks, which have about $1.5 billion of debts outstanding from meat companies. Their support is understandable since the proposal provided a windfall capital gain to recipients and would therefore strengthen balance sheets.
The proposal was strongly criticised by others, particularly producers and smaller meat processors who were not members of the MPC. Producers argued that the consequences would be barriers to entry and hence less competition in meat processing. Smaller processors considered larger incumbents would be favoured relative to smaller exporters and new entrants. Some commentators suggested banks would be the major beneficiaries.
ACIL recently participated in a major research project on the same topic in Australia. The work demonstrated that capturing in full the benefits of the US beef quota arrangements is more complex in practice than in theory. Many of the negative consequences of past and proposed approaches are hidden, and sometimes counter- intuitive.
The MPC proposals got it partly right. So did the critics. Capitalisation is an effective method of benefit capture. However, the proposal had consequences in terms of the distribution of benefits. The claims that competition would be suppressed were overstated by the critics and the 'disadvantages to new entrants' argument is something of a red herring.
It is not possible to cover the subject in detail here. However, the logic that explains what an industry must do to capture and keep the benefits in full is straightforward. In general, it is the same logic that applies to bundling - if you distribute the benefits in any manner that incorporates them in producer prices, a proportion of the benefits will be lost to overseas consumers. Equity considerations - who should get the benefits - are a separate issue.
If the benefits are initially captured in full by the New Zealand marketer(s), using either regulation or commercial cooperation, and it is accepted they belong to the industry concerned, then the key issue is the consequences of how they are distributed.
• The ACIL report demonstrated that in the case of the Dairy Board there is only one way the benefits can be distributed - via the milk price. This leads to the bundling consequences discussed in ACIL's report. Higher milk prices result in more production (for example, Southland conversions) which is sold in lower priced markets. It is through this process that part of the United Kingdom butter premium ends up in the hands of overseas consumers of New Zealand dairy products - Russian butter consumers, for example.
• Exactly the same thing happens with current methods for allocating the US beef quota but the mechanics are slightly different. A meat company 'earns' an allocation on the basis of livestock throughput. It effectively buys entitlement by bidding up livestock prices to increase throughput. In the recent 'procurement war' it was suggested that this effect was exacerbated by an expectation on the part of some companies that the MPC proposal would succeed. Companies wanted to 'earn' a bigger entitlement in perpetuity.
• The producer views higher livestock prices favourably. They appear to be ensuring the full quota premiums are received by the producer. However, what is not apparent is the second round effect. The resulting increase in livestock production and delivery (producer responses to higher prices) yields meat which is sold on lower priced markets. Consumers in these markets effectively receive some of the US quota premium in a manner analogous to the dairy case. Only the processors receive none of the benefit, having competed it away to producers and overseas consumers in the 'earning' process.
This is why the current allocation system must be changed. The changes must ensure, in both the meat and dairy cases, that all the premium is retained in New Zealand. To achieve this in the meat industry, two requirements must be met:
• an entitlement must be determined by a process other than 'earning' it through bidding higher prices for livestock; and
• if the quota premium is to be returned to producers, then it must be in a form that does not influence production decisions; that is, it must not be in proportion to livestock sales.
The MPC proposal met the first requirement. In gifting an entitlement in perpetuity to a meat company the benefits of the US quota would be capitalised into an asset which the company owned. This action would secure the benefits in New Zealand and remove the unfavourable consequences of having to 'earn' entitlement. But what would then happen to the benefits?
Here the MPC proposal failed to meet the second requirement, but not for the reasons which figured prominently in the debate.
Around 70 percent of New Zealand's meat production comes from cooperatives. Like the Dairy Board, they bundle returns. An improved balance sheet means a greater capacity to compete for livestock. For a cooperative the ability to recognise quota benefits in the form of dividends, which would not distort livestock prices, is severely restrained.
Thus, if producers want to obtain full quota benefits, the cooperative must be corporatised and the benefits delivered in a dividend form. A corporatised meat cooperative solely owned by farmers would deliver the benefits in full to the farmer shareholders. If interests other than farmers were shareholders they too would receive benefits. Therefore, capitalising the benefits before outside shareholding is introduced is important if producers want them all.
At this point in the reasoning it is logical to consider the equity issues. Who, within New Zealand, should receive the benefits? The basis on which meat companies would receive entitlement in perpetuity under the MPC proposal favoured some companies at the expense of others. Even if it had been accompanied by corporatisation proposals to avoid the bundling problem, producers not involved with a cooperative would have missed out.
An obvious way to remove this inequity would be to allocate (capitalise) quota entitlements by putting them out to tender. This would allow the market to determine allocation and ensure a market-based value. Assuming the Meat Board conducted such a sale, what should happen to the proceeds?
If it is desired that the proceeds end up in the hands of producers, this could be done, without creating distortions, by making a one-off payment to producers in proportion to their previous season's livestock sales. This would contain an element of 'rough justice' but there is no perfect system for resolving the problem once and for all.
It is likely that heavily indebted meat companies would not find this approach as attractive as the MPC proposal. Producers are likely to have the opposite view.
It was frequently claimed during the debate over the MPC proposal that the capitalisation of quota would disadvantage new entrants or small companies wanting to expand and having to buy quota. This is not really the case and is even less of an issue under the alternative approach proposed above.
If entitlement is capitalised, and its ownership and value determined in a competitive market, it becomes an asset which is essentially the same as other meat processor assets. A company wanting to enter the industry and expand, and wanting to export to the United States, would have to acquire entitlement in the same way as it would have to buy processing plant and equipment. Because the entitlement could not be left idle, the owner would have the incentive to find its most economic use.
It should not be overlooked that, under existing arrangements, new entrants have to 'buy' entitlement, albeit indirectly. They have to enter the market and pay the going livestock prices in competition with everyone else who is bidding to 'earn' throughput as the basis for entitlement. This means they 'buy' entitlement a year at a time. If entitlement were capitalised, processors would buy it in one transaction. Otherwise, the commercial implications of the alternatives are identical.
It has now been announced that, for the current season, quota will be allocated on a basis similar to that used in the past. In making this announcement, the MPC said that the decision would "result in a scheme that continues to provide equal opportunity to gain entitlement for both existing and new entrants to the industry which has been a major issue of contention".
In fact, what the scheme continues to do is ensure that part of the quota benefits are received by overseas consumers of New Zealand meat. The 'equity' issue, a red herring from the outset, is the reason why the industry has failed to solve the fundamental problem.
There has been much pain for no gain. The problem remains to be resolved and the industry's regulatory and political environment will make this a difficult task in the short term. Meanwhile, producers will have less money in their pockets than is potentially available.
Bundling distortions are now widely acknowledged as a major problem with producer boards and cooperatives.
However, there is still confusion over the implications of bundling for effective accountability and performance measurement. Many still erroneously believe that these deficiencies can be overcome by performance audits and more accountability of the political kind. Similarly, there are still some who believe that bundling is avoided by putting trading activities at 'arms length'. Both responses are ineffective.
The issue which is really focusing minds on the bundling issue is how to meet capital requirements for further processing and marketing investment. There is growing recognition that bundling is contributing to this problem in two separate but reinforcing ways.
First, bundling sends farmers a price signal which misleads them into thinking that more production is profitable. Since some boards and cooperatives are 'obliged' to accept whatever is produced, it is necessary for them to invest in more infrastructure. But the only source of equity capital is the supplier/shareholder. Equity from this source is limited.
The implications of bundling for investment have been evident for some time in the dairy and meat industries. They are rapidly emerging as issues to be addressed in the apple industry.
In April 1993, the Chairman of the New Zealand Dairy Group, which processes nearly half New Zealand's milk, was reported as having called for "voluntary" contributions to lift the company's balance sheet and extend processing capacity.
ACIL responded at the time that this reflected a concern about the company's ability to fund future investment in a situation where bundling encouraged loss-making production and the cooperative could only raise equity funds from its dairy farmer suppliers. The Dairy Group Chairman said ACIL's comments were "absolute rubbish".
More recently, however, the Chairman conceded that the industry may have over-invested in plant rather than optimised returns on capital. He said "because the cooperative has to maximise annual returns, we have bundled returns on capital into the price we pay our suppliers for their milk."
He strongly defended the cooperative structure but noted that:
"...at present we have one major disadvantage. Our charter requires us to maximise annual returns to our shareholder suppliers. Our international competitors maximise the long term wealth of their shareholders. They can invest to optimise their long term returns. There must be an emphasis on the creation of shareholder wealth, not simply the maximising of annual returns to shareholders."
The Chairman of the Dairy Board also effectively acknowledged the bundling problem when he suggested the industry had to "look at ways to deal with marginal milkfat production." He said that the main contributor to increased milk supply was increasing production by existing dairy farmers rather than new entrants alone. This additional milk would have to be sold "at the lower end of the returns".
However, about the same time a senior Board executive was telling Victoria University students that farmers "don't want the Dairy Board to make a profit" and that they want the Board "to take all the goods that are produced". This implies that the Board is nothing more than a disposal agency selling on a 'commission' basis. There is clearly a good deal of confusion in the industry as to what its basic commercial objectives should be.
Surely dairy farmers want their marketing business to be profitable? They want all their other investments to be profitable. They must realise that insisting their marketing business operates as a disposal agency is the antithesis of profit maximisation. It is vital for this fundamental point to be recognised.
An Irish dairy industry expert visiting New Zealand last June told a dairy farmer conference that "the cooperative system is being nudged out in Ireland". He said that returns on capital available elsewhere were higher than those available in Irish milk processing. Consequently, the cooperatives had problems raising the equity capital they needed for growth.
The Chairman of the Apple and Pear Marketing Board has said that a massive projected increase in national and international apple production is probably the biggest challenge facing the Board. The New Zealand pipfruit crop could double over the next five years. If this occurs there will be a need for additional investment in processing and marketing.
In the context of deregulation of the domestic apple market, the Chief Executive of the Board has been quoted as saying:
"In the past our role has been to maximise returns to our suppliers. Now the growers will have an investment in Enza Fresh [the Board's domestic marketing company] and will want to see a return on their investments."
AFFCO, New Zealand's largest meat company and a cooperative, stated in its 1991 Annual Report that it:
"... has consistently failed to separate the interests of its shareholders and suppliers. While the company has had to pay competitive prices for livestock, the need to produce commercial rates of return on shareholders' funds has not been given priority. As a consequence the company's performance overall has been unsatisfactory".
In April 1993, AFFCO's Chairman said the company was looking at several options "to boost its low ratio of shareholders' funds to assets." Included in the essential features of any restructuring were the following:
• "separation of shareholder returns from supplier returns; and
• "establishment of a true market value for shares which would unlock shareholder wealth."
While these steps represent slow progress, at least they are in the right direction.
In the dairy industry, past decisions on the nature and location of plant investment have been driven by milk production growth in response to the bundled return. When product prices reflect more accurately what marginal markets pay, as will be the case when unbundling occurs as it inevitably must, some of the industry's past investment decisions will be shown to have been unwise.
Further delays in unbundling carry the risk of more unwise investment decisions as cooperatives find it is a physical necessity to build more processing capacity. The alternative is to require farmers to tip some of each day's fresh milk production down the drain - a practice for which the European dairy industry is roundly criticised.
Producers have become frustrated by their inability to assess performance and ensure that those running 'their' organisations are effectively accountable to shareholders. The response has been changes to assessment and accountability regulations. However, these are likely to be of minimal benefit. Only genuine investor choice - tradeable shares and conventional dividends - will deliver satisfactory accountability and meaningful performance measurement. Until such measures are put in place, changes of the type made recently in a number of industries will be as ineffective as the rearrangement of the deck chairs on the Titanic.
A number of boards now have performance audits as part of their legislation. These audits are aimed at delivering independent assessments of performance.
For those with the unenviable task of conducting the audits, maintaining independence must be difficult as the body being audited is the client who also writes the terms of reference and pays the bill. Added to this constraint is the ability of the boards to summarise (sanitise?) the findings and provide them only in this form to shareholders. Finally, those audited have considerable influence over the remedial action taken should any imperfections be found. It is a particularly controlled and non-transparent process of dubious effectiveness.
However, these are second order deficiencies. The main problem is that important comparative information is simply not available to the auditors. Comparisons of marketing margins and market shares, and judgments about the quality of marketing strategies, indicate nothing useful about investment performance. To say, as the boards frequently do, that customers are happy with present arrangements could also be misleading. They might be happy because they are getting a good deal at producers' expense.
No one knows or can calculate whether these organisations are achieving an acceptable level of profitability. Without that information, and the ability easily to trade shares as the owner sees fit, producers will continue to be frustrated over performance assessment and accountability.
The Kiwifruit Marketing Board was the subject of a performance audit just prior to the disastrous 1992 season. It failed to identify the weaknesses in the KMB's operations and strategy. However, this is not to reflect unfavourably on the competence of the auditors - you cannot make bricks without straw.
Yet another review of the kiwifruit industry's marketing arrangements is to occur now that a short-term solution to its calamitous circumstances has been put in place. However, media comments suggest some are concerned the process will take too long and that the minister's requirement that it incorporate the development of a strategic plan is imposing an outdated process.
The summary of an audit of the Dairy Board has just been released. The review was not directed at the essential economic policy issues concerning the industry which were the subject of the ACIL study. These are the case for comprehensive export controls and the problem of distorted price signals to farmers resulting from the cooperative structures of the Dairy Board and the dairy companies. The Board's statutory position and powers under the Dairy Board Act 1961 were not subject to the audit.
The terms of reference of the review did, however, allow and arguably require some examination of these issues. In particular, the consultants were asked to review "the objectives established by the Board for the performance of its functions". This ought to have involved a fundamental examination of whether the appropriate objective is the maximisation of unit returns for milk or of returns on investment throughout the industry - which goes to the heart of the so-called 'bundling' issue. However, the summary report fails to tackle this issue squarely and contains only an oblique commentary on the problem. The issue of export controls is not dealt with at all.
The key issue for dairy farmers in the audit should have been the answer to the question: "How profitable is my investment in the Board and how does it compare with alternative investments available to me?" However, the audit sheds no light on this question. The Boston Consulting Group evaluated objectives and strategy in terms of consistency with the Board's mission statement ("To maximise the sustainable income of New Zealand dairy farmers") rather than with profitability. A glaring deficiency (from a corporate finance perspective) was the absence of any ranking of the performance measures used. In effect, the 11 categories into which the performance assessment was divided appeared to be given equal weight, which from a profitability perspective makes no sense. There is no way of knowing from the report whether the Board is deficient in the crucial areas for profitability and in the top bracket for the less crucial ones.
Some hints that information about profitability is difficult to discover nevertheless appear in the report:
"Payout, which as a measure of overall performance does not provide a complete indication of the Board's performance;"
"The lack of emphasis on return on investment measures relative to volume measures;"
The "room for improvements in the Board's practice and policies regarding investment. ... NZDB has not effectively used financial measures to monitor investment performance;" and
The fact that "the Board falls short of the best practice in its understanding of the current and potential profitability of its products, channels, customers and markets in the short and long term."
The audit also appears to hint at problems in respect of the Dairy Board's costs and its performance with respect to innovation, and its comments are somewhat clearer on the problems of the payments system (the 'bundling' problem):
"A failing of the present system is that it provides possibly sub-optimal incentives for continually increasing milk volume. It also may not adequately convey market signals in terms of service and quality levels or go far enough in providing incentives for additional investment to ensure the best product mix in the long term;"
"Appropriate incentives should be used to encourage optimal milk production levels required by the market;" and
"The payments system should be reviewed to align it with the industry vision so that initiatives which are consistent with the industry's priorities are sufficiently rewarded and those which are not, are discouraged."
However, the audit fails to explore the implications of any of these findings and suggest concrete solutions. The problems can only be fully corrected by deregulation and corporatisation of the Board. As an exercise which was reported to cost dairy farmers around $6 million dollars (including Dairy Board costs), its value appears to be strictly limited. The issues concerning profitability and payments mechanisms which it touches upon need to be analysed in a much more fundamental way.
A performance audit of the Apple and Pear Marketing Board is to be undertaken next year. The changes to industry regulations discussed earlier, involving the introduction of limited competition, are likely to produce performance information for growers that will be more useful than the audit, and possibly available before it is completed.
Over the past year, there have been two attempts at improving accountability in the meat and wool industries, although the more recent attempt is probably seen by some as more akin to a political coup. Both have been largely ineffective because they have not addressed the fundamental cause of the problem.
The Weir committee recommended a number of changes aimed at improving producer democracy and exhorted producers to take more interest and become more involved in their industry. The recommendations have not yet been implemented and require more legislation if they are to be put in place.
The committee's failure to deal with the key issues reflects unfavourably on its terms of reference rather than on the committee. However, material which cogently set out what had to be addressed to improve the situation was presented to the committee in submissions.
The second attempt to improve accountability resulted in the 'Farmers for Change' group gaining majority representation on the Meat and Wool Boards' Electoral Committee. The continuing domination of tradition over common sense was well illustrated in the rural press where one editorial claimed that if existing board directors and committee members did not "rise to the challenge" then the risk would be "an uncontested self-destruction of the 70 year old committee."
No self-destruction has occurred. The changes have generated considerable heat but not much light. A referendum of producers is proposed to determine how their board representatives should be elected. There is some confusion and debate over how changes to voting procedures will fundamentally improve performance measurement and accountability. The answer is they will not.
Producer frustration will continue if only because there remains confusion over what needs to be done. The minister of agriculture made this point when addressing the new electoral committee:
"It was clearly a sense of frustration that they wanted to see some change and weren't quite sure what they wanted. The big responsibility that you have as a college is to determine precisely what the next phase is."
The only practical solution is corporatisation of the boards' businesses and removal of most of the competition-restricting regulations, as recommended in the ACIL report.
There has long been disquiet over the 'poacher and gamekeeper' roles played by all boards. Being responsible for the rules and regulations, and being involved in commercial activities, are rightly seen as a conflict of interest and a source of unfair competitive advantage for the boards. Where single sellers do not exist a common response has been to put the businesses at 'arm's length' from the board that owns them.
Even with single sellers the arm's length notion is catching on. For example, the Apple and Pear Marketing Board has said its domestic marketing company, Enza Fresh, will be "genuinely arm's length from the Board."
This approach sounds fine and constitutes some improvement on what it replaces. However, it leaves unaddressed both the bundling and the performance measurement and accountability problems. It does not answer satisfactorily the question of why these statutory businesses need to exist at all. In terms of genuine regulatory reform, putting statutory businesses at 'arm's length' is shadow rather than substance.
The Meat Board has created two subsidiary companies in order to place its operations on an arm's length basis. Primary Resources Ltd is a holding company which has taken over the Board's shareholding in Freesia Investments Ltd - this is largely a change in name only. New Zealand Meat Enterprises Ltd will hold the Board's shareholding in Anzco Ltd and Janmark Ltd.
The Board's Chief Executive has said that the recently announced sale of investments in Anzco to Huttons is the forerunner of further announcements in the next six months "that will show the world at large that we are moving down that track." However, the Board's Chairman has pointed out that it is not easy to find people willing to take over the Board's investment in meat companies in the current commercial climate.
Demand for these assets will obviously depend on their price. It is easy to price the assets out of the market and then use the absence of buyers as an excuse for not divesting. The process needs to be more transparent so producers can have a basis for expressing a view. The MIA has indicated it would like to see a firm timetable for divestment of the Board's commercial activities. This would provide a very useful discipline to achieve the agreed objective.
The Wool Board has established a subsidiary company, New Zealand Wool Services International. Its objectives are "to be a leading and profitable international wool enterprise, focusing on the innovative marketing of New Zealand wools." The Board says it is looking at ways in which New Zealand Wool Services International shareholding can be opened up but it is unclear exactly what this means.
In October New Zealand Wool Services International took over the buying and marketing of Drysdale wool - previously undertaken by the Drysdale Cooperative. The company has leased the Drysdale brand for five years. ACIL's report explained in detail how previous Wool Board intervention in the wool market contributed significantly to this cooperative's demise. The Board's company recently announced it had opened an office in China. Its commercial activities appear to be expanding rapidly.
The question of why statutory businesses need to be involved in most of these activities was touched on earlier. So long as they exist, statutory bodies will find things to do and superficially plausible reasons to justify their activities.
This consideration apart, the main deficiencies with the 'arm's length' expedient are that it does nothing to remove bundling distortions and to ensure satisfactory performance measurement and accountability. Producers have no way of knowing whether these statutory businesses are profitable. Notional balance sheets, and profit and loss calculations where they are attempted, are not adequate substitutes for market-based determination of these indicators.
If it happens that these businesses are profitable, the only way profits can be returned is by the indirect and distortionary route of livestock levies being lower than they otherwise would be. That is, the only means of distributing the profits of board companies is via the livestock prices received by the farmer - a bundling distortion just like that of the cooperative meat companies.
There is only one way these deficiencies can be overcome and that is to corporatise the businesses. The arm needs to be amputated.
There are two issues which commonly arise when producers, having acknowledged that bundling needs to be addressed, consider the options for change. One is a view that there are good returns in processing and marketing and they want to share in them. The other is a desire to have some workable form of ownership and control.
There are approaches for removing the bundling distortions and effectively achieving these producer objectives. Furthermore, they have been shown to work in practice.
Two examples are discussed here. One is the 'Wesfarmers model' which is already being discussed in New Zealand. The other is the investment trust concept which is currently being attempted by the National Farmers' Federation in Australia. This option has received limited media coverage in New Zealand, some of it misleading.
Wesfarmers is now one of Australia's larger rural and resource companies having just purchased Australia's second biggest pastoral house, Dalgety Ltd. It started life as a rural marketing and supply cooperative in Western Australia. It now has an unbundled structure - the business is a publicly listed company but farmers have retained majority ownership through the original cooperative. Many farmers also individually own listed shares.
Majority farmer ownership is protected through a founder's share. This share guarantees the cooperative a voting majority in the company for as long as this status is supported by a majority of cooperative members.
This structure has been successful in attracting very competent management and non-farmer equity. Investors are attracted by its good performance which is clear for all to see through its market-determined share price and dividends. Majority ownership by producers has not dissuaded others from investing for these reasons.
The Wesfarmers model is being discussed in the dairy and meat industries. It has considerable potential in the apple industry as it considers its options for the future.
The dairy industry invited a Wesfarmers representative to a recent conference. He told farmers that the lesson from corporatisation was that the discipline of a listed company focused effort on shareholder profit. The profit focus also resulted in more accurate commercial signals to farmer shareholders.
Australian farmers also believe there are profitable investment opportunities in agribusinesses beyond the farm gate. The National Farmers' Federation has been instrumental in establishing a Farmers Investment Trust which will be a vehicle for farmers to invest in agricultural processing and marketing.
From the inception of this idea over a year ago, there has been a dominant view among farmers, particularly their leaders, that investing in such a fund should be voluntary and that profits should be returned as dividends. This was seen as important for assessing the performance of the Trust and avoiding bundling problems. Australian farmers are acutely aware of the need to avoid bundling.
It is not, as some in the New Zealand media have suggested, a case of Australian farmers copying the Dairy Board 'model'. In fact, it has been developed deliberately to avoid the problem inherent in this model while, if commercially successful, delivering the benefits of being an investor.
The Trust intends to take a stake, not necessarily a majority holding, in companies associated with the rural sector where performance and profitability are expected to be good. Now that it has been established, farmers are being invited to take minimum $2000 units in the Trust. It has been announced that the Trust's first investment will be a 30 percent shareholding in Elders Ltd.
The Trust will provide a vehicle for farmers to invest off-farm. Farmers will have access to a diversified investment portfolio and choice over the size of their investment. Many are expected to choose not to invest. Those who do invest can be relied on only to stay with the Trust provided it achieves returns at least comparable with alternatives. Those managing the Trust know this and have said it will be the incentive they need to perform. Australian farmers have indicated they would not have it any other way.
Many regulatory changes over the past year affecting agricultural marketing have been in the right direction. Some will lead inevitably to further deregulation. But they have been very piecemeal and, for the most part, timid.
The role of politics in the debate is plain for all to see. Those threatened by change are holding the line where they can, or falling back and regrouping where this appears strategically sensible. The major conclusions from ACIL's research have not been challenged or rebutted in any substantive or convincing manner. As the Director-General of the Ministry of Agriculture and Fisheries said in commenting on the ACIL report:
"Producer boards have alluded to inaccuracies and dated examples, but have not been forthcoming on specific problems with the analysis. We doubt that the range of uncertainty surrounding the data would substantially affect the analysis or the conclusions."
The major regulatory reforms that are needed are not amenable to gradualism. Furthermore, it is evident from other areas of the economy that worthwhile gains are only achieved when reform programmes are comprehensive and decisive.
Producers need to realise that being only 'half-unbundled' does not remove the problems or deliver many benefits. For example, it is naive to expect outsiders to invest in an industry where there are restrictions on trading equity, and no markets to value it or reflect commercial performance.
Similarly, investment in processing and marketing, and access to international expertise and market connections, will not occur to any large extent until regulations restricting exporting are substantially removed. Even where they are not being used, regulations which allow intervention carry sovereign risks that are unacceptable to many investors. This is all the more so given the way these powers have been used in the past.
From the producer's perspective, the 'system' is its own worst enemy in many respects in retarding reform. In an interview in the Wool Board's latest Annual Report, the Chairman was asked about progress with marketing reforms suggested in the 1992 Arthur D Little consultancy report. He prefaced his answer by saying that:
"the [wool] industry still operates very much on a consensus basis and at times this means it moves only at the pace of its slowest participant."
New Zealand producers have a right to expect, and should be demanding, something better than that. If they do not, it will probably fall to the government to ensure it happens. The national interest must have priority over the interests of any particular sectional group.
The government has responsibility for regulatory policy throughout the economy. In delivering regulatory reform in agricultural marketing it must look not only to the interests of existing producers but also to the interests of future producers, new entrants and the wider community.
The overall national interest should be paramount. Regulations which distort resource use, constrain beneficial competition and lower national income are not in the national interest.
Many producers, or more particularly their leaders, are using the same types of arguments against change as were used by industries or groups in other formerly protected areas of the economy. For example, monopoly unions argued that competition would allow employers (the hirers of labour) to exploit workers and drive down wages. Having introduced competition it has been confirmed that, in fact, wages are determined by labour supply and demand, and that workers' best protection is bargaining freedoms and competition for their services. Those suggesting competition would be bad in agricultural marketing stand in the same relationship in this debate to the former monopoly unions, and use similar arguments and rhetoric.
An internal paper prepared in the Ministry of Agriculture and Fisheries warned that achieving beneficial change would not be easy "because of the enormous influence and power that the producer boards and farmer organisations can influence over politicians and individual farmers".
When this and other advice from the Ministry became public, the acting minister for agriculture said that the government "is not about to strip producer boards of their monopoly powers. This government has a long-standing commitment to consult with producers before any structural changes are contemplated."
However, in other areas of the economy where regulatory reform has been necessary, industry participants, rightly, have not been allowed to dictate the form and rate of change. Trade unions were not permitted the right of veto over labour market reform and manufacturers were not permitted to dictate the terms of trade liberalisation. Farmers applauded this 'national interest first' approach. The same principles and logic have to apply to producers in the case of agricultural marketing regulation.
It is not reasonable for producers, by a majority or otherwise, to be able to determine policies with such major implications for the national interest. An example of this unacceptable stance was the comment of the President of the Fruitgrowers Federation when he said, in respect of the Apple and Pear Marketing Board, that "the board exists because growers want a single desk system to maximise exports".
The kiwifruit debacle involved ignoring the wishes of a significant minority in an industry while giving the national interest scant regard. As an editorial in the Herald observed at the time:
"The Administration has guaranteed the Kiwifruit Marketing Board's right to export beyond Australia this season despite previous performance, despite its disinclination to sell the entire crop and despite the arrival of an alternative marketer offering to sell at least the remainder of the harvest. A poll suggesting a significant minority of growers wanted a choice of market representation cut no ice with the cabinet. Compulsory unionism might be banished from the labour market but majority rules in commodity selling."
In a similar vein, and when the debate over deregulation of the domestic apple market was raging, the Herald again commented:
"How many other countries would invite a poll of producers to decide whether consumers deserved a choice of brands and prices? If the orchardists had voted to continue their cartel the minister presumably would have blessed it."
When policy changes are inevitable, the clever strategy for a sector is to stop being defensive and support the reform process so that it proceeds smoothly and at minimum cost. To do otherwise is to incur costs - both the costs of defending the indefensible and the continuing economic costs - trying to prevent outcomes which are going to eventuate anyway.
An appropriate report card for the twelve month period since the ACIL report was released would conclude:
Performance over the past year has shown improved understanding of basic concepts and some willingness to change. However, much greater effort will be needed next year if major disappointment is to be avoided.