The milk powder bans

The NZ milk powder bans dairy product bans  (make that all dairy products for Russia, and milk powder from Australiasia from China), in China and Russia are undeniably a big deal.  The most important point is of course that no-one gets hurt – so having the countries ban milk powder until there is information available makes sense. The encouraging sign in this regard is:

Capital & Coast District Health Board infectious diseases specialist Dr Tim Blackmore said botulism was extremely rare in New Zealand.

Given the time since the contamination and that no cases had been reported, it was unlikely the bacteria would still pose a risk, he said.

So that is a plus.

Given all this, people will also be interested in the ways this type of event may impact upon economic outcomes in NZ.

A point people will bring up is the impact on Fonterra’s reputation – and the impact it receives on any “premium” received for dairy products.  I will just leave that to the side here.

Instead I’m going to focus on how this is different than other “shocks” to demand for a small open economy, in the short-term.

Usually, I’d point out that NZ only makes up about 1% of global dairy supply.  As a result, if a bunch of countries banned our products we would just sell (as a residual claimant) somewhere else – Fonterra might have to put up with slightly lower prices, but quantities wouldn’t change.  And so near term GDP wouldn’t suffer a direct hit from agriculture.  Consumption etc would be lower, as our incomes would be, but GDP wouldn’t necessarily be hit.

So if this had happened randomly, the fact that China (24.7% of our dairy exports in the June 2013 year) and Russia (1.2%) banned NZ exports may not have all that big an impact.  However, this isn’t a random shock – it actually stems from a characteristic of NZ production!

The magical ability of a small open economy to do this relies on the idea that they are selling a homogenous good.  But this is a specific NZ shock – people all around the world are a bit nervous about Fonterra – hence an article about it on Bloomberg.  So the entire demand curve for NZ dairy products has fallen – implying that the price effect will be larger.

On top of this, a bunch of the “stock” of dairy production has been destroyed.  It is now essentially worthless and this is a cost.  Since it sounds like none of this milk powder has been sold in its retail form we need to ask whether it had already been exported by not reached retail yet (in which case Fonterra’s compensation to these groups will turn up in the capital account) or whether Fonterra still had it on hand (in which case it was in inventories – and will appear as a drop in inventory accumulation in the GDP stats).

How extreme this is for the near term outlook for Fonterra, and the broader NZ economy, will come through in the exchange rate and Fonterra’s share price today.  The Global dairy trade index could also be useful heads up – but remember that it includes a whole bunch of suppliers, not just Fonterra!

Note:  And before people go to make some sort of firms/insufficient regulation are evil/the cause – lets try to understand how these things happen.  Ex-ante all firms, institutions and individuals are taking on risk (this includes government) – the fact something happens ex-post doesn’t mean it was “100% likely” ex-ante, and given ex-ante expectations (probabilities of things happening) people were making choices.  There may well be some type of institutional failure, or it may be down to some sort of “production line” failure the occurred even in the face of best practice.

This is not to say this was due to genuine uncertainty – this sounds like the sort of thing that a probability distribution can be pinned to.

And for people suggesting regulation, I’m genuinely unsure what type of regulation helps here.  It sounds like a knee-jerk “something must be done because” response, rather than anything that makes sense.  Let us at least try to answer some questions first, how did the pipe get contaminated, what are the probabilities around it getting contaminated in that way?

Update: On the reputation impact Liam Dann has a good piece here.  I’d just be a little bit careful with the final line though:

This is a warning to us all that New Zealand needs to keep pushing to diversify its economic interests beyond the farm gate.

Fonterra is a firm, not New Zealand.  Being a small open economy with a large exporter it does involve risk and the benefits of specialisation, this is true.  But the question is more why New Zealander’s aren’t diversifying and their incentives – not a question of how we could make them diversify.  This distinction is subtle, but important.

ANZ also comments on reputation impacts here.

Update 2:  Good post by Homepaddock on this.

Update 3:  Aaron Schiff comments on the idea of diversification – pointing out that Fonterra was created legislatively, not by way of a competitive market.  Good point.

Update 4:  Interesting facts from a bunch of experts in microbiology and medical sciences.  Via Peter Griffin.

Update 5:  China’s ban is only on whey and infant formula – not broad milk powder.  Also sounds like much of the product had been sold on – implying this will turn up more in the capital account than GDP (in a direct sense).

  • VMC

    However, i think it would be sensible for someone to check that the regulation that we do have is working. It seems odd that this could carry on for a year without it being detected and that does require an explanation, after all it might be sabotage just as equally as it might be carelessness. Worth considering what the consequences might have been if someone had died or got seriously ill. Could be a much needed warning. As recent events with meat have shown – if we want to exist as an exporting nation we need to improve our game.

    • “However, i think it would be sensible for someone to check that the regulation that we do have is working”

      100% agree – tells us that there needs to be an investigation. Food safety is not something we should mess around with, and we are lucky no-one appears to be hurt.

  • Shamubeel Eaqub

    On a slightly oblique and naughty angle: It will be interesting to gauge the reaction here to our mill being banned compared to labour wanting to ban them from buying our houses. I wonder how much outrage there will be?

    • VMC

      I assume that was meant to mean “Our milk”?

    • I suspect that, in the near term, all the anger is going to go on Fonterra. Tbh, I would like to see a bit more information first – I suspect that other organisations within the supply chain (farmers) are going to be furious. Third safety crisis in the last few years …

  • Aaron Schiff

    For something on the scale of Fonterra, isn’t there a valid public policy question about risk vs return and diversification? If Fonterra was not the dominant supplier/brand for example, maybe the damage would have been smaller.

    • I think that is an interesting question when the market structure is “imposed from above” … as it is in this case! If the market structure was set organically, I would expect this to be taken into account when firms decide whether to integrate or not.

  • VMC

    It turns out that while NZ might make 1% of the milk grown in the world (your figure above) it is involved in more than 30% of the global trade in milk (ANZ economist on the radio this morning). So maybe more than just a residual player in the market. And while I take your point about Fonterra being a firm, and not NZ – there are 2 points to bear in mind. Fonterra is a creation of the State, established through legislation. And, as we saw with a looming disaster in the quality of tertiary education (as provided to foreigners) some years back, China does not make the distinction. To them, if there is a problem with a firm (or a tertiary provider) they expect NZ to fix it up, and smartly.

    And, interesting to ponder the effect on the economy. It seems that the dollar has fallen this morning (it is claimed due to Fonterra fallout) so dairy farmers will get more for their milk and the rest of us will pay more for our petrol. A lower dollar may keep the Reserve Bank’s finger odd its trigger for longer – so some of us may do OK out of this disaster

    • “It turns out that while NZ might make 1% of the milk grown in the world
      (your figure above) it is involved in more than 30% of the global trade
      in milk (ANZ economist on the radio this morning). So maybe more than
      just a residual player in the market.”

      Indeedy, it is 30% of world export trade. But it is jumping into a series of large markets as a residual claimant – the world export line is a common misnomer IMO. Now in some market it may become more than a residual claimant – that is fair – but the 30% figure exaggerates Fonterra’s ability to control price, which is why I prefer to compare it to total supply 🙂

      ” Fonterra is a creation of the State, established through legislation.
      And, as we saw with a looming disaster in the quality of tertiary
      education (as provided to foreigners) some years back, China does not
      make the distinction. To them, if there is a problem with a firm (or a
      tertiary provider) they expect NZ to fix it up, and smartly.”

      Indeed – however, I’d hope Fonterra has enough institutional structure to see this as in their own interest!

      “And, interesting to ponder the effect on the economy. It seems that the
      dollar has fallen this morning (it is claimed due to Fonterra fallout)
      so dairy farmers will get more for their milk and the rest of us will
      pay more for our petrol. A lower dollar may keep the Reserve Bank’s
      finger odd its trigger for longer – so some of us may do OK out of this
      disaster”

      The milk powder that has to be thrown out is worth $0 no matter what happens to the dollar – I don’t think farmers are going to be too happy!

      • VMC

        Agreed, they will not be happy. But, I have also just learnt that it happened over a year ago – so am thinking that farmers have been paid for (and probably spent) that product. Seems to have a big impact on the Fonterra share price though – so all dairy farmers will be a bit sad if they were thinking of seeling their farms this week.

        • My impression was that much of the milk powder was still in storage – so I’m not sure if Fonterra’s liability will be through having to refund people further down the chain, or whether it was still in their inventory.

          Either way, it is likely to hit payouts for the year in some way – exactly how much is still an unknown, mainly because we are still all a bit short on information!