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Available online at www.sciencedirect.com
Journal of Policy Modeling xxx (2013) xxx–xxx
Imperfect competition, border protection and consumer
boycott: The future of the dairy industry in Israel夽
Dorothee Flaig a,∗ , Ofir Rubin b , Khalid Siddig a
b
a Agricultural and Food Policy Group (420a), Universität Hohenheim, 70593 Stuttgart, Germany
Department of Public Policy and Administration, Guilford Glazer Faculty of Business and Management, Ben-Gurion
University of the Negev, P.O. Box 653, Beer-Sheva 84105, Israel
Received 22 September 2012; received in revised form 28 December 2012; accepted 30 January 2013
Abstract
Recent increases in prices of dairy products in Israel led to consumer unrest and boycotts against dairy
producers during the summer of 2011. The Israeli dairy industry is highly distorted with production quotas
and administered prices for raw milk, tariff rate quotas and an oligopoly in dairy processing. Since the issue
of self-sufficiency and food security is at the top of Israel’s national priorities, the future of the dairy industry
is generating heated debate. Thus, we use a general equilibrium model to estimate the effects associated with
particular alternative policies actually discussed to liberalize the Israeli dairy industry.
© 2013 Society for Policy Modeling. Published by Elsevier Inc. All rights reserved.
Keywords: Dairy; Computable general equilibrium (CGE) model; Imperfect competition; Tariff rate quotas; Israel;
Agricultural policy; Trade policy
1. Introduction
Recent increases in the prices of dairy products in Israel led to consumer unrest and, in some
cases, to ongoing protests and boycotts against particular dairy producers and specific dairy
products during the summer of 2011. The Israeli dairy market is not competitive in either of its
two segments – the production of raw milk and dairy processing – for the following reasons:
夽 The authors acknowledge the generous support of the Deutsche Forschungsgemeinschaft (DFG) for this research
project on “The Economic Integration of Agriculture in Israel and Palestine”.
∗ Corresponding author. Tel.: +49 711 459 22638.
E-mail address: [email protected] (D. Flaig).
0161-8938/$ – see front matter © 2013 Society for Policy Modeling. Published by Elsevier Inc. All rights reserved.
http://dx.doi.org/10.1016/j.jpolmod.2013.01.001
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first, Israel maintains a closed system of production quotas and administered prices for raw milk,
and the import of raw milk is not practical due to the geographical distance of Israel from its
major trade partners. Second, in practice, dairy processing is dominated by three large firms –
Tnuva, which controls about two thirds of domestic consumption, and Tara and Strauss, which
jointly supply almost the entire remaining amount. In addition, tariff rate quotas (TRQs) protect
domestic production from competition from imported processed dairy products. The current
industry structure has thus remained unchanged for a number of years. However, as a result
of the wide-ranging consumer protests of the summer of 2011, the social cost of maintaining the
above-described structure is currently being reassessed by policy makers.
Currently, a government committee (the Kedmi Committee) is addressing possible ways to
deal with the situation.1 In particular, two central policies involving structural changes are being
considered – liberalizing trade in dairy products and liberalizing domestic production. Opening
the market for importing dairy products has already been applied for a small range of hard cheeses
and is expected to extend to other products if import policies are further liberalized. With regard
to domestic production, the Committee recommended to publicly support the construction of
additional milk processing plants with the aim to increase competition among milk processors.
Another expected policy change will take the form of a permanent decrease in the regulated price
of raw milk to farmers together with the establishment of a secondary out-of-quota production
market. The ultimate goal of this move is learning by doing the impact of liberalizing the production
quota mechanism toward removing it entirely in the long run.
Naturally, this move has drawn objections from the agricultural lobby in Israel. The arguments
include the risk related to exposure to world price volatility and the inability to balance the seasonal
gap between domestic demand and supply. Another argument (not treated here) is based on the
ideological grounds of supporting rural communities in Israel, since it is generally understood
that the recommendations of the Committee are expected to have significant welfare effects on
dairy farmers, processors, importers and consumers. Moreover, since the issue of self-sufficiency
and food security is at the top of Israel’s list of national priorities, the future of the dairy industry
is currently generating heated debate in many parts of the population.
The lessons of what a textbook example for a small country as Israel can do in order to solve
this situation goes far beyond this study. Small countries are often characterized by one or more
of the following: high protecting tariffs, a concentrated processing phase and a milk production
quota system. Due to the complexity associated with structural changes, the liberalization of each
segment is usually considered and analyzed separately. In Israel, present circumstances force the
Israeli government to reconsider all its policies along the supply chain of milk and dairy products
at the same time. Which motivates a simultaneous side-by-side comparison of implications of
partially and full liberalization.
The aim of this paper is to model the particular alternative policies currently being considered
by the Kedmi Committee and hence to predict the effects associated with these particular policies.
With the background of the consumer boycott the question arises how different consumer groups
are affected by the policies and to what extent consumers should care which liberalization policies are actually applied. To this end, we examine four alternative policy scenarios for the Israeli
dairy and milk sectors, which are actually discussed in Israel. Because the alternative policies
would constitute a dramatic change in Israel’s agricultural sector, it may be expected that any
1 The preliminary debated recommendations of the Kedmi Committee can be viewed (in Hebrew) on the Israel government portal at http://www.shituf.gov.il/discussion/657.
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one of them would have implications for the entire economy. Therefore, the study uses a computable general equilibrium (CGE) model that has been adapted for the research questions posed
here.
Although there is a broad consensus on the relevance of market power for the modeling of
the food supply chain,2 there are only few CGE studies which address this issue. For instance,
Gasiorek, Smith, and Venables (1992), Burniaux and Waelbroeck (1992) and Mercier (1995)
incorporate imperfect competition (IC) in a CGE model to analyze the EU integration (i.e., the
“1992” program). Harris (1984) compares IC and perfect competition outcomes of trade liberalization for Canada and Flôres (1997) evaluates the gains from market integration for the four
MERCOSUR countries. Common to all studies mentioned is a strong effect on the projected
policy results when including IC. This finding is also stated in more recent studies by Shaikh
(2009) and Fugazza and Maur (2008). They do not include IC in their works but argue that welfare effects would be higher if IC is considered in their models. With respect to dairy markets,
Kempen, Witzke, Domínguez, Jansson, and Sckokai (2011) study the impact of abolition of the
milk production quota in Europe using the CAPRI model and Griffith, Lattimore, and Robertson
(1993) model the impact of removing national dairy policies on world markets. Both studies do
not consider market power. IC in the dairy market is studied with a partial equilibrium model
for the EU by Soregaroli, Sckokai, and Moro (2011) whose focus is on the estimation of market
power parameters. They show that market power has crucial implications on the model results.
With this strong evidence for the relevance of IC in CGE modeling, the question arises, why IC is
included so little in CGE literature. The reason might be some theoretical and practical difficulties
when incorporating IC in the framework of a CGE-model (Hoffmann, 2002). These difficulties are
mainly related to the determination of the optimal mark-up and the quantities demanded. In our
study, first, IC is reflected in the data, hence the quantities are known. Second, the price mark-up
is estimated from price data and not in the model, thus it is possible to overcome the problems
elaborated by Hoffmann (2002).
The paper is organized as follows: the next section provides an overview of the Israeli raw
milk and dairy sector and the relevant trade policies. Section 3 describes the database and the
methodology. In Section 4, we provide details about the scenarios analyzed and present and
discuss the results. Concluding remarks and foreseen policy implications are addressed in the
final section of the paper.
2. Israeli market for raw milk and dairy produce
Milk production in Israel is regulated by production quotas and import protection. The domestic
price of milk is determined by the government, with the price being based on a survey of the
production costs of dairy farmers. The government thus sets the producer price of raw milk at the
average production cost, which in turn guarantees a steady domestic supply. In 2004 the producer
nominal protection coefficient (NPC) published by the Organization for Economic Co-operation
and Development (OECD) was 1.6 (OECD, 2011), which indicates that prices for milk in Israel
were 60% higher than those on the world market at that time.
In Israel, the quotas on imports of milk and various dairy products change from time to time
in response to temporary domestic shortages. Because raw milk cannot be stored or imported,
2 Several empirical studies which particularly address the beef and dairy sector find evidence for market power. See for
example Anders (2008) for the German beef and pork sector, Alvarez, Fidalgo, Sexton, and Zhang (2000) for a study of
the dairy industry in Spain and Kawaguchi, Suzuky, and Kaiser (2001) for the dairy sector in the U.S.
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250
200
150
100
Consumer boycott started
50
0
Raw milk
8.00
7.00
6.00
5.00
4.00
3.00
2.00
1.00
0.00
NIS/liter raw milk
NIS/250g cottage cheese
D. Flaig et al. / Journal of Policy Modeling xxx (2013) xxx–xxx
Cottage cheese
Fig. 1. Prices of raw milk and cottage cheese in Israel between 2006 and 2011.
Sources: ICBS (2012) and Israeli Dairy Board (2011).
domestic and imported milk powder and imported butter are used to balance the seasonal fluctuation in supply. High tariffs (the average applied most favorite nation (MFN) tariff for milk fell
from 172% in 2002 to 153% in 2008) led to the share of imports in total domestic consumption
of only 1.6%. The average applied MFN tariff for dairy was 108% in 2008, with an import share
of 2.5%.
Today, there are only few dairy products whose consumer price is still regulated by the Israeli
government. Among them are the most basic milk products, i.e., butter, cheese and yogurt. Yet,
in 2011, these products jointly accounted for 30% of dairy sales in Israel,3 due partly to the large
price differences between regulated products and market-based-priced dairy products. However,
regulation itself has not guaranteed price stability to dairy consumers in Israel: remarkably, in
August 2008, the price of a 250-g cup of cottage cheese increased from 4.83 New Israeli Shekels
(NIS) to more than 6.23 NIS in nominal terms (Fig. 1). At that point in time, the Israeli government
decided to remove cottage cheese from the list of regulated dairy products in hope that this step
would enhance competition and increase consumer welfare. In reality, however, the price kept
rising to reach a peak of 7.05 NIS by February 2011 (implying a 46% price increase in about 5
years). During the same period, the nominal price of raw milk, the central input factor in cottage
cheese production, increased by only 22% (Fig. 1). Remarkably, it can be seen from Fig. 1 that
over the years 2006–2011 there were some years during which a continuous decrease in the price
of raw milk was accompanied by an increase in the price of cottage cheese.
In response to the escalating price, Israeli consumers started a boycott of cottage cheese in the
summer of 2011, with the “cottage cheese boycott” being considered by many as the main trigger
for the current heated debates on the need for government intervention in dairy pricing. Despite the
consumer boycott, Tnuva announced during the summer of 2011 that prices were not expected to
drop until the end of that year. In September, the national student organization called for a boycott
on all Tnuva’s dairy products. In October, during an investigation carried out by Israel’s Antitrust
Authority, Tnuva’s CEO, who had refused to make public the firm’s financial documents, stepped
down. Shortly thereafter, Tnuva cut prices of most of its dairy products by 15%, and the other
two large dairy firms followed suit with similar discounts on their products. This chain of events
3 Published online on 19.5.2011 in TheMarker (in Hebrew), http://www.themarker.com/consumer/1.644240 (accessed
February 2012).
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provoked intensive policy debates regarding the degree of government intervention needed in all
parts of the supply chain of dairy produce in Israel.
3. The model and the database
3.1. Main features of the applied model
This study uses an augmented version of the single country CGE model STAGE, which was
developed by McDonald (2009).4 The model is based on a social accounting matrix (SAM) for
Israel of the year 2004 (Siddig, Flaig, Luckmann, & Grethe, 2011) with a mix of non-linear and
linear relationships governing the behavior of the model’s agents. In this model, households maximize utility subject to preferences represented by Stone-Geary utility functions. They consume
composite aggregates of domestic and imported commodities that exhibit constant elasticity of
substitution (CES) and are modeled as imperfect substitutes applying the Armington assumption,
where the relative price determines the optimal mix of domestic and imported goods consumption.
Israel is a classic example of small country in the world market, and therefore world market prices
for imports and exports are fixed in the model.
Domestic production is modeled as a two-stage production process, with either CES or Leontief
technologies being applied. Therefore, to generate their output of commodities, producers first
determine the mix of intermediate inputs and value added, depending on the aggregate relative
prices. In the second stage, intermediate inputs are used in fixed proportions according to their
baseline input/output coefficients, with Leontief technology being applied, while for the value
added, i.e., production factors, CES technology is applied, where the optimal mix of the different
production factors is determined according to their relative prices.
3.2. The tariff rate quota
To model the tariff rate quotas (TRQs), we follow the mixed-complementary-problem (MCP)
modeling approach of van der Mensbrugghe et al. (2003). In such a case, the government distributes
licenses for in-quota imports via auction. Typically, the quota premium is specified as government
income, a situation that does not reflect reality in Israel, since the Israeli government allocates
import licenses for in-quota imports according to a first-come first-served system, which is usually
free of charge. Accordingly, we adjusted the standard approach of van der Mensbrugghe et al.
(2003) to account for this special feature.
For products with TRQs, the quantity imported (QM) consists of in-quota imports (QMI) and
over-quota imports (QMO). There are three possible scenarios for the premium rate of the quota.
First, if the quantity imported is greater than the quota, the premium rate (τ p ) is exactly the
difference between the out-of-quota tariff and the in-quota-tariff. Second, if the quota is binding,
i.e., when the imported quantity equals the quota, the premium varies between zero and the
difference between the two tariffs rates. Finally, if the quota is not fulfilled, the premium must
equal zero.
τp ≤ τo − τi ,
4
with QMO ≥ 0
Refer to McDonald (2009) for a detailed description of the model.
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If a quota exists, the import tariff rate (TM) comprises of the in-quota-tariff (τ i ) that is levied
on in-quota imports (QMI) and the out-of-quota tariff (τ o ) that is levied on out-of-quota imports
(QMO). Accordingly, TM is calculated as a weighted average tariff as follows:
TM =
(ti∗ QM + τp∗ QMO)
QM
The import price (PM) is determined by the world market price of imports, the in-quota-tariff
(τ i ), the quota premium (τ p ) and the exchange rate (ER), as follows:
PM = PWM ∗ (1 + τi + τp ) ∗ ER
Alternately, PM can be expressed as the world market price of imports (PWM) including the
import tariff rate (TM) multiplied by the exchange rate (ER). For calculating the full spread
between PWM and PM, the private premium accruing to the private sector is added. This private
premium consists of the quota rent (τ p *PWM*ER*QMI) earned by importers divided by total
imports (QM). If the quota is not fulfilled, the premium (τ p ) is zero, and thus only the in-quota-tariff
is applied.
PM = PWM ∗ 1 + TM + τp∗ QMI/QM ∗ ER
As noted above, quota licenses in Israel are not sold but are allocated to importers free of charge.
To apply for an import license, the importer must be Israeli citizen or the importing company must
be situated in Israel. The quota rent therefore accrues to Israeli enterprises and may be added to
the enterprises’ income from other sources (YENT).
YE = YENT + (τp ∗ PWM ∗ ER ∗ QMI)
where YENT is the basic income of enterprises without quota rent and YE is the total income of
enterprises including the quota rent.
3.3. Imperfect competition
Imperfect competition is modeled to depict the reality of the Israeli market for dairy processed
goods in which three large firms dominate the industry. The introduction of imperfect competition
follows the approach applied in GLOBE-IC (McDonald, 2007), which follows Francois and
Roland-Holst (1997).
In a monopolist regime, the production decision is based on marginal revenue. Formally, the
relationship between price and marginal revenue can be described the following:
1
,
MR = P ∗ 1 −
ε
where ε represents the price elasticity of demand.
Thus:
(MC − P)
1
= ,
P
ε
which defines the product price as the mark-up over the industry’s marginal costs.
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In the case of an oligopoly, for n symmetric firms, this relation becomes (see for example
Francois & Roland-Holst, 1997):
Ω 1
(MC − P)
=
∗
P
n ε
where (/n) is the Cournot parameter, which allows for different degrees of imperfect competition
and takes values between 0 and 1. In applied work, the mark-up parameter can be set to some
arbitrarily known value to represent the degree of effective market power. We implement this
method in our study.
With regard to our model, the producer price for domestic supply is denoted by PDS, the
domestic consumer price by PDD and the oligopolistic mark-up is depicted by the parameter
MKP, i.e.:
1
PDD = PDS ∗
(1 − MKP)
The oligopolistic mark-up creates an income of
Mark-up income = mkpsh ∗ (PDD − PDS) ∗ QD,
where QD is the domestic demand for a commodity and mkpsh is the mark-up share.
The mark-up income is added to the income of the owners of the dairy firms, which belong
to the group of the richest Jewish households in our model. As expected, the introduction of
market power in the model results in higher prices and lower quantities compared to the case of
a competitive market.
3.4. The database, adjustments and assumptions
The 2004 SAM for Israel used in this study (Siddig et al., 2011) has several distinctive features.
First, the SAM differentiates between activities and commodities, i.e., multi-product activities
can and do exist. Second, it provides detailed data on trade and transportation margins. Third, it
includes 10 (representative) household groups and 36 different labor categories, with the latter
being differentiated by profession, ethnicity and gender. Further, the Israeli SAM incorporates 43
sectors and 18 tax categories in addition to taxes on production factors.
The particularities of the Israeli milk and dairy markets require some database adjustments.
Historical data show that the farm gate price obtained by Israeli dairy farmers is consistently higher
than world market prices. To depict the reality of the Israeli dairy and milk markets correctly, the
world market price of imports (PWM) is decreased in the database according to the NPC data of
the OECD (2010).
Milk and dairy imports are considerably insignificant in the base data, with an import share of
1.6% and 2.5% for the two products, respectively. Most of milk and dairy imports in the base data
enter the country duty free. According to the SAM, this leads to a tariff rate of 0.1% for milk and
of 0.6% for dairy products (Siddig et al., 2011). These applied tariffs are chosen as in-quota-tariff
rates. The out-of-quota tariff rates are chosen to equal the applied MFN tariff of 153% and 108%
for milk and dairy products, respectively (OECD, 2010), as shown in Table 1.
Raw milk is almost not traded at all due to its perishable nature. This situation implies that
imports are poor substitutes for domestically produced drinking milk, and the Armington elasticity
for milk, which governs the substitutability between imported and domestically produced goods,
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Table 1
Import shares and quota tariff rates for Israeli dairy and milk imports.
sharea
Import
In-quota tariff ratea
Out-of-quota tariff rateb
Armington elasticity
Oligopoly mark-up
a
b
Milk
Dairy
1.6%
0.1%
153%
0.5
2.5%
0.6%
108%
5.75
23%
ICBS in Siddig et al. (2011).
OECD (2010).
is thus set to a low level of 0.5.5 Due to imperfect competition in the Israeli dairy market, one
would expect a strong increase in dairy imports if the border measures are abolished. Similar to
raw milk, there are some dairy products that cannot be imported for reasons of perishability. The
actual composition of the Israeli dairy demand gives a reasonable and realistic maximum import
share. Raw milk is processed to dairy goods in the following proportions: 31% goes to drinking
milk and milk beverages, 32% to soft cheeses, 13% to fresh dairy products (yogurt and flavored
dairy-based goods), 23% to hard cheese and 1% to table butter.6 The first two categories cannot be
imported or reconstructed using milk powder and butter, but some portion of fresh dairy products
can be imported or reconstructed. For the last two categories, which jointly account for 24% of
processed dairy products, perishability is not an issue, and hence import is feasible. Overall, it
is assumed that one third of domestic dairy consumption could be supplied by imports. Starting
from a very low level of dairy imports in the data, a relatively high Armington elasticity of 5.75
was chosen for dairy products to allow for realistic changes in import quantities.
Real-world data on private oligopolistic mark-ups are scarce for obvious reasons. However,
the recent cottage cheese boycott has provided a rare opportunity to approximate the size of this
mark-up in the Israeli dairy industry. The price of cottage cheese fell by 23% due to the consumer
boycott in the summer of 2011 (Fig. 1). Remembering that the price of raw milk stabilized at that
time and did not decrease and assuming that dairy processing firms do not make negative profits,
it was possible to extract a mark-up of at least 23% on non-regulated dairy products in Israel.
Because no boycotts against dairy producers took place earlier, we assume that a mark-up of the
size of 23% also characterized the Israeli dairy market in 2004. We believe this assumption to be
conservative, since cottage cheese is considered to be a basic product, whereas for luxury dairy
products the mark-up is probably substantially higher. Therefore, we believe that a 23% mark-up
is reasonable for characterizing the market power shared by the three large Israeli dairy firms.
4. Scenarios and results
4.1. Scenarios
Four scenarios are run to estimate the effects of liberalizing the Israeli dairy sector, one
scenario that represents the base situation and three scenarios simulating different policies and
combinations proposed by Kedmi Committee (Table 2).
5 In practice, milk powder and butter are used to construct some dairy products but the quality of constructed drinking
milk products is substantially lower than that obtained using raw milk.
6 Personal correspondence with Tamir Liron, chief economist of the Israeli Dairy Board, on December 1, 2011.
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Table 2
Setup of the scenarios.
1. Base
2. Liberalized domestic
market (freedommarket)
3. Free trade (freetrade)
4. Free market (freemarket)
TRQ: milk and dairy
Oligopoly: dairy
Administered price and
production quota: milk
Yes
Yes
Yes
No
Yes
No
No
No
No
No
Yes
No
Base: The base scenario represents the actual situation in the Israeli dairy sector in which the
TRQ for milk and dairy products is binding. The quota premiums on imports of milk and dairy
products are 50% and 59%, respectively. There is a price gap between the world market price and
the domestic producer price according to the NPC for milk and dairy products published by the
OECD (2011). The domestic producer price for milk is administered and hence may not decrease.
In the dairy market an oligopoly is in place, realizing a price-cost mark-up of 23%. Thus, the milk
and dairy markets are highly distorted in the base data.
Liberalized domestic market for raw milk: This scenario simulates the liberalization of the
domestic milk market, i.e., abolishing the administered price for milk and breaking up the dairy
oligopoly, while maintaining the border protection for milk and dairy products. For this purpose,
the oligopolistic mark-up in the dairy market is set to zero, and the price for milk is determined
in the market.
Free trade: The free trade scenario analyses the effects of abolishing the TRQ on raw milk and
dairy products. Thus, the out-of quota tariff of 153% for milk and 108% for dairy is decreased
to the applied in-quota tariff of 0.1% for milk and 0.6% for dairy products. Hence, the TRQ is
abolished and converted into a typical tariff system. International dairy producers start competing
with the domestic dairy producers, the oligopoly is broken up, and the administered price for raw
milk is maintained.
Free market: A fully liberalized domestic milk market and free trade are analyzed in this
scenario. The tariff rate is set to the applied in-quota tariff of 0.1% for milk and 0.6% for dairy
products, the oligopolistic mark-up is eliminated, and the price of raw milk is determined in the
market.
For all the scenarios the macroeconomic closures are modeled as follows: all factors in the
economy are fully employed and mobile among sectors of production. On the foreign exchange
market, the current account balance is fixed and the exchange rate is the equilibrating variable.
World market prices of imports and exports are fixed (Israel being a small country). Lastly, the
model is investment driven, and the consumer price index serves as numeraire.
4.2. Results
In this section we investigate the effects of Kedmi Committee’s policies on the Israeli economy
in general and the Israeli dairy industry in particular. We analyze changes under the three policy
simulations as percentage deviations from the base scenario.
4.3. Macroeconomic effects
Relaxing the regulation of the Israeli dairy and milk markets results in overall positive benefits
for the Israeli economy. As shown in Fig. 2, the GDP grows in all scenarios. Increasing income
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Fig. 2. Macroeconomic effects, % changes.
Fig. 3. Household income, % change and EV in % of income.
leads to increasing import demand in all scenarios, strengthened by the abolishment of TRQs in the
dairy and milk market in case of the free trade and free market scenarios. To absorb the increased
import demand, the exchange rate depreciates by 0.8% in the liberalized domestic market scenario
and 0.9% in the free trade and free market scenarios, which increases the competitiveness of
exports. Private consumption, government consumption and absorption increase. Positive effects
are significantly stronger when allowing for trade, as simulated in the free trade and free market
scenarios, in comparison to the liberalized domestic market scenario.
4.4. Households income and welfare
The increase in private consumption is associated with increased household income and welfare, which is depicted by the equivalent variation in percentage of income (EV, Fig. 3): household
income (which includes factor income and income from enterprise as main sources) and EV
increases in all scenarios for all households except for the Jewish fifth quintile. This is because
this group contains the owners of the oligopolistic dairy firms who lose the oligopolistic mark-up
revenue, which makes up 1.1% of the group’s total income.
Welfare and income effects are less strong in the liberalized domestic market scenario and
more beneficial in the free trade and free market scenarios, being slightly stronger in the free trade
scenario. Welfare effects are smaller than income effects and show a different development: income
effects are less positive for poorer household groups than for households in higher quintiles, except
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Fig. 4. Purchaser and producer prices; domestic production and total supply, selected sectors, % change.
the Jewish richest quintile, while welfare effects are more positive for poorer household groups.7
In terms of policy implications, we see that all three liberalization scenarios are progressive in
the sense that they enhance the welfare of poorer families.
4.5. Raw milk and dairy produce
The strongest price impact observed is caused by the breaking up of the oligopoly of the
three large dairy processing firms. Our results show that this is true for any liberalization scheme
considered. On the one hand, dairy purchaser prices drop substantially by 23.1% in the liberalized
domestic market scenario and even further in the other scenarios (Fig. 4). On the other hand,
milk prices show only marginal response. The purchaser price for milk increases by 1.1% in
the liberalized domestic market scenario, whereas in the free trade and free market scenarios,
it decreases by 2.0% and 0.8%, respectively. On the producer side, although we observe price
changes in the same directions, the decrease in the dairy producer price is significantly lower
than the decrease in its purchaser price in all scenarios, which implies that liberalizing policies in
the dairy sector may have large welfare effects for the Israeli economy and gains for the Israeli
consumer.
Effects on production vary markedly between the different scenarios (Fig. 4). Liberalizing the
domestic market increases production in all sectors, especially in dairy and milk production and
in related industries such as cattle or crop production. In the free trade and free market scenarios
the results clearly show negative effects on production quantities in dairy, milk production and
related industries.
Total supply, which represents the total quantity supplied to the market, i.e., including imports,
shows the same effects as production. An exception is dairy in the free trade and free market
scenarios, where composite supply increases while domestic production drastically decreases.
This is caused by a marked increase in imports from a share of 2.6% of total supply in the base
data to 25.3% in the free trade scenario and 26.0% in the free market scenario.
7 This observation may be attributed to increasing purchaser prices. Purchaser prices increase in all scenarios by less
than 1.0% for most agricultural food products and for the manufacturing and services sectors. These results are omitted
due to space limitations; they are available from the authors upon request.
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Mutual to all simulated policies is the breaking up of the oligopoly in the dairy processing
phase in Israel. Accordingly, all scenarios predict increases in income and welfare to all but the
owners of the dairy processing industry firms and considerable decrease in the purchaser price of
dairy products. Different effects occur mainly between the liberalized domestic market scenario
and the other two scenarios; free trade and free market. The liberalized domestic market scenario
is different than the other two policies for it keeps TRQs intact. If this policy is to be adopted,
lower prices for dairy products caused by the switch to a competitive processing regime would
increase domestic production. This in turn would increase demand for domestic milk production
and thereby stimulate the expansion of the dairy farming sector in Israel.
Abolition of the TRQ is modeled in the two other simulated policies. In the free-trade scenario
the opening of the border breaks up the oligopoly, resulting in a drop of the dairy purchaser price
by 27.1%, which exceeds the oligopoly’s mark-up. An increased demand for dairy products of
7.1%, induced by the decreased price, is satisfied by greatly increasing cheap imports. The world
market price for milk and dairy products is 60% below the Israeli price level in the base data
(see Section 3.4), which further contributes to the drop in the domestic purchaser price for dairy
products and milk. Domestic dairy production in Israel is not competitive compared to the world
market: the main input, milk, is hardly tradable, and the domestic price in Israel is strengthened
by an administered price. Thus, Israeli dairy production decreases by 12.5% to a share of 74% of
the total dairy consumption, which is nearly the amount of dairy products that is hardly tradable.
The marked decrease in dairy production considerably reduces the demand for milk, resulting in
declining milk production, accompanied by declining cattle production. Increasing production,
mainly in the non-agricultural sectors, increases the demand for factors of production, which
increases input costs for all sectors and results in increasing producer prices in most sectors of the
economy. Increased import demand caused by increased GDP and – in addition to the liberalized
domestic market scenario – the abolition of the TRQ on milk and dairy results in a depreciation of
the exchange rate of 0.9%; this increases the competitiveness of exports and increases domestic
production. The benefit to households is higher than before, due to markedly increasing income
and steeply declining dairy prices.
Interestingly, there are no major differences between coupling the abolition of the TRQs on
milk and dairy products and liberalizing the price of raw milk in the free market scenario. Since the
administered price for milk in Israel is based on the average production costs in the industry, the
resulting slight decrease of the milk producer price is sufficient to further suppress milk production
in Israel. In the first step, milk demand strongly decreases, as in the free trade scenario, but with
the difference that less milk is available. The decrease in the purchaser price for milk is therefore
smaller, and thus input prices for domestic dairy production decrease less than in the free trade
scenario, resulting in a stronger contraction of dairy production than in the free trade scenario.
This effect causes slightly smaller positive effects on the macro and household levels than in
the free trade scenario. To sum up, whether breaking up the oligopoly of the processing phase
is achieved by decentralizing domestic production or by liberalizing trade, this is the key for
reducing dairy products prices substantially and enhancing consumer welfare. Furthermore, we
predict that liberalizing trade by itself gives better results compared to an additional abolition of
the milk production quota system.
5. Conclusions
Dairy industries in many small countries are characterized by one or more of the following: high
protecting tariffs, concentrated processing phase and milk production quota system. The dairy
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industry in Israel has them all. A recent consumer uprising in the country has led policy makers,
academics and industry leaders to debate whether it is necessary to continue regulating this sector
and hence to protect domestic supply from the influence of importing dairy produce at the expense
of consumer welfare. The lessons of what a textbook small country example as Israel can do in
order to solve this situation gives valuable insights for policy options of other small economies.
Currently a government Committee put forward several recommendations to reform the Israeli
milk and dairy sector. In this study we examine the potential effects of the policies proposed, thus
we simulate three scenarios that deviate from the actual situation in the Israeli milk and dairy
markets: the first simulates the abolishment of the milk production quota and the breaking up of the
dairy oligopoly, while maintaining border protection. The second scenario simulates the opening of
the border for milk and dairy while maintaining the production quota and the related administered
price for milk. Finally, in the third scenario, we simulate the abolition of both – domestic milk
production quota and border protection. The abolition of the TRQ creates competition with foreign
dairy producers and therefore breaks up the dairy oligopoly in the second and third scenarios.
While the inclusion of market power in the modeling of agricultural sectors showed to be
significant but problematic in other setups, the unique economic environment of Israel motivated
us to expand the CGE modeling framework to account for imperfect competition. In particular,
price data before and after the Israeli consumer uprising in summer 2011 provided us with a scarce
opportunity to approximate the actual price mark-up in the Israeli dairy sector.
The liberalization of the domestic dairy and milk markets leads to a drop in the dairy consumer
price. This price drop results in increased dairy demand, thereby stimulating dairy production,
which, in turn, increases milk demand. It is important to note that price drops occur mainly on
the consumer side due to the elimination of the oligopoly’s mark-up, while the producer price
remains nearly constant. Thus, the welfare loss associated with market power in the processing
phase is shown to be significant for the Israeli economy. Simultaneous abolition of the oligopoly
and the abolishment of the milk production quota provides the means for satisfying the increased
milk demand with increasing milk production.
The picture looks different when international trade in dairy and milk produce is liberalized;
here, we should take into account the fact that dairy can be imported into Israel up to 30% of
total consumption, while milk is hardly importable. Domestic dairy producers cannot compete
with world markets (NPC for dairy is 1.6), and dairy imports therefore increase markedly. Thus,
the liberalization of trade policies results in a reduction of the size of the domestic dairy industry
(12.5% and 13.3% for milk and dairy products, respectively).
Finally, when comparing the goals of the consumer boycott – to lower purchaser prices for
dairy products and increasing consumer welfare – with the results from the simulations it is
obvious that these goals are reached for all household groups (but the owners of dairy processing
firms) with all policy packages. Interestingly, it matters only slightly which policy is actually
chosen, despite differing effects on production. The effect on households and the total economy
are stronger positive when international trade is liberalized, but in this case, Israel will be exposed
to world price volatility and the risk of losing self-sufficiency, which is a serious political concern
in Israel.
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