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There is good news and bad news for Canada’s dairy farmers.

The good news is that the U.S. has apparently backed off its insistence that Canada phase out the supply management system, which tightly regulates prices and production levels in the dairy and poultry sectors.

If the two countries reach a deal to renegotiate the North American free-trade agreement in the coming days, Prime Minister Justin Trudeau can claim he saved supply management.

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But it would be a pyrrhic victory for farmers.

The bad news is that the concessions Ottawa appears ready to make to salvage NAFTA could deliver a lethal blow to supply management over the longer term, particularly in the dairy industry.

First, Canada will have to give up a significant piece of its protected dairy market. The betting is that it will ultimately cede at least 3 per cent to the Americans – in line with the concessions it made to Australia and New Zealand in the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (formerly the TPP). And that’s on top of the nearly 10 per cent of the market that was bargained away in the free trade deal with the European Union.

These concessions represent hundreds of millions of dollars in potential losses to Canadian farmers.

But farmers have even more to fear if Ottawa also deals away a special wholesale pricing regime for dairy ingredients. Early last year, Canadian marketing boards created a new lower wholesale price for so-called Class 7 milk – a move that virtually shut off exports to Canada of U.S. ultrafiltered milk, a protein-rich ingredient used to make cheese, yogurt and other dairy products.

The new pricing scheme enraged U.S. dairy producers, who convinced the Trump administration to make it a red-line issue in the NAFTA talks.

The problem isn’t just that reversing course on Class 7 milk would reopen a market for the United States worth as much as $200-million a year.

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The greater threat is what this will do to the Canadian market. Several dairy processors, including Parmalat and Gay Lea, invested heavily in new and expanded Canadian plants to make dairy ingredients domestically by exploiting the new lower wholesale price. These plants could be forced to close or cut production if the price of wholesale milk goes back up.

But here’s where it gets complicated. The milk pricing scheme wasn’t just a clever way to block U.S. imports. It was also a way to deal with an unsustainable and growing surplus in Canada of skim milk. That is the milk that remains after butter-fat has been skimmed off to make butter and cream. Using skim milk to make dairy ingredients helps soak up the excess.

And because Class 7 is set at the world price, the milk can be exported into an already glutted world market – a fact that further irritates the Americans.

If Class 7 is scrapped, farmers will face a stark choice. They’ll have to start dumping massive quantities of milk because there will be no market for it. That won’t look good in a world of poverty and hunger.

More likely, farmers will have to accept a dramatic cut in how much milk they can produce. Agricultural economist Al Mussell, lead researcher at Agri-Food Economic Systems, in Guelph, Ont., predicts the reduction could reach as high as 15 per cent – delivering more pain to farmers than all the previous trade concessions combined.

Dairy farmers have had it pretty good in recent years, expanding production to meet growing demand, including for dairy ingredients. Many purchased new equipment and expanded herds, taking on more debt in the process.

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Rolling back production would leave many of these farmers in precarious financial condition, according to Mr. Mussell.

And Canadian farmers would be powerless in the face of this unfortunate series of events. Provincial marketing boards would impose the production cuts, along with lower payouts. Large, efficient farms would suffer along with more marginal ones. With supply management, it’s all for one and one for all.

Faced with that predicament, some dairy farmers may lose their faith in supply management and demand the same free market reforms the Americans wanted all along.

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