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Lori Joyce and Heather White have trouble keeping costs down in their cupcake business due to the price of dairy.

Caught between her company's commitment to all-natural baking products and Canada's high dairy prices, Lori Joyce, co-owner and co-founder of Cupcakes by Heather and Lori, has found herself in a precarious position.

"We only use butter in our products, whether it's in the cake or in the buttercream, but now with the costs going up so much on butter, it is being recommended to me that I consider changing my recipe," she said. "That means adding oils and margarines, and I won't do that. My customer comes to me because I make an all-butter, all-natural product, but I can only sell a cupcake for so much before they decide to buy something else."

The dairy industry in this country operates within a tightly controlled system, where prices paid to farmers are fixed, high tariffs on fluid milk are imposed to ward off foreign competition, and strict production quotas regulate how much supply can enter the market.

Though many politicians are hesitant to challenge the supply management systems for dairy, poultry and eggs, the Trans Pacific Partnership negotiations, which wrapped up in Hawaii the last week of July without reaching a deal, has recently put Canada's dairy industry into the spotlight. "Although parties did not conclude the negotiations, significant progress was made, with only a few issues left to resolve," said a representative from Foreign Affairs, Trade and Development Canada.

Unwilling to compromise on the use of butter in her products, Ms. Joyce fears that increasing her prices to keep up with the rising cost of the raw materials will reduce her customer base. Furthermore, Ms. Joyce has had difficulty launching an all-natural ice cream brand to complement her cupcake franchise, unable to find a price point that allows her to remain competitive in the market.

"The incentive isn't to help the small business at all in that situation. It's not a free market," she said. "It's an archaic, out-of-date political arrangement that shouldn't exist any more."

Between 2001 and 2011, the Organization for Economic Co-operation and Development (OECD) estimated that the average Canadian family spent $300 more a year for milk as a result of supply management, even as global dairy prices were falling. But the system affects small businesses that use large quantities of dairy and poultry products more acutely. Members of Restaurants Canada, for example, buy approximately $5-billion worth of dairy and poultry products a year, according to Joyce Reynolds, the executive vice-president of government affairs for Restaurants Canada.

"It costs 28 cents for a slice of cheese to put on a burger in Canada, whereas it costs 7 cents in the U.S. from the same supplier," she said. "One operator wanted to put milkshakes on their menu, but they would have to charge $12 in order to make it profitable."

Ms. Reynolds adds that while many customers assume that restaurants pay less when purchasing staples such as milk, butter, eggs and cheese in bulk, they often have to pay grocery store prices.

"There are very thin margins in a restaurant business, and restaurant operators are telling us constantly about their frustration with the high cost of dairy in particular," she said. "The provincial milk boards make their decisions on price and supply without consultation from retailers or restaurants or consumers."

National producer compensation and supply quotas are set by the Canadian Dairy Commission (CDC), a Crown corporation established in 1966 to "stabilize revenues and avoid costly surpluses," according to its website.

"Before the seventies, there was a tremendous fluctuation in milk prices, and tremendous fluctuation in the quantity of milk produced," said Chantal Paul, chief of communications and strategic planning for the CDC. "The decision that was made by the provincial and federal governments, with some pressure from the dairy farmers, was to establish this system, a kind of an exchange. The producers agree to exert discipline in their production by obeying a quote-unquote 'quota,' and in exchange they get a price that is fair and allows them to make money."

The Dairy Farmers of Canada's website points to the fact that Canadians do not directly subsidize the dairy industry, that the retail price of milk rose after Britain and Australia deregulated their dairy market, and that Canada still imports large quantities of dairy products such as concentrated milk protein, used in the manufacture of yogurt and cheese, from abroad.

In the mid-1990s, the CDC established a Special Milk Class Permit Program to provide preferred pricing options on dairy supplies that are ultimately used to make other products, such as Ms. Joyce's cupcakes.

"The prices that the farmer gets under this program are based on U.S. prices," said Ms. Paul, adding that while the dairy farmer's compensation is regulated, the price that eventually gets offered to the small business owner is not. "We can't force anyone to offer a certain price," she said.

Ms. Joyce says that Cupcakes by Heather and Lori does enjoy a small discount as a result of this program, "But what's the price compared to? Just going into the store and buying butter?" she said, adding that the discounted prices are still not competitive with other markets like the United States.

While the supply management system was established to help protect Canadian dairy farmers, it hasn't prevented the number of dairy producers from declining by 91 per cent since 1971, from about 145,000 to about 12,000.

"Dairy, poultry and eggs make up a mere 6 per cent of Canadian agriculture, yet you have this marketing campaign, this ongoing thing that says supply management is necessary for Canadian agriculture," said Martha Hall Findlay, executive fellow at the School of Public Policy at the University of Calgary, who has argued in favour of overhauling Canada's supply management system.

"Canadian consumers are unwittingly paying inflated prices, which in turn support the large amounts of money spent by the lobby to retain the system."

Ms. Hall Findlay points to Australia and New Zealand's dairy industries, as well as Ontario and British Columbia's wine industries, as examples of successful transitions away from supply management.

"Why do we rely on an attitude that says, 'We can't compete, we need to be protected,' when in virtually every other sphere, we've proven the opposite?" she said, adding that a transition would require fair compensation for producers. "We make really good milk, so we should have an attitude of 'Yes we can' as opposed to 'We need to keep it protected.'"