China buying NZ dairy farms doesn't affect the price of dairy products

I enjoy reading the occasional opinion pieces of former University of Waikato vice-chancellor Bryan Gould. Invariably the opinion pieces are on economic issues - Gould fancies himself an armchair economist. Unfortunately, occasionally he gets some things wrong. As he did in this opinion piece earlier this week. Gould writes:

We, however, seem unaware of what is happening. It is no accident that this direct supply to the Chinese market has accompanied a fall in the proportion of New Zealand dairy production handled by Fonterra. While the proportion of our dairy production under Chinese control is still quite small, there can be little doubt that it will grow.

Low dairy prices will force the sale of a number of farms to foreign owners. As the Chinese increasingly control their own sources of supply, their reduced requirements for dairy produce on international markets will inevitably mean downward pressure on prices.

The problem is, that China buying New Zealand farms to supply dairy produce directly to the Chinese market (bypassing Fonterra and other New Zealand exporters) probably has no effect at all on the international price of dairy products.

To see why, consider the diagram below, which represents the international market for dairy products. With China owning no farms in New Zealand, demand is D0 and supply is S0, leading to an equilibrium price of P0, and the equilibrium quantity of dairy products traded is Q0. Now, China buys some New Zealand farms, to supply its market directly. This reduces the amount of dairy products China demands from the international market (because that part of their demand is being satisfied by the Chinese-owned New Zealand farms), reducing demand to D1. However, it also reduces the supply of dairy products to the international market to S1 (because those New Zealand farms are supplying China directly rather than supplying the international market). Notice that the quantity demanded and the quantity supplied in the international market both reduce to Q1. That is because the quantity of dairy products that the Chinese-owned New Zealand farms are supplying to China matches the quantity of dairy products that the Chinese-owned New Zealand farms are no longer supplying to the international market. What happens to the price? Nothing.

Of course, a more thorough analysis would consider more general equilibrium trade impacts. And the reduction in processing might limit the gains from economies of scale to dairy producers in New Zealand, increasing the costs of production. But if your worry is that Chinese ownership of New Zealand farms will dampen international dairy prices, your fears are probably misplaced.

More on the dairy sector:

• The cobweb model and the boom-bust cycle in the NZ dairy market