‘nothing cures high prices like high prices’ – but will market forces be enough?

The alarming rise of butter prices has become a real source of frustration for New Zealand consumers, as well as a topic of political recrimination. The issue has become so serious that Miles Hurrell, chief executive of dairy co-operative Fonterra, was summoned to meetings with the government and opposition parties this week.

After meeting Hurrell, Finance Minister Nicola Willis appeared to place some of the blame for the high price of butter on supermarkets rather than on the dairy giant.

According to Stats NZ, butter prices rose by 46.5% in the year to June and are now 120% higher than a decade ago. The average price for a 500g block is NZ$8.60, with some local brands costing over $10.

But solving the problem is not a matter of waving a magic economic wand. Several factors influence butter prices, few of which can be altered directly by government policy.

And the question remains – would we want to? Proposals such as reducing exports to boost domestic supply, or cutting goods and services tax (GST) on dairy products, all carry consequences.

A key factor driving butter prices in New Zealand is that 95% of the country’s dairy production is exported.

Limited domestic supply and strong global demand have pushed up prices for a range of commodities – not just milk, but beef as well. These increases are reflected in local retail prices.

Another contributing factor is rising costs along the supply chain. At the farm level, producers are receiving record prices for dairy. But this comes at a time when input costs have also increased significantly. It is not all profit.

Weighing the options

Before changing rules around dairy exports, the government must weigh the broader consequences.

On the one hand, high milk prices benefit “NZ Inc”. The dairy sector accounts for 25% of exports and employs 55,000 New Zealanders. When farmers do well, the wider rural economy benefits – with flow-on effects for the country as a whole.

On the other hand, there is the ongoing challenge of domestic food security. Many people cannot afford basic groceries and foodbank use is rising.

So how can New Zealand maintain a food system that benefits from exports while also supporting struggling domestic consumers?

One option is to remove GST from food. Other countries exempt dairy products from such taxes in an effort to make staples more affordable.

This idea has been repeatedly reviewed and rejected – including by the 2018 Tax Working Group. In 2024, it was estimated that removing GST could cost the government between $3.3bn and $3.9bn, with only modest benefits for the average household.

Fonterra or supermarkets?

Another route would be to examine Fonterra’s dominance in the supply chain. There are advantages to having a strong global player. And it is not in the national interest for the company to incur losses on domestic sales.

Still, the structure of the market may warrant scrutiny. For a long time there were just two main suppliers of processed dairy products – Fonterra and Goodman Fielder – and two main retailers – Foodstuffs and Woolworths. This set up reduced the need to compete on prices.

While there is arguably more competition in manufacturing sector now, supermarkets are still under scrutiny and have long faced criticism for a lack of competition.

The opaque nature of the profit margins across the supply chain also fuels suspicion. Consumers know what they pay at the checkout and what farmers receive. But the rest is less clear. This lack of transparency invites speculation about who benefits from soaring prices.

In the end, though, the government may not need to act at all.

As economists like to say: “Nothing cures high prices like high prices.” While demand for butter is relatively inelastic, there comes a point at which consumers reduce their purchases or seek alternatives. International buyers will also push back – and falling global demand may redirect more supply to domestic markets.

High prices also act as a signal to producers across the globe to increase production, which could happen relatively quickly if there are favourable climatic and other conditions.

We only need to look back to 2014, when the price of dairy dropped by 48% over the course of 12 months due to reduced demand and increased supply, to see how quickly the situation can change.