The introduction of a common market for agriculture by the original six Member States (MS) was a pivotal task in the formation of the EEC. We propose here an assessment of the effect of the CAP on domestic economies, in order to show what domestic factors permanently pushes for a reform.

I The objectives of the CAP

A - Article 39

The objectives of the CAP are clearly defined in the Article 39 of the Treaty.

1 - Productivity and technical progress

To increase agricultural productivity by promoting technical progress and by ensuring the optimum utilisation of all factors of production, in particular labour.

2 - Fair standard of living

To ensure a 'fair standard of living for the agricultural community', in particular, by increasing the individual earnings of persons engaged in agriculture.

3 - Stabilise markets

This would be a gain for producers. Can better foresee their revenues. Can better compute their investment calculations.

4 - Ensure the availability of supply

· Memories of food shortages in the post-war period.

· Strategic commodities in case of war

5 - Reasonable prices for the consumer

This objective contradict objective 2.

B - A de facto hierarchy

1 - These objectives conflict

These objective conflict with one another. E.g. reasonable prices v fair farm incomes.

2 - The true objectives

·Most stress has been put on the objective of increased farm incomes, notably at the expense of the consumer.

· EL-AGRAA : 'the true objectives of the CAP were established after the Stressa conference in 1958 :

1) to increase farm incomes mainly through a policy of transfer from the non-farm population through a price support policy and of rural industrialisation

2) allowing for specialisation within the community and eliminating artificial market distortions

3) preserving the family farm

II - Successes of the CAP

Let us try to evaluate the cost-effectiveness of the CAP. It has had success and failures. However, everything good or bad with EC agriculture cannot be systematically attributed solely to the CAP. There are indeed, many other factors.

As we have seen, the Treaty specify five main objectives of the CAP (TEU, 39). As the EC expanded form the original six to nine, 13 and then 15 members, certain key feature of CAP changed.

A - Intra-EU free trade

Intra-EU free trade has been accomplished through the removal of all intra-EU trade impediment.

B - Structure and productivity (objective 1)

1 - A rapid increase in labour productivity

During the 1961-1990, the average labour productivity growth in the Community's industry was about 2.9 per cent a year, while in agriculture it was more than 5 per cent. This rapid increase in productivity came about mostly because of larger farm size and the fast pace of mechanisation.

This increase in productivity has resulted in a sharp decrease of the labour force employed in this sector.

2 - However, agricultural productivity still lag behind other sectors

However, despite the progress, the relative productivity ratio between agriculture and the other sectors of the EU economy is less than 0.5 per cent.

3 - Labour productivity varies considerably between members states

The accession of Greece, Portugal and Spain brought to the Community relatively unmodernised labour-intensive agricultural sectors with low labour productivity and small agricultural holding.

In contrasts, that accession of Finland and Sweden brought in capital intensive, highly subsidised agricultural sectors of large agricultural holdings. Consequently, labour productivity varies considerably from one MS to another.

4 - Assessment

Some tremendous progress. But still low labour productivity (as compared to other industries).

C - Market stability (objective 3)

An indicator of market stability should be the stability of market prices.

1 - The theory

In the EC, the prices of agricultural products are administrated as the instrument for increasing farmers' incomes. Therefore, in the EC, the price of agricultural products should reveal three tendencies :

1) Relatively high levels (target of higher farm incomes)

2) Relatively high rate of increase (to close the gap)

3) Relatively low fluctuations (target of market stability)

2 - The practice

1) prices were defined well above the world prices (in that sense they were high, at the expense of consumers)

2) during 1973-1984 the intervention prices rose by about 7 per cent yearly. After 1984, with problems in financing the Community budget, they started to fall by 0.2 per cent annually. In real terms producer prices were much lower in 1990 than in 1985.

3) Community administrated prices were stabler than the world prices.

3 - Assessment

Price stability, but high prices. The market stability served farmers' interest, at the expense of consumers'.

D - Availability of supplies (objective 4)

1 - Security of supply

Security of supply is ensured by the CAP through :

- an increased self-sufficiency

- an intensive storage policy

- a stable import policy

2 - However, EU is the world's largest food importer

Despite the increase in agricultural production and the large stocks, the Community remains the world's largest importer of food. EU exports certain types of commodities and import other.

3 - Butter mountains and wine lacks

Large surplus of some important commodities were generated. The surpluses of milk powder and butter were very notorious. These surplus, further to the initial costs of build-up and storage, caused new problems when they were disposed of within the Community or as exports at prices below costs.

4 - Assessment

The CAP has been even too successful in that respect.

III - The negative overall welfare effect of the CAP price support mechanism

A - A twofold system of price support : external protection and intervention buying

1 - Changes in relative importance

In the 1980s and early1990s, the primary instrument of price support has been intervention buying (notably because the EU has move from the position of net importer to next exporter).

Although major changes have since been introduced (reforms of the 80s and the 1992 reform), the mechanism still applies to many products and shed light on some of the disastrous consequences of the policy earlier on.

2 - But must work together

However, the external control mechanism (MIPs & VIL) has been necessary to protect the operation of the intervention buying system. In other words, an intervention buying system cannot be operated without a MIP policy. Indeed,

Given the fact that the intervention price is well above the world price, without the VIL it would become economically rewarding to import world products and to sell them to the national authorities.

B - External protection : MIPs and VILs

1 - External control was already present before the CAP

In the post-war period, the dominant method of agricultural support had been import tariffs, which were effective means of raising agricultural prices, since, in the early 1960s, the six MS were net importers. With this background of external protection, the movement to a common market (abolition of internal barriers) was politically acceptable.

2 - MIPs & VILs

Instead of fixed tariffs, the EEC adapted a system of Variable Import Levies (VIL). This entailed the setting of Minimum Import Prices (MIPs) with Variable Import Levies equal to the differences between the minimum import price and the lowest price offered by importers at the Community's borders (i.e. include transport cost). In the case of cereal, the MIP is called the threshold price (guide price for beef).

3 - Effects on price and quantities

The MIP for all major products was consistently maintained above the international price (Pw), EU market prices of imports have been forced upwards. Consequences :

- EU domestic prices are well above world prices

- EU domestic production increases

- EU imports decrease

- Consumption decrease on the whole

4 - A net economic welfare loss

· Our analysis assumes that the EU does not influence the world price (unrealistic).

· The increase in internal EU prices causes producer surplus to rise by the value of the area A

· Budgetary revenues equal in value to C (from the import levies). This can be counted as a gain.

· However, these gains are more than offset by the loss in consumer surplus equivalent to the areas A+B+C+D.

· The overall economic welfare loss to the EU from the policy is therefore B+D.

· This result confirm a basic result of comparative static economic theory, that free trade is optimal and that trade interventions result in a loss of economic welfare.

GRAPH

· Inefficient allocation of resources

The cost of the extra domestic production entailed by the MIP is B+E (area under the supply curve). This is approximately the value of the extra, that is the cost of the extra output due to the MIP policy. However, the same extra output could have been imported at a lower cost (E). Therefore, the area B is a pure loss of resources for the EU, which could have allocated them to other useful productions.

· Damage to consumption

Consumers have reduced their consumption which they value at F+D, but which cost them only F before the imposition of the MIP. This results in a welfare loss of D

· The total welfare 'dead-weight loss' is B+D.

6 - Further implications

· The EU market became completely insulated from all movements in international prices (unless the Council modify the MIP)

· this entailed an increased volatility of world prices.

· International market prices are forced downwards.

C - Intervention buying at guaranteed prices

1 - An increasing importance

The second key feature of the price support mechanism was the system of intervention buying. This system was all the more important since the EU became a net exporter (due to technical progress, price support and low growth rate of domestic demand).

2 - The system

- national authorities offer to buy products (meeting a minimum standard quality) at a price Pi. (intervention price). At this price, producers face a perfectly elastic demand curve.

- Pi is set at the annual price fixing round, and is the basis of common pricing throughout the Community

- Pi acts as a floor price in the market, and has been consistently set above the export price Px, which could be obtained by exporting the surplus.

3 - A net economic welfare loss.

· Our analysis assumes that the EU does not influence the world price (unrealistic, but simplify the exposition of the problem)

· The higher price and additional stimulates the domestic output. This result in increased producer surplus of H+I+J+K.

· Consumer surplus is reduced by H+I, as demand is cut from Dx to Di.

· The domestic surplus (Si-Di) is sold to national authorities at the intervention price Pi. Once purchased into intervention stores (beef and butter mountains, wine lacks), these stocks are meant to be sold on the world markets at the price Px. Therefore, the budgetary costs arising form intervention is equivalent to I+J+K.

· N.B. we should note that the area I+J+K tends to underestimate the budgetary costs of the surplus management, since it does not allow for 1) storage costs 2) deterioration of the product while stored.

· If however, we accept this measure of the budgetary costs, we end up with a net economic welfare loss that amounts to I+K.

C - A net overall welfare loss

Both external control (MIPs and VILs) and intervention buying lead to a net economic welfare loss for the EU. Indeed, the losses to consumers (due to higher prices) largely offset the producer benefits (due to an increased production) and the taxpayer benefits (due to the revenue from the import levies).

IV - Massive redistributional effects and problems of social justice

A - Transfers between EU Member States Þ pressure of importing countries

1 - >Principle of common financing From (taxpayers of) importing to (producers of) exporting countries

EU revenues are raised through direct national budgetary contributions and through import and sugar levies. This is because of the principle of common financing of the Union's costs. These revenues are then used to finance storage, subsided exports of surplus, etc.

2 - transfer from surplus producing countries to deficit countries within the EU

It follows that countries that which import more agricultural products tend to contribute more. Moreover, there is a net transfer to countries with greater surpluses to store and export.

In 1992, the largest net contributors to the CAP budget were Germany (10 billions of Ecus), the UK (2.5). The main net gainers were Greece (3.5), Spain (2.5), Ireland (2) and Portugal (2). Therefore the CAP has massively subsided southern Europe. Inevitably, some countries have pressed for budgetary reform with less enthusiasm than others.

B - Transfer between intra-national groups Þ pressure of consumers

1 - Very high price

Consumer prices are on the whole much higher than the producer prices, and there is no close relationship between the two. The EC consumer has gained from availability of plentiful supplies, but he has lost from high prices.

The objective of reasonable prices for consumers is a complete failure(objective 5).

2 -Why ? Weakness of consumers' lobbies / Strength of agro-industry lobbies

The apparent unfair transfers implied by the CAP, as well as the excessive burden for the consumers have been identified and recognised for a long time. However, the political lobby for consumers' interests has not developed the same weight of influence as the farm and agro-industry lobbies.

Thus, it has been largely left to academics to argue for CAP reform on the ground of excessive cost to non-farm families as consumers and tax-payers.

The Commission had been working hard for a proper reform of the CAP. But the strength of the agricultural lobby has been the main deterrent.

C - Socially unfair

1 - Consumers pay more than taxpayers (socially unfair)

Empirical studies show that the transfer costs from consumer exceed the transfer from taxpayers by significant margin. The consumer pays for the CAP relatively much more than the taxpayer.

2 - 'Consumers' include more poor people than 'taxpayers'

This is socially unfair, since many consumer are poor non-taxpayers. Moreover, as the poor in the population spend a relatively large share of their disposable income on food, the poorer people and the poorer member states of the Community are paying a large share of the burden of the CAP.

Various estimates have been made of the average cost imposed on EU non-farm families through higher prices and taxes to support the CAP. A 1986 study estimated this at 600 Pounds per family per year. The estimate is 360 Pounds for non tax payer families (poorer).

3 - Price support benefits disproportionately large producers

Price support policy induces farmers to producers as much as possible, irrespective of market demand. A consequence of this is that higher support prices benefit most the large producers (who realise economies of scale).

It is estimated that 80 per cent of the CAP support accrues to the richest 20 per cent of the farmers.

4 - The result : from relatively poor consumers to relatively wealthy producers

Given that :

- even non tax payers (which are the poorest members of society) have to bear 360 Pounds per year

- large farms and wealthier farmers benefit most

The result is that the CAP transfers funds from the poorest members of society (since all must eat) to some who are relatively well off.

V - CAP has distorted the allocation of resources and adjustment processes

A - CAP has modified the process of allocation of resources

1 - Massive intervention has distorted the price system

Massive intervention support in favour of one economic sector changes relative prices and thus resource allocation in directions different from those reached by a free and efficient market mechanism.

2 - Excessive resources directed to agriculture

Production, specialisation and trade were thus determined by the comparative strength of policies and not by comparative advantage. In a nutshell, for a long period, excessive resources were directed towards agriculture.

The dissociation of demand and supply has resulted in huge surplus. The annual growth of production was 2 per cent, the annual growth of demand 0.5 per cent.

3 - No incentive for economic conversion

Cap has failed to encourage farmers to seek alternative occupations. The high price support policy has maintained poor farmers in the agricultural sector.

B - The result has been a slow adjustment process

1 - CAP has increased the factors' immobility

Agricultural production factors are quite immobile factors (farming is a life style), in the sense that they can only slowly move from on economic sector to another. CAP has even increased this immobility.

One has only to consider the repartition of the budget : 95 per cent of CAP's budget are spent on current price support and only 5 per cent on restructuring the sector. The priority was clearly not structural adjustment (i.e. the necessity to reduce the labour force).

2 - Without CAP, more adjustment

More investment for restructuring combined with the cessation or drastic reduction of protection Þ would have speeded up the adjustment. However, this would have required a social policy to reduce long-run unemployment and hardship.

3 - Failure or success ?

This slow adjustment process can be seen either as a success (CAP as a social policy, softening the hardship of the mutations of the agricultural sector) or a failure (waste of useful resources for the Community). In this light, CAP can be seen as a relatively successful social policy which has accompanied an inevitable long-term adjustment.

VI - An inefficient social policy (unfairly financed)

A - Standards of living (objective 2) : failure of the price support strategy

1 - Objective and method : a fair standard of living by price support

The second objective of the CAP is to ensure a fair standard of living for the agricultural community by increasing their earnings. The CAP pursued this objective mainly by producer price support (through a system of external control -MIPs and VILs- and intervention buying which guarantees a floor price).

2 - Y = P x Q - C : an increase in price does not neecessarily raise income

The outcome of this policy is not an unqualified success. The CAP fixes a high price P. But net income, Y, is the revenue from sales, Q x P, minus the cost of production, C. Thus, the net income is Y = P x Q - C.

Of these three variables (cost, quantity and price) only price is controlled by the CAP.

3 - P : in real terms, agricultural prices declined relative to the general price level

Despite the price support policy (which insulated the EU market from the instability of world markets) agricultural prices declined relative to the general price level in the EC economies. The increase in productivity, though higher than in other sectors, was not large enough to prevent farm incomes from falling. During the period 185-1990 :

- in France the Consumer price index rose by 16 per cent, while the agricultural prices rose by less than 6 per cent

- in Italy, the CPI rose by 32 per cent, while the agricultural prices rose by 18 per cent.

- In the EC as a whole, the CPI rose by 23 and the agricultural prices by 15 per cent.

Thus, in real terms, the prices of agricultural products fell (almost by 25 per cent between 1985 and 1993). In contrast, production costs (depreciation, interest, rents) in

4 - C : intermediate consumption prices have not declined enough

Prices of intermediate consumption goods and services (e.g. fertilisers, animal feedstuffs) fell but much less than the prices of final products.

5 - C : prices of investment goods have steadily increased

Moreover, the prices of inputs of investment (machines), have increased at a much higher pace than the output prices. On the whole, the evolution of input prices have not been very satisfactory. Practically speaking, many farmers got into debts.

6 - The result: sharp expansion of the output for a slight increase in real income

Given the decrease (in real terms) of agricultural prices, the maintenance of relatively high costs, and the fixed prices guaranteed by the CAP, the only way farmers had to increase their net real income was to massively increase their production.

Þ The outcome is over-production and unsold surplus.

Þ Real income per agricultural worker has risen slightly (helped by the steady fall in the agricultural labour force in all the Member States)

7 - However, agricultural incomes still lag behind. Disparities

Agricultural incomes still lagged behind those of other sectors of the economy. The increase in farmers' purchasing power is on average smaller than in the other sectors of the economy. There are considerable disparities in the farming world, depending on countries(Richest farmers in Netherlands, poorest in Greece), region, type of production and size of holding.

8 - Assessment : price support policy is not an efficient method for raising farm incomes

The conclusion is that Price support policy is not an efficient method for raising farm incomes and closing that gap between agricultural and non-agricultural factor rewards.

B - Economic inefficiency

1 - Price support policies entail welfare loss

As we saw. External control (MIP and VIL) entails a loss of A+B. Intervention buying (with guaranteed prices) entails a loss of I+K. These losses are comparable in size

2 - Price support policies did not achieve the farm income objective

As we have seen, for different reasons (decrease of agricultural prices in real terms as compared to the general price index, richer farmers benefiting more), the CAP did not managed to close the gap between agricultural and other sectors incomes.

3 - Deficiency payments are more efficient

Price support policy is clearly not the best policy. The same or better results could have been achieved by less expansive and fairer policies.

It is clear that direct subsidy and deficiency payments are, in that order, economically superior to the VIL and MIP system.

When a deficiency payment scheme is in operation, Pd is a guaranteed farmer price. This leads to an increase in domestic production (from Sw to Sd) which in turn result in an increased producer surplus of A.

This extra domestic production entails a deficiency payment of A+B, which is a budgetary cost born by the taxpayer. The consumer still faces the price Pw. Therefore his surplus is stable. Therefore the overall economic welfare effect is A - (A+ B ) = - B.

The net welfare loss amount to B, which is less than the net welfare loss entailed by the external protection (MIP and VIL) and intervention buying (floor price).

4 - Direct income support is the best policy

Direct income support policies are straight cash transfers related or independent of the output volume and prices. Naturally this policy is the most effective for reaching a target level of income. The income transfer system is the most efficient mechanism for farm income support. The VIL or import quota system is the lest efficient in this respect.

In a purely static analysis, direct income subsidies have no economic costs (see Johnson, 1965), particularly since they do not harm the consumers or the foreign supplier.

The CAP has for a long time (MacSharry reform in 1992) failed to adopt the most efficient method of implementing its own objectives.

Conclusion

Therefore the domestic factors that permanently push in favour of a reform can be said to be :

Two groups of economic agent have a direct interest in a reform :

1) Pressure from Consumers who are the most worse off

2) Pressure from EU importing countries (who massively subsidy exporting countries)

Other factors put pressure upon the CAP :

1) The net economic welfare loss (due to inefficient allocation of domestic resources and a lower consumption)

2) Social injustice entailed by financing the CAP

3) Existence of alternative policies which are clearly more efficient

The paradox is that the CAP has been very difficult to reform because of:

1) the importance of the farmers' lobby

2) and the fact that the CAP has not very successfully achieved its primary objective of decent farmers income (for two reason : price support favours large farms, and agricultural prices have decreased in real terms, as compared to the general price index).

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