The CAP of the EU is a remarkably complex assembly of instrument and regulations (trade control, price support, conservation policies , income transfers, production and export subsidy, investment grant.), managed by a huge bureaucracy.

       This policy has been increasingly under a quadruple pressure (that we shall analyse first). IN response to these pressure, the CAP underwent a major change in 1992/93 which added to its complexity (reforms named after the then Agriculture Commissioner Ray MacSharry).

Throughout the existence of the CAP, its policy instruments and regulations have been adapted to the various economic and political circumstances of the Community. The CAP reform has therefore been an ongoing process, with some major turns.

A - Domestic pressure

1 - net overall economic welfare loss

2 - massive redistributional effects raise question of social justice

-         from importing to exporting countries

-         from consumers to producers

-         consumers pay more than the taxpayer Þ poor non farm families pay relatively a lot

-         large farmers benefit most

3 - failure in bridging the income gap between farm and non farm families

4 - economic distortions

-      distortion of the price system Þ too many resources directed towards agriculture

-         CAP slowed down the pace of structural adjustment.

B - External pressure

 

There is no doubt that the shape of the reform was greatly influenced by the negotiations on agriculture in the Uruguay round of the GATT, and especially by the bilateral agreement (USA/EU) signed in November 1992 (the so-called Blair-House accord).

1 - CAP and trade diversion

2 - CAP and resource misallocation at world-wide level

 - The agricultural strength of the EU is not based upon comparative advantage                           

- The CAP squeezed more efficient producers out of the market                                                

3 - CAP and intensified competition

4 - Actual implications for non member exporters     

- Australia and New Zealand                                                                                                    

-  USA                                                                                                                                    

- CAP and the developing world

C - Environmental pressure

1 - Problems

As agricultural production has intensified since the 1960s, particularly in the northern countries, concern about its adverse environmental impacts has grown :

-         high nitrate and phosphate levels in rivers and lacks : inorganic fertiliser

-         loss of wildlife : by eliminating hedgerows, woodlands and trees for Increased field sizes

-         damaged food chain : pesticides and herbicides

-         habitat loss to birds, plants, amphibians : draining of wetlands

2 - Agricultural neglect and depopulation

While these change have occurred in areas of higher agricultural potential, more remote areas have been struggling to maintain farming systems held to have high landscape value. There is the underlying problem of agricultural neglect and depopulation of some areas.

3 - Causes

Most of the environmental concerns are the consequence of intensification of the production.

In turn, intensification of the production has been stimulated by EU price support.

4- Pressure groups

Diverse strong environmental pressure groups have emerged arguing for agricultural policy reform. The Commission's 1984 green paper 'Perspective for the CAP' explicitly recognised that there was a need for agricultural policy to take more account of environmental policy.

D - Budgetary pressure

1 - CAP's pressure upon the budget

The budgetary costs of the CAP was one of the persistent source of pressure leading the MacSharry reforms of 1992.

 

CAP expenditures/EU budget

1980 : 73 percents

1989 : 66 percents

1993 : 55 percents

1999 : +/- 50 percents

2 - Failure of small scale reforms

Some of the measures to contain budgetary costs and surpluses prior to the 1992 reform package were quite significant (such as the milk quotas, co-responsibility levies). These measures failed to alt the relentless rise in the budget required for the CAP, and the reform of 1992 became inexorable.

 

Throughout the existence of the CAP, its policy instruments and regulations have been adapted to the various economic and political circumstances of the Community.

A - Strategy : attempting to increase consumption

1 - Problem : growing surpluses

During the 1970s, in response to the growing surpluses of some commodities, the EC introduced several new measures to the CAP, designed to encourage domestic consumption

2 - Method (1) : subsiding final consumption

Measures included subsidies to certain categories of final consumers

3 - Method (2) : subsiding intermediary consumption

- subsidies to industrial users of food product

- 'denaturing premium' to encourage the use of grain in livestock feed.

B - Attempt to reduce the cost of intervention buying

1 - Problem : cost of intervention

Alternatively, the EC attempted to decrease the budgetary cost of intervention buying , by manipulating its rule of operation.

2 - Method (1) : manipulation of the rules of intervention

For many commodities :

-         the period of availability of intervention buying has been shortened

-         the quality standards for acceptance have been raised.

3 - Method (2) : a 'buying-in price' below the normal intervention price

The prices received for sales have been reduced to a so-called buying-in price , some percentage points below the relevant intervention price.

C - Failure

However, few, if any, of these patching measures did anything substantial to alleviate the mounting pressures for more radical reforms.

A - A new strategy : supply control

1 - Three new supply control mechanisms

It was not until the early 1980s that more significant changes to the CAP were initiated, with the introduction of three new supply control mechanism (marketing quotas, co-responsibility levies, and budgetary stabilisers).

2 - The end of the unlimited guaranteed price

       The introduction of these supply control mechanisms essentially marked the end of unlimited price guarantees.

3 - A new principle : producer co-responsibility for surplus

Each of these mechanisms incorporated what has become known as the 'fourth principle of the CAP', producer co-responsibility for surplus production.

For commodities covered by such policy instruments, if production exceeded a certain fixed level (known as the 'guarantee threshold), action was triggered which ensured that at least part of the cost of the additional surplus disposal was borne by the producers.

B - 1980s : Marketing quotas

1 - The milk problem

Marketing quotas were first imposed on EC dairy producers in spring 1984, against a background of :

-         long-term structural surpluses of dairy products

-         an extremely depressed world market

-         escalating budget costs of milk support

Throughout the 1970s and the 1980S, the milk regime accounted for the largest proportion of total guarantee expenditure of the CAP (This feel from 30 per cent of EAGGF expenditures in 1984 to 18 per cent in 1992). In 1983, the situation became unsustainable. A possible solution was either to sharply reduce the intervention prices (12 per cent). This was politically unfeasible.

2 - The system

Instead the EC chose to maintain the level of price support at its existing level and adopt a system of marketing quotas. It consists in charging a very high tax (super levy) on excess deliveries beyond the quota.

Initially each MS was allocated a notional quota or 'reference quantity' set equal to their 1981 milk delivery plus 1 per cent. Quotas were then allocated to individual farmers, again on the basis of their historical production levels.

3 -  Welfare effects of a quota

The welfare implications of quotas, as compared to those arising from a straight price support reduction for dairy products are shown in the following figure. This welfare analysis assumes a scenario of surplus production and f the EU maintaining a support price above the world price PW. This reflect the EC industry in the 1980s.

The imposition of a total quotas at Q*, shifts the supply curve to SS*. At output Q*, the supply curve is perfectly inelastic. Indeed, the penalty for surplus production is sever enough to discourage any farmers from exceeding the production threshold and thus incurring a super levy.

 

Consumers are unaffected by the quota policy : they continue to purchase the same level of output Di, at the same price (significantly above the world price PW). There is no change in the consumer surplus.

The farmers lose a producer surplus equal to the area - E . The budgetary saving amounts to the area +(E+F+H). Therefore, the overall net welfare gain is + (F+H).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

4 - Welfare effect of a straight intervention price reduction

In comparison, a straight reduction in the level of intervention price for dairy products from Pi to Pi' would cause consumers to increase their consumption from Di to Di' and farmers to decrease their production from Si to Si' by moving down the supply function SS.

       Consequently, the consumer surplus increases by area A + B. The producer surplus decreases by -(A+B+D+E) The budgetary cost of support iis reduced by +(G+D+C+D+E+F+H). Therefore, the overall net welfare gain is +(B+G+F+H) which is greater than the one entailed by quotas (greater by ++).

       We now understand that a quota (as compared with support price cut) entails :

-         a small producer loss

-         generate a 'producer rent'(equal to A+B+C+D)

5 - Choosing quotas : weight of farmers interests /  fear of perverse demand response

Why did the EC chooses to implement milk quotas given the fact that a straight cut in support price offered the greatest potential net welfare gains ?  Two answers :

 

1)      The choice of quotas was a political one . Quotas, whilst restraining the budgetary cost, minimised the dislocation cause to the farm sector. The weight given to farmer's interests in the decision making process if far higher than afforded to the consumers of taxpayer. In this sense, the choice of milk quotas simply conformed with past precedent.  This was politically unfeasible.

2)      Many policy-makers were afraid of a possible 'perverse demand response' to a support price cut, whereby this cut would entail an increase in the level of production - to maintain farmer's incomes.

C - Co-responsibility levies (CRL)

1 - The logic

CO-responsibility levies (CRL) were first introduce into the milk regime and then extended to the cereals. The authorities wanted to send the signal to farmers that they had to share in the responsibility of dealing with surplus production.

2 - The system

· Consumer price remains unchanged (high above the world price).

· Producers have to bear a small tax (levy). They therefore earn a few percentages less than the intervention price.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3 - Implications

·Consumers are unaffected by the system. They face the same price, they purchase the same level of output.

· Farmers undergo a producer surplus loss.

· The system therefore introduces some marginal budget savings. However, it is not very efficient in reducing the output - especially since the supply curve is quite price inelastic (in the short run).

4 - Poor results

Far less incentive to an individual producer to reduce output levels.

D - Budgetary stabilisers : Maximum Guaranteed Quantity and retaliation

1 - The budgetary crisis of 1988

In 1988, following a budget crisis in the Community, a new general scheme of 'budget stabilisers' was introduced. In practice however, there were no political will to implement it. However, the concept of 'stabiliser' remained in the regulations.

2 - The concept of 'stabiliser'

E.G. grains

A physical volume of grain, the Maximum Guaranteed Quantity (MGQ), was defined by the Community (was set at 160 millions tonnes).

Producers collectively were told that if production exceeded this quantity in any year, the following year, the co-responsibility levy will be increased and the intervention price reduced. These changes were meant to be cumulative.

3 - Poor results

Free rider problem. At an individual level, it is rational to produce more and more. A rational individual producer will respond to a quantitative threshold on output only if that threshold has been imposed directly on his own production. Otherwise he is a price taker, and in spite of the threshold for aggregate output, he perceives the demand for his won output as perfectly elastic at the going price.

 

As we have seen, the MacSharry reform package owed much to the multinational trade negotiation and the pressure from agricultural trading partners to reduce the level of trade distortion caused by the CAP.

A - Reform of the price support system

1 - Maintaining of the price support scheme but lower guaranteed prices

1)      The basic support price scheme have been retained

2)      But a significant cut in the level of support will significantly weaken its effectiveness.

E.g. cereals : cut by 29 per cent ; beef -  15 per cent ; oilseed and pulses : no price support from 1993 onwards.

2 - Welfare effects

The welfare effects of a support price reduction are well known. Consumers benefits from lower prices, taxpayers benefits from budgetary saving, producers undergo significant surplus loss. The net welfare effect is positive.

B - Conditional compensatory direct income payments

1 - Direct income support - a move towards 'decoupled farm income support'

To compensate farmers for their loss of income, the EU has decided to give direct income payment to farmers.

By partly replacing price support with direct income payments, the correlation between the amount of support received and the amount of output produced has been weakened. IN the jargon of the GATT, the MacSharry reform package marks a move towards 'decoupled farm income support'.

2 - Conditional on voluntary input use restraint

Direct income compensation is made conditional upon their voluntarily adhering to certain restraint on input use :

 

-         for livestock producers, compensation payments will be limited to a fixed number of animals based on historical herd sizes.

-         For arable producers, compensation will be paid only if farmers agree to set aside (take out of production) a proportion of his/her arable land (the exact proportion being determined by the Council each year).

 

The changes to the arable regime of the CAP are particularly significant, due to the importance of cereals within agricultural industry.

A - A new supply curve

1 - Each farmer faces an alternative

Each cereal farmer producing more than 92 tonnes faces a decision of whether :

-         (a) to use the whole of its arable land and receive the new (lower) market price for its output

-         (b) to comply with the set-aside requirement and thus be eligible for compensation payments in addition to its market returns.

-          

For those who adopt the latter strategy and opt into the set aside  scheme, two types of compensation payments can be distinguished :

-         price compensation on land farmed (arable area payment)

-         set-aside compensation

2 - Taking the decision : comparing the market price with the indifference price  

Given :           -    the farm's yield

-    the value of compensation payments

 the decision depends on the relative position of

-        the market price

-        and the 'indifference price'

 

The indifference price can be defined as the price of cereal which gives rise to economic equivalence between using the land or setting it aside.

At the indifference price, the value of compensation payments equals the revenue secured from planting the area which would be set aside.

Therefore, when the market price for cereals are high the opportunity cost of leaving land is also high and a farmer is less likely to participate in the scheme. The

3 - Indifference prices will vary between producers / according to their efficiency

Because farms are not identical (different production levels and productivity) indifference prices will vary between cereals producers.

 

Þ We can expect inefficient, high-cost producers to have a low opportunity cost of idling land, and thus a relatively high indifference price.

Þ Conversely, one could expect efficient, low-cost producers to have a high opportunity cost of leaving land fallow and thus a relatively low indifference price.

4 - Consequences for the aggregated supply curve

Taking such variability into accounts and aggregating across all producers in the industry, the supply curve for cereals under the new voluntary set-aside scheme would shift from its original competitive level , SS, to the linked curve S'S.

 

        

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pih and Pil represent the highest and the lowest indifference prices in the industry respectively. At any price above Pih, the market return for cereals is sufficient to deter all farmers from participating in set-aside. Therefore, the total arable area would be utilised and the supply curve would coincide with the competitive supply curve, SS.

 

However, once the price falls below Pih, the least efficient, high cost, producers would chose to opt out of full production and into set-aside. Thus, the supply curve rotate to the left.

 

As the price further falls, more and more farmers would opt into set-aside and more and more land would be withdrawn form production.

 

Once the price had fallen to Pil, all farmers would chose to idle the necessary proportion of their land in order to be eligible for compensation payments.

5 - The leftward shift of the supply curve may be less pronounced

 

The rotation in cereal supply curve shown in the above figure, may be less  pronounced than initially implied. This is due :

 

-         problem of 'slippage' : whereby a certain reduction in cereal area does not necessarily entail the same percentage reduction in cereal output.

-         producers of less than 92 tonnes of cereals (+/- 15ha) do not have to participate in set aside to qualify for area of compensation.

 

 

B - Welfare effects of the new arable regime

 

We shall now assess the changes in welfare and transfer effects between the old and the new cereals regime.

Effect

1 - Implication of the reform

-           The intervention price falls from Pi to Pi'.

-           Owing to the reduction in the volume of subsidised exports from the EU, the world market price increases from Pw to Pw'.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2 - The welfare effect upon EU consumers

These changes in price entail a change in the consumer surplus given by (A+D)- (A'+B'). Therefore, it is clear that the consumer benefits from the reform.

3 - The welfare effect upon producers

The welfare effect of the producer is less clear-cut. From a starting position surplus gain of (A+B+C) under the old regime, their surplus is reduced to (A'+B'+C').

 

However in addition they receive direct compensation payments. Since, as drawn, the new (lower) price support Pi' correspond to the lowest indifference price of the industry, we can assume that all farmers participate in the set-aside scheme.

 

The total amount of the arable area and set-aside payments can be shown as area I+J+K+L.

 

Thus the change in producer surplus gain is given by (A+B+C) - (A'+B'+C'+I+J+K+L+M).

Whether this is positive or negative depends on whether the compensation payments larger or smaller than the loss in producer surplus from reducing output level to S'.

4 - The budgetary effects

The impact of the new regime on the budgetary cost of cereal support is also not easily predicted. It depends on two developments :

 

-         (+) The value of the saving in terms of the disposal of surplus production(export subsidies) is (B+C+D) - (B'+C'+D').

 

-         (-)  The value of the compensation payments is (I+J+L+M).

5 - The overall net welfare effect

The reduction in net welfare loss caused by the policy reform is less ambiguous. Taking into account the preceding analysis, the change in net welfare loss is represented by areas (B+D) - (B'+D').

 

The conclusion is therefor that the MacSharry reform reduce but do not eliminate the trade distortion caused by CAP support for cereal producers with the level of exports falling from (Si - Di) to (Si'- Di').

 

 

However, despite this recognition, environmental measures introduced as part of the CAP prior to the 1992 reforms were limited.

A - 1985 : setting up of ESAs

1 - Principle

An agricultural structures policy Regulation of 1985 permitted the designation of Environmentally Sensitive Areas (ESAs).

       Within these ESAs, contractual payments were paid to farmers to compensate them for the profitability loss as a result of agreeing to deintensify production and take measures to conserve traditional methods, features and habitats.

2 - A limited scheme

·limited to specific areas

· depending on voluntary recruitment of farmers

· Up to 1990, ESAs were implemented in only four MS

Þ this policy did little to alleviate the mounting environmental concern.

3 - Infringement of the PPP

Moreover, the scheme violated the Polluter Pays Principle adopted by EU environmental policy.

B - The Agri-Environmental Programme accompanying the 1992 reform

An Agri-Environmental Programme accompanied the 1992 Cap reform. It has substantially enhanced the role of environmental policies within the CAP.

1 - Agro-environmental measures

In addition to the changes in the various commodity regimes, a set of accompanying measures were introduces as part of the CAP reforms to

-        encourage  farm forestry

-        farmer retirement

-        generalise the existing agro-environmental policies

2 - A new financing device : from the structural funds to the Guarantee section

Previously, these types of measures were funded under the Agricultural Structures Policy, and they received little budgetary support. As part of the reform package financial support was switched from the Structural funds to the Guarantee Section of the CAP's budget and 5 per cent of the total guarantee budget was earmarked for policies under the Agri-Environment Programme.

However, the degree to which the reformed CAP has embraced environmental concerns remains far from complete. Notably, there are very few requirements of cross compliance whereby the payment of farmers would require farmers to comply with some pre-agreed environmental conditions.

 

Several important factors mean that further reform of the CAP cannot be delayed for long

A - The international pressure for liberalisation and less support

B - Enlargement

1 - The queue

The biggest challenge to the CAP arises from the possibilities of enlarging the EU15 to include Central and East European Countries (CEECs) and the Baltic States.

              First wave : Poland, Czech Republic, Slovakia, Hungary and Slovenia

              Second wave: Estonia, Latvia, Lithuania

              Third wave : Bulgaria, Rumania at the end of the queue.

2 - The prospect of EU membership

There is a large latent capacity for agricultural output to increase substantially in these countries.

Incorporation into the EU holds out the prospect of major investment and foreign companies involvement in their agricultural system, perhaps a massive increase in subsidies for agriculture.

3 - The problem of CAP

To extend the current CAP support system to these countries is basically not feasible. Expenditure involved is gigantic.

4 - Scenario 1 : a two speed CAP

One way to handle the problem is to try to preserve the status quo by

1)      strengthening supply control for the EU15

2)      establishing a second tier CAP for new members

 

Problem : this would violate the whole spirit of having a Common agricultural policy, and equality of treatment between members.

5 - Scenario 2 : massive switch to direct income support

Another is to go for radical reforms of the CAP by slashing support prices, abolishing quotas and supply management measures, reducing compensatory payments and switching to direct income support.

This would ease the assimilation of new members, provided new members are not eligible for direct income support.

6 - Scenario 3 : the Commission's scenario

Agricultural Strategy Paper of November 1995.

1)      further reduction in price support (with some compensation payments)

2)      more subsidiarity : a higher proportion of the CAP expenditure would be self-financed by the MS.

 

 

 

 

What is clear is that further reform of the CAP is inevitable, and that will involve further reduction in price protection and support.