EU Policies The Common Agricultural Policy

1
EU Policies The Common Agricultural Policy

• EC329 Economics of the European Union
• Holger Breinlich
• University of Essex

2
Introduction

• Look at some of the most important EU policies
• Competition policy (lecture 2)
• Agricultural policy
• Trade policy
• Regional policy
• Start with the Common Agricultural Policy (CAP)
• Still biggest expenditure share in EU budget (ca.
  40 in 2006)
• Historically even more important (ca. 80 of
  budget in the 1970s)
• Major cause for trade conflicts with the rest of
  the world

3
Plan of Talk

• The early CAP (1962-1992)
• Domestic price support arrangements economic
  implications
• Distributional consequences of the early CAP
• Problems with the original arrangements
• Disposal and budgetary problems
• Distributional and environmental problems
• CAP reforms
• Early attempts
• The MacSharry reform in 1992
• Further reforms
• Evaluation of todays CAP
• Summary and Learning Outcomes

4
The Early CAP
5
The Early CAP Domestic Price Support

• Farming treated differently from other industries
  in most countries
• Rich countries tend to support farmers with
  subsidies and price stabilisation programmes
• Developing countries often tax agriculture,
  especially export crops (part of
  import-substitution strategies)
• Farm support in Europe began in the 1920s and
  1930s
• Agriculture was an integral part of the Treaty of
  Rome
• In the 1950s, 20 of Europeans lived on farms
• So achieving an ever closer union among the
  peoples of Europe necessarily implied the
  inclusion of agriculture
• Art. 3d calls for the adoption of a common
  policy in the sphere of agriculture

6
The Common Agricultural Policy

• CAP started as a simple price support policy in
  1962
• EU was net importer of most food, so could
  support price via import tariff
• Technically known as a variable levy adjusted
  daily before 1995 to offset fluctuations in world
  market prices
• Analysis similar to import tariff (figure)
• Useful to interpret CAP as food consumption tax
  plus production subsidy (figure)

7
Simple price support with tariff
Home Demand
Home Demand
Home Supply
Home Supply
price
price
pss
Price floor (PwT or PwT)
Price floor
T
T
B
A
Pw
C1
C2
Pw
Pw
Imports (with floor)
Q
Q
Zf
Cf
Z
C
Zf
Cf
Z
C
Imports (without price floor)
8
Food tax interpretation
Home Demand

• Price floor supported by tariff is like
  all-in-one package made up of simpler policy
  measures.
• (i) free trade in the presence of
• (ii) a consumption tax equal to T and
• (iii) a production subsidy equal to T.
• Price, quantity, revenue and welfare effects are
  identical
• Makes plain that it is consumers who pay for a
  price floor enforced with a variable levy.
• Part of what they pay goes to domestic farmers
  (area A),
• Part of it goes to the EU budget (area B),
• Part of it wasted (areas C1 and C2).

Home Supply
price
Price floor
B
A
C1
C2
Pw
Q
Zf
Cf
Z
C
9
Distributional Effects of CAP

• Farm sizes and levels of efficiency vary
  enormously across the EU (figure)
• Price support mechanisms (e.g. through tariffs)
  will be more beneficial for larger, more
  efficient producers (figure)
• Pre-reform CAP rewarded production, so bigger
  farms (with richer owners) got most of the
  benefits
• In 1987, biggest 20 of farms got 80 of CAP
  benefits (13,333 per farm)
• Remaining 20 spread over 80 of farms (833 per
  farm)
• Analogy to family-run food stores vs. supermarket
  chains

10
Farm Size Distribution in 1987
Source European Commission

• 1987 Biggest 7 of farms owned 50, smallest 50
  only 7 of farm land
• Distribution got more uneven with 1995
  enlargement and much more so with 2004
  enlargement!

11
Uneven Impact of Price Support
price
price
price
Family farm supply curve
Commercial farm supply curve
Total supply curve
PwT
Atotal
Asmall
Abig
Pw
B
Q
Q
Zsmall
Q
Zbig
Ztotal
12
Distributional Effects of CAP

• Impact of implicit tax on consumers also uneven
• Early CAP basically a food tax plus production
  subsidy
• Rich households spend smaller share on food
• A given price increase thus hits poor households
  harder
• E.g. CAP-induced price increase of one third
• For poor households (food expenditure share 30),
  implicit tax increase is 10 of their budget (
  0.31/3)
• For rich households (food expenditure share 9),
  implicit tax increase is only 3
• CAP has regressive taxation properties
• ? Impact on both production and consumption side
  of CAP is more favourable for richer
  farms/households

13
CAP Problems
14
CAP Problems

• Before the 1970s, CAP enjoyed substantial support
  within the EU
• Farmers obviously benefited
• Attractive for policy makers fostering social
  cohesion between rural and urban Europe,
  increasing food production and reducing
  dependence on imports, additional tax revenues
• Even consumers didnt complain (fast income
  growth, memory of food shortages, empathy with
  farmers)
• As EU farming became more and more productive,
  problems started
• High prices encourage investment in better
  agricultural technology (machines,
  pesticides/herbicides, chemical fertilizers )
• Rapid productivity and output growth (figure)

15
Wheat Production and Net Exports
Production (1,000 tons)
Export-Imports (1000 tons)
Cheese
Area Harvested (1,000 ha.)
Yield (tons/ha.), right scale
120000
7
Butter
1967-70
6
1996-99
100000
Poultry
5
80000
4
Pork
60000
3
40000
Beef
2
20000
1
Sugar
0
0
-20000
-1
Wheat
1961
1966
1971
1976
1981
1986
1991
1996
2001
-40
-20
0
20
40
60




EU wheat production and net exports, 1961-2000.
Source US Department of Agriculture
EU net exports of selected agricultural products.
Source US Department of Agriculture

16
CAP Problems

• Rapid increase in output coupled with slow demand
  growth meant that net imports became smaller and
  smaller
• Problem aggravated by low price elasticity of
  demand for food (world food prices falling by
  2/year for decades)
• In open-economy supply and demand diagram supply
  curve shifts outwards along steep demand curve
  (figure)
• Net export meant that EU had to directly
  intervene in markets and act as buyer of last
  resort (figure)
• This posed two problems
• How to dispose of the acquired food?
• How to finance the interventions?

17
Falling Net Imports
price
S1
S3
S2
S4
p1ss
p2ss
p3ss
Price floor
a
e
c
b
d
p4ss
More price-elastic home demand (hypothetical)
Home Demand
Q
18
EU as Buyer of Agricultural Goods
price
price
S1
EU purchase
S4
Price floor
Price floor
e
a
d
B
S
A
C1
C2
Pw
EU purchase
Home Demand
Q
Q
Zf
Cf
19
CAP Problems - Disposal

• Storing surpluses
• Initially, situation thought to be temporary so
  stockpiling seemed okay
• But as net export became permanent, stocks
  increased rapidly (e.g. beef stock in 1987 was
  700,000 tons or 30 of annual world trade cereal
  stock in 1985 was 18.5 million tons or 70kg per
  EU9 citizen)
• Became a serious PR problem (consumers pay high
  prices for products that cannot be sold and must
  be disposed of)
• Dumping on world markets as a solution
• Rather than destroying food surpluses, EU tried
  to export them
• Since price floor higher then world market price,
  subsidies needed
• Generally forbidden under GATT but exceptions for
  agriculture
• Two-fold negative impact on world market prices
  (figure)
• Major trade conflicts (with Cairns group, USA and
  Canada)

20
World Market Impact of CAP

• Price support required import tariffs
  (terms-of-trade effect since EU is major consumer
  of agricultural goods ? shift of MD curve)
• Dumping increases world market supply (MS curve
  to the right)
• Both measures lower world market prices and harm
  non-EU food exporters

21
CAP Problems - Finance

• Subsidised exports required large increase in CAP
  expenditure
• No expenditure on CAP in the first years
  (1962-1964)
• Increase to 9 billion in 1964-1978.
• Further increase to 40 billion in 1979-2000
• Budget share declining due to massive overall
  increase in spending (on regional policy, in
  particular)
• Figure expenditure and budget share

22
Spending Increases on CAP
Total CAP cost (bill.euros)
CAP's budget share (right scale)
23
More Problems Farm Income

• Average farm incomes fail to keep up with EU wage
  increases despite huge protection and budget
  costs
• Major reason is that most of money goes to big
  farms that could survive without it
• Farmers continue to exit farming - about 2 per
  year for last 4 decades
• Dual structure emerging (figure)
• Large industrial farms
• Small family farms which increasingly earn a
  living outside agriculture (20 in Germany, up to
  67 in the UK and 75 in Sweden)
• Medium-sized farms with farmers trying to make a
  living from agriculture go out of business

24
Changes in the Farm Size Distribution 1970-1987
Source European Commission
25
More Problems The Industrialization of Farming

• CAP encouraged production and thus the
  industrialization of farming
• Intensive land use through use of fertilizers,
  pesticides etc. and specialization in more
  heavily subsidised crops
• Factory farming of animals
• Emergence of large-scale farms and decline of
  traditional farming (see earlier figures)
• Led to concerns about environmental impact of CAP
  (pollution, animal welfare )
• Bad for image and thus public support for CAP

26
CAP Reforms
27
CAP Reforms

• Main source of all problems is the artificially
  high price of agricultural products in the EU
• But reduction not politically feasible
  (well-organised farm lobby, continued support by
  most Europeans)
• EU level of effective subsidies also not
  unusually high for rich countries (13,000 in
  1994, roughly similar in USA and Japan and twice
  as high in Scandinavia, Switzerland, Austria)
• So various other attempts at reform since the
  1980s

28
Initial Attempts at Reform

• Initially, reaction to higher CAP costs was to
  raise EU members contributions to the budget
• But 1986 enlargement led to shift towards
  regional aid and put additional pressure on CAP
• Initial attempts at reform were through supply
  controls
• 1980s, experimentation with ad hoc complex set
  supply controls to discourage production
• Generally failed technological progress high
  guaranteed prices overwhelmed supply controls.

29
MacSharry Reforms

• First serious reform was driven by pressure from
  the EUs trading partners (Cairns group, USA)
  during the Uruguay GATT round (1986-1994)
• EU resistance over agricultural trade
  liberalization threatened to derail negotiations
• Increased pressure from domestic industry lobby
  finally forced concessions in 1992 (MacSharry
  Reforms)
• Basic idea cut price supports to near
  world-price level and compensate farmers with
  direct payments
• Does not change overall CAP expenditure but its
  nature money given directly to farmers rather
  than indirectly via higher prices
• Also encouraged production cuts and
  pro-environmental and animal welfare measures
• Compensation based on farmed land area, so big
  farms again benefited most

30
Subsequent Reforms

• Logic similar to MacSharry package was underlying
  subsequent reforms
• March 1999 meeting of European Council Agenda
  2000
• June 2003 reforms in preparation of the WTO
  Doha-round
• Both involved price cuts compensation
• Further decoupled production and subsidies (e.g.
  no specific crop requirements) (figure)
• Emphasis on pro-environmental and animal welfare
  criteria further increased

31
Increase in Direct Payments
32
Evaluation of Todays CAP
33
Farm Income and the Inequity of CAP Support

• MacSharry reforms did not change the uneven
  distribution of CAP spending
• 25 largest farms get 70 of support
• The new direct payments allow to actually see who
  gets support (though many governments refuse to
  give this information)
• Some figures for England (in 2006)
• The Duke of Westminster 1 million over two
  years, the Queen and Prince Charles 1.5 million
• Big multinationals got even more Nestlé (30
  million), Tate Lyle (180 million)
• 12.5 of payments to top 20, 50 to top 2000
  recipients out of ca. 25,000 in total bottom
  10,000 recipients only got 13
• A large part of CAP spending (almost 50)
  effectively goes to non-farmers (landowners,
  input suppliers etc.)

34
Other Achievements Failures

• Shift away from industrial farming has begun but
  still most support for large-scale farms
• Oversupply problems have been reduced
• Lower price floors meant less need for direct
  intervention
• Late 1990s also saw sharp (exogenous) increase in
  world market prices
• Stock levels less than half of pre-1992 period
  (figure)
• Dumping of agricultural products on world markets
  reduced but EU remains by far the most important
  user of food dumping (90 of total)
• Budgetary problems not solved since no reduction
  in overall spending

35
EU Stocks of Major Agricultural Products
36
Summary Learning Outcomes

• Functioning of the early CAP
• Economic impact of domestic price support schemes
• Distributional consequences of the early CAP
• Problems with the original arrangements
• Disposal and budgetary problems
• Distributional and environmental problems
• CAP reforms, in particular the MacSharry reform
  of 1992
• Evaluation of todays CAP