stylised facts on CAP

The CAP is justified on the basis of Engel Law which suggests that while proportion of income spent on food goes down as the income rises (demand for food tends to be inelastic), increasing supply (from technological changes) will lead to a long-run decline in food prices. To prevent shrinking agriculture and reliance on imported food, the CAP is created for five objectives; maintain farmers’ income, maintain price stability, improve productivity, ensure fair living standards and avoid food scarcity.

The CAP remains justified as long as the assumptions of EC as major food importer and rising world food price hold. Both assumptions are violated; EC has become a major exporter since 1976, and world food prices have been on downward trend. Lucas’s (1976) critique suggests that if the CAP were based on a model of fixed parameters (e.g. self-sufficiency), the policy regime (CAP) would change the behaviour of such parameters (e.g. inefficient food exporter). Hence, initial justification for CAP cannot hold.

 

simple economic model of the CAP

                The CAP set the price support above the world market price and uses tariffs to stop cheap imports. The costs accrued to households/consumers (from higher prices) and to taxpayers (from subsidies. The ‘extra’ benefits to farmers are small while large exporting/storing firms gain most (since export subsidies to get rid of surplus).

Intuitively, the naïve model suggests that the costs are too large, and the ‘directed’ benefits are too small; the CAP is a very inefficient way to give money to farmers. Of the small benefits which go to the farmers, by default, large farmers receive the lion share of the benefits e.g. 20% of the farmers receive 80% of the subsidies. The ‘Newcastle CAP model’ estimated the cost to consumer represents an explicit tax of 14% on food (Hubbard, 1989). However, modelling of the CAP is limited by quality of data on prices, etc.

On a broader basis, when the CAP pushes the agricultural prices above their market level, the demand for inputs into agriculture (land, capital and labour) would rise ‘beyond efficient level’, leading to rising input prices. Landowners and capital owners would receive the subsidies indirectly while farmers are receiving very little. Despite model limitation, the CAP is allocative inefficient locally (too much from taxpayers, too little for small farmers) and internationally (‘artificially’ depressed world price, punishes poor countries).

 

stylised facts on previous CAP reform

                Throughout 1980s, the CAP budget spiralled, and capped by quota on milk and sugar. In 1992, the McSharry reform aimed to pay the farmers not to grow, in order to offset the reduction in over-production cost (i.e. costs of storing and exporting surplus). However, this angered the taxpayers.

The reform also attempted to reduce price support to world price (partially successful) and set a fixed amount per land (limited compensation). On the whole, while there were little changes to the CAP, the reform represented a necessary and turning point.

               

external pressure on reform

The GATT trade talk among the US, Japan and the EC  generally agree to reduce tariffs (to allow agricultural imports), reduce export subsidies and open up the market access. While the average price support is set at 15% in GATT round, the CAP can be modified to average it out by setting high price support for vital crops and allowing low price support for least important crops; this is an ineffective cut on subsidies.

However, the EU’s defeats in successive talk rounds in early 1990s has highlighted the need for the CAP reform rather than reliance on 'anti-dumping measures’ (a neat way to protect agriculture) e.g. banning US’s cattle derivatives on the basis on BSE (‘mad cow disease’).

 

internal pressure on reform

If supply keeps increasing (due to high support price à investment à higher productivity à higher profit à investment), the CAP budget is simply unsustainable because cost to taxpayers expands. Since the EU review March 1998 attempts to freeze EU budgets in real terms in 2000-2006, this provides a case to minimise the growth of rectangular ABCD. Also, note that the EU’s new members e.g. Poland are excluded from existing CAP benefits, but such two-tier system is unlikely to be maintained in the long term. If they were to get such benefits, the supply curve shifts enormously to the right; a huge ‘explosion’ in taxpayers’ cost.

                While the McSharry reform’s compensation-for-support price has lower the upper bound P_CAP, there is a problem of overcompensation for cereals (e.g. £2 bn in 1995-96) and for beefs (e.g. Ecu 800 m in 1992-1996) (EU auditors, Nov 1997).      

 

Fischler reform – virtual cow solution & structural funds revampment

The virtual cow solution aims to cut guaranteed prices for beef, cereals and milk sharply, and compensate the loss by direct payments related to the size of their holdings or herds. For instance, dairy payment is determined by a farmer’s quota by the average EU yield of milk per cow to give a ‘virtual cow’ number (paid £84 each). Hence, farmers would be paid according to how many cows they would have had if they had an average yield rather than the number they do have.

This generally punishes (inefficient?) low-yielding countries such as Ireland, Portugal and Spain but probably be better (or fairer) than previous system which punishes high-yielding countries like Sweden and the Netherlands.

The structural funds aims to more on simplify rural development and overhaul their financing, rather than shifting the CAP from ‘first pillar’ of CAP subsidies to ‘second pillar’ of rural development. While non-farmers would prefer the second concept to improve environment (forestry especially), renovate villages and invest in tourism, such funds will only represent 10% of the CAP budget by the end of 2006 (in contrast to 90% for subsidies). Commitments to extend rural development have been watered down, as leaks from current proposals suggest (FT, March 98).

 

prospects and constraints

On the price-quota system, France opposes milk price cuts (if quota remains) while Italy would prefer quota removed. On the issue of compensation, countries with large farmers (average size of 70 hectares) e.g. the UK, Denmark and Germany (on East Germany) tend to oppose a maximum ceiling on direct payments of Ecu 100,000 /£70,000 (since it discriminate efficient large firms?) while countries with small farmers e.g. rest of EU would not mind (e.g. EU’s average size of 17 hectares). It is not clear whether the conflict among EU members (of different interests) would actually facilitate or hinder the pace and speed of the CAP Agenda 2000 reform.

 

Conclusion:

                The question is no longer whether we should reform the CAP, but how do we reform the inefficient and unequal method of the CAP. Generally, we can see the shift from inefficient price support to direct compensation is desirable to reduce food mountain, though the issue of penalising large farmers remains political rather than social.

Likewise, a shift from agricultural subsidies to rural development may raise equality (more rural receiving benefits), but then again, taking away from existing beneficiaries remain a politically sensitive issue. A step-by-step reform may mitigate the political risk of the EC and governments, but increasingly economic pressure (and social as well) is likely to speed up the process of reform.