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The Common Agricultural Policy has always been economically indefensible. It is fortunate that a combination of external and internal pressures is going to make the case for fundamental reform even stronger.


1)      Intro

2)      History

a)      Politically motivated creation to get France in

b)      Organised pressure groups in agriculture versus unorganised consumers.

3)      Economic justifications

a)      Eliminate shortages when imports fail

b)      Price stability

c)      Fair price

4)      Result

a)      50% of budget

b)      125% self sufficient

c)      Dumping in world markets

d)      Large farms with intensive and non-organic production techniques

5)      Reform caused by internal pressures:

a)      Exploding budget

b)      United consumers

c)      Awareness about intensive farming damages

6)      External Pressures

a)      GATT – third world countries have united against dumping. Reduction of 30% needed.

b)      Unification – mostly agricultural economies

7)      Reform will initially in Agenda 2000:

a)      Cap the total amount of support

b)      Target organic producers, hedges etc.

8)      Criticism

a)      Has caused farmers to have highest suicide rate

b)      Has eliminated food shortages

c)      Has helped to integrate Germany and France and thus prevented revolutions etc (farmers are a military bunch).

d)      Cutting the dog’s tail bit by bit?

Common Agricultural Policy was created together with the EEC in 1960-s in order to trade France into joining EEC. It has widely been regarded as a failure and major reforms have been initiated since 1992 SEA.


The original aims, according to the Art. 39 of EEC treaty were to increase productivity and promote technological process by ensuring optimal utilisation of factors, especially labour. It also aimed to ensure a fair standard of living for agricultural community, stabilise the world markets, assure availability of supplies and ensure that supplies reach consumers at reasonable prices.


With the hindsight of 40 years of CAP history, most commentators now agree that the main reason for CAP was to create a medium to transfer funds from Germany to France. France has a large agricultural sector and is one of the main benefactors of CAP. Germany, being defeated in the Second World War, was willing to offer a concession to France in return for a political union.


Agriculture was chosen as means of transfer largely because its lobby is highly organised – the so-called closed group organisation, whereas the opposite side, consumers, is not organised into strong pressure groups. Thus, CAP was politically feasible.


It was justified on economic grounds. The main reason was the immense disutility a food shortage brings. In order to eliminate that, food production was encouraged, as to stop relying on imported food, because supplies can finish in war. However, this aim was fulfilled a long time ago. Europe is now 125% self-sufficient on food production and has to subsidise export heavily in order to dump the surplus to world markets.


Another economic justification was to reduce the variance in food prices. As the demand and supply for food are very inelastic, and quantities are subject to random shocks in weather, the price can fluctuate widely. When one assumes a quadratic convex utility function, this is undesirable. Thus, the government used a stock mechanism to guarantee prices and buffer the fluctuations. However, the dis-utility associated with fluctuation was surely affecting producers as well as consumers. Therefore, they should have been able to provide the storage facilities centrally. Furthermore, there has been an active futures market in USA for more than 20 years now, eliminating all of the risk arising from price variation. There seems to be no case for market failure, and thus state intervention.


Then there is the equality justification. Agricultural policy can be seen as a redistributive instrument. Still, cash benefits to poor people are surely a more effective and equal way.


Finally, 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 (for food is an inferior good), increasing supply (from technological changes) will lead to a long-run decline in food prices. The CAP could remain justified as long as the assumptions of EC as major food importer and rising world food price hold. Both assumptions are now empirically 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. causing inefficient food exporters to appear).


So, there seems to be no economic justification for CAP, but very strong political ones. Still, when talking about reform most writers concentrate on justifying CAP reform on economic grounds – to make it more efficient. What one should perhaps look, is a political justification for the CAP reform and then view the desirability of such reform from an economics viewpoint. For example, there is very little threat of neo-nazism left in Germany and it has become a dominant nation in Europe. Thus politically, it has no need to support French farmers any further. That is why one sees a reform into individual country based accounts, virtual cows etc. Still, this is an economic essay, and I will leave the essential point of political motivation aside and look for economic motivations.


The main economic pressures have come from inside Europe. The CAP now accounts for about 60%-70% of EU budget, and without control it would expand even further. The main problem is a classical asymmetric information problem associated with most insurance schemes called moral hazard. The farmers have an incentive to claim too much. However, these are just part of the true cost of CAP.  The CAP also 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 ‘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.


In addition to internal budget pressure, there is now pressure coming from united consumer organisations fighting against the welfare losses. In addition to high costs, they claim that CAP is also unfair, as high food prices affect least well off most. Additionally, of the small benefits which go to the farmers, by default, large farmers receive the lion share of the benefits (20% of the farmers receive 80% of the subsidies). Furthermore, the consumer organisations fight for more diversity and extensive farming practices that CAP does not provide today.


This is directly linked to the third pressure group, the environmental pressure. CAP encourages intensive production, with the use of hormones, antibiotics, and low quality food, as everything has a guaranteed price. This will not be environmentally sustainable, and there is now a strong European Greens body fighting for reform.


In addition to internal pressures to reform, EU has lost out in successive rounds of GATT and is forced to reduce the support it gives to farmers. Whereas before, the third world countries had no institution to use in fighting against EU dumping, it is now provided by GATT. The pressure arose as EU was beginning to export more and more and adversely affected Australia, New Zealand and USA among others. The GATT trade talk among the US, Japan and the EC generally agreed 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. 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’ like banning US’s cattle derivatives on the basis on BSE (‘mad cow disease’). Instead, BSE expenditure was forcing further spending cuts to keep the budget in limits.


A further external pressure comes from the prospect of enlargement. The prospective new candidates each have a large and ineffective agricultural sector and the community budget could not manage in financing CAP in these countries. At present the new applicants will be excluded from CAP, but this difference cannot be sustained forever.


The surpluses of CAP became apparent already in 1960-s, when the first attempt by Mansholt was made to reform the budget to favour restructuring. This was a failure, because of political unpopularity (Mansholt was labelled the peasant killer, etc).


In 1984, the Council accepted Commission proposals for CAP reform. Measures included quotas allocated to individual states, overproduction was subject to 75-100% super-levy. A set-aside system was also introduced. The reformes caused food prices to stop increasing, but only had a limited effect on budget.


The 1992 MacSharry reforms introduced some further notations. The farmers were compensated for historic yields, thus no bonus for increased productivity. It also introduced compensation for less intensive production methods, and introduced the agri-environmental programme encouraging farmers to introduce conservation of reserves, ponds, hedgerows etc. Budgetary impact was thus positive at the beginning due to higher costs from compensation. In addition, the aim of long-term structural change was not achieved, the only success lied in reducing the export subsidies. Much of the failure can be explained by the political obstacles to reform. Agricultural groups still had a strong lobby and thus prevented the effective execution of the policies.


The reform proposals now carry the code-name of “Agenda 2000” and with the immense unpopularity of CAP and the pressures it faces, could prove to be successful. It aims to reduce the price support mechanism, and shift into direct payments as a safety net for low income farmers. Further decentralisation will mean that funds can be distributed according to national preference. There are also further financial ceilings being introduced and lots of bureaucratic simplification.

Fischler reform, for example, suggests a virtual cow solution to cut intensive farming. It 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 low-yielding countries such as Ireland, Portugal and Spain, as opposed to existing system, which punishes high-yielding countries like Sweden and the Netherlands.


Finally, environment is now even more of a priority. The structural funds aims to 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).


It seems that there had been a case for reform for already a long time, but nothing substantial has happened, and although the economic pressures for reform are gradually increasing, without political reform there would be little change. However, with the treaty of TEU in 1997 qualified majority voting was introduced and much of the management of CAP shifted to the European Commission. This should ensure a more pragmatic approach that puts more weight on economic factors.


Although there is clearly a need for reform, the existing system has not done badly according to historical standards. There have been no food shortages in Europe and the prices have stabilised. CAP has also played a role in integrating Europe even closer, and thus prevented revolutions and conflicts. The question is, of course, whether this could have been achieved without CAP anyway.


Furthermore, farmers are clearly under lots of stress due to reforms. They have the highest suicide rates in Europe and are on very low incomes. This seems to suggest that gradual reform has not been beneficial to them, and can be compared to cutting the dog’s tail of bit by bit. Maybe a better policy would be to design a complete overhaul of the system, and put it to hold for a few years to overcome the political pressure in implementing it. Anyhow, the new Single Market system is still too young to make any firm conclusion about its political flexibility. In addition, as the previous reforms of CAP, that were initiated just by economic reasoning, have shown, the prospects for any significant reduction, beyond the reduction in export subsidies achieved by GATT, is unlikely if the political climate is not favourable.


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