Sunday, April 4, 2010

Common Agricultural Program (CAP) reforms and likely implications of Single Farm Payment (SFP) policy

CAP 2004 beneficiaries
The concept of Common Agricultural Policy (CAP) emerged after Second World War with the objective of securing domestic production. The creation of a common agricultural policy was proposed in 1960 by the European Commission. It followed the signing of the Treaty of Rome in 1957, which established the common market. The CAP combines a direct subsidy payment for crops and cultivated land with price support mechanisms, including guaranteed minimum price, import tariffs and quotas on certain goods from outside the EU. European farmers responded
CAP Farm spending by sectorImage via Wikipedia
quickly to the high domestic prices created through such protection measures. This was further supported by increasing agricultural productivity through development of new technologies in the 1960s and 1970s. The consequence was that the European Union switched from net food importer to net food exporter in the late 70s. With the continuation of such policy, production increased significantly and later EU disposed surplus food products in the international market with export subsidy which depressed the world market price.
Percentage of EU farmland by countryImage via Wikipedia

The policy, internationally, continues to attract criticism. The major criticisms are its anti-development and anti-globalization nature. It is argued that creating an oversupply of agricultural products which are then sold in the Third World and simultaneously preventing the Third World from exporting its agricultural goods to the West, the CAP increases Third World poverty by putting Third World farmers out of business. CAP is also frequently criticized for its biasness towards larger farmers. As CAP has traditionally rewarded farmers who produce more, larger farms have benefited much more from subsidies than smaller farms. Another big issue affiliated with CAP is its effect on environmental degradation through intensive mono-crop farming through creating artificially high price in the domestic market. In response to these issues, CAP has gone through various reforms since 1990. In this context, this paper has tried to evaluate the CAP reforms in different period. Specifically, this article is focused on the analysis of the Single Farm Payment (SFP) policy under CAP reform and its likely implication on Agricultural production, welfare and environment.

CAP reform 

CAP has undergone several reforms since 1980s. High internal budget and increasing pressure from other countries during the Uruguay Round of the GATT gave rise to a major reform of the CAP in 1992. Various reforms of CAP with different objectives outlined briefly hereafter.

1992 MacSharry reform- 1992 CAP reform redirected the emphasis of farm support from markets to direct subsidies. The direct payments introduced in 1992 have been coupled to production, which means that farmers had to produce a certain crop/livestock products in order to be eligible for subsidies.
Agenda 2000- The planned EU enlargement and the continuing WTO trade negotiations towards further liberalization were the reasons for a further CAP reform in 1999. The agenda 2000 reforms brought price cuts in the cereal, beef and dairy sector, starting in 2005. Agenda 2000 was the set of reforms which not only dealt with CAP reform but also the future financing of the CAP, the structure funds, EU enlargement.
2003 reform- The mid term review of Agenda 2000 resulted in a new fundamental reform. The 2003 reform (referred to as Luxembourg agreement, or Fischler reform) of the CAP introduced a new system of single farm payments (SFP) and cut at least partially the link between support and production. The SFP is delivered to farmers irrespective of what and how much they produce (hence decoupled from production) and it is based on historical entitlements. However, member states could choose individually to maintain a limited link between subsidy and production within clear limits. This is a new development of the CAP towards re-nationalization of agriculture policy in the EU.
2004 reform- The second wave of CAP reform in 2004 introduced the SFP in the Tobacco, Hops, Olive-oil and Cotton sectors. In the sugar sector, a reform was adopted in February 2006 and the compensatory aid for sugar beet growers was integrated in the SFP.
 Appraisal of CAP policy reform- Decoupled Single Farm Payment
Frequently raised question is: Whether the decoupled single farm payment is decoupled in reality or  just a new version of old market protection measures?
Following is the predicted mechanism of SFP on output and market price.
Decoupling--> Relative profitability of different enterprise changes--> Optimal land use decision change--> change in farm investment decisions--> change in the use of factors of production--> changes in output and market prices
Most of the analysis carried out is based on the above framework. However, it will lead erroneous conclusion if based only on such framework. The decision making in dynamic world should not be based on such static analysis. This framework lacks the dynamics of complex relationships between and among different policies. So, analysis of such a big policy shift should be carried out in a very dynamic setting considering various factors like internal and external, price and non price, economic and non economic, short term and long term. Unfortunately, many of the studies carried out in the past to assess the impact of decoupling are based on partial equilibrium. Thus, referring such results to chalk out the conclusion could be misleading. Following is the brief  review of the analysis of impact of SFP on three variables - production, welfare and environment.
Agricultural production issue- The assessment of impact of decoupling on various sub-sectors within agriculture and livestock varies in results in different publications especially due to different approaches and methodologies used for measuring such impact. Agriculture and Food science center, Queen’s University, in the publication of “Analysis of the Impact of Decoupling on Agriculture in the UK” using FAPRI modeling compared the situation with decoupling with that of  without decoupling through producing baseline projections of key variables in the main agriculture sectors. Key variables include price, production and total receipts. The study assumed three hypothetical scenarios- A) producers base their production decisions on the basis of market return alone and no production response with decoupled single farm payment B) production response is attributable to 30 percent of the decoupled direct payments C) production response is attributable to 60 per cent of the decoupled direct payment. The impact on beef sector showed that with scenario-A, the level of production of beef and veal would be decreased by 10.6 percent by 2010 and reference price would be raised by 16.1 per cent. But this situation would be different in scenario B and C with less production reduction and less price rise. The impact on sheep production showed that sheep meat production would be reduced by 12.3 per cent by 2010 and price raise by 22.9 percent if scenario-A exists otherwise production and price rise would be lesser. But in case of Dairy, very little impact on UK milk production was anticipated because of modest premium in dairy sector. In case of crop sector, only modest decrease in production and consequently modest increase in price were anticipated in the study.
The result leads to the conclusion that the impact of decoupling on production and price depends on  the  level of decoupling. The above analysis is based on assumptions that the current export subsidy and import tariff are continued in the offing. However, it is very unlikely that this assumption exists because of possibility of reduction of the level of tariffs and export subsidy due to WTO trade negotiation.
In the same way, study commission by DEFRA entitled as “Decoupling and UK agriculture- A whole farm approach” using partial equilibrium analysis predicted the decoupling might trigger a long run reduction of production. The result is quite contrast than that of the result generated by using FAPRI model, which estimates quite higher price rise. Utilizing the different price rise scenario in FAPRI and partial analysis model, the farm level linear programming modeling has suggested that rise of 4% price in beef sector do not stimulate production under decoupled situation whereas it occurs only if more than 7% price rise. So variability of prediction of the impact of decoupling exists and definitive path can not be ascertained.
Decoupled payment has other side effects in the form of wealth and insurance effect. Due to fixed decoupled payment, wealth increases which enhance the farmers risk taking behavior while decoupled payment lead farmers expose to the vulnerability of market price fluctuations that may subside the insurance as was in the case of direct subsidy payment and thus, farmers may be more risk averse to take opportunity from market. So, these behaviors also affect the overall production scenario and should be eligible to be considered in the study of policy implication.
Welfare issue- The CAP, unreformed, will leave the EU economy around 100 billion poorer over the period of the next financial perspective than it would otherwise have been (DEFRA, 2005)). These costs are large in the context of the significant success the EU has had in improving the prosperity of its citizens through other policies. According to OECD estimates, even following the 2003 reforms around half of the CAP’s total cost is still in the form of market price support, the burden for which falls mainly on consumers and is disproportionately borne by the poorest. Around 30 billion is provided as direct payments to farmers, the burden being borne by taxpayers. Moreover, the CAP is inefficient in delivering benefits to the very people at whom it is principally directed- farmers in the EU. The OECD has estimated that only around 10 percent of market price support actually reaches farmers in their capacity as farmers. The OECD has estimated that up to 90 per cent of the value of coupled area payments is rapidly capitalized into land prices so that the benefit accrues mainly to the landowner who may or may not be a practicing farmer. With around 40 percent of EU farmland owned by non farmers, only half of the value of direct payment actually benefits farmers themselves. Thus, support through market prices or based on historical production or farm size takes no account of farm household income or wealth.
Environmental issue- The high level of market price support under CAP has encouraged farmers to intensify agricultural production. This has exacerbated agriculture’s contribution to negative impact on bio-diversity and wildlife. Some of the major consequences are surface water pollution due to increased levels of minerals, chemicals and organic material in water courses, groundwater pollution from the leaching of minerals and chemicals used in the agricultural production process, salinization caused by irrigation and the over use of aquifers.
The decoupled single farm payment with cross compliance is supposed to improve the agri-environment. However, there is still danger that taking decision freely on the basis of market signals with profit motivation may yield negative environmental consequences. Lots of  past evidence showed that competitive paradigm leads maximum utilization of resources but not the sustainable utilization of the resources. However, it can be logically anticipated that CAP with reform should yield better environmental consequences than that of without CAP reform as artificial higher market price in without CAP reform scenario led to a maximum exploitation of land, labor and capital resources leading to surpassing supply over market demand . At least in decoupled situation, market forces will automatically control over-production through price mechanism

In the short run, there will be no substantial change in the production scenario. Whatever the incentive provided through SFP is capitalized in the land price in the long run and change of input and output price may compelled farmers to take decision on the basis of market signals to maintain profit in the business, which is unlikely in the short term. In the long run scenario also, it is not rationale to analyze the issue of SFP solely. Because, the agricultural sector and its various sub sectors are influenced by other factors apart from SFP, for example, whether the current level of export subsidy and tariff exist or not, the import and export policy of other non EU trading partners, macro economic variables like fiscal and monetary policy affecting exchange rate and interest rate, different agricultural trade negotiations in WTO etc. Thus, definite impact on agriculture sector of EU can not be ascertained without logical and correct anticipation of the behavior of such variables.

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