Decoupling of direct payments

Lecture 9.

Economics of Food Markets

Alan Matthews

Lecture outline

• To provide an economic analysis of decoupling of direct payments

• To review studies on the impact of the MTR both in the EU and Ireland

Impacts of decoupling

• Many studies– Teagasc FAPRI-Ireland– OECD– Commission Impact studies– FAPRI-US– Dixon/Matthews (forthcoming)

• We look at some results from the Dixon/Matthews study

Decoupled payments – conceptual overview

• OECD dimensions (OECD, 2001)– Theoretical dimension – how do agricultural policies,

including direct payments, potentially affect production and trade

– Empirical dimension – what do we know about the actual production and trade impacts of different types of agricultural policies, including decoupled payments

– Regulatory dimension - ‘best practice’ in the design of the most decoupled policies or policy practices, not least to be WTO compatible.

Decoupling - definitions

• Full decoupling – policy is fully decoupled if it does not influence

production decisions of farmers and if it permits free determination of market prices

– Importantly, both the shape and the position of the supply and demand curves should not be changed

• Effective full decoupling– Where policy results in a level of production and trade

equal to that which would have occurred if the policy were not in place

– Example would be a coupled payment combined with a quantitative restriction equal to the old production level

Example of how the definitions differ

Although new policy (represented by S’) yields the same level of output initially, adjustment to a demand shock leads to a different output level than before

The degree of decoupling

• Comparing the degree of decoupling requires a reference, usually taken as the output effect of market price support

• From producer perspective, defined as 1 minus the ratio of the production effect of the policy package over the production effect of the equivalent (in PSE terms) price increase

Can decoupled payments affect production?

Source: Baldwin June 2003 CAP Reform

Decoupled payments in an uncertain world

• Where farmers are risk averse– Wealth effects: Change in farmer’s total wealth can

affect his attitude to risk– Insurance effects: If policy reduces the total risk faced

by the farmer (e.g. price stabilisation scheme) it will have positive effect on output

Decoupling in a dynamic world

• Where there are capital market imperfections, any kind of income support – even decoupled – will be partially reinvested in agriculture

• Where there are expectations of a future policy change and farmer can hope to influence this (e.g. change in base acreage for a payments scheme) decoupled scheme can affect production.

Decoupling: the effects

• Output effects– By how much will output fall

• Environmental benefits arise through more extensive production…

• …but danger of land abandonment in marginal farming areas

• Long term sustainability?

Source: OECD 2005 Decoupling – Policy Implications

Change in volume of output as result of MTR

Source: Dixon and Matthews, forthcoming

Farm Incomes

  SHORT RUN LONG RUN

Cause

Primary factor price index Output (c) GVAF

Primary factor price index Output (g) GVAF

(a) (b) =(a)+(b) (d) (e) (f) =(e)+(f) (h)

Dairy Market Reform 2.34 0.01 2.35 2.30 -2.66 0.04 -2.62 -2.55

Decoupling 4.10 -5.11 -1.00 -1.00 9.14 -8.64 0.50 0.84

Rest of EU 1.79 0.38 2.17 2.18 1.38 0.66 2.03 2.00

Total 8.24 -4.72 3.52 3.48 7.85 -7.94 -0.09 0.29

Change in agricultural greenhouse gas emissions (CO2 equivalent)