European Economic Integration – 110451-0992 – 2014

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European Economic Integration – 110451-0992 – 2014European Economic Integration – 110451-0992 – 2014

Prof. Dr. Günter S. Heiduk

VI Core Policy 2 Common Agricultural Policy (CAP)

CAP reformPlan would revamp EU agricultural policy to secure food supply, protect the environment and ensure rural areas are developed sustainably.

A taste for EuropeEU quality labelling systems protects1000 names used to designate traditional agricultural produce and foods

Europe is one of the largest producer of agricultural products and both a major exporter and the world’s largest importer of food, mainly from developing countries!

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WORLD TOP 10: WHEAT PRODUCTION STATISTICS YEAR 2012

RANK COUNTRY MILLION METRIC TONS

1 China 125.6

2 India 94.9

3 United States 61.8

4 France 40.3

5 Russia 37.7

6 Australia 29.9

7 Canada 27

8 Pakistan 23.5

9 Germany 22.4

10 Turkey 20.1

European Union approx. 133.0

Source: FAO??????

Wheat – Supply and Demand by Top 10 Producer Countries, 2010 (thousand metric tonnes)

Source: http://www.spectrumcommodities.com/education/commodity/statistics/wheattable.html

0

10000

20000

30000

40000

50000

60000

70000

80000

90000

100000

110000

120000

China India USA France Russia Canada Australia Germany Pakistan Turkey

Production Consumption Imports Exports

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Utilised agriculture area, % EU-27, 2010

European Integration VI Core Policy 2 Common Agricultural Policy (CAP)

Utilised agriculture area by land use, EU-27, 2010 (% share of utilised agr area)


EU-27, production of selected agricultural products, 2010


Index of the real income of factors in agriculture per annual work unit, 2005=100

0

20

40

60

80

100

120

2004 2005 2006 2007 2008 2009 2010 2011

Trends in EU agricultural income per work unit, Indicator A, 2005-2012 (% change compared with previous year)

Source: EUROSTAT, aact_eaa06



Share of exports/imports by Member States on extra-EU-27 trade in SITC 0-1, 2010

19%

13%

14%10%

8%

7%

29%

France Germany Netherlands Italy UK Spain Rest

Exports

9%

15%

16%

9%15%

10%

26%

France Germany Netherlands Italy UK Spain Rest

Imports


Source: European Commission, The CAP towards 2020.


Top 5 World Agricultural Exporters Top 5 World Agricultural Importers

EU-27 - Main Agricultural Exports, 2011 EU-27 - Main Agricultural Imports, 2011

Source: http://ec.europa.eu/agriculture/publi/map/01_12_en.pdf


Source: EUROSTAT (2011), External and Intra-EU Trade, edition 2010, p 21.


EU-27 - Agricultural Exports by Destination EU-27 - Agricultural Imports by Origin

EU-27 – Trade with USA EU-27 – Trade with Russia

Source: http://ec.europa.eu/agriculture/publi/map/01_12_en.pdf


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The member states of the EEC in Article 39 of the Treaty establishing the European Community (signed on March 25, 1957) agreed that the objectives of the Common Agricultural Policy (CAP) should be:

(a) “to increase agricultural productivity by promoting technical progress and by ensuring the rational development of agricultural production and the optimal utilization of the factors of production, in particular labor;

(b) thus to ensure a fair standard of living for the agricultural community, in particular by increasing the individual earnings of persons engaged in agriculture;

(c) to stabilize markets;

(d) to assure the availability of supplies;

(e) to ensure that supplies reach consumers at reasonable prices.”


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The member states were aware of

(a)”the particular nature of agricultural activity, which results from the social structure of agriculture and from structural and natural disparities between the various agricultural regions; (b) the need to effect the appropriate adjustments by degrees…” (Article 39, 2.).

The member states agreed that a common organization of agricultural markets should be established. They opted for three different types depending on the product: (a) “common rules on competition;(b) compulsory coordination of the various market organizations;(c) a European market organization.” (Article 40, 2.)

The Common Agricultural Policy (CAP) was originally a market organization systembut later replaced the market mechanism by

- guaranteed administrative minimum prices, and- protectionist trade barriers

This system contrasts to the direct income supporting system (US system).


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In the case of administrative fixed prices, farmers are guaranteed a certain price for their products, which lies above the world market price (otherwise the floor price would not be binding). Such a support strategy can only be realized through a combination of external and domestic measures: on the one hand, cheaper imports, which might drive down the administrative price, have to be prevented (by external measures such as tariffs). On the other hand, intervention into the domestic market mechanism becomes necessary to maintain a given price level (by domestic measures, e.g. intervention buying or output restrictions). In the EU the initial policy instrument was the setup of such an administrative fixed market price above the domestic equilibrium price. For a long time, there had been no output restrictions imposed because of the initial goal of self-sufficiency in food supply. As producers no longer bore a price risk this strategy set an incentive to expand production to increase producer income (equal to the fixed price times production quantity). If the price cannot react, the income elasticity of the demand for agricultural goods is low and foreign markets are relatively closed, surpluses are something like an inevitable result of such a policy. These surpluses have to be taken from the market by policy intervention to maintain the administrative price, e.g. by buying the surplus or by paying a premium for discarding agricultural products. Governments can also attempt to reduce surpluses by setting output restrictions in the form of positive incentives for reductions or penalties for excessive production.


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E

Price

Quantity

D S

C P Fixed admin. minimum price Pa

Equilibrium price Pe

0 QaC Qe Qa

P

1. Assumptions At the market equilibrium E, supply S equals demand D The market clearing price is Pe , the corresponding quantity is Qe The intervention agency sets a fixed minimum price Pa

2. Purchase of surplus is guaranteed by the intervention agency at Pa 3. Market effects 4. Welfare effects 5. Possible solutions to diminish welfare loss

new equilibrium at P guaranteed purchase quantity by the intervention

agency: QaC Qa

P reduction in consumption: Qe Qa

C increase in production: Qe Qa

P

increase in farmers’ income: (P pa 0 QaP) – (E Pe 0 Qe)

gain in producers surplus: a + b + c + d loss of consumer surplus: a + b governments’ intervention expenditures: P C Qa

C QaP (if

financed by taxpayers = consumers, the total consumer loss amounts to a + b + P C Qa

C QaP)

misallocation of resources: area b

a b

c

R

QgP

d

government sets production quota to decrease government expenditures to R C QaC Qg

P

consumers pay a + b + c + d directly to the producers (e.g. as income support)

Effects of a fixed administrative (minimum) price

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If the domestic agricultural sector is open to the world market, which has a lower price than the administrative one (and maybe also lower than the domestic equilibrium price), this price can only be sustained by protectionist measures at the border. The most common instrument to achieve this is a tariff, which increases import prices by a certain percentage of import value. Domestic producers are protected from foreign competition if the tariff is high enough to raise import prices to the domestic price level. This means that with constant tariffs, declining world market prices diminish protection. In that case, the administrative authority has to bring the tariff in line with the new world market price. By setting up minimum prices, inefficient domestic producers are sustained leading to a loss in international sector competitiveness. Furthermore, this policy can lead to excess production. In order to reduce surpluses the administrative authority can either purchase excess quantities or subsidize their export. Such a strategy of tariffs and export subsidies is highly trade distorting. On the one hand, imports are kept out of the market. Combined with subsidized exports, this increases worldwide supply of agricultural products driving world market prices down. Farmers in other export countries might lose their competitiveness facing this new, artificially lowered price. Importing countries in contrast are the winners.


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Taken together, there are a number of winners and losers from such a protectionist strategy. On the winning side are:

farmers (higher incomes), consumers outside the protectionist country (lower world market prices)

and to some extent the government itself (generating tariff revenue from agricultural imports).

On the losing side, one finds:consumers in the protectionist country (paying excessive prices and higher taxes to finance market intervention), farmers in this country (paying higher taxes to finance market intervention),producers in exporting countries (lower world market prices, loss of the EU as a major market) and to some extent the government itself (facing higher expenditure from

market intervention).

Although exact quantities of welfare loss are difficult to determine, this short overview already indicates that the overall welfare losses from such a protectionist strategy exceed the gains (especially when considering that within the EU, the group of main benefactors, i.e. farmers, is by far smaller than that of the main ‘losers’, i.e. consumers).

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d

c

a’

Price

Quantity

DH SH

PTH

PW

0 QSH QC

H

1. Assumptions National equilibrium: EH in the home country, EF in the foreign country Equilibrium of both countries at free trade:

o world market price: PW o import quantity of the home country QS

H QCH equals export quantity of the foreign

country QCF QS

F 2. Introduction of a tariff by the home country: PT

H PTF

3. Market effects 4. Welfare effects 5. Redistribution effects Note: Both countries have to bear the price effect of the tariff. The home country has to bear a smaller part if its elasticities of supply and demand are high and those of the foreign country are low.

gain in producer surplus: area a’ loss in consumer surplus: area a’ + a + d + b tariff income to the government: d + c loss in allocation efficiency: areas a and b gains of increased terms of trade: area c net gain: c – (a+b)

decreased import quantity in home country: QSH

T QCH

T decreased export quantity in foreign country: QC

FT QS

FT

increased price in the home country: PTH

decreased price in the foreign country: PTF

Price

Quantity

a b

QSH

T QCH

T

DF SF

Home Country Foreign Country

tariff

QCF QS

F

QCF

T QSF

T

0

c’

PTH

PTF

redistribution of consumers to producers: a’ redistribution of consumers to government: d

EH

EF

Effects of a tariff in a large country

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Effects of export subsidies in a large country

PSF

Price

Quantity

DH SH

PW

0 QSCH QSP

H

Price

Quantity

Home Country Foreign country

0

PSH C

DF SF

1. Assumptions: Home country imports QFP

H QFCH

Foreign country exports QFCF QFP

F Re-import prohibition of exports leads to a separated market

2. Producers in the home country receive export subsidy 3. Market effects

Home country

Foreign country 4. Welfare effects

Home country

Foreign country

E

increased production: QFPH QSP

H decreased consumption: QSC

H QFCH

imports (QFPH QFC

H) are replaced by exports (QeH QSPH)

decreased world market price: PSF

decreased production: QFPF QSP

F

increased consumption: QFCF QSC

F exports (QFC

F QFPF) are replaced by imports (QSP

F QSCF)

net gain in producer surplus: P J E

loss of consumer surplus: H E Pe PW subsidy expenditures: QSP

H P J We (if financed by taxpayers = consumers, the total consumer loss amounts to H E Pe PW + QSP

H P J We)

P

A H B G

QFPH QFC

H

H’ G’

QSPF

QSCF

QFCF QFP

F

loss of producer surplus: P’ H’ PW PSF

gain in consumer surplus: C’ G’ PW PSF

PW

PeH

QeH

J

K

P’ C’

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Direct income payments of government to farmers are a completely different support system and can come in a variety of ways. These range from direct payments (that can be headage payments or related to current or historical input or output levels) to indirect payments (e.g. tax exemptions). They differ from guaranteed price support systems insofar as, there is no necessity to protect the domestic market. This implies that they are far less trade-distorting than the administrative price system (i.e. the negative welfare effects on non-domestic parties described above do not occur). If the market is open, the domestic price level equals the world market level because otherwise imports would rise, thereby equalizing price levels. Direct income payments then allow farmers to close the gap between their income at world market prices and production costs. In the end, one has to take into account that these income payments have to be financed, e.g. by taxes. In that case consumers and producers have to bear the costs. However, consumers benefit compared to a minimum price because they can buy agricultural commodities at world market prices. Regarding farmers, the support and protection function of direct income payments is less perfect than that of a combined minimum price/tariff system: The exposure of the producers to price changes in the world market is relatively high. Furthermore, the adaptability of subsidies to changes in the world market seems to be lower than the adaptability of minimum prices and tariffs. From a welfare perspective this system of direct income payments is less negative than the administrative minimum price: on the one hand, consumers no longer pay twice and on the other hand, negative effects on other countries (through trade distortions) are reduced.

Although these two support systems are at the heart of agricultural support in industrialized countries, reality is far more complex. Different factors contribute to the complexity of any analysis of agricultural markets:

Policies across different product categories and within the same country differ significantly. This is why general statements about the agricultural market even within one country are difficult.Policies within one product category differ internationally. This is why it is difficult to compare levels of protection between countries. Policies within one product category typically comprise a complex set of tools. Policies have changed significantly throughout history.


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Common Agricultural Policy (CAP) The first model of European market organization

Target price

Threshold price

Intervention price (= market clearing price)

World market price

A

H G

K

I

J F N

D C

B L

IMPORT EXPORT

M E

0

Quantity

Price, Border

Ex

po

rt

lev

y

Total domestic production

Total domestic consumption

Varia

ble

lev

y

Demand curve at fixed import price

Assumptions: EU market price = threshold price EU export price = intervention price world market price = EU equilibrium price Base case (export and intervention = red line) storage costs = G I J N intervention expenditures = A N J L export subsidies = F N C D producers’ export proceedings = D C A B producers’ net gain = F N K

Supply curve

Price, Border

Alternative case 1 (no export) storage costs = F H I J intervention expenditures = B F J L Alternative case 2 (only export) no storage costs export subsidies = D F J M

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0

50

100

150

200

250

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

( in € per metric tonne )

EU intervention price EU common wheat market price US (SRW Gulf)

The evolving role of EU support prices - wheat

Source: Haniotis, T.

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Three views of benefits and costs of the CAP

An evaluation of the effects of the CAP could be based on different approaches. Firstly, the traditional analysis of trade distortions uses an efficiency-oriented approach to quantify the welfare effects for domestic and foreign farmers as well as consumers. Players outside the agricultural market, their behavior and the effects on the pattern of protection are excluded (e.g. tax payers). Secondly, “political economy”-models of protection focus on distribution-oriented considerations. The main players are political decision-makers and interest groups. It is assumed that both groups pursue their own interests. Politicians use their regulatory power to transfer income to the “clients” of the special interest groups, e.g. to the farmers. Tariffs are seen as political instead of economic prices. Several alternative models have been developed especially in the USA; some have been tested successfully (Grossman/Helpman 1994; Baldwin/Magee 1998; Eicher/Osang 2002).And thirdly, these two approaches might be supported by plausible intuition where models resulting in exactly determined effects have its limits.

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1. Market model view of tariffs as well as of price support (allocative efficiency)

Producers ConsumersGovernment

(=EU)Welfare

Domestic

market

increase in

producer

surplus

- loss in consumer surplus

- distribution of income to

producers and government

- increase in

income from

tariffs

- expenditures

for support

Welfare according to figure 12

negative, if

- tariffs are high

- elasticities are low

- country is small

Foreign

market

loss in

production

increase in consumption, if

the foreign country has to

bear a part of the tariff

_____

The difference of consumer

gain and producer loss

(including terms of trade effect)

is large if

- tariffs are low,

- elasticities are high,

- tariff imposing country is

large


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2. Political Economy view of protection (distributive efficiency)

Government (=Council of

Agri Ministers)

Lobby on the EU

levelProducers Consumers

Inside

Pressure

- gain, if re-elected

- tariff income

gain, if tariff

increases

gain, if tariff

protection higher

than costs for

lobbying

- loss of consumer

surplus

- distribution of income

to producers and

government

Outside

pressure

foreign governments:

retaliation measures due to

strong negotiation power of

foreign lobbyists

foreign lobbyists:

stronger negotiation

power*

_____ _____


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3. Plausible intuition (no theoretical proof of allocative and distributional efficiency)

Domestic economy Foreign economies WTO

Benefits

- high degree of self-sufficiency

- gains from increased specialization possible

- income convergence in the EU agri. sector

- price stability

- sustainable rural life

decreasing world

market prices if a

large country

provides export

subsidies

_____

Costs

- misallocation of resources

- adverse specialization possible if worldwide share of

production of developed countries increases

- sectoral income inequalities because wages in the

subsidized sector could be higher

- structural distortions because large farms get a

relatively higher share of support

- environmental damages

- decreasing growth

- loss of

competitiveness

- negative impetus

on growth

- unfair competition

- blocking liberalization

- dispute settlements

procedures involving three

parties (domestic

government, foreign

government and WTO

staff)

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0

20

40

60

80

100

120

Billion of euros

CAP expenditure EU budget

0%

10%

20%

30%

40%

50%

% of GDP

CAP expenditure All EU public expenditure

CAP cost, 2008,absolute terms

CAP cost, 2008,relative terms

44% of EU budget

0.43% ofEU GDP

Agricultural expenditures

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Direct payments

MarketsMarkets

Pillar I

Pillar II

RuralDevelopment

Modulation

Haniotis, T, The CAP Reform Process in Perspective: Issues ot the Post-2013 Debate. European CommissionSlide 20-22.

The CAP Reform

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The road of the EU’s CAP reforms: Decoupling production and support

The 1992 reform (MacSharry reform)

-reduction of intervention prices,

- increase in income supports under the condition of setting productive land aside,

-discriminating the level of income support between large and small farms to the advantage of the former,

-compensation for an early retirement of farmers older than 55 years,

-paying more attention to product quality,

-subsidies for farmers who have to cope with disadvantageous local conditions,

- environmental improvements by taking into account that protection of nature increases the quality of life.

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Agricultural expenditures

2007 constant prices

0

10

20

30

40

50

60

70

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

% GDPbillion €

0,00%

0,10%

0,20%

0,30%

0,40%

0,50%

0,60%

0,70%

Export subsidies Other market support Coupled direct paymentsDecoupled direct payments Rural development % of EU GDP

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Cumulative % reduction in price support from 1991 to 2009

-100

-80

-60

-40

-20

0

Softwheat

Durumwheat

Beef Rice Butter SMP Sugar

In nominal terms In real terms

Cumulative reductions in EU price support

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Impact of the CAP reform on expenditure structure in the cereals sector* - A clear shift from market intervention (export refunds and storage intervention) to direct aid

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Impact of CAP reforms on EU net production surplus

-15%-10%

-5%0%5%

10%15%20%25%30%35%40%45%

Wheat Barley Maize Beef Pork Poultry SMP Butter Cheese Sugar

Net production surplus: 1990/94 ol avg Net production surplus: 2004/08 ol avg

Net production surplus as % of consumption

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Recent evolution of agricultural input and output prices

75

90

105

120

135

150

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

( 2000 = 100 )

Input prices (nominal) - EU-27 Output prices (nominal) - EU-27Input prices (deflated) - EU-27 Output prices (deflated) - EU-27

CAP Reform 2014-2020

The CAP Post-2013: From Challenges to Reform Objectives

Source slides 37-45: EC (2013), Overview of CAP Reform 2014-2020, http://ec.europa.eu/agriculture/cap-post2013/

CAP Budget

Pillar 1: Direct payment and market-related expenditurePillar 2: Rural development

Pillar 1 and 2: 38.7% of total EU budget 2014-2020Pillar 1: Minus 1.8%Pillar 2: Minus 7.6%

CAP Actual Payments 1990-2012, Commitments for 2013 and the New MFF Ceilings 2014-2020

MFF = Multiannual Financial Framework 2014-2020 (EU Budget)

“The radical change in the orientation of the CAP is demonstrated by the evolution of expenditure, echoing the policy shift since 1992, away from product based support towards producer support and considerations for the environment.”

CAP 2014-2020

New Features

Joint provision of public and private goods

“Farmers should be rewarded for the services they deliver to the wider public, such as landscapes, farmland biodiversity, climate stability even though they have no market value. Therefore, a new policy instrument of the first pillar (greening) is directed to the provision of environmental public goods, which constitutes a major change in the policy framework.”

Efficient, targeted and coherent

“Both pillars of the CAP are aimed at meeting all three CAP objectives more effectively, with better targeted instruments of the first pillar complemented by regionally tailor-made

and voluntary measures of the second pillar. “

New flexibility

“… in the budgeting and implementation of first Pillar instruments, acknowledging the wide diversity of agriculture, agronomic production potential and climatic, environmental as well as socio-economic conditions and needs across the EU.This flexibility will however be framed by well-defined regulatory and budgetary limits in order to ensure a level-playing field at European level and that common objectives are met.”

CAP 2014-2020

How the key objectives of the reform are addressed

Enhanced competitiveness of EU agriculture“Competitiveness is addressed directly by changes to market mechanisms, particularly the removal of production constraints. All of the existing restrictions on production volumes for sugar, dairy and the wine sector will end, allowing farmers to respond to growing world demand.Measures to facilitate producer cooperation under both pillars of the CAP should also boost the competitiveness of farming by reducing costs, improving access to credit and adding value to the primary sector.A new crisis reserve (of EUR 400million per year in 2011 prices) is established to secure the financial resources needed in case of crisis, through deductions from direct payments, with unused amounts reimbursed to farmers in the consecutive budget years. “

A more sustainable EU agriculture

CAP 2014-2020

A more effective and efficient CAP… through more targeted and equitable direct payments

New design of direct payments

CAP 2014-2020

“The performance of the CAP will also benefit from a more balanced, transparent and more equitable distribution of direct payments among countries and among farmers. The reduction in disparities of the level of direct payments between Member States, known as external convergence, will reinforce the credibility and legitimacy of the support system at EU level.

Changes in the distribution of direct payments

Baseline: Average national payments per hectare by 2020 compared to teh status quo.

CAP 2014-2020

…and a more strategic approach to R&D spending

Rural development policy

CAP 2014-2020

Actions targeted under both pillars

CAP 2014-2020

SUMMARY

European Economic Integration – 110451-0992 – 2014

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