The impact of the Common Agricultural Policy on income distribution and welfare in Central and Eastern European Countries.

Transcription

1 EERI Economic an Econometric Reearch Intitute The impact of the Common Agricultural Policy on income itribution an welfare in Central an Eatern European Countrie Pavel Ciaian EERI Reearch Paper Serie No 2/2002 Copyright 2002 by Pavel Ciaian EERI Economic an Econometric Reearch Intitute Avenue e Beaulieu 60 Bruel Belgium Tel: Fax:

2 The impact of the Common Agricultural Policy on income itribution an welfare in Central an Eatern European Countrie Pavel Ciaian Katholieke Univeriteit Leuven an EERI Economic an Econometric Reearch Intitute Abtract In thi paper we evelop a partial equilibrium moel for agricultural ector to ae the impact of CEE integration with the EU on welfare an income itribution of agricultural factor. The moelling framework i bae on the concept of market imperfection an tranaction cot. We perform everal policy imulation with ifferent level of irect payment a given in the mot recent European Commiion propoal. We fin that even the mot ceptical European Commiion propoal of awaring the CEE farmer only 25% of the irect payment will increae welfare an income of farmer. However, the itribution of CAP rent are affecte by the intitutional tructure. We fin an avere impact on allocation of income an welfare that are generate by the integration in Slovakia an in the Czech Republic. The major part of it - between 65% to 93% - i tranferre to owner of prouction factor, uch a hire labour, lanowner an variable capital upplier, but not a eire to upport farmer income. In Polan the gain reulting from the integration are allocate more favourably to farmer. Factor owner retain only aroun 24% to 6%, epening on the level of irect payment. Key wor: Partial equilibrium, moel CAP, EU enlargement. JEL Claification: D57, 7, 8.

3 . INTRODUCTION EU integration of Central an Eatern European countrie (CEEC) will ignificantly change, among other, their current agricultural policie. Firt, the level of upport to agriculture will increae for the majority of CEEC, an econly the compoition of the policy intrument will be affecte. One of the mot hotly ebate iue on enlargement i whether the CEEC houl get acce to full CAP upport, in particular the irect payment. Yet, no matter what eciion i taken, agricultural policy change with acceion are likely to change the income itribution an welfare in CEEC. There i a growing literature on the impact of EU enlargement of CEEC in agriculture. Recent tuie ae the impact on EU bugetary expeniture, on CEEC' protection level (Bane et al. (2000), Hartell an Swinnen (2000), Hertel et al. (997)), an on commoity market, trae an WTO an the macroeconomy (Munch (2000), Hertel et al. (997)), Bane (2000)). However, the impact of acceion on factor market an on income itribution i le explore. Thi i urpriing given the prominence of thee argument in the ebate an whether or not CEEC farmer houl get acce to full CAP ubiie, incluing irect payment. The impact of the enlargement on the agricultural factor' income wa in majority tuie euce bae on the output evelopment. However, the itribution of income to the factor employe in agriculture, or the itribution of the farmer' income veru the other factor' income, i more complex an require to incorporate a more etaile factor market tructure into the moel. For intance, in an agricultural ector where the outier own the mot of the agricultural lan an alo the majority of labour i hire, the increae of output oe not neceary lea to a ame increae of the farmer' income. Conequently, the hare of farmer' income in the total agricultural income may be averely affecte. The lan rent relative to the price of the other factor may increae an the factor upplie by the farmer are uually le reponive to a price change compare to factor upplie by the outier; thu proviing a change in farmer' income that iffer from that of the output change. Further, the iue of imperfect factor market, extenively emphaie in the general literature an in the policy ebate, i aree by none of the above paper. Creit i uually not eaily acceible to farmer - they are ratione - an concerning the agricultural lan market i working imperfectly in CEEC, ue to intitutional contraint. 2

4 Thi paper preent the firt attempt (a) to ae income itribution effect within the CEEC economie of CAP acceion, an (b) to analye how factor market imperfection affect the outcome. For thi we ue an empirical moel to evaluate the effect of introucing the Common Agricultural Policy (CAP) on the income itribution an welfare of the owner of agricultural prouction factor (lan, labour an capital) in Polan, the Czech Republic an Slovakia after joining the EU. A a firt approach, the moel i partial equilibrium, ingle prouct an tatic. The moel explicitly moel tranaction cot an creit rationing to integrate imperfection in lan an creit market. The three countrie were choen becaue they are expecte to be among the firt group that will join the EU an becaue they have very ifferent farm tructure, which allow to incorporate the impact of thi variation in the analyi (ee table -3). Polan i repreentative for the countrie where the farm ector i ominate by iniviual family farmer, uch a Slovenia, Latvia, Lithuania an Romania. Slovakia repreent the other extreme, where the farm ector i ominate by large corporate farm i.e. partially tranforme collective an tate farm. The Czech Republic i omewhere in between with a ualitic farm tructure, where iniviual farm a well a large corporate farm are operating in the agricultural ector. Hungary, Etonia an Bulgaria alo have uch ualitic tructure. The paper i organie a follow. The next ection give a hort ecription of the ituation of the agricultural ector in Polan, the Czech Republic an Slovakia. The moel ecription i preente in ection three. The fourth ection icue the reult an the lat ection ummarie. 2. AGRICULTURE IN POLAND, THE CZECH REPUBLIC AND SLOVAKIA The agricultural ector, a can be een from table 4, i more important in the overall economy of Polan, the Czech Republic an Slovakia than it i in the EU. The hare of agricultural prouction, the hare of agricultural employment an the hare of foo conumption on the total economy are at higher level for all three CEEC when compare to EU-5 average. The mot ubtantial ifference i in agricultural employment in Polan, where a ignificant portion of the Polih population erive it income from the agricultural ector. It hare of the total employment i about four time higher than the EU average, while for the Czech Republic an Slovakia, thee value are higher jut by a factor of le 3

5 then two. The two other inicator - hare of total agricultural prouction of the GDP an hare of foo conumption on total expeniture - o not iffer by a uch high margin, a in the cae of Polih agricultural labour, but they are till higher by a factor ranging from.5 to 2.3 compare to EU average. In the evelopment of agricultural prouction uring the tranition, two perio can be itinguihe for the three CEEC. The firt perio i immeiately after the fall of Communim, aroun , when agricultural prouction ha ecline ramatically, reaching in 993 only aroun 60% to 80% of the correponing figure in 989 (figure ). Thi wa mainly caue by eep tructural change that took place at that time, epecially privatiation, liberaliation an ubtantial ecreae in agricultural protection. The paper of Macour an Swinnen (2000) foun that almot half of the output ecline can be attribute to price liberaliation an to ubiy cut. Other important factor foun to be relevant in explaining thee output evelopment were tranition uncertainty, rought, each explaining aroun 0%, an privatiation. The econ perio i after 994, when prouction tabiliation to new relative price an economic environment eem to have taken place. Thi tabiliation i relevant for election of the bae year for the moel calibration. Otherwie, if too many iequilibria exite in thoe economie, then calibrate parameter may be mileaing. Regaring the farm tructure, all three countrie iffer ubtantially, both among themelve an with repect to EU-5 average a well. The Polih farm ector i fragmente into a large number of mall family farm totalling aroun 2 million an averaging 7 hectare per farm (table ). On the other han, agriculture in Slovakia i ominate by large farm, preominately former co-operative or joint tock an limite liability companie that have been create from the former tate farm or have been tranforme from the former cooperative. Their average ize i 225 ha for joint tock an limite liability an 537 ha for co-operative (table 3). The farm tructure in the Czech Republic i omewhere in between thee two countrie with a higher hare of iniviual family farm then in Slovakia. Their hare in the total agricultural area (TAA) i aroun 24%, while in Slovakia it i jut aroun 9%, (table 2 an 3). For comparion purpoe, the average farm ize in the EU i aroun 8.4 hectare, an the total number of farm i cloe to 7 million (European Commiion). 4

6 3. THEORETICAL FRAMEWORK To analye the impact of the implementation the CAP on welfare an income in Polan, the Czech Republic an Slovakia, we ue a tatic an partial equilibrium moel of the agricultural ector. It reult repreent the long-run outcome bae on a comparion between an initial conition (i.e. with current CEEC' policie) an a counterfactual equilibrium compute with the change policie, that i, with the integration of CEEC in the EU an conequent aoption of the CAP. The moel i calibrate on the benchmark year 999. Conequently ome parameter are ajute to fit the moel with benchmark ata. Elaticitie are taken from the economic literature (ee appenix A for etail). The moel conier following market participant: one ometic conumer, foreign conumer, one farm, reource upplier (agricultural factor input owner) an government, all aume to behave competitively, exempt for the market imperfection in lan an creit market, an government, which exogenouly impoe it policie. There i aume one prouct in the market, which i the monetary value of farm prouction (crop an livetock prouction). Creit rationing i aume in the creit market an the concept of tranaction cot i ue to are the iue of lan market imperfection. To a large extent, the tructure of the moel reemble the moel of Hertel (989), exempt for the market imperfection. He ha evelope a long-run partial equilibrium moel with approximate functional relationhip an linear in elaticitie an percentage change in quantitie an price. The tructure of hi moel conit of an aggregate prouct eman, farm ector repreente by a contant return to cale prouction function, an factor upply equation. The moel wa ue to bring a general evaluation of the impact of ifferent agricultural policy intrument on agricultural market with pecial attention on the tructure of the prouction technology an factor mobility. Alo, he ha applie the moel for the US agriculture. The iavantage of thi approach i that the aumption of one prouct in the ector appear to be retrictive by not being able to capture the ifferential repone of the ifferent prouct categorie to policy change. Aitionally, partial equilibrium moel can not capture the change of non-agricultural meaure introuce in the other area of the economy after The literature that ha aree the enlargement iue ha ue partial-equilibrium moel (European Commiion (2002), Kanc an Weber (200), Munch (2000), an Aneron an Tyer (993)), general equilibrium moel (Hertel et.al. (997), Bane (2000) an Liapi an Tiga (998), or a combination of partial an general-equilibrium moel (Bane et.al. (2000)). 5

7 the CEEC integration, which might affect the agricultural ector a well. Neverthele, we think that the moel i a goo approximation to explain the evelopment of income an welfare of the agricultural factor after the acceion, which i the main intention of thi paper. The truth i that ome of the output categorie may react in a very ifferent manner when the agricultural policie are change, but overall, the impact on the aggregate agricultural prouct houl be the ame for both conieration, for the ingle prouct moel or for the moel with a more richer output tructure. 3.. DEMAND Following Armington (969) we aume that the ometic conumer ifferentiate the goo by it prouction location (ometic veru foreign). Conequently, the prouct purchae on the international market ( ) i an imperfect ubtitute for the ame prouct I purchae from the ometic proucer ( ). Thi conumer behaviour lea to the phenomenon where a country both import an export the ame commoity. In aition, the avantage of thi pecification i that it oe not lea to too exceive pecialiation when aeing the change of trae policie. Deman i then etermine in two tep. Firt, the equilibrium eman 2 of compoite bunle X i etermine auming contant elaticity a follow: m X C M () where i the price inex of the compoite goo an equal ( P ( t )) I ( PI ( t )) ; where C i a contant;, I are hare parameter; t i an a valorem conumer tax (ubiy if negative); M refer to aggregate income;, m are own-price an income 2 The equilibrium eman iffer from the orinary eman in the ene that the former allow for equilibrium ajutment in proceing inutry an final eman market a output price,, change; the latter one inicate how inutry, X, repon to alternative output price given all price in up-tream inutrie are hel fixe. The conequence of thi conieration i a price elaticity ifference between thee two pecification. It i lower for the equilibrium eman than for orinary eman. Thi ifference arie becaue effect of price change,, are alo hifte to all up-tream inutrie, thu mitigating the effect on X. What concern welfare meaurement of a market intervention, the change of conumer urplu calculate from the equilibrium eman, i in fact the change of urplu of all up-tream inutrie altogether (thi hol uner ome retriction regaring final conumer, otherwie thi urplu change i an approximation). 6

8 elaticitie of eman, repectively; an ; i the elaticity of ubtitution between I P i the ometic price; an finally, P I i the import price, itorte proportionally by tariff with repect to the worl price, P w, hence P P ( ). I w In the econ tage the conumer elect the optimal compoition of minimiing expeniture on I X, explicit eman equation for I I an I an ubject to the contraint may be erive a follow: I an. By I P ( t I PI ( t ) ) X ; (2) X. (3) Foreign eman i itinguihe for three region, the EU, an the ret of the worl, e EU e C 2 P ; CEEC e C ) e 3 Pe ( EU ; e. They are given a follow. EU ; the CEEC, e 4 Pe ( CEEC (4) C ) CEEC ; wherec 2, C3, C4 are contant; e i the own-price elaticity of foreign eman; Pe i the price pai by foreign emaner an i equal to P e P e ) ; ( S e, if poitive, then repreent the unit ubiy to exporter (otherwie tax). The price, P, that the exporter (farmer) get i higher than the price at what he i elling, P e ; t i a valorem conumer tax (ubiy if negative); an, are import tariff of the EU an CEEC, repectively. Thee tariff will become zero uner the EU integration cenario. EU CEEC 7

9 PRODUCTION The agricultural farm ector i repreente by a ingle prouction unit (one farm) aume to behave competitively. Thi farm prouce agricultural prouct by uing contant return to cale technology (CES): K V L A C k v l a 2 (5) with the contant elaticity of factor ubtitution given by ) (. where 2 C i contant, k v l a,,, are itribution parameter ( k v l a ); i output of the farm an upplie to the output market (ometic or international); an prouction factor, agricultural lan (A), labour (L), variable capital (V) an invetment capital (K), repectively, ue to prouce. Concerning the creit market, everal tuie inicate that farmer in tranition countrie are creit contraine. Conequently, the moel aume creit rationing, in the ene of Stiglitz an Wei (98). We aume that upply, ue to imperfect information preent in the loan market, offer to farmer a fixe amount of creit, enote by K, at a fixe price k. Given input price, creit contraint an government policie, the farm operate o a to minimie cot of proucing at a given output level. The firt-orer conition of the farm problem yiel factor eman which are a follow: H C r A a a 2 ) ( ; H C w L l l 2 ) ( (6) H C v V v v 2 ) ( ; K K S S S S S S S S S S S S S S S S a a k v v l l a a r A K v w r H )) ( ( )) ( ( )) ( ( )) ( ( where v w r,, refer to the price per unit of agricultural lan ( r ), labour ( w ) an

10 variable capital ( k ); an if i poitive then it i a valorem input tax (otherwie it i input ubiy) (for i = A,L,V,K). All rent that the farm obtain are itribute to input factor, uch that the profit of the farm are zero: p P ( t) S. tc. r. A r ( ) A w ( ) L v ( ) V k ( ) K 0 (7) a The poitive value of t refer to a valorem irect output ubiy that the farm get; P i the price at which the proucer ell the prouct to conumer; S - are ubiie given to the farm l v k which are not bae on the prouction level or the factor ue; an p. tc.. i the total r A benefit that the farmer i able to ubtract from lanowner rent a a reult of imperfect agricultural lan market (explaine in the next ection (3.3)). The foreign upply of the agricultural prouct i coniere to be perfectly elatic; available to the ometic conumer at an exogenouly etermine worl price, P w, itorte by tariff, PRODUCTION FACTOR SUPPLY The agricultural prouction factor are aggregate in four main categorie: agricultural lan, labour, variable capital an invetment capital. Each of them, except invetment capital, i itinguihe accoring to whether it i owne (or upplie) by the farm or not. Factor upply function for lan, labour an variable capital, imilar to the equilibrium eman function, are aume to have a contant elaticity form. The function are eparately given for factor upplie by the farmer an factor upplie by the outie upplier who are not involve in farming. Supercript notation are, repectively, o for the own factor an p for the purchae factor. A o ao C ( r ( ( tc) )) ; farmer own lan upply (8) ao a A L L p o p ap Cap ( r ( a )( tc)) non-farm (outie) lan upply (9) w lo w o lo ( ( l ; farmer own labour upply C )) lp p lp ( w ( l w non-farm (outie) labour upply (0) C )) V o C vo ( v ( v )) vo farmer own variable capital upply 9

11 V p vp Cvp ( v ( v )) non-farm (outie) variable capital upply () where i i i ai, Cli, Cvi Ck are contant; A L, V, K C,, are quantitie of factor, repectively, agricultural lan, labour, variable capital an invetment capital, upplie to the farm; r, w, v, k are price receive by the owner (upplier) of factor agricultural lan, labour variable capital an invetment capital, repectively;,,, are own-price elaticitie of upply for lan, labour variable capital an invetment capital, repectively; i i labour upply elaticity with repect to opportunity wage, (for i= o,p.); w i the wage that can be earne in other ector of the economy (opportunity wage); an i if poitive then it i a valorem input ubiy (otherwie it i input tax) given to upplier (for i= A, L, V, K). The moelling of the lan market require a more etaile explanation. The concept of tranaction cot, equation 9, i ue in orer to incorporate lan market imperfection into the moel, enote tc. Thee cot are face by the lanowner who are not farming their lan themelve but intea rent it out to farm. 3 They uually have le information on how the farm i run, about farm profitability, about the opportunitie, they are boun by the rental contract an they uually have to face withrawal cot an bargaining cot when they are interete to take out their lan from the co-operative. Aitional cot arie when the lanowner i interete in changing the tenant or in fining a buyer for hi lan. Thee cot eem to be high, ince the oberve eman for lan i low, epecially in Slovakia an the Czech Republic where even a reference lan price i not available to market participant. Fragmentation of lan i an other impeiment, which retrict the agricultural lan market 4. In Polan, where mall family farmer ue the majority of the lan, thi fact caue ifficultie in negotiating the leaing or elling contract. An owner, who inten to ell or rent hi lan out, coniting of more plot, incur higher tranaction cot compare to a ituation when the plot are conoliate into one parcel. The reaon i that the iperion of the plot may not fit the exiting lan tructure of a potential buyer/uer, conequently, thi prolong the earching perio an require for the negotiation to take place with more interete partie. Alo, the buyer/uer uually prefer larger plot. On the other han, in Slovakia an the Czech Republic where the majority of lan i uner the uage of cooperative an commercial farm, the fragmentation of lan make an owner more reluctant ai li vi k 3 In thi paper we will refer to them a "lanowner". 4 A of January 998, there were ownerhip paper, an the lan i ivie into parcel in the Czech Republic, thu giving an average parcel of aroun 0.4 hectare. Concerning Polan, accoring to a 0

12 to withraw hi lan out of the co-operative or the commercial farm. Thi i becaue the gain from oing thi are low - epecially becaue it i ifficult to fin omeone who will rent it in, the rent i low an practically it i impoible to ell it, an thu mall plot give practically zero return - compare to cot which are relatively high - namely withrawal cot, bargaining cot an earch cot 5. That i, a given in the equation 9, the price effectively receive by the lanowner i lower than the market price, r, by the unoberve amount tc an equal to r ( tc). Thee cot, a alreay explaine, arie becaue lanowner may be le informe about opportunitie, bargaining cot, contractual etting, etc. For intance, an owner interete in changing contractual partner will incur cot relate to changing a not terminate contract, earch cot, withrawal cot an bargaining cot. Someone, however, ha to get the above cot or the lot revenue of the lanowner that arie ue to the imperfection in lan market. The one who are the beneficiarie of them are the farm an thi revenue are aume to affect their behaviour in a manner imilar to that of S (equation 7). Thi hift of revenue from owner to farm occur becaue the farm pay a lower price to the lanowner than the equilibrium price by the amount of tranaction cot, tc. The lanowner accept thi lower price becaue otherwie, in equilibrium, the increae in price that he woul be able to negotiate when changing the contract or tenant woul jut compenate incurre tranaction cot. Conequently, the farm gain the price ifference ( tc * ) multiplie by the amount of lan emane ( r p A ) minu the cot incurre to farm 6, which are aume to be a fixe proportion of the total lanowner' lot revenue,, 0,. Hence, the portion of tranaction cot incurre to lanowner that remain with the p farm i enote by an total farm revenue equal to * tc * r * A (equation 7). There are no reliable etimate of the ize of the lanowner' tranaction cot, tc, an of the farm benefit reulting from imperfect lan market,. Therefore, we make ome aumption an the value for thee parameter will be choen the one, which eem to be the mot reaonable for each of the three coniere countrie. European Commiion tuy, ome 43% of farm are plit into four or more plot, an on 45% of farm the furthet plot wa more than 2 km away (European Commiion, 998, p. 5). 5 For a icuion about agricultural lan market in Polan an the Czech Republic, ee Ciaian (200). 6 The cot that farm face are relate to earch cot that may till arie when a farm leave the ector or rent out ome of hi lan. In aition farm (co-operative) may incur bargaining cot that arie when the lanowner i trying to withraw hi lan from the co-operative.

13 Equation 8 - the farm own lan upply - inclue alo tranaction cot tc. However, in thi cae they reflect their effect on the rental income tax that farmer pay. The lan rent that farmer earn from hi own lan upply i not fully oberve in practice for ifferent reaon uch a not reporting own conumption. Thu the reference rent for income tax calculation i taken the one that farmer pay to lanowner or the market rent lowere by the amount of tranaction cot, tc. Concerning the creit market, creit rationing i aume in the moel. Several factor le u to conier thi aumption. In general, the financial market in tranition countrie are unerevelope, which make it ifficult for the interete partie to obtain neceary creit to run a healthy buine. Thi i particularly a a reult of the financial ector' poor intitutional tructure, of the pat policie (buinee were not ue to operate uner har buget contrain), of the poor contract enforcement, of the lack of a kille banking taff, of the poor evelope accountancy an booking ytem an of the poor informational ytem in thee countrie (ee Koeter (200) an Swinnen an Gow (999)). Aitionally, the pecificity of the agricultural ector in general, uch a the exitence of many uncertaintie face by agricultural buine (eg. weather conition) an the ector' low profitability, a well a unfavourable input an output price evelopment in thee countrie, lea to a greater unwillingne of the financial ector to finance invetment project to farmer compare to other ector of the economy. The fragmente farm ector in mall family farm, a it i in Polan, alo contribute to lack of interet in the financial ector to provie creit to farmer in nee. Thi i becaue uually mall borrower are more riky an alo creening problem arie. In Slovakia an the Czech Republic thi eem to be le problematic becaue mot farm, co-operative an commercial farm are large. However, ue to the fact that the lan market i not working properly, the farm cannot ue lan a collateral, which i important to ecreae lener' rik, an thu having an eaier acce to creit. The implet way to moel creit contraint i by fixing capital upply. The lener offer farmer a fixe amount of creit, enote by K, at a fixe price, k. Thu K i the maximum amount of creit available to agricultural ector, which bin the proucer to expan invetment capital tock. However, in the cae of overupply of creit, that i when the creit upply i not bining, the upply i aume to have uual upwar loping hape repreente in figure 2 by the curve a. Thu the creit upply i a follow: 2

14 K min( K, K ), where K C ( k ( k (2) k k )) A final remark regaring the agricultural input factor i relate to their mobility to other ector of the economy. The upwar loping hape of the upply function - equation 8, 9, 0,, 2 - reflect their imperfect mobility. For the agricultural lan thi rather traitforwar: it upply i retricte an it cannot be ue in other ector of the economy therefore the lan upply i highly inelatic at the aggregate level. Concerning the capital, it pecificity make it imperfect mobile between the other ector. For the agricultural labour, low eucation level, agricultural pecific kill, farmer' unk invetment an unerevelope rural infratructure in CEEC make it le mobile (ee Swinnen et al. (2000)). However, in the long-run it i expecte that labour i able to ajut fater to economic conition in the country, hence the moel conier a relatively high labour upply repone to a change in agricultural wage but till being imperfectly mobile EUILIBRIUM CONDITIONS () Price equilibrium (3) P P ; P P ( ) ; I w P e P ( e ) r r ; w w ; v v ; k k k (2) Prouct market clearing (4) t ; I where: t I i total eman for ometically prouce goo. (5) e EU CEEC (3) Factor market clearing (6) 3

15 A L V A L V o o o A L p p V p K K 3.5. AGRICULTURAL POLICIES APPLIED IN THE MODEL Beie agricultural policie, the moel alo inclue general policie (VAT, income tax etc.) that are impoe on all economic agent in the coniere countrie. Thu the moel i calibrate for the bae year 999 with all policie inclue, agricultural a well a general one. The imulate cenario or counterfactual equilibrium i calculate with change agricultural policie only, a they were in the EU in 999. Thee inclue all agricultural meaure of the EU: market price upport, irect payment, export ubiie, tariff an other meaure. The import tariff an export ubiie were erive from the OECD ata from the percentage market price upport (%MPS) component of the proucer upport etimate. %MPS equal to the value of the price ifferential ivie by the prouction value. % MPS ( P S W. (7) S P P ) Thu the extent to which ometic price excee worl price ( P P W ) i given by ( % MPS). Thi price ratio i exactly analogou to a nominal import tariff or export ubiy. The acreage payment given uner the CAP to farmer wa moelle a a lan ubiy given to farmer ( a ). It value wa calculate a the average payment per hectare for 999. Concerning heaege payment, it wa aume that farmer will ue thi money to finance their invetment. Uually the farmer own the livetock bae on which the heaege payment are grante an not the lanowner that rent the lan to the farmer; thu thi money are expecte to tay with the farmer. Conequently, bae on thi conieration, thee payment will be ue by the farmer to ubtitute the creit, which i not available ue to the imperfect creit market, an they irectly increae the tock of invetment capital, which alo inclue livetock. 4

16 4. SELECTED SIMULATION RESULTS A recent European Commiion propoal et the trategy that will eal with the enlargement iue in agricultural area. A ytem of graual increae of irect payment for CEEC wa propoe tarting immeiately after the integration at a rate equivalent to 25% of the EU level an with a graual increae afterwar uch that, in 203 the full level of irect payment i reache. In orer to get an inie picture on how thee ifferent level of irect payment affect income an welfare in integrate CEEC, imulation with five level of irect payment were performe. Thee level are a follow: 0%, 25%, 35%, 60% an 00%. Regaring tranaction cot incurre to lanowner (tc) an tranaction cot incurre to farmer (- ) pecific value were choen, a hown in table 5 that eeme to be the mot reaonable for each of the three coniere countrie. The reult of the above imulation provie an important argument in upport of the propoal of the European Commiion not giving full level of the irect payment to CEEC farmer. The actual purpoe of the irect payment wa to compenate farmer for the income eterioration after the ecreae in market price upport of agricultural prouct, which wa the reult of the CAP reform. Table 6 how the change in income of the agricultural prouction factor with repect to bae year income, with five level of irect payment applie after the integration in Polan, the Czech Republic an Slovakia. Total agricultural income 7 in all three countrie increae ubtantially after the integration, even when the farmer get zero percent of the irect payment, thu giving no reaon to compenate farmer' income in CEEC. Polan experience the highet growth, while Slovakia experience the leat growth in both income categorie when comparion i mae between countrie. Difference in initial protection level applie in thoe countrie an ifference in compoition of the initial agricultural upport are main factor that explain thee figure. Polan an the Czech Republic apply motly market price upport, which i highly market itortive, an their initial upport level i lower than the one in Slovakia. On the other han, market price upport in Slovakia i le important in the overall agricultural upport, while a ubtantial hare have irect payment. 7 Total agricultural income i um of the all prouction factor' income earne in the agricultural ector. It inclue () farmer' income, (2) hire labour income, (3) lanowner' rental income an (4) income of the outie upplier of the variable capital (or outier' variable capital income). The farmer' income i further plit in () labour income, (2) rental income, (3) variable capital income an (4) invetment capital income. 5

17 A far a pecific income categorie are concerne the rental income experience the highet change, when compare with the other income categorie, by a factor between 0. an 8.7 (table 6). The explanation i rather traightforwar. The area payment given to farmer uner the CAP are irectly tranmitte into rental price change, ince lan upply i highly inelatic. Conequently, the change in the level of irect payment grante to CEEC' farmer will be reflecte in the change of lan rent an thu in the change of the total rental income. When looking at the change of labour an variable capital income, a common feature arie in all three countrie: the change i alway lower for the income of farm-upplie labour an variable capital than for the income of labour an capital that i upplie by other upplier. Thi i a a reult of the aumption of maller farmer' factor upply repone to price change compare to the repone of outier who react fater to price change, reflecte in lower own price elaticity for former input factor compare to latter input factor. The bugetary conequence of thee imulation are hown in table 7. Mot triking i the cae of no irect payment, which lea to a ecreae in government expeniture for Slovakia becaue of complete reuction of irect payment; thi i fairly important in the bae year 999. Table 8 how the etimate income itribution of factor employe in agriculture for Polan, the Czech Republic an Slovakia, repectively. Thoe value repreent the hare of pecific factor income category earne in agricultural ector on the total income generate by thi ector, with policie inclue. A a reult of higher involvement of iniviual family farm in Polan than in Slovakia an in the Czech Republic an a a reult of the ifference in intitutional tructure of thoe countrie, the income generate by the agricultural ector i itribute more favorably to farmer in Polan. Agricultural income in Polan i evenly allocate between farmer an other agricultural prouction factor (hire labour, lanowner an outie variable capital upplier) - 50%-50% - meanwhile in the Czech Republic an epecially in Slovakia, only le than a quarter of income generate by the agricultural ector remain in the ector, 23.4% an 9.2%, repectively, for the bae year. The larget hare of the total agricultural income goe to variable capital upplier' in all three countrie - between 78% an 85% - for the bae year 999, wherea the mallet hare goe to lanowner - between 2.2% an 5.6%. Following from lan ownerhip tructure an agricultural labour compoition, the hare of farmer' labour income an the hare of farmer' rental income i 6

18 higher than the hare of hire labour income an the hare of lanowner' rental income, repectively, in Polan for the bae year. The revere i vali for the Czech Republic an Slovakia. After the integration farmer' income increae le for the majority of the imulation compare to increae in the total agricultural income (table 6). Thee evelopment lea to a eterioration in the hare of farmer' income in the total agricultural income a hown in table 8 (A) Polan, (B) Czech Republic, (C) Slovakia. Due to intitutional ifference, uch a lan market imperfection an ownerhip tructure, only Polan, experience a higher increae in farmer' income than the total agricultural income increae, in the cae of full level of irect payment, an thu proucing a light improvement in farmer' income hare on the total agricultural income. The hare improve from aroun 50% in 999 to aroun 5% after the integration. Direct payment have a ignificant impact on lan rent, a hown in table 9, which may the reult of the moelling approach. The above mentione European Commiion propoal give the option for CEEC to implement a implifie an e-couple ytem of granting irect payment to farmer. An average area payment woul be calculate for each country that woul be applie to the whole agricultural area. Thi ytem i relatively highly tranparent, an the information on the level of area payment applie in each country woul be eaily acceible to all lanowner, farmer a well a lanowner, eg. trough new meia. Conequently, knowing the level of irect payment, lanowner may be willing to rent their lan only if they receive a portion of thee payment. Following thi reaoning, the treatment of irect payment a a irect farm lan ubiy in the moel eem appropriate. The imulate reult how that the rent in comparion to bae year 999 have increae by a factor between -0.9 an 2 for the cenario zero percent of irect payment an by a factor between 2 an 8 for the cenario of full level of irect payment. However, the preence of the tranaction cot, tc, in the lan market prouce a ituation in which lanowner' get a lower price than the market price i. Thi i hown in table 9. Thi arie becaue the increae of price which lanowner can obtain - for intance by earching for a better lan uer or by withrawing hi lan from the co-operative an again earching for a more efficient uer - will jut compenate the tranaction cot incurre. Conequently, it give no incentive to lanowner to take uch action, rather they continue to rent the lan to the ame uer. The mot affecte i Slovakia where, for the low level of irect payment grante to Slovak farmer, the lanowner rent i lower than the one obtaine in the bae year

19 Welfare effect of thee imulation reemble the above income evelopment to a large extent. Table 0 how the welfare before an after the integration for all three countrie an for all five level of irect payment. Both, the total welfare an the farmer' welfare increae even when farmer are grante zero percent of irect payment. Total welfare increae by 59% for Polan, by 45% for the Czech Republic an by 3% for Slovakia. For farmer' welfare, thee change are 53%, 28% an %, repectively. With the full level of irect payment, the welfare increae between 60% an 0%, the highet change being oberve in Polan an the mallet in Slovakia. In fact, total gain in welfare that reulte from the integration are motly channelle to non farm upplier of prouction factor in Slovakia an in the Czech Republic, uch a hire labour, lanowner an outie upplier of variable capital. Their gain are between 65% an 90% of the total integration welfare gain, epening on the level of irect payment. Contrary to Slovakia an the Czech Republic, in Polan the non-farm upplier of prouction factor get only about 24% to 40% of the total welfare gain reulte from the integration. 8

20 5. CONCLUSIONS A partial equilibrium moel for agricultural ector wa evelope to ae the impact of integrating Polan, the Czech Republic an Slovakia into the EU on welfare an income itribution of agricultural factor in thee three countrie. The moel ue the concept of tranaction cot to approach the problem of imperfect lan market an concerning creit market, creit rationing i aume. The moelling reult repreent the long run equilibrium ituation of the agricultural ector that arie after the aoption of the Common Agricultural Policy (CAP) by thee three countrie. The moel wa calibrate for the bae year 999, which i alo ue for comparion purpoe. Several imulation were performe in the paper with ifferent level of irect payment a given in the mot recent European Commiion propoal. Polan, with it large number of mall family farmer, with high labour intenive agriculture an with relatively better performing agricultural lan market, gain the mot in term of total value of ubiie an in term of increae of agricultural income an welfare after the integration. Depening on the level of irect payment grante to CEEC' farmer, the CAP expeniture on Polan are between 2 an 5.2 billion Euro, total agricultural income increae by aroun 5. to 6.2 billion Euro an finally welfare increae by aroun.9 to 3.3 billion Euro after the integration into the EU. When looking at pecific factor categorie, lanowner experience the larget gain in welfare an rental income ue to large increae of acreage payment. However, the hare of overall farmer' income on the total agricultural income, which comprie all income ource that are earne by input factor upplie by the farm, i practically unaffecte after the full aoption of the CAP, an it i negatively affecte if Polih farmer woul get only a mall hare of the irect payment applie in the EU. On the other han, Slovakia which ha an agricultural ector ominate by large farm that motly hire labour an rent lan from lanowner, a rigi agricultural lan market, an a higher initial protection level, gain the leat in term of increae in income, in ubiie an in welfare. Depening on the level of irect payment grante to CEEC' farmer, the CAP expeniture on Slovakia are between 0.2 an 0.55 billion Euro, total agricultural income increae by aroun 0.52 to 0.7 billion Euro an finally welfare increae by aroun 0.3 to 0.25 billion Euro after the integration into the EU. The rigi lan market caue a ubtantial hift of rental income from lanowner to farmer - motly to co-operative an commercial farm. For the low level of irect payment grante to CEEC' farmer the rent woul not 9

21 reach even the bae year perio level. The farmer' rental income increae the mot among all income categorie. However, it hare in the total agricultural income remain at a very low level after the integration. Thi evelopment can be attribute motly to the preence of a large number of co-operative an commercial farm, which itort agricultural lan market. Contrary to farmer' rental income, the hare of total farmer' income i averely affecte by the integration. It continue to ecline from a alreay low value, le than half-quarter, oberve before the integration. The Czech Republic i omewhere in between thee two countrie, in term of gain ue to integration, reembling mot cloely the Slovak cae a a reult of their imilarity in intitutional tructure. Thi i obviou ince both countrie plit from the ame country, Czecholovakia, in 993. The mot notable ifference i in a higher preence of private family farm in the Czech Republic, which contribute to income itribution more favourable to farmer, but till being far ifferent from the polih income itribution that repreent the other extreme. Depening on the level of irect payment grante to CEEC' farmer, the CAP expeniture on the Czech Republic are between 0.34 an.07 billion Euro, total agricultural income increae by aroun.2 to.4 billion Euro an finally welfare increae by aroun 0.3 to 0.50 billion Euro after the integration into the EU. Even the mot ceptical European Commiion propoal to give CEEC' farmer only 25% of the irect payment will bring an increae in welfare an income to agricultural factor in all three countrie. Thu, the fear that farmer woul be wort off after the integration compare to the ituation before the integration can be rule out. However, another iue arie, namely that of the itribution of extra income an welfare generate by the integration of CEEC in the EU an conequent aoption of the CAP. Intitutional tructure that i in Slovakia but alo in the Czech republic ha an avere impact on allocation of income an welfare that are generate by the integration. The major part of it - between 65% to 93% - i tranferre to outie input factor upplier, uch a hire labour, lanowner an outie variable capital upplier an not a eire to upport farmer' income. In Polan the gain reulting from the integration are allocate more favourably to farmer; outier retain only aroun 24% to 6%, epening on the level of irect payment. 20

22 APPENDIX A A.. Output Deman Elaticitie Regaring the choice of elaticitie, the literature wa conulte in earch of plauible value for thee parameter. There are few paper proviing etimate for CEEC, epecially at the aggregate level. Therefore, the moel ue proxie for thee parameter bae on the etimate foun in the literature for other countrie. A urvey of own-price eman elaticitie,, an income elaticitie, m, (for equation ()) i given in table 9. The own price-eman elaticity varie from a very low value of to a value of.49. The explanation for thi relatively high variation i ambiguou. Firt of all, the etimate eman elaticity epen on functional form pecification. On the other han, it i generally accepte that the own price elaticity of foo a a whole houl ecline in abolute value a income increae. 8 Thi argument i upporte by Finke et al.' (984) etimation of own-price elaticitie for 30 countrie. However, Pollak an Wale (978) report the convere. Thee value increae (rather then ecreae) with income. Thi paper follow the generally accepte argument, in chooing the own price elaticity of eman for CEEC. The pecific value for each CEEC i taken the Finke' (984) etimate elaticity of a country with imilar income a coniere CEEC. Thu, in general, a CEEC with a higher income ha own-price elaticity lower than a CEEC with a lower income. Table 2 (firt row) how electe elaticitie. Concerning the choice of income elaticitie, imilar argument were coniere a in the cae of the own-price elaticity, even though there are tuie reporting reult contrary to thi reaoning (Crombrugghe (997), Floo el al. (984)). For example, De Crombrugghe (997) etimate the income elaticity for the Netherlan increae over time, from 0.34 in 980 to 0.47 in 988. Thi implie an increae of elaticity with income. However, the ame paper alo report a ecreae in the income elaticity over time for the Unite State (US), from 0.60 in 94 to 0.55 in 950 an in 972. Moving further to the own-price elaticity of foreign eman (equation 2), a hort examination of the literature i ummarie in table 3; table 2 (row three) how the elaticie ue for the moelling. The fining of Breahl et al. (979) how a ubtantial 2

23 change in the elaticity when trae protection of the country that buy the exporte prouct increae. Therefore, crucial for chooing a pecific value for CEEC wa the trae protection of major CEEC' traing partner. In 999, aroun 62% of CEEC' export ha flown to EU an CEEC. Thu, upon integration the trae barrier will be lifte, making the eman more enitive to price. Finally, concerning the Armington aumption of prouct ifferentiation, the literature in mot cae i upportive for thi aumption. Mot notably, Trefler (995) fin that moelling an Armington home bia i tatitically an economically ignificant in explaining trae flow between countrie. Thi ifferential perception of actually phyically ientical goo may arie becaue of ifference in convenience of purchae, availability in time, after-ale ervice bunle with the goo, or even conumer' perception of inherent unobervable quality. The paper of Blonigen (999) bring ome evience, among other, that trae barrier may increae home bia, thu lowering the Armington elaticity,. A theoretical tuy of Turrini (200) argue that home bia arie ue to higher legal cot when buine i one abroa becaue of the ifference in legal ytem of traing countrie, thu making it cheaper to buy from ometic proucer. Further, he ugget that legal ytem harmoniation may increae cro-borer trae. Upon EU integration of CEEC, their economie will form a common market with the EU countrie, trae barrier will be lifte an the acqui communautaire will enter in force. Since in % of import to CEEC come from the EU an CEEC, the moel conier a relatively high elaticity of ubtitution between home prouct an importe prouct. A hort urvey of the literature on Armington elaticity of ubtitution, i given in table 4, an table 2 (row 4) give value applie in the moel. A.2. Prouction Elaticitie The elaticity of ubtitution between input,, i critical in aeing the impact of EU integration on factor' income. A value of lea to a Cobb-Dougla prouction function with the contant factor' income hare. The other intereting ituation i when the elaticity i zero; in thi cae the factor proportion are contant. However, thi oe not imply that elaticity of ubtitution of one or zero i wrong, the quetion i rather what the true value of thi parameter i. 8 The argument i bae on Engel' Law, tating that if income elaticity ecline with income, then the income 22

24 For the hort-run moelling the elaticity may be coniere cloe to zero becaue the factor compoition, epecially the tock or replacement of invetment capital, i not expecte to change ubtantially, even though the true elaticity i higher then zero. In the long-run moelling, however, all factor may change thu important i to know true value. Table 5 how that the ue of machinery an fertilier in majority CEEC i much lower than in the EU (revere i vali for labour). Therefore, if coniering that CEEC an EU have imilar technology, then ajutment in factor proportion nee to take place when the relative price will change ue to the aoption of CAP. Conequently, thi reaoning implie a relatively high elaticity of factor ubtitution (efinitely higher than zero) for the prouction function. A urvey of the literature on the etimate elaticity of ubtitution, uing a claification of factor' aggregation imilar to the one ue in thi paper, i provie in table 6. The meian of the etimate range from 0.2 to.. Table 2 (row 5) how the value ue in the moel for each CEEC. A.3. Prouction Factor' Elaticitie The following fact were aume or taken in conieration when chooing the elaticitie an other parameter for factor upply function. Farm labour i more attache to agricultural ector than hire labour i. The paper of Drie an Swinnen (2000) how a trong correlation between the regional outflow of labour from agriculture an the importance of tate farm in Polan. The higher the preence of the tate farm in a region wa the higher outflow of labour from the agriculture wa in that region. Thi implie a higher incentive of labour to tay in agriculture for the region where the iniviual family farming i more important. Agricultural labour i le eucate relative to labour employe in other ector of the economy (table 7). Hence, agricultural labour' alternative job opportunitie are retricte to ector that require le eucation an le kill, coniere in thi moel to be manufacturing or inutrial ector. Conequently a proxy for the opportunity wage of agricultural labour i ue average wage earne in the inutrial ector. effect component of own-price elaticity ecreae, thu leaing to a maller own-price elaticity. 23

25 Technically, an for agronomic reaon, it i more cotly for farmer to increae the upply of variable capital than for outie upplier. A a conequence of the above concluion, the farm-owne factor upply elaticitie are aume to be lower than elaticitie of purchae factor upply. A literature ummary of labour upply elaticity i reporte in table 8, an table 2 how the elaticitie ue in the moel. Due to natural retriction, lan upply i highly inelatic at the aggregate level. 24

26 APPENDIX B: DATA Thi appenix provie a hort ecription of the parameter an the variable ue in the moel an lit the ata ource: Variable or Parameter name Proxy ue Data Source Aggregate income, M GDP for 999, in current price -OECD: Main Economic Inicator: Non Member countrie 200; publihe by Statitic Directorate & CCNM, -OECD: Gro Dometic Prouct (GDP), from internet page of Tariff an export ubiy,, EU, CEEC, e EU CEEC e Export,, ; an import a I,,, l v k Calculate from PSE Monetary value of total export an import OECD -Documentation -OECD, Agricultural Policie in OECD countrie -OECD, Agricultural Policie in tranition countrie -European Commiion Value ae tax -Doing Buine in Polan Conumer tax, t - OECD: The tax ytem in the Czech Republic, Economic Department working paper No. 245, Low No 289/995: Low on value ae tax, Slovakia Monetary value of total -European Commiion: Economic account for agriculture Farm prouction:, agricultural prouction Calculate by uing the F.O.C, Ditribution parameter, factor' cot hare an bae year factor eman uantity of agricultural lan, A Utilie agricultural area -FAO internet ata bae uantity of own agric. lan, -Expert opinion o A uantitie of agricultural labour, L uantity of own labour, Opportunity wage, w o L Total population economic active in agriculture Average wage in inutrial ector -European Commiion: Economic account for agriculture -FAO internet ata bae -OECD: uarterly labour force Statitical yearbook of the republic of Polan, FAO internet ata bae -OECD: uarterly labour force Statitical yearbook of the republic of Polan, Statitical yearbook of the republic of Polan, Zelena zprava, Czech minitry of agriculture - Zelena prava, Slovak minitry of agriculture - Statitical yearbook of the Republic of Polan - Statitical yearbook of the Czech Republic - Statitical yearbook of Slovak Republic uantity of variable capital, V Total fertilier - conumption -FAO internet ata bae uantity of invetment capital, K Monetary value of invetment capital cot -European Commiion: Economic account for agriculture Lan tax an for integration Lan tax (ubiy if negative), a cenario area payment a well Variable capital tax (ubiy if negative), v Variable capital tax (ubiy if negative), v - Doing Buine in Polan - OECD: The tax ytem in the Czech Republic, Economic Department working paper No. 245, Low No 37/992: Low on property tax - Slovakia -European Commiion: DG agriculture Variable input ubiie -OECD, Agricultural Policie in OECD countrie, OECD, Agricultural Policie in tranition countrie, Zelena zprava, Czech minitry of agriculture -Zelena prava, Slovak minitry of agriculture -European Commiion: DG agriculture Creit ubiie an for integration cenario heaege payment. -OECD, Agricultural Policie in OECD countrie, OECD, Agricultural Policie in tranition countrie, Zelena zprava, Czech minitry of agriculture -Zelena prava, Slovak minitry of agriculture -European Commiion: DG agriculture Output ubiy, t Subiie bae on output -OECD, Agricultural Policie in OECD countrie, OECD, Agricultural Policie in tranition countrie, Zelena zprava, Czech minitry of agriculture -Zelena prava, Slovak minitry of agriculture -European Commiion: DG agriculture Dimantle ubiie, S Input upplier tax (ubiy if poitive), i Subiie that are not bae on prouction level or the factor ue Peronal income tax +ocial ecurity -OECD, Agricultural Policie in OECD countrie, OECD, Agricultural Policie in tranition countrie, Zelena zprava, Czech minitry of agriculture -Zelena prava, Slovak minitry of agriculture -European Commiion: DG agriculture - Doing Buine in Polan OECD: The tax ytem in the Czech Republic, -Economic Department working paper No. 245, Low No 366/999: Low on income tax - Slovakia 25