EFFECTS ON INVESTMENT OF THE 2003 CAP REFORM: A HOUSEHOLD PRODUCTION MODEL FOR DUTCH DAIRY FARMS

Transcription

1 EFFECTS N INVESTMENT F THE 2003 CAP REFRM: A HUSEHLD PRDUCTIN MDEL FR DUTCH DAIRY FARMS Jack Peerlings Agriculural Economics and Rural Policy Group Wageningen Universiy Hollandseweg KN Wageningen Tel.: Fax: Inerne: Paper prepared for presenaion a he 11 h congress of he EAAE (European Associaion of Agriculural Economiss), Copenhagen, Denmark, Augus 24-27, 2005

2 EFFECTS N INVESTMENT F THE 2003 CAP REFRM: A HUSEHLD PRDUCTIN MDEL FR DUTCH DAIRY FARMS Absrac This paper develops a non-separable household producion model capable of analysing he effecs of he 2003 CAP reform, and especially EU farm paymens, on individual Duch dairy farms. Model resuls show ha he 2003 CAP reform farm paymens do no fully compensae he income loss caused by he milk price decrease. This implies ha savings, and herefore, invesmen decreases. Invesmen shifs away from on-farm invesmen o off-farm invesmen. n-farm invesmen in milk quoas falls compared o invesmen in capial and land because he shadow price of milk quoas decreases relaively o he shadow prices of land and capial. Keywords: Direc income paymens, invesmen, household producion model JEL: Q12, Q18 1. Inroducion Direc income paymens are a common and increasingly used policy insrumen in developed counries o suppor farm incomes. Direc income paymens can be coupled, linked o producion, or decoupled, no linked o producion. The European Union (EU) inroduced in he 2003 Common Agriculural Policy reform (2003 CAP reform) farm paymens, replacing all oher exising direc income paymens (European Commission, 2003). Farm paymens are direc income paymens linked o land and based on hisorical suppor levels. These farm paymens are claimed o be decoupled because hey are no linked o acual producion levels. Because farm paymens are made radable wihou he acual ransfer of land he link o land is also weak. To provide really decoupled direc income paymens is probably impossible because direc income paymens influence income levels, and herefore, savings. Savings in urn affec invesmen decisions, and herefore, fuure producion. Through he influence of direc income paymens on income, on-farm and off-farm labour supply decisions could also be influenced. This also has an effec on producion. The degree of decoupledness is an imporan issue in WT rade liberalisaion negoiaions where especially developing counries quesion he decoupledness of he direc income paymens in boh he EU and US. To undersand and quanify he effec of direc income paymens on producion i is necessary o develop heoreical and empirical models ha ake ino accoun no only producion behaviour of farms bu also savings and invesmen behaviour of farm households and labour supply decisions of farm households. These models have o be farm-specific because of large differences in he level of farm paymens, income and invesmen behaviour. Non-separable household producion models are a possible candidae (see Löfgren and Robinson, 1999; Taylor and Adelman, 2003). Alhough household producion models are common in he developmen economics lieraure hey are scarce for developed counries. Moreover, o he bes of our knowledge we do no know examples of household producion models ha focus on invesmen. The aim of his paper is o develop a non-separable household producion model o simulae he effecs of he EUs 2003 CAP reform and especially he farm paymens on invesmen behaviour by individual Duch dairy farms. Analysis of invesmen behaviour gives insigh in he degree of decoupledness of farm paymens. 1

3 Secion 2 describes he empirical model used o analyse he effecs of he 2003 CAP reform and especially inroducing farm paymens in Duch dairy farming. Secion 3 describes daa and calibraion procedure applied. Model simulaions and resuls are he subjec of secion 4. The paper concludes wih he main findings and a general discussion of he model used. 2. Empirical model This secion presens an empirical saic household producion model for individual Duch dairy farms. To simplify noaion he subscrip indicaing individual farms is omied. The subscrip indicaes years (alhough he model is saic). Producion We assume ha echnology can be represened by a consan reurns o scale CES producion funcion (e.g. Sao, 1967). A CES producion funcion implies ha all inpus are subsiues and he subsiuion elasiciies beween all possible combinaions of inpus are equal. To simplify he analysis we assume a single fixed oupu (milk). Inpus defined are capial (i=1), labour boh hired (i=2) and self-employed (i=3), land (i=4), dairy cale (i=5), feed (i=6) and oher inpu (i=7). Wih consan reurns o scale pure profis are zero and producers will minimise cos. Cos minimisaion also follows from he fac ha oupu (milk producion) is assumed fixed. Cos minimisaion leads o he following inpu demand funcions and zero profi condiions respecively: σ 1 σ M 1 σ σ σ 1 σ xi, = yγ αi wi, αi wi, i=1,,m (1) i= 1 M wi, xi, + ren = py (2) i= 1 wih: x i, : inpu i; Γ : efficiency parameer; y : oupu; w i, : price of inpu i; p : oupu price; α i : disribuion parameer; σ : subsiuion elasiciy; ren : quoa ren. A bar indicaes fixed. We assume capial, hired labour and land fixed. This implies ha equaion (1) gives he inverse shadow price equaions for hese inpus. Capial depreciaion and paid facor coss Paid facor coss (e.g. paid ineres and lease coss of milk quoas) are assumed fixed wihin a year. We assume capial depreciaion also o be exogenous. Capial depreciaion is relevan for capial bu also for milk quoas. If he laer are bough han hey can be depreciaed (in 8 years ime). Paid facor coss and capial depreciaion equal: B = (3) B WAF = WAF (4) wih: B : paid facor coss; WAF : capial depreciaion (value). 2

4 Consumpion The farm household derives uiliy from he consumpion of goods and services and leisure. Consumpion expendiure is assumed exogenous. The household supplies off-farm labour and on-farm labour. Toal labour supply, and herefore leisure, is assumed fixed. From he supply of off-farm labour he farms receives exernal labour income. The farm household supplies capial boh o he farm and o non-farm aciviies. From he laer i receives exernal income. We assume off-farm capial supply and income from capial supplied o non-farm aciviies fixed. Expendiure on goods and services equals: C = (5) c Y c wih: C : expendiure on goods and services; Y : income spen on consumpion of goods and services. Assuming a CET ransformaion funcion and revenue maximisaion from labour supply leads o he following supply funcions for on-farm and off-farm labour supply: ( ) 1 ( ) 1 σ L o a 1 o σl o σl o σl o σl σl σl σ L L, L, L L L, L L, L 3, ( θ ) ( ) ( θ ) ( ) ( θ ) ( ) z = z Γ q q + w (6) σ L a 1 σl σl o σl o σl σl σl σ L 3, L, L L 3, L L, L 3, ( θ ) ( ) ( θ ) ( ) ( θ ) ( ) x = z Γ w q + w (7) wih: o a o z L, : off-farm labour supply; z L, : oal availabiliy of labour; q L, : effecive off-farm o wage; x 3, : on-farm labour supply; Γ L : efficiency parameer; θ L : disribuion parameer for off-farm labour supply; θ L : disribuion parameer for on-farm labour supply; σ L : ransformaion elasiciy. Equaions (6) and (7) show ha on-farm and off-farm labour supply depend on oal labour supply (which is fixed) and he relaive prices of on-farm and off-farm labour supply. Labour supply is herefore assumed o be income independen. Equaions (6) and (7) imply ha if a farm does no supply off-farm labour i will also no do in any of he simulaions. Because of he consan reurns o scale assumpion profis equal he sum of he quoa ren and facor rewards from supplying household labour, capial and land on-farm. Toal household income equals profi (income from farming) plus income from labour supplied ouside he farm plus exernal income (including income from capial supply) minus paid facor coss minus capial depreciaion: L o o = q z (8) Y L, L, = 1, w1, + x3, w3, + x4, w4, π x + ren (9) Y L E = π + Y + Y B WAF (10) wih: Y : income from exernal labour supply; π : profis; : oal household income; E Y L : exernal income. Ne savings ( S c S ) equal income minus expendiure on goods and services: = Y Y (11) Y 3

5 Invesmen We assume a simple invesmen model in which a farm follows wo possible sraegies. Firs, he farm decides o inves is savings eiher on-farm or off-farm. Capial depreciaion is used o keep boh capial and quoas a heir iniial levels. So, he farm finances ne invesmens compleely wih is own savings. This sraegy could be considered as defensive. Second, insead of using savings o finance ne invesmens savings are used o arac as much as possible exernal financial means. However, invesmens are limied by a solvabiliy requiremen. Furher we assume no off-farm invesmen akes place because financing offfarm invesmen wih non-farm capial seems conradicionary. So, invesmens are only parially financed wih own capial and no off-farm invesmen akes place. This sraegy could be considered as offensive. In his saic model we calculae invesmens for boh opions. However, because we have a saic model we do no look a he dynamic effecs (e.g. effec on producion and capial depreciaion in nex years). Defensive invesmen sraegy In he defensive sraegy he value of invesmen ( I 1 ) equals savings. The value of invesmen is he produc of a quaniy of capial invesed ( w S I, ) and a reurn on invesmen ( ). Moreover, he value of invesmen equals he sum of he value of invesmen on-farm and invesmen off-farm: I1 = S = S S = w I + w I (12) w on on of of I, I, I, I, S I, wih: quaniy o be invesed; : weighed average reurn on savings; : on-farm reurn; w on S I, S I, w I, of w I, : off-farm reurn. Assuming a CET ransformaion funcion and revenue maximisaion leads o he following supply funcions for on-farm and off-farm invesmen: ( ) 1 ( ) 1 σ I on 1 on σi on σi o σi on σl of σi of σi σ I I, I I I, I I, I I, ( θ ) ( ) ( θ ) ( ) ( θ ) ( ) I = S Γ w w + w (13) σ I of 1 of σi of σi o σi on σl of σi of σi σ I I, I I I, I I, I I, ( θ ) ( ) ( θ ) ( ) ( θ ) ( ) I = S Γ w w + w (14) on of on wih: I I, : on-farm invesmen; I I, : off-farm invesmen; Γ I : efficiency parameer; θ I : disribuion parameer for on-farm invesmen; invesmen; σ I : ransformaion elasiciy. of θ I : disribuion parameer for off-farm Equaions (13) and (14) sae ha on-farm and off-farm invesmen are imperfec subsiues and depend on he level of savings and he relaive reurn on on-farm and off-farm invesmen. Given on-farm invesmen he farm eiher invess ino capial (buildings and machinery), land or quoas. These invesmen alernaives are assumed o be imperfec subsiues. Assuming a CET ransformaion funcion and revenue maximisaion leads o he following supply funcions for invesmen in capial, land and quoas: σ cap on 1 cap σ 1 σ σ ( θ ) ( 1, ) I = I Γ w J (15) 4

6 σ land on 1 land σ 1 σ σ ( θ ) ( 4, ) I = I Γ w J (16) σ quo on quo quo 1 σ σ 1 σ ( θ ) (, ) cap σ σ land σ σ quo σ ( θ ) ( 1, ) ( θ ) ( 4, ) ( θ ) ( quo, ) I = I Γ w J (17) J = w + w + w cap land wih: I1 : ne invesmens (value); I : invesmen in capial;: I invesmen in land; quo cap I invesmen in quoa; wquo, : shadow price quoa; Γ : efficiency parameer; θ : land θ σ disribuion parameer for capial; : disribuion parameer for land; parameer for quoa; σ : ransformaion elasiciy. quo θ (18) : disribuion Furher i is rue ha: on on cap land quo w I = w I + w I + w I (19) I, 1, 4, quo, So on-farm invesmens in capial, land and quoas depend on he relaive reurns on hese invesmens and he oal level of on-farm invesmen. These relaive reurns equal he shadow prices of he fixed inpus land, capial and quoas. Equaions (12) ill (19) can be inerpreed as he way he farm divides he money o be invesed over he differen invesmen opporuniies. If here is a relaive change in he shadow prices of one of he fixed inpus and he off-farm reurn his affecs he disribuion. n-farm invesmens do no equal he acual increase in land, capial and quoas. This increase depends on he marke prices of land, capial and quoas. ffensive invesmen sraegy Wih he offensive sraegy he farm ries o borrow as much exra money as possible. Banks in general will impose he farm wo resricions. Firs, he farm should be able o pay back ineres and insalmens. Second, he farm should mee a solvabiliy requiremen so i can pay back is long erm debs. These requiremens lead o differen amouns of money ha can be borrowed. The payback requiremen gives: I2a = S r + ϕ ( 1 ϑ ) (20) The solvabiliy requiremen gives: I 2 b = ((1 dvv ) TV VV (21) Invesmen equals: I 2 = min I 2a, I 2b ) (22) ( wih: I 2a : ne invesmens when farm aracs as much as possible exernal financial means given ineres and axes; ϕ : share of he money ha has o be paid back yearly; VV : money borrowed; ϑ : share of income ha has o be paid on income axes; r : ineres; I 2b : invesmen when he farm aracs as much exernal financial means given ha he farm wans o mainain a cerain level of solvabiliy; dvv : solvabiliy requiremen; I 2 : level of invesmen when he farm invess as much as possible. 5

7 Equaion (20) gives he presen value of he savings. So i is assumed ha he farm uses every year savings o pay ineres and insalmens correced for axes. Replacemen invesmens are excluded here because i is assumed ha capial depreciaion covers invesmen coss. The firs erm in equaion (21) gives he oal money ha can be borrowed given he solvabiliy required. The firs erm on he righ hand side gives he maximum amoun of money o be borrowed. The las erm on he righ hand side gives he money already borrowed. The difference beween boh erms gives he exra money ha can be borrowed. Equaion (22) saes ha he acual invesmen level equals he minimum of he oucomes of equaion (20) and (21) respecively. From equaion (22) oal on-farm invesmen follows. Using equaions (15-19) invesmens in capial, land and quoas can be deermined. 3. Daa and calibraion The model is calibraed using daa for all dairy farms in a represenaive sample of Duch dairy farms in he year 1999/00 ha keep a financial bookkeeping for he Agriculural Research Insiue (LEI). Calibraion means ha coefficiens are chosen such ha he model reproduces he acual daa for 1999/00. All prices are se equal o one implying ha all price changes are relaive o base year prices. Assuming prices equal o one he quaniies of fixed inpus are calculaed by dividing profi using he shares in normaive coss of labour, land, capial and milk quoas. Equaions (15-19) are calibraed using he disribuion of oal invesed capial in he differen asses (capial, land, quoas and off-farm invesmens) in 1999/00. The acual invesmen levels (change in oal capial invesed) in 1999/00 are no aken ino given ha we look in his paper a differen possible sraegies giving differen oucomes. Exra informaion is needed on he subsiuion and ransformaion elasiciies. Given ha he model is a shor o medium-erm model hese elasiciies are chosen o be small. Subsiuion and ransformaion elasiciies are se arbirarily equal o 0.4. For ϕ (share of he money ha has o be paid back yearly) a value of 0.1 (10%) is chosen. Forϑ, he share of income ha has o be paid on income axes, a value of 0.4 (40%) is chosen. This is he mos common marginal ax rae in he Neherlands for enrepenuers. For he ineres rae ( ) we ake 0.06 (6%). We se he solvabiliy requiremen dvv equal o 0.4 (40%). The laer implies ha of all capial invesed in he farm 40% has o be financed by own means. r 4. Simulaion and resuls Scenario Base scenario The base scenario is he acual siuaion in 1999/00. This implies ha he model calculaes back he acual inpu use, income levels and savings of he individual farms in he sample. The model hen calculaes wha invesmens would be under he wo sraegies defined (boh on-farm and off-farm invesmen and invesmen equal o savings; invesmen only on-farm and invesmen equal o he maximum borrowing capaciy) CAP reform In his scenario we inroduce he 2003 CAP reform (European Commission, 2003). We assume a milk price decrease of 15%. This is he expeced milk price decrease in he Neherlands. Moreover, milk quoas increase by 1.5%. The hird elemen is a decoupled direc income paymen of 35.5 euro per onne of milk producion. This paymen is modelled as an exogenous income ransfer from he governmen o he farms (see equaion 10). 6

8 Direc income paymen To isolae he effec of he direc income paymen we inroduce in his scenario a decoupled direc income paymen of 35.5 euro per onne of milk as in he 2003 CAP reform. A he same ime we decrease he milk price wih he same value of 35.5 euro per onne of milk. This scenario keeps oal household income unchanged. The model is applied for a subse of 41 farms in he sample insead of all 464 farms in 1999/00 given lack of ime. Resuls Resuls show ha quoas are sill binding afer he 2003 CAP reform for all farms excep one farm. For his farm he quoa is only jus no binding. This implies ha changes in he demand of variable inpus and shadow prices of he quasi-fixed inpus are only deermined by he 1.5% quoa increase. Demand for variable inpus and shadow prices of fixed inpus increase (become scarcer). The increase in shadow price for household labour leads o a decrease in off-farm household labour supply of 1.1% (on-farm use is more profiable). The way off-farm labour supply is modelled implies ha farms ha in he base run do no supply off-farm labour (21 farms) canno swich o off-farm labour suppliers. The higher shadow price also makes ha household labour is parially subsiued by variable inpus (including hired labour for hose 23 farms ha already in he base run hire labour). The increase in producion leads o an increase in he shadow price of milk producion (marginal cos of milk producion) of 1.8%. This increase in he shadow price of milk producion has a negaive effec on he shadow price of he milk quoa and quoa ren. Alhough he milk price decrease does no affec producion i has a (srong) negaive effec on he shadow price of he milk quoa and quoa ren. The increase in quoa and he milk price decrease lead o a milk quoa price reducion of 57.2%. Given consan paid facor coss household income from farming is negaively affeced. In he iniial siuaion one farm has a negaive income from farming, afer he 2003 CAP reform his is 17 farms. The average reducion in income from farming is euro. The reducion in off-farm household labour supply negaively affecs off-farm income. The direc income paymens do no compensae for he full income loss. Toal household income falls on average wih euro. This resuls also in a reducion of average savings of average payback capaciy of euro because he value of consumpion expendiure is kep consan. Table 1. Effecs of he 2003 CAP reform (resuls in percenage change or change in euros compared o he base run for he average farm) CAP reform Percenage change in: Milk producion 1.5 Shadow price milk producion 1.8 Shadow price milk quoa ff-farm labour supply -1.1 Feed 2.2 Household labour 0.1 Absolue changes in: Income from farming Household income Savings Pay back capaciy

9 Invesmen In he base run 21 ou of he 41 farms have posiive savings. Afer he 2003 CAP reform 12 of hem sill have posiive savings. In he case farms inves savings boh on-farm and off-farm (defensive sraegy) off-farm invesmen becomes more aracive in comparison o on-farm invesmen bu boh decrease. Toal off-farm invesmen falls on average wih 36.8% (for hose farms sill invesing) while on-farm invesmen falls on average wih 53.0% (for hose farms sill invesing). The increase in he shadow price of land and capial make i relaively more aracive o inves in hese wo asses (capial -45.0% and land -44.7%). The large decrease in he shadow price of he milk quoas, caused boh by he milk price decrease and he increase in quoas, make i less aracive o inves in quoas (-58.7%). In he case farms inves only on-farm and invesmen equals he maximum borrowing capaciy (equaion 22) in he base run only 13 farms inves. The reason for his smaller number is ha alhough more farms have posiive savings (21) he solvabiliy requiremen prevens farms from invesing. In case of he 2003 CAP reform only 9 farms wan o inves. All hese 9 farms also have posiive savings. These farms average on-farm invesmen shows a decrease of 48.7% (capial -39.9, land -38.2, quoa -54.7). Direc income paymens A decoupled direc income paymen of 35.5 euro per onne of milk in combinaion wih a decrease in he milk price wih he same value of 35.5 euro per onne of milk producion, inpu use, shadow prices of fixed inpus, oal household income and savings he same. The fall in income from farming (-18.4%) is fully compensaed by he direc income paymen. So, oal invesmens are no affeced. However, he milk price decrease reduces he shadow price of he milk quoas (-30.9%). This makes i more aracive o inves off-farm and in capial and land and less aracive o inves in milk quoas. In he case farms inves only on-farm, invesmens in capial, land and quoas change wih 8.6%, 8.4% and -4.4% respecively. In he case farms inves boh on-farm and off-farm, off-farm invesmens increase wih 7.1% and on-farm invesmens fall wih 1.1%. Invesmens in capial, land and quoas change wih 7.4%, 7.4% and -5.3% respecively. 5. Discussion and conclusions The aim of his paper is o develop a non-separable household producion model ha is capable of simulaing he effecs of he 2003 CAP reform, and especially EU farm paymens, on individual dairy farms in Duch dairy farming. f special ineres are he effecs on invesmen as hey affec fuure producion levels, and herefore, give insigh in he degree of decoupledness of direc income paymens. Dairy farming operaes under a supply quoa regime implying ha oal milk producion is no affeced as long as quoas are binding and rade in milk quoas is no aking ino accoun. Model resuls show ha he 2003 CAP reform farm paymens do no fully compensae he income loss caused by he milk price decrease. This implies ha savings are reduced. This implies invesmen decreases excep for hose farms ha do no wan o inves. Invesmen shifs away from on-farm invesmen o off-farm invesmen. n-farm invesmen in milk quoas falls compared o invesmen in capial and land because he shadow price of milk quoas decreases relaively o he shadow prices of land and capial. Model resuls show ha decoupled direc income paymens wihou any oher changes increase savings, and herefore, invesmen levels for some (bu no all) farms. In he Duch dairy secor where milk quoas are binding oal producion will no be affeced bu wihin he secor producion will shif beween farms (wih quoa radabiliy) and here will be an effec on inpu use (given he differences in echnology beween farms). In real world siuaions direc income paymens will be accompanied by oher measures, e.g. price decreases. Direc income paymens ha compensae exacly for he income loss will sill have an effec on how invesmen akes place because he oher measures will change he profiabiliy of he alernaive invesmen opporuniies. 8

10 The model is subjec o some qualificaions. Firs, dynamic effecs of invesmen on producion and fixed inpus are no aken ino accoun. The model calculaes he value of invesmen in he differen asses using he relaive shadow prices of hese asses. Acual invesmen levels also depend on he prices of he asses (acquisiion coss). Second, he model is no economerically esimaed nor esed. Fuure research will be direced owards a dynamic version of he model and economeric esimaion. Moreover, model resuls sill have o be calculaed for he remaining farms in he sample. Despie he qualificaions he model is a srong ool o analyse he effecs of policy changes in Duch dairy farming and analyse he poenial effecs of direc income paymens. References European Commission (2002). Communicaion from he Commission o he Council and he European Parliamen: Mid-Term Review of he Common Agriculural Policy - CM(2002) 394 final: Brussels. (hp://europa.eu.in/comm/agriculure/mr/comdoc_en.pdf) Löfgren, H., and S. Robinson (1999). Nonseparable farm household decisions in a compuable general equilibrium model. Amercian Journal of Agriculural Economics 81-3: Sao, K. (1967). A wo-level Consan-Elasiciy-of-Subsiuion producion funcion, Review of Economic Sudies 34: Taylor, J.E. and I. Adelman (2003). Agriculural household models: genesis, evoluion, and exensions. Review of Economics of he Household 2: