CAP reforms: effects on agriculture and environment

CAP reforms: effects on agriculture and environment Franz Sinabell and Erwin Schmid WIFO - Österreichisches Institut Für Wirtschaftsforschung franz.sinabell@wifo.ac.at Introduction The implementation of the Common Agricultural Policy (CAP) has been one of the core responsibilities of the European Union (the European Communities before the Maastricht Contract, respectively). According to the Treaty in 1962, the objectives of the common agricultural policy are: (1) to increase agricultural productivity by promoting technical progress and by ensuring the rational development of agricultural production and the optimum utilisation of the factors of production, in particular labour; (2) thus to ensure a fair standard of living for the agricultural community, in particular by increasing the individual earnings of persons engaged in agriculture; (3) to stabilise markets; (4) to assure the availability of supplies; (5) to ensure that supplies reach consumers at reasonable prices. The history of the CAP is a history of ever ongoing reforms (Ackrill, 2000) and a continuous struggle to make progress in attaining the policy goals. The policy instruments had remained untouched during the first three decades of the CAP, except

the introduction of milk quotas in 1984. In the 1980s, it became evident that the various mechanisms resulted in commodity surpluses, ever growing budgetary burden, and surmounting social costs (Buckwell 1982). A turning point in the operation of the CAP was introduced by Commissionar McSharry, who proposed a reform in 1992. When the reform was implemented in 1994, the dogma to reach income goals by high producer prices had been overcome. The reform introduced a set-aside scheme in the crop production sector, which allowed to curtail the crop land and to gain control of surpluses in some sectors. Three accompanying measures including an early retirement scheme, an agri-environment scheme, and a scheme for afforestation were part of the reform. The objective of the reform was to better address the goals listed above by a set of fine-tuned instruments, which took two more reforms to make the progress needed. The 1992 CAP reform introduced accompanying measures (CR 2078-1992), which were directed towards limiting the adverse effects of the reform of market regimes (price drops and introduction of crops and livestock premiums). Since then, funds allocated for such measures have taken up an ever increasing part of farm payments. Political agreement on the Agenda 2000 was reached at the Berlin European Council on 26 March 1999. The reform was launched in the form of twenty legislative texts with agriculture being among the priority fields. Emphasis was put on the continuation of the McSharry reform with a view to stimulating European competitiveness and taking greater account of environmental and food quality considerations. The reform acknowledged the multifunctional role of the European model of farming. At the instrumental level, the reform further reduced price supports for beef and cereals. Intervention prices for dairy products were lowered as well, but the implementation was postponed to the 2005/2006 marketing year because of the budgetary costs of the compensation of producers. The Agenda 2000 package brought about a new agenda for agriculture. It introduced the idea of an integrated rural development policy as a second pillar of the CAP. Therefore the policy addressed no longer one specific sector but a territorial entity. This move was not integrated into the structural policies of the EU but has remained in the domain of agricultural policy. Operationally, this brought together the 2

accompanying measures of the McSharry reform plus compensatory allowances under the less favoured areas measure, as well as rural development measures previously financed by the FEOGA Guidance Fund, into a single Rural Development Regulation. After the Agenda 2000 reform, these measures became part of the rural development programme (CR 1257-1999), which established the tools for a European model of agriculture. This vaguely defined long-term strategy has been aiming at strengthening rural development, improving the well-being of the farming community, and trying to achieve efficient and environmentally friendly farming. The programme is a synonym for the second pillar of the CAP, the rhetorical alternative to the first pillar of the CAP (market regimes for specific farm commodities, e.g. intervention, export refunds, production quota). Measures of the "first pillar" are financed solely by the EU funds. Financing of second pillar measures is shared between Member States and the EU. The CAP reform in 2003 The Agenda 2000 agreement covered the period 2000-2006, but mandated a mid-term review in 2003. In the summer of 2002, the European Commission published the midterm review of the Agenda 2000 reform. Based on this document, a detailed proposal for a Council Regulation was submitted in January 2003 in which elements for a followup reform were defined in detail. After a thorough discussion of reform issues between the European Commission and agricultural ministers of the EU member states, the Greek presidency achieved a compromise on 26 th June 2003. Decoupling of direct payments from farm output and the reduction of administrative prices were core elements of this reform. The goals of the reform were less output of cereals, beef and milk, to stabilise farm incomes, and a farm sector that should be more competitive. 3

The Mid-Term Review (MTR) had three main elements: (1) Decoupling - the bundling of all production-linked payments into a single farm payment (SFP). Farmers get payments on the basis of their historic entitlements and are linked to land rather than production levels. The eligibility for payments is subject to cross-compliance with a variety of EU environmental, animal welfare and food safety standards. (2) Continuation of the sectoral reform process - changes to the market regimes for important commodities such as durum wheat, rice and rye. (3) Modulation the transfer of money between CAP objectives - up to 5% of the value of the SFP to larger farmers will be transferred to rural development measures. (4) Financial discipline mechanism - payments can be further reduced to ensure that overall CAP expenditure on market and income support remains within budgetary limits. While this agreement is the core of the Mid-Term Review, further reforms were agreed in April 2004 with respect to a number of Mediterranean products (cotton, olive oil, tobacco). The Commission pushed forward reforms of the market orders of several more commodities like sugar, vegetables and wine in the aftermath of the 2003 reform. Model simulations showed that the objectives of the reform could likely be achieved. One result of such changes would be a slight acceleration in the rate of structural change (owing to the fact that the demand for farm labour will further decline). In order to facilitate the gradual structural adjustment, the presidency's compromise offered a wide scope for national modifications. Effects of the CAP reform 2003 on selected economic indicators The OECD publishes an international comparison of indicators of support for the agricultural sector in the annual monitoring report (Figure 1). The key indicators of this survey are the Producer Support Estimate (PSE) and the estimate of the Market Price Support (MPS) element within the range of support measures: 4

PSE is an indicator of the annual monetary value of gross transfers from consumers and taxpayers to support agricultural producers, measured at farm gate level. The PSE measures support arising from policies targeted at agriculture relative to a situation without such policies, i.e. when producers are subject only to general policies (including economic, social, environmental, and tax policies) of the country. The PSE is a gross value implying that the costs associated with such policies and incurred by individual producers are not deducted. It is also a nominal assistance value, i.e. increased costs associated with import duties on inputs are not deducted. Furthermore, it is a value net of producer contributions to help finance the policy measure (e.g. producer levies), and it shows a given transfer to producers. MPS is an element of the PSE, indicating the annual monetary value of gross transfers from consumers and taxpayers to agricultural producers arising from policy measures that create a gap between domestic producer prices and international reference prices. Conditional on the production of a specific commodity, MPS includes the transfer to producers for total production (for domestic use and exports), and is measured by the price gap applied to current production. In the case of livestock production, it is net of the market price support for domestically produced coarse grains and oilseeds used as animal feed. 5

Figure 4.1: Production, PSE, MPS, and the EAGGF expenditure in the EU 300,000 280,000 260,000 240,000 220,000 200,000 Total Value of Production (at farm gate) Mio. EURO 180,000 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 Producer Support Estimate (PSE) M arket Price Support (M PS) EAGGF Expenditure 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Source: OECD The comparison of the levels of PSE and MPS over the last two decades shows the effects of the CAP reform in 1992: an ever decreasing part of farm support (measured as PSE) is due to (direct and indirect) measures to lift domestic market prices above world market prices (see MPS versus PSE in Figure 1). This process has continued since the Agenda 2000 reform. Market price support was at its lowest level in the most recent years and much lower than during the time when the EU had only 12 Member States. The shift among support measures has several implications: the weight of direct support measures has been increasing, and the weight of export subsidies has declined. The reform efforts since 1992 have gained considerable momentum in 2003. The share of subsidies that are linked to output has been reduced considerably (see column subsidies on products in Table 4.1). Decoupled direct payments were paid first in 2005. The process of decoupling has not been adopted consequently in all EU Member States. In Germany, Luxembourg, Denmark and in the UK decoupling was thoroughly implemented. However, in France and in Spain there have been even more coupled subsidies in 2005 than in 2003. 6

The 2003 reform was achieved in a consensual manner because the overall volume of transfers was not touched. The volume of other subsidies was increasing in 2005 compared to 2003. National subsidies to agriculture did not change at EU level, but the levels of support changed within the EU Member states. 7

Table 4.2: Development of employment and income in Agriculture and GDP Employment in real factor income per real GDP agriculture labour unit 2003 2005 2003 2005 2003 2005 Ø 1999/2001= 100 Ø 1999/2001= 100 Ø 1999/2001= 100 EU 27 90 85.. 105 110 EU 25 93 89 100 99 105 110 EU 15 94 90 99 94 105 109 Belgium 97 93 102 101 104 109 Bulgaria 105 83.. 115 130 Chech Republic 102 91 82 143 109 121 Denmark 92 82 84 96 102 107 Germany 89 85 79 110 102 104 Estonia 62 60 160 250 125 149 Ireland 99 94 90 110 119 132 Greece 106 104 87 82 114 124 Spain 93 92 115 94 110 118 France 95 91 95 89 105 109 Italy 92 87 95 85 103 104 Cyprus 96 92 99 87 108 118 Latvia 94 93 120 208 123 147 Lithuania 93 74 98 195 125 144 Luxembourg 92 92 93 88 111 122 Hungaria 85 77 84 133 113 124 Malta 93 88 91 91 101 105 Netherlands 96 90 90 85 103 107 Austria 97 94 102 105 104 108 Poland 91 91 88 149 108 118 Portugal 96 85 88 92 103 105 Romania 78 75 111 93 116 131 Slovenia 90 85 102 163 110 120 Slovakia 83 69 89 108 113 126 8

Finland 94 85 111 125 107 114 Sweden 97 99 118 107 107 115 United Kingdom 88 87 128 116 108 113 Source: Economic Accounts of Agriculture, EUROSTAT Structural change in the agricultural sector is progressing in the EU. In EU-15 the farm sector lost 10 percent of its labour force within half of a decade (measured in annual working units, the statistical equivalent of fully employed persons). Not only employment declined but also real factor income per annual working unit. Therefore, EU farmers were worse off in 2005 compared with the reference period 1999/2001. Table 4.2 shows that GDP grew in every EU Member State in the same period. Farmers of the countries that entered the EU in 2004 were better off in 2005 than they were in 2003 and before. The same was true only in some EU-15 Member States. The assesment of the effects of the 2003 CAP reform on agriculture based on statistical data therefore shows that farmers in EU-15 were not better off after the reform. However, a longer term comparison is necessary for a final judgement. Expected effects of the CAP reform of 2003 on the environment results from case-studies Production linked subsidies, the predominant transfer vehicle in agriculture, are classified by the OECD as environmentally harmful (Portugal 2002; Steenblik 2002). Some observers maintain the position that on global scale agriculture is the primary threat for the environment (Clay 2004). Hence, attempts to quantify the impact of subsidies granted to this sector and the magnitude of their consequences for the environment is of substantial interest. The recent CAP provides an interesting example to analyze the consequences of farm subsidies on the natural environment because European agriculture is substantially subsidised and reliable agri-environmental indicators are available (OECD 2001, 2002). 9

An analysis of the Agenda 2000 reform concluded that it had significant economic costs but almost no effects on the environment neither positive nor negative (Wier et al. 2002). This case study was done for Denmark. For the case of Austria, Schmid and Sinabell (2007) analysed whether this conclusion holds for the 2003 CAP reform as well. A coherent way to evaluate the environmental improvements after policy reforms is to monitor indicators. OECD has developed a set of internationally accepted environmental indicators. In the field of agriculture, the work on indicators has been fruitful and recent publications allow sound country comparisons (OECD 2001). Consequently, the current CAP reform gives an opportunity to analyse how environmental indicators might change due to the abolishment of subsidies that were previously linked to farm output. OECD (2001) classified agri-environmental indicators according to the following categories: agriculture in the broader economic, social and environmental view with contextual information (like agricultural value added, farm employment) and information on farm financial resources (farm income, agri-environmental expenditures); farm management indicators of whole farms (organic farming, farm management plans), nutrient pest, soil, land, irrigation and water management; use of farm inputs and natural resources concerning nutrient use (nitrogen balance and efficiency), pesticide use and risk, and water use (water use intensity, water efficiency, water stress); environmental impacts of agriculture with respect to soil and water quality, land conservation, greenhouse gases, biodiversity, wildlife habitats, landscape and ecosystem diversity. 10

Schmid and Sinabell (2007) made a comparison of likely environmental consequences between a CAP policy with subsidies partly linked to production (Agenda 2000) versus decoupled subsidies (2003 CAP reform). The base-line scenario is a continuation of the Agenda 2000 reform in Austria until 2008. It is compared with two other scenarios: a) Austrian decoupling : This scenario is modelling the actual implementation of the reform the introduction of the single farm payment in Austria, given that the 'good agricultural and environmental condition' of land is maintained. Within limits, the payments coupled to heads of livestock (suckler cows and heifers), and to the output of beef (40% of the slaughter premium) will not be abolished. b) Complete decoupling : This scenario is similar to a) but goes beyond the reform. The single farm payment will be granted even if farmland is afforested. In this scenario it is possible to identify the implications of the conditionality of the single farm payment, which requires that land must be maintained in good agricultural condition. 11

b) Complete decoupling : This scenario is similar to a) but goes beyond the reform. The single farm payment will be granted even if farmland is afforested. In this scenario it is possible to identify the implications of the conditionality of the single farm payment, which requires that land must be maintained in good agricultural condition. Table 4.3: Expected environmental effects of the 2003 CAP reform in Austria Austrian complete implementation decoupling economic, factor use and output indicators gross value added plus other subsidies +0.7 +1.4 variable cost livestock products +2.5 3.4 variable cost crops 0.8 5.6 arable land 1.7 7.0 meadows and pastures +3.1 2.6 output of beef 3.3 6.8 output of pork ±0.0 2.1 farm management and environmental indicators organic farming on arable land 1.0 2.7 organic farming subsidies +1.0 2.6 soil cover during winter 1.6 7.3 livestock units (total) 0.3 3.1 average livestock units per hectare 1.0 +1.9 methane emission 0.5 3.5 carbon storage in soil +0.1 +1.1 nitrate from manure 0.1 3.1 nitrate from mineral fertilizers 0.9 7.2 nitrogen surplus (OECD method) ±0.0 2.8 Source: Schmid and Sinabell, 2007 12

According to these results, cross compliance conditions (among them maximum numbers of livestock per hectare, and good agricultural practices) have no environmental consequence in this case study. This is due to two factors: i) the requirements of the agri-environmental program are stricter and ii) almost all land is managed according to the rules of this program. The requirement to maintain land not only in good environmental, but also in good agricultural condition, prevents farmland afforestation. If this condition was relaxed, the acreage of farmland, in particular arable land would shrink significantly (column complete decoupling in Table 4.3). The remaining farmland would be managed relatively more intensively (e.g. on average more livestock-units per hectare). Environmental indicators measuring soil fertility (organic carbon), air pollution (methane emission), and water quality (surplus of nitrates and livestock density) are showing diminishing pressures on the environment. This is mainly due to changing land uses (expansion of grassland while arable land is reduced) and a smaller cattle herd. The acreage of arable land that is organically farmed decreases slightly, but to a lesser extent than conventionally managed arable land. This can be explained by the assumption that support for organic farming in 2008 will be the same as before the reform. This implies that the share of premiums for organic farming in crop revenues will get larger. Soil cover in wintertime is declining at the same pace as arable land but the relative share remains the same. The environmental benefits of the 2003 CAP reform are primarily the consequence of changing land-uses (more grassland means more soil organic matter compared to arable land) and a smaller herd of bulls (less methane emission, fewer livestock units and less nitrogen surplus). According to the model results, declining outputs of crops and beef will not be compensated by a corresponding rise of pig or poultry production; therefore, the benefits of lower production levels will not be offset. The fact that the conditions of the single farm payment do not allow afforestation is 13

interpreted to be positive because summer tourists in Austria have a preference for open agricultural landscapes (Hackl and Pruckner 1997). After the 2003 CAP reform, the opportunity costs of adopting farm practices, which are widely assumed to be environmentally friendly, are lower. This view is supported by the findings of the model simulations. Given that arable land would shrink between 1.5 and 7%, whereas organically managed arable land would only decline between 1 and 2.7%, indicates that organic farming will become more attractive for farmers. Conclusions The CAP reform 2003 was a consequent further step of the reform initiated by commissionar McSharry in 1992. The market distorting effects of direct payments has been reduced by decoupling some of them. Not all Member States have implemented the reform as consequently as intended by commissionar Fischler in 2003. Therefore, the commission has taken the initiative in the current CAP reform evaluation (health check of the CAP reform 2003) debate to push forward reforms on the way for further decoupling. The results of the OECD show that market distorting interventions of the EU have been reduced. In the EU-27, the level of market price support in nominal terms is lower than it was 15 years ago. Negative spillovers to other commodity markets and to international markets of agricultural products have been reduced. Further steps in countries like France, Netherlands and Spain will be needed to progress with the process of decoupling support from production. It is too early to draw final conclusions on the effects of the 2003 CAP reform for the agricultural sector and the environment. Model results from Austria suggest that decoupling has positive effects on the environment because farming will become more extensive. High commodity prices as those observed in 2007 will counterbalance this 14

effect but one of the claims of the 2003 reform farming will become more sustainable seems to be justified. Another claim that farmers will be better off has not yet materialised for all EU Member States. References Buckwell, A., (1982) The Costs of the Common Agricultural Policy, (London: Croom Helm). Ackrill, R., (2000) The Common Agricultural Policy. Contemporary European studies 9. (Sheffield: Sheffield Acad. Press). Clay, J., (2004) World Agriculture and the Environment. A Commodity-by-Commodity Guide to Impacts and Practices. (Washington DC: Island Press). Hackl, F and G. J. Pruckner, (1997) Towards more efficient compensation programs for tourists' benefits from agriculture in Europe, Environmental & Resource Economics 10, 189 205. OECD, (2001) Environmental Indicators for Agriculture Volume 3 methods and results, (Paris: OECD). OECD, (2002) Environmentally Harmful Subsidies Policy Issues and Challenges, (Paris: OECD). Portugal, L., (2002) Methodology for the Measurement of Support and Use in Policy Evaluation. OECD Directorate for Food, Agriculture and Fisheries, Paris, available at: <http://www.oecd.org/dataoecd/36/47/1937457.pdf.> Schmid, E., and F. Sinabell, (2007) On the Choice of Farm Management Practices after the Common Agricultural Policy Reform 2003. Journal of Environmental Management. 82:3, 332 40. Steenblik, R., (2002). Subsidy Measurement and Classification: Developing a Common Framework. Environmentally Harmful Subsidies: Policy Issues and Challenges. (Paris: Organisation for Economic Co-operation and Development), 101 41. 15

Wier, M. J., Andersen, M., Jensen, J. D., Jensen, Th. C., (2002) The EU's Agenda 2000 reform for the agricultural sector: environmental and economic effects in Denmark. Ecological Economics, 41:2, 345 59. 16