CAP Reform – the Luxembourg Agreement 2003 and Decoupling

1. CAP Reform – the Luxembourg Agreement 2003 and Decoupling Lecture 9. Economics of Food Markets Alan Matthews

2. Lecture outline • To describe the component elements of the Mid Term Review (MTR) Agreement in 2003 and how it has been implemented • To review studies on the impact of the MTR both in the EU and Ireland • To provide an economic analysis of decoupling of direct payments

3. The MTR Agreement • June 2003 Agreement • Intervention price cuts (rice, dairy) • Decoupling • Cross-compliance • Modulation • Financial discipline • Mediterranean package April 2004 • Sugar November 2005

4. Intervention price cuts - dairy • Dairy quotas will be maintained until the 2014/15 season. • Asymmetric price reductions for butter and SMP. The intervention price for butter will be reduced by 25% between 2004 and 2007 (10% more than agreed in Agenda 2000), for SMP, prices will be cut by 15%. • Compensation payments are provided to milk producers as part of the Single Farm Payment from 2007, but Member States may introduce it from 2005.

5. Decoupling: rationale for Commission proposals • Simplification of payment arrangements • Encourages greater market orientation • Will reduce pressure on environment • Will improve efficiency of income transfer to farmers • Will make it easier to extend CAP to accession countries • Will make it easier to defend payments in the WTO

6. Decoupling – the options • Full or partial decoupling • Various shares of payments can remain commodity-specific (coupled) – next slide • Time of implementation • Between 2005 and 2007 • Choice of payment schemes

7. Partial payment options

8. Calculation of entitlements • Historic payment scheme SFP aid per hectare = (Sum of farmer’s individual aid 2000-2002 / average of farmer’s eligible hectares 2000-2002) * payment rate for 2002 Deductions made for national reserve • Regional Aid – flat rate SFP aid per hectare = (Average Sum of aid in region 2000-02 / Average eligible hectares in region 2000-02) * payment rate

9. Payment options in the UK • Northern Ireland – static vertical hybrid • Consists of a flat rate, area based payment topped up on historic basis for individual farmers • Scotland – historic entitlements • Top slice the payment using the National Envelope mechanism to provide specific support to beef • Wales • Adopted the historic model • England – dynamic hybrid • Moving to a flat rate system from historic entitlements over a transition period to 2012. Two regions defined with different flat rate entitlements

10. The Single Farm Payment in Ireland • Financial ceiling applicable to each Member State – Ireland €1,322m (including dairy premium) • Where sum of entitlements exceed ceiling linear % reduction applies • 3% reduction for modulation, increasing to 5% - €5,000 threshold (85% of modulated funds remain in Ireland for Rural Development) • Up to 3% reduction for National Reserve • Entitlements can be leased with land, and sold with or without land • Stacking of entitlements allowed in some circumstances

11. Decoupling: the effects • Output effects • By how much will output fall • What will be the knock-on effects on agro-industry and agri-services • Environmental benefits arise through more extensive production… • … but danger of land abandonment in marginal farming areas • Long term sustainability

12. Cross compliance - requirements • Farmers receiving direct payments -SPS- must respect cross compliance • Statutory Management Requirements (Annex III) • Good Agricultural and Environmental Condition (Annex IV) • Farmers - as all citizens - expected to respect legislation without support. So payments cannot be justified on multifunctionality grounds that society is paying farmers for unpriced services valued by society • The monitoring of standards: Introduction of farm audits • Mandatory for producers receiving more than €5,000 in direct payments • Financial aid for audits to be available

13. Statutory Management Requirements (SMRs) • From 19 Community legislative acts • 5 directives on environment • Wild Birds, Groundwater,Sewage Sludge, Nitrates and Habitats • 4 Directives/Regulations on the identification and registration of animals • 7 Directives on public, animal and plant health • 3 Directives on animal welfare Directives apply as implemented by MS

14. Modulation : budget rebalancing • Key problem is how to increase the funding of the second pillar within the constraint of a fixed overall agricultural budget • Modulation already introduced as a voluntary option in Agenda 2000 • Commission’s original 20% modulation proposal opposed: • Leads to redistribution within farming • Leads to redistribution between member states • Countries find it difficult to find the counterpart funds • Second pillar schemes have high transactions costs • Agricultural Ministers not necessarily keen on second pillar spending • Problems in finding sufficient worthwhile rural development projects

15. Modulation decision • Distribution of funds raised through modulation • One percentage point will remain in the Member States where the money is raised • Remaining amount will be allocated among Member States according to: • criteria of agricultural area • agricultural employment • GDP per capita in purchasing power • Every Member State will receive at least 80% of its modulation funds in return

16. Financial discipline • Direct support will be adjusted from 2007 when forecasts indicate that CAP Pillar 1 expenditure comes to within €300 million of the ceiling set out in the Financial Perspectives • Expectation that this will be needed to cover costs of Bulgarian/Romanian accession (7%) plus possible costs of any further CAP reform

17. Impacts of decoupling • Many studies • Teagasc FAPRI-Ireland • OECD • Commission Impact studies • FAPRI-US • Dixon/Matthews (forthcoming) • We look at some results from the Dixon/Matthews study

19. Change in volume of output as result of MTR Source: Dixon and Matthews, forthcoming

20. Farm Incomes

21. Change in agricultural greenhouse gas emissions (CO2 equivalent)

22. Growth in importance of direct payments in the CAP • Introduced in MacSharry reform, strengthened under Agenda 2000

23. Source: US FAS Gain Report No. 34044 CAP Reform 2003

24. Decoupled payments – conceptual overview • OECD dimensions (OECD, 2001) • Theoretical dimension – how do agricultural policies, including direct payments, potentially affect production and trade • Empirical dimension – what do we know about the actual production and trade impacts of different types of agricultural policies, including decoupled payments • Regulatory dimension - ‘best practice’ in the design of the most decoupled policies or policy practices, not least to be WTO compatible.

25. Decoupling - definitions • Full decoupling • policy is fully decoupled if it does not influence production decisions of farmers and if it permits free determination of market prices • Importantly, both the shape and the position of the supply and demand curves should not be changed • Effective full decoupling • Where policy results in a level of production and trade equal to that which would have occurred if the policy were not in place • Example would be a coupled payment combined with a quantitative restriction equal to the old production level

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

27. The degree of decoupling • Comparing the degree of decoupling requires a reference, usually taken as the output effect of market price support • From producer perspective, defined as 1 minus the ratio of the production effect of the policy package over the production effect of the equivalent (in PSE terms) price increase

28. Can decoupled payments affect production? Source: Baldwin June 2003 CAP Reform

29. Decoupled payments in an uncertain world • Where farmers are risk averse • Wealth effects: Change in farmer’s total wealth can affect his attitude to risk • Insurance effects: If policy reduces the total risk faced by the farmer (e.g. price stabilisation scheme) it will have positive effect on output

30. Decoupling in a dynamic world • Where there are capital market imperfections, any kind of income support – even decoupled – will be partially reinvested in agriculture • Where there are expectations of a future policy change and farmer can hope to influence this (e.g. change in base acreage for a payments scheme) decoupled scheme can affect production.

31. Source: OECD 2005 Decoupling – Policy Implications