In June 2003, the European
Union (EU) adopted a program of agricultural policy reform,
building on earlier agricultural policy reforms enacted since 1992.
This program was expanded to include additional commodities in 2004.
The policy changes under these recent reforms will dramatically
alter the way that producers are supported and alter the incentive
structure for EU farmers, but are likely to have modest impacts
on EU production and consumption. The policy reforms will have implications
for competition in global food and agricultural markets as well
as for the EU's position in World Trade
Organization (WTO) agricultural trade talks.
For decades, the United States and the European Union
have dominated world agricultural markets. The U.S. has long been
a leading producer and exporter of agricultural products, but in
more recent years, the EU has also become an agricultural
trade powerhouse. As recently as the 1970s, the EU was a large
net importer of nearly all major agricultural products, but by the
1980s, it had become a major exporter of wheat, sugar, meat, and
dairy products. The EU now competes with the U.S. as one of the
world's two top agricultural exporters. In the 2000-02 period, the
U.S. and the EU together accounted for over a third of the world's
agricultural exports, with the U.S. accounting for nearly 19 percent
and the EU nearly 17 percent. The growing competitiveness of the
EU is also reflected in the change in the balance in agricultural
trade between the EU and the U.S., with the U.S. moving from an
agricultural trade surplus to a substantial deficit. The EU however
is still the world's largest agricultural importer and remains a
net food importer, owing to its large and affluent population and
small land base.
The EU's success in expanding agricultural production
and exports is due in part to support provided to member states'
producers under the Common
Agricultural Policy (CAP). High and stable support prices guaranteed
by the CAP, in combination with restrictive import policies for
agricultural commodities, were a hallmark of the program since its
inception in the 1960s. Thus, the CAP stimulated production and
slowed consumption growth, leading to chronic surpluses that were
exported with the aid of subsidies. The escalating costs of surplus
disposal, however, led to a series of EU budget crises. In 1992,
domestic budget constraints and external demands of multilateral
agricultural trade negotiations pressured the EU to make substantial
reforms to the CAP. The policy changes reduced support prices for
selected commodities—primarily grains, oilseeds, protein crops,
and beef—and introduced direct payments to producers based
on crop area or cattle numbers to compensate for lower prices. Additional
agricultural policy reforms were enacted under the EU's Agenda
2000 program, which helped prepare for EU enlargement by further
reducing selected support prices and compensating producers through
direct payments.
2003-04 CAP Reform Shaped by
Environmental and Consumer Concerns
Like the earlier reforms, the June
2003 CAP reform was motivated by the agricultural negotiations
in the WTO and the need to prepare for EU enlargement. Like the
previous reforms, the latest CAP reform is aimed at reducing current
and potential commodity surpluses, assuring the EU's ability to
stay within agricultural budget limits, and increasing the market
orientation of EU agriculture by replacing some support prices with
producer payments as the primary instrument of domestic support.
However, the latest reform program was also motivated by new issues
raised by consumers and environmentalists and recognized by policymakers
(and farmers) as important to the long-term well-being of EU agriculture--food
safety and quality, animal welfare, and environmental concerns.
The main features of the 2003 reforms and the April 2004 reforms
include the following (for more details, see table):
Policy
changes under 2003 and 2004 CAP reforms
Program/commodity
Policy change
Rye
Crops
Rye intervention price support eliminated. Rye-producing
areas receive temporary transitional aid.
Grains
Minimum of 75 percent decoupled
aid. Monthly storage increments to support price reduced 50
percent.
Durum wheat
Supplemental durum payment reduced
in traditional producing areas, phased out for other areas.
Payment included in single farm payment (SFP), but countries
may opt to retain up to 40 percent linked to production. Durum
quality premium paid on per hectare basis on limited area.
Rice
Intervention support price reduced
by 50 percent, intervention purchasing limited. Direct income
payment; part included in SFP, part converted to crop-specific
aid.
Starch potatoes
Part of direct payment included
in SFP, remainder is crop-specific payment.
Nuts income payment
Fixed flat-rate payment based
on fixed acreage.
Protein crops
Protein crop supplement (increase
in payment to encourage protein crop production) preserved.
Set-aside payment
Included in SFP.
Carbon credit for energy crops
Aid of 45 euro/hectare for energy
crops, up to maximum of 1.5 million hectares.
Dried fodder income payment
Single farm payment paid to growers
plus support to industry through direct payment.
Cotton
Minimum of 65 percent decoupled
payment with 22 million euros provided for transition to other
uses. Begins in 2006.
Olive oil and olives
Minimum of 60 percent decoupled
payment and 4-year reference period (2000-03) of which 3 are
chosen for payment reference period. No trees count if planted
after May 1, 1998. Begins in 2006.
Tobacco
Minimum of 40 percent decoupled
to be phased in from 2006-09. In 2010, 50 percent of aid in
SFP with remainder in restructuring fund. Begins in 2006.
Hops
Minimum of 75 percent of aid decoupled.
Begins in 2005.
Beef
Livestock
Beef payments converted to SFP. Member states may
opt to retain some payments, in full or in part, as coupled
to beef production.
Ewe/goat premium
Included in SFP; member states
may opt to retain up to 50 percent coupled to production.
Dairy
Reduced intervention prices for
butter (-25 percent), skim milk powder (-15 percent). Intervention
purchases of butter limited. Dairy income payments plus member
state additional payments, 2004-08. Dairy income payments included
in SFP after 2008.
Single farm payment
General
Direct income payment based on historical entitlement
replaces payments from arable crops, beef, ewe/goat, and dairy
(after 2008) sectors.
Member state payments
Member states may make additional
payments to encourage production (quality, environmental) up
to 10 percent of national SFP ceilings; amount reduced by amount
of retained coupled payments.
Quality incentives
Support for promotion (quality
assurance, geographical indication, organic farming).
Support to help farmers meet standards
Support for farm audits, aid to
farmers to help implement standards in areas of environment,
food safety, animal welfare, and occupational safety.
Support to farmers for improving
animal welfare
Support to extent of additional
costs involved in improving welfare of farm animals.
Investment support for young farmers
Increased investment aid for young
farmers.
Rural development measures
Funds from taxation of large farms
(“modulation”) to be used to increase spending on
rural development measures.
Commodity support price reductions. The new
CAP reform continues the process of reducing support prices for
selected commodities, eliminating price support for rye, and substantially
cutting back support for rice, butter, and skim milk powder. The
EU continues to support prices of major grains, dairy products,
sugar, and, at reduced levels, beef and rice. Prices for EU sugar,
dairy products, and beef remain well above world levels.
Single farm payment. The EU's current
system of direct payments is tied to production of specific products—
arable crops (grains and oilseeds) and set-aside payments on an
area and yield basis and livestock payments on a per head basis.
Single farm payments (SFP) will replace the current direct payments
beginning in 2005-07 at the discretion of the member states. As
"decoupled payments," SFPs are not tied to current production
because they will be based on producers' 2000-02 historical payments
and will not require production (see box,
"Why Switch to Decoupled Payments?"). Member states
will have significant discretion in implementing the SFP. They
may choose to retain a portion of current payments as production-linked,
within limits set by the EU. They may also choose when to adopt
the SFP (2005, 2006, or 2007), whether to vary the degree of decoupling
in different regions, and how to allocate the payments among farms.
For example, member states may choose to make the single farm
payment a flat per hectare payment to all farms in a region or
vary the payment by farm based on its historical payments. Member
states may "top up" payments by up to 10 percent of
the SFP, but for each member state, total payments must not exceed
limits established for that country by the European Commission.
The net effect may be that the "Common" Agricultural
Policy may not be as common among member states as it has been
in the past three decades.
Why
Switch to Decoupled Payments?
Decoupled payments
are fixed payments that are not tied to current production
activities, inputs, or practices. No production decision or
change in market price can alter the size of the payment owed
to eligible producers. In contrast, "coupled" subsidies
directly affect production decisions by changing the producer's
net returns for specific commodities.
Decoupled payments are increasingly being used
as a policy tool to support farm income, especially in the
United States and the European Union. Use of decoupled payments
enables policymakers to address both domestic and international
policy goals.
Domestically, decoupled payments reduce variability
in budgetary outlays, since the payments are based on fixed
factors (like historical production) and the payment rates
are generally known in advance. In addition, use of decoupled
payments greatly reduces market distortions associated with
agricultural support programs. Since decoupled payments are
not tied to current production or price, producers are free
to base production decisions on market incentives rather than
on expectations of government payments.
International commitments to the World Trade Organization
(WTO) also create a strong incentive to use decoupled payments.
WTO rules limit the use of domestic
support
("amber box") programs that encourage farmers to
increase production. Currently, WTO rules allow countries
to provide unlimited support for so called "green box"
policies, such as decoupled payments, that do not encourage
farmers to expand production. A special class of payments
that limit production and meet specified criteria is also
exempted because such payments are considered partially decoupled
("blue box"). Presumably, the current WTO agreement
reflects the negotiating countries' assumption that decoupled
payments do not distort production decisions and create only
minimal incentives to expand production, thus encouraging
countries to switch to this type of support because it would
reduce trade distortions.
Cross-compliance and environmental programs.
Though farmers receiving SFPs are not bound by production requirements,
they must adhere to environmental standards and keep the land
in "good agricultural condition." SFPs are also contingent
on compliance with food safety and animal health and welfare standards.
Support will be available to help farmers adapt to these standards.
Funding for rural development programs.
Under Agenda 2000, EU member states were allowed to reduce payments
for larger farms and redirect the savings to rural development
programs. The 2003 CAP reform expands this program, and member
states will be required to reduce SFPs for large farms, with most
of the savings going toward a rural development fund.
Budget measures. Reforms were motivated
in part by concerns about the impact on the EU's agricultural
budget of the 10 new members that joined in May 2004, including
a few large agricultural producers, such as Poland and Hungary.
CAP reform, by fixing payment rates and establishing a financial
discipline measure to stay within the CAP budget, alleviates some
of these concerns. The CAP budget allows for 1-percent annual
increases from 2007 to 2013, and the financial mechanism will
reduce the SFP if support outlays threaten to breach this ceiling.
Enlargement. Ten additional countries
joined the EU on May 1, 2004: Czech Republic, Poland, Hungary,
Slovakia, Slovenia, Estonia, Latvia, Lithuania, Malta, and Cyprus.
For the purposes of the SFP, the treatment of the 10 new member
countries will differ from that of the current EU members. Producer
payments will be phased in over a 10-year period beginning in
2004, but converted to SFPs in 2005 at 30 percent of the EU-15
level, (although the new members are allowed to top up their SFPs
with their own funds by an additional 30 percent of the full payment).
Because the new entrants have no history of payments, their SFPs
will be based on their average area and yield between 1995 and
1999. During this period, yields in the 10 new member countries
were only about half the level for the EU-15; as a result, SFPs
for the incoming members will be lower than for EU-15 members.
New members will not be subject to payment reductions under the
budget discipline mechanism until their payments are fully phased
in by 2013.
The policy changes will move the EU further from supporting
the market through commodity price support to supporting producers
directly. Decoupled payments will be established as the main policy
instrument for supporting EU producers of most commodities, while
some coupled support may be retained to prevent land abandonment
in marginally productive areas. With support no longer tied to production
of these commodities, farmers will have more flexibility as to what
they can produce, with the exception of explicitly excluded commodities—mainly
fruits and vegetables. Also, the new policy will provide EU members
with greater discretion over the timing and method of policy implementation,
thus returning a certain degree of national control of agricultural
policy to the members.
Production and Trade Impacts Likely To Be Small
Painet Stock Photos
The effects of CAP reform on global markets will depend
on the impacts on domestic production and consumption. Overall effects
on EU production and consumption from CAP reform are likely to be
small because support price cuts are limited to a handful of commodities.
Rye, rice, butter, and skim milk powder are likely to be affected
the most because the reform cuts support prices for these products,
but other crops will be affected indirectly because of a reallocation
of resources. For example, barley production is expected to increase
as rye production becomes less profitable following the elimination
of price support. Beef production is likely to decline by more than
arable crop production because the SFP replaces beef payments that
were tied to herd numbers. Arable crop producers already had considerable
flexibility under the old system— they were able to switch
among certain crops or leave the land idle. EU milk production is
likely to remain constrained by production quotas, but lower support
prices should increase consumption of dairy products, reduce production
and exports of butter and skim milk powder, and increase cheese
production.
The effects of reforms on production will also depend on the degree
of decoupling of support payments chosen by member states. Arable
crop payments will be decoupled by a minimum of 75 percent, but
the percentage of decoupling for livestock payments will be smaller.
If members opt to retain production-linked support to the maximum
extent allowed, production changes will be smaller. Marginal land
operations, which are most likely to be affected by the reforms,
are the least productive, and their retirement will thus have minor
effects on total production. However, the land must be kept in good
agricultural condition and may not be sold for development purposes.
This requirement strongly suggests that the land will not exit agriculture,
thus creating a minor incentive for production despite the decoupled
nature of the SFPs. Decoupling may lead to efficiency gains as subsidy
reductions spur resource allocation that could contribute, in the
longer term, to structural change.
Any decline in EU production in response to the decoupling of payments
would reduce exports and increase imports. While the direct and
indirect effects of CAP reform on EU production will likely be small
relative to the EU market, the effects on world prices could be
larger because EU exports of some commodities account for a significant
share of the world market.
Because intervention price support continues, the EU is likely to
continue to require subsidies to export beef and dairy products,
and depending on exchange rates and world prices, possibly grains
as well. Export subsidies will also be required for high-support
products not affected by the policy changes. The recent appreciation
of the euro relative to the U.S. dollar has increased the likelihood
that export subsidies will be needed to export many EU food and
agricultural products. However, lower support prices will facilitate
reductions in (per unit) export subsidies for selected commodities.
Production effects will differ in the 10 entrant countries because
they are not currently receiving support prices or payments. For
some products, like beef, the production effects of higher support
prices are likely to outweigh any impact from decoupling of payments.
Without reform of rye support, accession to the EU would have brought
large increases in rye output, particularly in Poland, where rye
is an important crop. With the elimination of support for rye, the
Eastern European countries will likely increase barley production
to replace rye.
WTO Impacts More Dramatic
The policy reforms are likely to have a greater impact on world
trade (and the EU's position in WTO negotiations on agriculture)
than on EU production or consumption. The CAP policy changes will
affect the treatment of EU support programs under the WTO's current
rules on agricultural domestic support. The WTO Agreement on Agriculture
accords domestic support programs different treatment depending
on the extent to which they are coupled or decoupled from production
decisions. Under the current CAP, many EU payments to farmers meet
WTO blue box criteria and are exempt from reductions (see
box, "Why Switch to Decoupled Payments?"). Most of
these payments will be converted to the single farm payment, which
will be based on a producer's historical payments, rather than tied
to production of a specific product. The EU is expected to report
these payments to the WTO as green box payments.
This payment conversion in the latest CAP reform is very timely
for the EU. In the agricultural negotiations in the current Doha
Round, changes in domestic support policies have been proposed,
including limits or reductions to blue box support. By moving a
considerable portion of EU producer support from blue box to green
box, the EU may exempt this support from possible WTO disciplines.
CAP reform would allow the EU to accept further disciplines on domestic
support, but does not address market access at all, and will have
only marginal effects on export subsidies. Reducing support prices
for rye, rice, and milk would result in some further reductions
in coupled ("amber box") support. However, import barriers
remain unchanged under the new CAP provisions, and export subsidies
would be reduced only in response to limited support price reductions
and lower export levels.
Additional Policy Reforms Agreed on Mediterranean Crops
In April 2004, the European Commission adopted reforms of the support
regimes for tobacco, olive oil and olives, cotton, and hops. The
reforms follow the principles established in the June 2003 CAP reform
but differ in the details: a significant part of current production-linked
support will be converted to the decoupled SFP, although a portion
of support can be retained as production-linked aid for producers
with small holdings or in marginal areas. These new reforms will
begin in 2006 for all but hops, which begins in 2005. On July 14,
2004, the EU Commission proposed a reform of the sugar sector, calling
for lower support prices, decoupled payments, and a reduction of
the production quota. Final agreement is not expected until 2005.
Reforms in these sectors, if implemented as envisioned, would shift
EU domestic support from the amber box to the green box, rather
than the blue box, and help the EU to meet additional commitments
to reduce domestic support that might result from the ongoing WTO
negotiations on agriculture.
Conclusions
Will the latest CAP reform further enhance the EU's competitiveness
in agricultural trade? Severing the link between producer payments
and production of specific products will give EU producers greater
flexibility, within limits, to produce those goods best suited for
production and market conditions. Further cuts in support prices,
along with the delinking of payments from production, represent
a move toward greater market orientation that could improve competitiveness.
Some marginal land is likely to go out of production, leading to
some decrease in production and exports, and thus increase world
prices. However, prices of most EU agricultural products are still
supported above world prices through government purchases, storage
aid, or import barriers, and continue to interfere with market signals.
The increases in EU exports and share of world exports, to the extent
that they have been aided by high support prices, export subsidies,
and production of surpluses, could be reversed by the move toward
increased market orientation.
The member states themselves may be the wild card in this latest
CAP reform. The path of reform selected by each member state could
have consequences for production, efficiency, land prices, and other
factors with the potential to affect trade. Member states may even
decide that the costs of administering national programs are prohibitive
and revert to the default EU policy, which would essentially decouple
all payments. Much remains to be decided in the EU over the next
3 years before the full impact of this potentially very complex
reform of EU farm policy can be fully evaluated.
This article is drawn from...
CAP Reform of 2003-04,
by David Kelch and Mary Anne Normile, WRS-04-07, USDA/ERS, September
2004.