Memorandum submitted by Professor Sir
John Marsh
IMPLEMENTATION OF CAP REFORM IN THE UK
PART A—CAP
REFORM AND
UK INTERESTS
1. The Character of the 2003 CAP Reform and
UK Interests?
1.1 The Fischler reform is the most profound
change in the CAP since its origin in 1962. The MacSharry reform
of 1994 broke the link between consumer prices and the prices
received by farmers by introducing direct payments. The 2003 reform
breaks the link between direct payments and commodity production
by introducing the principle of decoupling. The justification
for payments to farmers has become a mixture of environmental
targets, social targets (including rural communities and equity),
and compensation for lower prices. These payments are visible.
As a result they will have to compete with other demands on the
budget of the EU.
1.2 As things stand, although payments are
decoupled from commodities the amount paid is still based on historic
levels of payments to farmers, derived primarily from past production
practices. Whilst this meets a need to compensate losers from
the change in policy, it is inconsistent with the other reasons
given to justify payment; the environment and equity. This makes
the payments increasingly vulnerable in terms of the goals of
the policy itself. This is reflected in the decision to introduce
degression and modulation This enables a gradual reduction of
direct payments and a shift to other, defined objectives. Money
saved by degression will also become available to support the
reform of other commodity regimes and to cope with the extension
of the CAP to new members.
1.3 The reform was conceived in preparation
for the final negotiations of the Doha round of WTO trade negotiations.
That process collapsed in Cancum but is widely expected to be
revived in further negotiations. Any settlement will require improved
access to protected markets, notably that of the EU and the reduction,
if not the elimination of export subsidies. The effect of this
is likely to be lower and more volatile commodity prices within
the EU.
1.4 This radical change in the CAP, especially
if viewed in the context of a successful outcome to the WTO negotiations,
is greatly in the interests of the UK. It will lower consumer
food prices and require UK farmers to adjust their farming activities
in order to maximise their incomes. It will lead to more efficient
resource use, discouraging production where the value of output
is less than the costs of inputs, where both are measured at market
prices. However, the CAP still imposes considerable costs on the
UK. These arise because reform is spread out over a long period,
because there remain several costly and unreformed regimes and
because the UK will remain a net contributor to the EU budget,
the distribution of which is based on past levels of production
in member countries. This does not reflect current public interests
of the UK or EU. A general theme of this note is that the strategic
aim of the UK must be to establish a timetable for the phasing
out all payments based on historic criteria and a requirement
that any continuing payments from the EU budget relate explicitly
to current public interest goals of the Community as a whole.
2. Member state discretion
2.1 An important element in the reform is
the extent to which its introduction and application is left to
decision by the member states. This creates a possibility of distortion
in intra-Community trade. The Commission has responsibility to
prevent this. However, its record in relation to beef imports
is not reassuring. This must be an area of continuing vigilance
for the UK Government. Some of the areas of discretion are discussed
in the following paragraphs.
3. The single farm payment
3.1 This is due to start in 2005 apart from
milk, which comes into the scheme from 2006-07 Member states may
postpone its introduction until 2007. They may also choose to
decouple the milk single payment as early as 2005. In terms of
rational resource use, the sooner decoupling takes place the better.
If some farm support systems remain coupled, whilst others are
not, this will delay the necessary adjustment in the use of the
resources. This will result in higher long run costs for farmers
and the economy. Farmers, in a wholly decoupled environment, will
have to rethink their production strategies plotting actual costs
against market receipts. This will involve substantial adjustments
in farming practice. Delay will simply continue inefficiency and
distort the adjustments between member countries. It violates
a major justification for the CAP, the retention of an undistorted
market for intra-Community trade.
3.2 The single farm payment represents a
means of sustaining income whilst the necessary resource adjustments
take place. Agreement on a date for its final withdrawal would
help to ensure that the decisions to use resources in agriculture
or in other sectors would be determined by the market, not by
some historic accident of past production.
3.3 The regulation also makes provision
for the payments to be paid per hectare, although their amount
is to be based on production at the end of 2002. This would bring
about a substantial income redistribution. This might have some
political justification by benefiting farmers who derived little
from past commodity regimes. It would, however, prop up farm businesses
that are non-viable. It is contrary to the logic of moving the
industry towards a market-oriented basis. If these payments become
legitimised in terms of social criteria the enlargement of the
EU could make them an enduring cost for the UK. This would frustrate
attempts to base expenditure not on past production levels but
current needs and demonstrated, verifiable benefits to the public.
4. Set aside
4.1 The continuation of set aside is evidence
of the failure of policy makers to allow markets to determine
the level of production. The regulation allows additional set
aside obligations to be required, "in the case of market
needs". This is a long way from a "market" solution.
If a WTO settlement bans export subsidies and removes a substantial
element of tariff protection, there will be no need for set aside.
Supply will settle at a level at which, taking one year with another,
allows market prices to cover costs. Set aside is a deliberate
waste of resource, it ties up land that could be used more productively
for other purposes and impedes the adjustment of the industry
to changing markets and technologies.
4.2 This crude supply control device has
been made respectable by linkage to environmental policies. To
secure genuine environmental gain complex rules have to be devised,
specifying what land may, and what may not be "set aside",
who can be exempt and what use, if any, may be made of the land.
Such regulations impose costs in enforcement and create opportunities
for evasion. Any environmental gain they secure depends on the
continuation of direct payments.
4.3 The UK government should seek the end
of set aside and allow market prices to regulate supply. Environmental
targets should be secured at least economic cost. To do so will
require a mixture of regulations designed to prevent environmental
damage and payments for defined public benefits for which land
users should compete.
5. Cross compliance
5.1 To receive payments farmers have to
respect statutory management requirements relating to public,
animal and plant health, occupational safety, the environment
and animal welfare. These are defined for the Community as a whole.
All permanent grass at the end of 2002 is to be retained. Farmers
also have to maintain "good agricultural conditions",
defined by the member state. Member states may add supplementary
management conditions. Farmers who fail to observe these requirements
will receive reduced or no payments.
5.2 In principle this is a device legitimising
payments by enshrining them in some currently approved farming
practices. It is hostile to innovation, it is insensitive to markets
and it is often defined in political terms. Its effectiveness
as an environmental instrument depends upon the continuation of
decoupled direct payments. The Council of Ministers succumbed
to this politically convenient approach and the UK government
has shown no reluctance to apply it. This should not be allowed
to obscure the more important goal of phasing out all direct payments.
5.3 The effect of cross compliance on UK
farmers will depend upon what happens in the market. Competition
within EU markets mean that differences in the definition of cross
compliance, and in the monitoring and enforcement of the defined
standards together with any supplementary requirements, will affect
the viability of farm enterprises differently within differing
parts of the EU. A WTO settlement, which involved freer access
to EU markets would expose producers in the UK to competition
from exporters who do not face similar constraints. Farmers in
this country may feel alarmed on two scores. First, the relative
power of the UK environmental lobby to secure objectives that
impose costs on the industry rather than the public purse. Second,
the tendency of the UK civil service to "gold plate"
regulations.
6. Degression and Modulation
6.1 Direct payments are to be reduced by
a formula that exempts the smallest farms. Part of the money saved
will be returned to the member state to support its rural development
programme. Part will be retained by the Community to fund the
reform of more CAP regimes. The formula used penalises the UK
because it has a larger share of bigger farms. This asymmetrical
impact of the reform on member countries stems from the origin
of the payments in terms of historic entitlements based on production.
A long-term solution depends upon funding being based on updated
spending criteria that enable the Community as a whole to derive
maximum benefit from budgetary resources.
6.2 Under Agenda 2000 member states had
been able to levy modulation up to 20% and apply the funds raised
through the "accompanying measures" that figured in
Agenda 2000. The 2003 Settlement makes modulation compulsory for
all member states but limits it to a level (4.5%). Compulsion
prevents distortions arising if member states impose differing
rates of modulation but the funds raised are less than those needed
to meet current or planned levels of expenditure under the UK
Rural Development Programme. The financial discipline, which is
part of the settlement, may mean that the EU will need to raise
the rate of degression to fund later stages of the policy, when
additional commodities are brought into the system. This, too,
may limit funding from EU sources available for rural development
programmes.
6.3 Modulation is essentially an attempt
to legitimise payments that derive from justifications that no
longer exist. They divert public funds to particular public interest
issues within the control of Agricultural Ministries. They do
not liberate them to be used where they can secure greatest value
for the Community as a whole. Politically they may make it more
difficult to argue for the total phasing out of direct payments.
The UK government should see this as, at best a temporary stop-gap
arrangement until the Community can move to more rational agricultural
and environmental policies.
PART B—THE
IMPACT ON
THE UK AGRICULTURAL
SECTOR
7. The benefits to the UK
7.1 Defra Economists have produced a valuable,
systematic analysis of the overall economic impact of applying
the CAP reforms[1].
This shows a net benefit to the UK economy of between
0.6 billion and
0.9 billion. For producer returns, too, the impact
is positive showing benefits of up to
0.5. The study makes clear the complex set of assumptions
that have to be made in reaching any conclusion and although it
was carried out in advance of the final settlement of the MTR
debate, its general conclusions still provide a sensible guide
about the likely short to medium term impact of the policy on
the UK agricultural sector. There are however a number of underlying
political and economic issues that need to be recognised.
7.2 The process of decoupling means that
profitability will depend upon market outcomes. Characteristically
agricultural markets are volatile, partly as a result of the impacts
on production of weather and disease and partly because investment
decisions are made by businesses that have no means of knowing
what their competitors are doing. Greater volatility translates
into increased real costs of production. How far it affects producer
incomes will depend upon their strategies for risk management.
One result of decades of commodity price support has been to diminish
the incentive to devise and apply risk management tools. The new
policy will add to the importance for UK agriculture of strong
links within the food chain.
7.3 Decoupled markets move in response to
aggregate supply and demand movements. During the past four or
five decades supply costs have been falling, and market prices
have tended to fall in real terms. Critics will argue that this
is the result of the underestimation of the social costs of production
such as pollution, loss of habitat etc. However, at a global level
it is unlikely during the next decade that these considerations
will have more than marginal impact on the costs farmers face.
As a result, it is not unreasonable to expect innovations in production
to lead to continued reductions in cost. Demand is expected to
grow, particularly in some populous countries of the Far East.
Much of the increased market will be supplied by the consuming
countries. However, world trade will also grow.
7.4 The outcome in terms of the prices available
to farmers in the UK will depend on the degree to which global
production increases. At this stage, there is no physical reason
why, given investment in areas so far under-capitalised, production
should not grow substantially. Ultimately climate change may alter
this picture but in the immediate future production is more likely
to be limited by uncertainties about the impact of political and
economic instability on world trade. The reformed CAP and a WTO
settlement imply that UK farming industry will have to compete
in this market. To succeed it will have to contain its costs.
7.5 Supply costs are the outcome of factor
prices and factor productivity. Within the UK, rising real incomes
lead to higher factor costs. Most obviously, the labour used to
generate farm inputs and the labour used on the farm is affected
by the overall level of rewards in the economy as a whole. Whilst
there may be some lag in adjustment, businesses have to pay the
going rate for labour or do without it. Factor productivity is
affected by innovation much of it derived from the application
of scientific discovery. In much of the world governments and
international agencies have invested heavily in support of research
and extension. This has enabled production to outstrip demand
despite rising wage levels.
7.6 There is no reason to believe that progress
in this direction cannot be continued, however, in the EU pressures
on factor pricing and factor use mean that it may be more difficult
to secure increased competitiveness. Where land and water are
required for urban development, roads or recreation the prices
for land these activities can afford greatly exceed any profit
that can be generated in farming. Politically Europeans see in
land a resource that is not just for food production but for a
diversity of values. These include measurables such as the storage
and management of water supplies and more intangible benefits
such as landscape, bio-diversity and wildlife. The reformed policy
responds to these preferences through its support for the environmental
programme and an increasing array of regulations. These may reduce
factor productivity, raising agricultural costs. Where farmers
have to compete in an international market, the outcome will be
a smaller agricultural sector.
7.7 For some commodities member states are
given discretion about the extent to which and the date at which
the single farm payment has to be decoupled from production. They
are also allowed to decide if these payments should be made to
the farmers whose previous production provides the basis entitlements
or are distributed on an area basis. These choices have some significant
economic and political consequences for the UK.
7.8 Where payments remained coupled they
directly impact on the profitability of particular enterprises.
The total return to "coupled" farmers will be the market
price plus the single payment (or such part of it as remains coupled).
The return to decoupled farmers will be the market price alone.
Implicitly this will compel decoupled farmers to adjust farming
systems and shift production away from areas where they face competition
from coupled farmers. This could shift production towards a pattern
not justified by relative costs. If we assume that the aggregate
production of the EU is constrained by market forces, farmers
in "decoupled countries" will be forced to make adjustments
to accommodate the failure to adjust in "coupled countries".
Such a situation would discriminate against new member countries
where no coupled payments are in view. The UK has opted for full
decoupling but it must ensure that any continuing "coupling"'
in other member countries is limited and temporary.
7.9 The choice of making payments on an
area basis is discussed briefly in paragraph 3.3 above.
PART C—PROGRESS
WITH PROPOSALS
OF THE
POLICY COMMISSION
8. Sustainable Farming and Food
8.1 The Government published its detailed
response to the Policy Commission on the Future of Farming and
Food in December 2002. Its paper The Strategy for Sustainable
Farming and Food, indicates acceptance of the approach adopted
by the Curry Commission and many of its proposals. Since then
it has established the Independent Implementation Group, chaired
by Sir Don Curry to oversee the application of the government's
strategy.
8.2 It is too soon to expect major results.
However, some important progress has been made and some institutional
machinery put in place. The Food Chain Centre is now up and running.
Co-operation through the food chain is being fostered by English
Farming and Food Partnerships. Public bodies have been exhorted
to buy more British Food. Demonstration farms have been selected
and progress has been made in developing an independent body to
ensure standards for the assured farm foods. The most discussed
part of the report, the introduction of a broad and shallow environment
scheme has found approval with government although relabelled
an Entry Level Scheme.
8.3 The analysis that informs the CAP reform
programme has much in common with that of the Policy Commission.
It is therefore frustrating that the outcome of CAP reform should
in some ways impede the redirection of funding proposed by Curry.
Before CAP reform the UK Government was able to remove up to 20%
of direct payments to use for environmental and rural development
purposes. The Commission recommended that the UK Government should
increase the amount modulated from 4.5% to 10% in 2004. Its proposals
for a broad and shallow scheme required this sort of level of
funding. The 2003 Settlement fixes a ceiling of 4.5%. The Government
may be able to negotiate some form of transitional arrangement
but the process illustrates the difficulty of making one policy
dependent upon the continuation of another one—as do both
cross compliance and modulation. In principle, and subject to
the agreement of the other members of the EU, that the sorts of
scheme proposed by Curry are not trade distorting, they should
be funded by member countries themselves in terms of their own
assessment of their interests. The route via Brussels is cumbersome,
bureaucratic and wasteful.
8.4 If the Strategy for Sustainable Farming
and Food is to be secure, it needs to be accepted, in its own
right, as a good use of UK public funds, competing successfully
with all other state supported activities. If it is not it will
be vulnerable to changes in the CAP including variations in the
way direct payments may be used and their eventual phasing out—a
key long run objective for the UK. At this stage it may be wiser
to adopt a smaller programme but one that that would endure even
if direct payments based on historic entitlements cease.
Professor Sir John Marsh
November 2003
1 Assessment of the Economic Impact of the Commission's
Long Term Perspective for Sustainable Agriculture. Agricultural
Policy and Food Chain Economics Defra. March 2003. Back
| 
