Select Committee on European Union Seventh Report



Purpose and Scope of this Inquiry, Structure of this Report

1.  The Committee's inquiry has been motivated by two forthcoming EU initiatives. The first is the decision to subject the 2003 reform[1] of the CAP to a "Health Check" in 2008. The second initiative is the Budget Review to be undertaken by the European Commission in 2008/09. The Review is being carried out in response to a request made by the European Council in December 2005, when political agreement on the current 2007-2013 Financial Perspective was reached (Council Document 15915/05). One of the specific elements of EU spending to be addressed in the Review is the CAP.

2.  The European Commissioner for Agriculture and Rural Development, Mariann Fischer Boel, has described these two initiatives as "one vision, two steps", suggesting that an "adjustment" of current arrangements will take place through the 2008 Health Check, while the Budget Review will address the CAP's future post-2013.

3.  The purpose of the Committee's inquiry was to take stock of the 2003 CAP reform, and to consider whether further reform may be required in both the short and long term. This report is intended to respond to the Commission's Communication on the Health Check (published on November 20 2007), and to feed into the debate over the longer-term direction of the CAP in anticipation of the Budget Review.

4.  In the course of our inquiry, we came to the conclusion that it would be essential to look ahead at what the long-term goals of the Common Agricultural Policy should be before attempting to evaluate whether the proposals contained in the Commission's Communication on the Health Check are taking policy in the right direction. Once the factual background to this inquiry has been set out, our report therefore considers what the long-term goals of the CAP should be, before returning to the instruments that may be used to deliver them, and how these might be adapted in the short and longer term.

5.  The inquiry that led to this report was carried out by EU Sub-Committee D, whose Members are listed in Appendix 1. We received written evidence and heard oral evidence from a wide range of witnesses, who are listed in Appendix 2. We are grateful to them all for their contributions. We would also like to thank those who facilitated our visits to Brussels and Edinburgh. We are particularly indebted to Sir John Marsh, our Specialist Adviser on this inquiry. We make this report to the House for debate.

Introducing the CAP post-2003

6.  The CAP reforms agreed in 2003 represent a radical shift in the EU's agricultural policy. Historically, the CAP has supported farmers' incomes and stimulated production through guaranteed product prices. By the 1980s, however, this policy had not only eliminated post-war food shortages but also resulted in costly surpluses of major agricultural commodities. The MacSharry reform of 1992 began to reduce the level of support prices for a number of commodities, in exchange for direct payments to farmers to compensate them for the resulting loss of income. The Agenda 2000 reform agreed in 1999 further reduced support prices, and introduced an integrated rural development policy intended to form a 'second pillar' of the CAP. The mid-term review of the Agenda 2000 agreement resulted in the 2003 CAP reform, which marks the culmination of a gradual shift in farm support from product support to direct income support.

7.  Today, the CAP thus rests on two "pillars": Pillar I, out of which direct payments to farmers and market management measures are funded, and Pillar II, which supports rural development and environmental programmes.


CAP Expenditure over the 2007-2013 Financial Perspective

Figures in billions of euros, based on 2004 prices
Total 2007-2013
Pillar I—Direct Payments and Market Support
293, 105
Pillar II—Rural Development
69, 750


8.  The main element of the 2003 Fischler reform—as with the 1992 reform, named after the Commissioner who proposed it—is the "decoupling" of subsidies from production in most sectors. All previous production-linked payments were bundled into a Single Farm Payment, to be paid to farmers on the basis of payments received during a reference period (historical basis) or the number of eligible hectares farmed during a reference period (area basis). To be eligible to receive Single Farm Payments, farmers are obliged to meet certain public, animal and plant health standards, to respect certain environmental and animal welfare standards, and to keep their land in good agricultural and environmental condition (GAEC). This element of conditionality associated with Single Farm Payments is known as cross-compliance. It has been presented as the public benefit delivered in return for Single Farm Payments.

What is cross-compliance?

In order to be eligible to receive their full Single Farm Payment, farmers are required to meet a number of Statutory Management Requirements (SMRs) and to maintain their land in good agricultural and environmental condition (GAEC).

Statutory Management Requirements derive from the provisions of existing EU legislation on environmental, public, animal and plant health and animal welfare. By 2007, aspects of 19 EU Directives or Regulations had been included in the list of SMRs.

Farmers must also abide by standards set in each Member State with respect to the maintenance of land in good agricultural and environmental condition. Each government establishes its own definition of GAEC by setting requirements under a number of headings (e.g. soil management) that were agreed by all Member States as part of the 2003 CAP reform.

Failure by farmers to respect one or both of these elements of cross compliance can result in deductions from, or complete cancellation of, Single Farm Payments.

9.  The decoupling of payments from production does not extend to all sectors. The 2003 agreement allows Member States to maintain some specific production-related direct aid where this is considered necessary to secure a minimum level of productive activity and environmental benefits. Most of the EU-15[2] thus maintain coupled or partially coupled payments in some sectors. Under Article 69 of the 2003 Regulation[3] introducing the reform, Member States were also given the option of retaining up to 10 per cent of their National Envelope[4] for a particular sector to support agricultural activities that are important for the environment or for improving the quality and marketing of agricultural products. A smaller proportion of Member States have taken advantage of this provision, but in Scotland, for example, it has been used to provide support for the Scottish Beef Calf Scheme.

10.  The 2003 reform placed greater emphasis on modulation—the mechanism whereby funds earmarked for direct payments to farmers under Pillar I can be diverted to fund measures under Pillar II. The Agenda 2000 reform already offered Member States the option to apply modulation on a voluntary basis, but few chose to do so. The 2003 reform introduced compulsory rates of modulation, intended to fund additional rural development measures. Member States can, however, continue to apply additional, voluntary modulation. Only the UK and Portugal have chosen to take advantage of this option.

What is modulation?

The term "modulation" is used to describe the transfer of funds from direct subsidy payments under Pillar I of the CAP to rural development expenditure under Pillar II of the CAP. It is a mechanism used to shift financial resources across otherwise separate budget lines.

Compulsory modulation was applied to all but the smallest farms in the EU-15 at a rate of 3 per cent in 2005, rising to 4 per cent in 2006 and 5 per cent in 2007. It is currently due to continue at 5 per cent until 2012, but the rate may be raised as part of the Health Check.

Member States or regions can opt for additional, "voluntary" modulation, reducing spending on direct payments by a maximum of 20 per cent. Under a compromise reached by the Council in March 2007, only the UK and Portugal will continue to make use of this option.[5]

At least 80 per cent of funds from compulsory modulation are retained in the Member State where they were raised. By contrast, funds from voluntary modulation are retained in their entirety in the Member State where they were generated.

11.  Although the decoupling of subsidies was designed to encourage farmers to produce in response to market demand, a series of market management instruments have been retained. These include production quotas (e.g. for milk), set-aside (whereby farmers must leave a proportion of their arable land fallow or use it for non-agricultural purposes) and export refunds, as well as intervention storage. These instruments were originally introduced in order to control the supply of agricultural commodities by reducing production and in order to clear surpluses.


12.  Rural development policy has emerged in a piecemeal way, as a result of successive reforms of the CAP. In 2005, however, existing programmes and budget lines were pulled together into a single funding and programming instrument known as the European Agricultural Fund for Rural Development (EAFRD). The fund supports projects across three 'axes': Axis 1 covers measures designed to improve the competitiveness of the farming and forestry industry, Axis 2 covers environmental and land-management schemes, while Axis 3 covers initiatives aimed at improving quality of life and the diversification of the rural economy. A fourth, separate, element of the fund is reserved for LEADER[6] initiatives, whereby local action groups in rural areas can secure funding for local development projects.

13.  Rural development policy under the EAFRD is implemented through national strategy plans prepared by each Member State on the basis of domestic priorities. These plans must be approved by the Commission, and are subsequently delivered through rural development programmes in each member state. In drawing up their plans, member states must respect certain minimum spending requirements in each of the four categories. Once plans are approved, spending must be co-financed according to fixed percentages, meaning that Member States must contribute national resources in addition to the funds provided by the EU.


Council Regulation 1698/2005 introduced a single instrument to finance rural development policy under Pillar II of the CAP from 2007: the European Agricultural Fund for Rural Development (EAFRD).

The Fund provides financial support for actions under three headings or "axes", with minimum spending requirements attached to each, to ensure that Member States spend their allocated funds across all three objectives. Rules on co-financing rates (determining the relative financial contribution of the EU and the Member State) also apply.

Axis 1 of the Fund—on which a minimum of 15 per cent of allocated funds must be spent—aims to support measures designed to improve the competitiveness of the agriculture and forestry industries (e.g. restructuring holdings, improving human capital and product quality).

Axis 2 of the Fund—on which a minimum of 25 per cent of allocated funds must be spent—aims to support land management measures designed to enhance the environment and the countryside (e.g. agri-environment schemes, animal welfare commitments).

Axis 3 of the Fund—on which a minimum of 15 per cent of allocated funds must be spent—aims to support policies that target improvements in the quality of life in rural areas (e.g. basic services provision, rural heritage conservation) and promote economic diversification towards non-agricultural activities (e.g. tourism).

A minimum of 5 per cent of EAFRD funds are ring-fenced for LEADER initiatives across the three axes. Under the LEADER approach, local action groups can secure funding for local development projects.

14.  Each Member State's overall allocation[7] of rural development funding from the EAFRD is made up of a number of elements: a share of the funds replacing the guarantee element of the European Agricultural Guidance and Guarantee Fund (EAGGF), receipts from the compulsory modulation of direct payments under Pillar I, and transfers from the Structural Funds component of the EU budget.[8] The European Commission uses a historic allocation key to distribute the main element of the EAFRD budget among the EU-15. This historic allocation key is based on rural development expenditure in each Member State during the mid-1990s, and has been inherited from the EAGGF regime previously in place.

The Health Check

15.  During the negotiations on the 2003 reform package, a number of review clauses were built into the final agreement as a condition for securing consensus. These review clauses are the basis for the Commission's "Health Check", which is intended to explore what further policy adjustments may be required as a result of market developments, a shifting international context, and the enlargement of the European Union.

16.  The Health Check was formally launched by the European Commission on 20 November 2007, when it issued a Communication outlining its approach to the review.[9] In an accompanying speech, the European Commissioner for Agriculture, Mariann Fischer Boel, made clear that the Commission "does not see the CAP Health Check as a 'new reform'."[10] But she also stressed that "the Health Check is more than 'fine-tuning'". The Commissioner argued that the Health Check should be viewed as "a policy initiative in its own right, which will cover necessary adjustments and simplifications for the period 2009 to 2013." She added that the initiative should also be seen as "a stepping-stone towards the Mid-Term Review of the European Union's Financial Perspectives—which will examine priorities for after 2013."

17.  The forthcoming EU budget review (on which more below) is expected to precipitate a debate about EU spending, the largest single share of which has traditionally been allocated to the CAP. This process should prompt closer scrutiny of the purpose of the CAP, and its effectiveness in achieving the goals set out for it. In this report, we therefore examine the Commission's Health Check proposals in this wider context.

Funding the CAP

18.  The expenditure side of the EC[11] budget is organised around a multi-annual Financial Perspective, which sets out expenditure limits both in total and for broad headings, over time. Each Financial Perspective is formally agreed through an Inter-Institutional Agreement (IIA)—an agreement between the Commission, the Council and the European Parliament. The current Financial Perspective runs from 2007 to 2013, and is based on the Inter-Institutional Agreement reached in 2006.

19.  Each Financial Perspective breaks expenditure down into several broad categories (budget headings). Budget heading 2 allocates funding to the 'Preservation and Management of Natural Resources'. It is the largest single item of expenditure, and the main budget line for funding the Common Agricultural Policy.


20.  In 2002, France's then President, Jacques Chirac, and Germany's then Chancellor, Gerhard Schröder, agreed that spending on Pillar I of the CAP should not rise by more than 1 per cent a year in cash terms until the end of the next Financial Perspective in 2013. This agreement is known as the Brussels Ceiling and was endorsed by the European Council in October 2002. In practice, it means that Pillar I expenditure is treated as frozen until 2013.


21.  When the 2003 CAP reforms were negotiated, it was anticipated that the combined effect of the Brussels ceiling and the admission of up to 12 new members to the EU would put substantial pressure on the CAP budget. The reforms therefore made provision for a "financial discipline mechanism", which reduces Single Farm Payments by the percentage necessary to keep total Pillar I expenditure below the agreed Brussels ceiling. Until 2013, the mechanism would apply only to payments to farmers in the EU-15. It would not operate in the new Member States until they became entitled to receive full direct payments in 2013. Box 4 explains how Single Farm Payments are being phased in in the new Member States.

22.  Due to unexpected savings on market management (particularly intervention costs) as a result of the boom in some agricultural commodity markets, it has thus far not proved necessary to apply the financial discipline mechanism. Forecasts now suggest that it is unlikely to come into effect before 2010.

Single Farm Payments in the new Member States

In the Member States that joined the EU since 2004, the funds available for direct payments under Pillar I of the CAP are being phased in over a period of nine years. They are allocated a percentage of the funds they would be entitled to were the transitional arrangements not to apply. This percentage rises from 25 per cent in 2004 to 100 per cent by 2013.

All the new Member States were given the option of allocating direct payments using a Single Area Payment Scheme (SAPS) rather than the Single Payment Scheme (SPS) used by the EU-15. Under the SAPS, subsidies are allocated on the basis of uniform payments per hectare of agricultural land. All the new Member States except Malta and Slovenia use the SAPS, but are currently required to make the transition to the SPS by 2010 (for 2004 entrants) or 2011 (for 2007 entrants). This provision may be reviewed.


23.  The resources (income) side of the EC budget is agreed through an Own Resources Decision (ORD)—a unanimous Council decision following consultation with the European Parliament. Negotiations on revenue and expenditure, and thus the overall size and composition of the EC budget culminate in a political agreement at the European Council. The political agreement on the 2007-2013 Financial Perspective and on a new ORD was reached at the European Council meeting in Brussels in December 2005.

24.  As part of progressive reductions in the overall level of EU expenditure during the course of the negotiations, the level of spending on the CAP was cut. Most of the cuts came from expenditure allocated to rural development under Pillar II, rather than from the expenditure allocated to Pillar I. The final allocation for rural development under Pillar II over the 2007-2013 period was €69.75 billion, down from the €74 billion proposed by the Luxembourg Presidency in June 2005, which was in turn lower than the original Commission proposal of €88.7 billion. By way of comparison, the budget for Pillar I was cut from €301.174 billion (the original Commission proposal) to €293.105 billion (the final Council compromise).


25.  The December 2005 agreement on the EC budget stipulated that the Commission should be asked to carry out a full review of EU spending and resources, reporting in 2008/9. The exact wording of the mandate invites the Commission 'to undertake a full, wide ranging review covering all aspects of EU spending, including the CAP, and of resources, including the UK rebate, to report in 2008/9. On the basis of such a review, the European Council can take decisions on all the subjects covered by the review.'[12]

26.  The Commission has recently issued a consultation paper as part of its preparatory work on the budget review.[13] Our report is intended to contribute to the debate on future priorities for EU spending that is expected to ensue.

Other Influences on the CAP: WTO Negotiations

27.  The widespread decoupling of farm payments as part of the 2003 CAP reforms means that most direct subsidies to farmers now qualify for "green box" status in world trade negotiations under the WTO. Green box subsidies must either not distort trade, or distort it only minimally. Box 5 explains how the WTO boxes work.

28.  However, the coupled payments that remain, together with the market intervention and price support instruments that are still in use, continue to distort production and trade. Export subsidies encourage the release of surpluses onto world markets, thus pushing world prices downwards, which affects third-country producers. Meanwhile import tariffs protect the EU's internal market in agricultural commodities, affecting third-country producers who wish to export into the EU market, and keeping prices within the EU artificially high, which affects EU consumers.

29.  If successful, the current Doha round of world trade negotiations would target some of these forms of support. Early on in the negotiations, the EU made a commitment to phase out all its export subsidies by 2013, and to begin removing some of those subsidies two or three years earlier. The European Commissioner for Trade, Peter Mandelson, told us that there is also room for agreement on the "green box" that would allow the EU to continue with the Single Farm Payment scheme and its rural development programme. On market access, he suggested that the proposed ranges of the tiered formula[14] for tariff reductions "are a perfectly acceptable basis for political agreement" (Q 747).

30.  However, the treatment of sensitive products[15] remains "the most sensitive area for our Member States and the most difficult for us to handle internally within the EU". Negotiations on geographical indications[16] are also proving tense—Mr Mandelson admits that the EU does "not have many friends" on geographical indications, which are "very, very important for our southern Member States" (Q 747).

31.  The Commissioner stressed, however, that "there is nothing happening in the Health Check that I would either want or expect to impinge on the offers we are making in this trade round"(Q 753). He insisted that the EU was "at the outer limit of what we can offer in those trade talks and I would not ask for or expect any Health Check to deliver a better offer" (Q 754).

What are the WTO Trade Boxes?

In the context of WTO negotiations, subsidies are categorized into coloured "boxes" that indicate the degree to which they are considered acceptable. Exceptions apply for developing countries.

       Amber Box

Domestic support measures considered to distort production and trade (with some exceptions) fall into this category. Examples are measures that support prices or subsidies that are directly linked to production quantities.

These types of subsidies are subject to limits. Those WTO members that exceed the limit are committed to reductions.

       Blue Box

Agricultural subsidies that would qualify for the Amber Box, but are linked to conditions designed to limit production, fall into the more acceptable Blue Box instead.

At present there are no limits on spending on blue box subsidies, but this is under negotiation in the current round of trade talks.

       Green Box

In order to qualify for the Green Box, subsidies must not distort trade, or at most cause limited distortion. They must be government-funded (rather than the result of higher prices charged to consumers), and must not involve price support. Subsidies that fall into this category tend not to target particular products. They include direct income supports for farmers that are not linked to (i.e. are decoupled from) current production levels or prices. They also include environmental protection and regional development subsidies.

There are currently no limits on spending on Green Box subsidies. There is disagreement among WTO members, however, over the types of payments that should qualify for the Green Box. Some countries argue that the current criteria are too lax, and that certain types of subsidies (e.g. direct payments to producers, income safety-nets, subsidised income insurance) should not qualify as they do distort trade more than minimally. Others view the current criteria as adequate and indeed wish to expand their scope, for example to include payments for environmental protection and animal welfare commitments.

Council Regulation 1782/2003 of 29 September 2003 and its implementing regulations. This Committee published a report on the external implications of this mid-term review of the CAP on March 27 2003.  Back

2   Those Member States who joined the EU prior to 2004. For practice in the new Member States-those that have joined since 2004-see Box 4. Back

3   Council Regulation No. 1782/2003 EC Back

4   The term 'National Envelope' is used to refer to a funding allocation that Member States are given flexibility to distribute according to their own priorities.  Back

5   See Council Regulation 378/2007. Back

6   LEADER is the acronym for "Liaison Entre Actions pour le Développement de l'Economie Rurale", which translates as "linkage between actions for the development of the rural economy". Back

7   For a detailed breakdown by Member State of Community support for rural development over the 2007-2013 Financial Perspective, see Commission Decision 2006/636/EC of 12 September 2006. Back

8   Commission Decision 2006/636/EC sets out the allocations by member state for the period 2007-2013.  Back

9   'Preparing for the "Health Check" of the CAP Reform', COM (2007) 722. Back

10   "The Health Check of the Common Agricultural Policy: fit for new opportunities", Speech by Mariann Fischer Boel before the Agriculture Committee of the European Parliament, 20 November 2007, SPEECH 07/727 Back

11   Technically, the budget remains the EC, not EU, budget. If ratified, the Lisbon Treaty would change this. Back

12   Council of the European Union, Financial Perspective 2007-13, 19 December 2005, 15915/05, Pa. 80. Back

13   'Reforming the Budget, Changing Europe-A Public Consultation Paper in View of the 2008/2009 Budget Review', Communication from the Commission, 12 September 2007, SEC (2007) 1188. Back

14   Reducing tariffs through a tiered formula means setting a number of tariff bands to which different rates of reduction apply. Back

15   Products nominated by WTO members as exempt from tariff reduction formulas by mutual agreement. There are two elements to such exemptions: the number of tariff lines that may be included under the sensitive product clause, and the percentage deviation from the agreed general tariff for the commodity sector that is permitted. Back

16   An indication that identifies a product as originating in the territory of a WTO Member, or a region or locality in that territory, and where a given quality, reputation or other characteristic of the product is essentially attributable to its geographical origin, for example Scotch whisky or Parma ham. Back

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