Select Committee on European Union Seventh Report

CHAPTER 4: PILLAR II AFTER THE HEALTH CHECK

Modulation

146.  Modulation is the mechanism whereby funds earmarked for Single Farm Payments in Pillar I can be diverted to fund rural development measures in Pillar II. The 2003 CAP reform made such transfers compulsory, fixing compulsory modulation rates of 3 per cent in 2005, 4 per cent in 2006 and 5 per cent from 2007 onwards until 2012.

COMMISSION PROPOSALS

147.  In its Health Check Communication, the Commission identifies a number of new challenges which in its view require "a further strengthening of the second pillar".[49] It also draws attention to the constraints placed on Pillar II resources as a result of the 2005 budget deal, which saw substantial cuts to the funds allocated to rural development. The Commission points out that "with the CAP budget now fixed until 2013", rural development funds can only be topped up through "increased co-financed compulsory modulation." It therefore proposes to increase compulsory modulation by 2 per cent annually in budget years 2010 to 2013, so that compulsory modulation eventually reaches 13 per cent at the end of the financial perspective.

WITNESSES' VIEWS

148.  The Agriculture Commissioner, Mariann Fischer Boel did not appear confident of securing Member States' agreement to this proposal. "If we manage to get through with plus eight [raising modulation from 5 to 13 per cent by 2013] then it would be one of the greatest victories we have ever had", she suggested. "It will be extremely difficult" (Q 699). The Commissioner also explained that she hoped to "agree with those countries that have introduced the voluntary modulation [that] they should reduce when we increase the compulsory modulation" (Q 686).

149.  The latter aspect of the Commission's proposal addresses a concern raised repeatedly by farmers' unions in the UK. NFU President Peter Kendall argued that voluntary modulation places English farmers at a competitive disadvantage relative to their counterparts in other parts of the UK and other Member States, where voluntary modulation is either lower or not applied at all (NFU, Q 111). Dai Davies, President of the NFU Cymru indicated that his members too felt they were being "unfairly treated with regard to the imposition of voluntary modulation" (Q 323). Andy Robertson of the Scottish NFU pointed out that only the UK and Portugal apply voluntary modulation, "which means that in practice UK farmers and Portuguese farmers are having their direct support reduced to a level which is significantly below that for farmers in the rest of the EU" (Q 357).[50]

150.  The farmers' unions were therefore broadly in favour of the Commission's proposal. Mr Davies told us he was very pleased that the Commission was proposing to match increases in compulsory modulation with decreases in voluntary modulation (Q 323). Peter Kendall accepted that "uniform compulsory modulation is definitely preferable to [voluntary] national modulation" (NFU Q132). England's Regional Development Agencies also favoured compulsory modulation over voluntary modulation, on the grounds that the latter has "a distorting effect" (Q 399).

151.  While welcoming increases in compulsory modulation, environmental groups were concerned that these should not be introduced in lieu of voluntary modulation. Natural England were looking for "an increase in compulsory modulation, but one which does not undermine voluntary modulation" because "50 per cent of the English requirement for agri-environment funds comes from voluntary modulation" (Q 142). The Royal Society for the Protection of Birds was hoping for modulation of up to 20 per cent, but wanted to "retain voluntary modulation as well" (Q 47).

152.  Dr Phillips of Natural England identified a need to "get away from this mantra that high levels of voluntary modulation are some kind of English peculiarity" (Q 163). Responding to the argument that voluntary modulation introduces competitive distortions, she insisted that "it is not a level playing field; everyone has not started from the same place; there are a lot of historic accidents as to how funding is distributed; and I think that we need to accept the reality that different economies are in a position to move at different speeds" (Q 163). Meanwhile Alan Buckwell of the Country Land and Business Association explained that because under voluntary modulation "all the receipts remain in the Member states, that is more attractive from our perspective than compulsory modulation where 20 per cent of it is siphoned off" (Q 226).[51]

153.  Professor Buckwell also drew our attention to a different problem, pointing out that "the UK is hoist by its decisions in the 1980s and 1990s to not make use of what we now call Pillar 2" (Q 226). Because the present allocation of rural development funds is based on historic allocations, the UK now has a "miserable" share of the Pillar II budget, Professor Buckwell observed. As a consequence, "if want to have sensible sized environment schemes and rural development schemes we have to modulate" (Q 226). Carmen Suarez of the NFU also noted that the historic distribution key "means basically that the UK gets very little, because the UK used to get very little" (Q 132). She emphasized the need to "ensure that there is a fair allocation of the resources of rural development funds", and suggested that if the allocation criterion were based on the percentage of land that is agricultural land, or the percentage of people living in rural areas, the UK would receive "a much fairer and definitely much higher allocation of rural development funds"(Q 132). Sonia Phippard of DEFRA agreed that having "a rural development share based on patterns of spend in the early Nineties will by 2010-2011 be completely ludicrous" (Q 23). Indeed the UK "would argue that it is fairly ludicrous now", she added.

CONCLUSIONS

154.  We support the Commission's plans to increase compulsory modulation, on the basis that funds invested in Pillar II of the CAP offer better value for the taxpayer than funds allocated to Pillar I. We share the view articulated by some of our witnesses that the high level of voluntary modulation applied by the UK can be traced back to its low share of rural development funds overall. If a historic allocation system for Single Farm Payments is considered indefensible—as the Commission has indicated, and as we believe—then a similar system for allocating rural development funds, based on a reference period even further in the past, cannot be justified. We therefore recommend that the distribution key for rural development funding be reviewed at the earliest opportunity.

155.  In the meantime, we support the Commission's intention to secure like for like reductions in voluntary modulation in return for increases in compulsory modulation. We recognise that environmental groups in the UK rely heavily on funds from voluntary modulation to support their activities. In our view, however, the preservation of a level playing field across the Single Market in agricultural goods must be the overriding purpose of the CAP. We therefore share the farmers' unions' concern that the high levels of voluntary modulation being applied in the UK may result in competitive distortions.

Risk Management

156.  Farmers face two main types of risk: price risk, stemming from volatility in input or output prices; and production risk, stemming from disease, weather, etc. In the EU, price support instruments have traditionally protected farmers from some forms of price risk, while production risk has in some cases been mitigated by making compensation available, for example when animals are slaughtered to prevent the spread of disease. Since the implementation of the 2003 CAP reform, decoupled direct payments have substantially reduced the risks to which farmers are exposed by providing a fixed level of guaranteed income.

COMMISSION PROPOSALS

157.  In its Health Check Communication, the Commission notes that changes in market instruments and the shift towards direct producer support have prompted discussion of different ways of managing risk.[52] It has in the past looked into the feasibility of an EU-wide risk management scheme, but concluded that "at least as long as intervention as a safety net continues", an EU-wide solution would not be appropriate. However, Community support for risk management has recently been introduced as part of reforms to the fruit and vegetable and wine regimes.[53]

158.  As part of the Health Check, the Commission wishes to encourage Member States, regions and producer groupings to devise their own tailor-made risk management measures under Pillar II of the CAP. It proposes to allow modulation receipts to be used for risk management measures, provided that they meet WTO green box criteria. It also intends to examine the need for additional measures should further adjustments to market mechanisms become necessary.

WITNESSES' VIEWS

159.  A number of our witnesses were wary of where these proposals might be leading. Peter Mandelson, the EU Trade Commissioner, warned that he would be "a bit nervous of reform moving in that direction because we are starting to become close to the sorts of trade distorting programmes that the United States like to operate" (Q 753). Lord Rooker too was cautious, pointing out that "other businesses—non-farming, non-agricultural—have to take account of the risks of running their business" (Q 913). "We see it as no different for farms; so we are a bit suspicious of the concept of, let us say, a new scheme of risk management". While acknowledging that private insurance is not always available (Q 961), Lord Rooker insisted that risk management was "a matter for the industry, not for Brussels to come along and impose some scheme or some regime of risk-management" (Q 913).

160.  Commissioner Fischer Boel assured us that the Commission's "ideas on risk and crisis management will always leave the responsibility to the farmer to tackle the normal risks that are in every business" (Q 721). She emphasised that "we do not want a European scheme for crisis management, we want Member States to create schemes, but we would be open to look at the possibility of co-financing the premium via the rural development scheme". She also addressed Mr Mandelson's concerns, warning that "if there should be any expectations of an income safety net, forget it". That, she argued "would be a countercyclical payment, exactly what we are accusing the Americans of using as the most trade distorting measure" and would not meet green box criteria. The Commissioner was adamant that "that simply will not fly" (QQ 721-724).

CONCLUSIONS

161.  We share the Government's view that risk management is a normal feature of any commercial activity, and should therefore take place within the industry to the maximum degree possible. However, we recognise that state intervention through the CAP over the years has impeded the development of industry-based solutions, and that private sector insurance and hedging instruments are not available in all sectors, nor necessarily adapted to the distinctive risks faced by farmers. As the agriculture sector becomes more market-oriented, and farmers are increasingly exposed to market risks, we therefore do see a role for the CAP in promoting the development of non-trade distorting, industry-based risk management methods. This may involve providing information (for example on the expected impact of climate change in a particular region), facilitating structural change (for example where risk is pooled through cooperatives, or through vertical integration in the supply chain), or co-financing insurance premiums as the Commission envisages—although the latter measure should in our view be time-limited rather than permanent. The ultimate aim would be to shift a greater share of market risk onto the agriculture industry. However, we recognise that the state is unlikely to be able to withdraw from this area altogether, notably where a private insurance market is unlikely to emerge—as may be the case with respect to risks posed by animal diseases or climate change, for example.

Climate Change, Bio-Energy, Water Management, Biodiversity

162.  The agriculture sector is both a significant contributor to climate change, and a prominent victim of its effects. The sector is increasingly likely to face environmental challenges such as water scarcity and flooding, but is simultaneously under pressure to reduce its greenhouse gas emissions. The industry also has a central role to play in protecting biodiversity and in allowing the EU to meet its biofuel and renewable energy targets.

COMMISSION PROPOSALS

163.  In its Health Check Communication, the Commission identifies climate change, bio-energy and water management as "three crucial new challenges for EU agriculture", with climate change as the pivotal one.[54] It notes that EU agriculture has contributed more than other sectors to the reduction of greenhouse gas emissions, but that it will be called on to curb its emissions further. The Commission also points out that the sector is highly exposed to climate change, and consequently identifies a need to improve adaptation practices. It predicts that targets for the share of biofuels (10 per cent) and renewable energy (20 per cent) in total fuel and energy consumption in 2020 are likely to have a significant impact on EU agriculture. The Commission notes too that the Health Check provides an opportunity to examine how water management issues can be integrated into the CAP, and recalls that biodiversity decline remains a major challenge.

164.  Although existing provisions already allow all four issues to be addressed in rural development plans, the Commission outlines a range of policy adjustments that could be introduced as part of the Health Check. Rural development guidelines could be adapted to create stronger incentives for mitigating and adapting to climate change, for sustainable water management, for providing bio-energy services and for biodiversity protection. Alternatively, climate change and water management objectives could be incorporated into one or both elements of cross-compliance. The Commission regards research and innovation as "crucial" to these new challenges, and proposes that incentives for research into second-generation biofuels should be reinforced. It also announces its intention to examine whether the present support scheme for energy crops is still cost effective in light of new market incentives for biomass production.[55]

165.  The Commission concludes that if measures to meet these challenges are to be effectively employed, further strengthening of Pillar 2 is essential.[56] It consequently calls for more financial resources for Pillar 2, to be obtained through an increase in compulsory modulation.[57]

WITNESSES' VIEWS: MITIGATION

166.  Commissioner Fischer Boel took the view that agriculture could do more to reduce its emissions from primary production, and that while possibilities already exist within the rural development scheme, "we need to reinforce the use of those possibilities" (Q 727). The English RDAs concurred on the need to create a stronger relationship between the climate change agenda and the principal environmental measures available to land managers, pointing out that existing environmental stewardship schemes in England did not address climate change issues but instead primarily addressed biodiversity issues (Q 371).

167.  Poul Christoffersen, Head of the EU Agriculture Commissioner's Cabinet, pointed out that "the greenhouse problem from agriculture is not so much CO2 as the other types of greenhouse gases" (Q 727). NFU President Peter Kendall acknowledged this, explaining that "it is quite a new preoccupation to focus on methane emissions from cattle" and that the industry will "have to look at how we can vary diets; how we can change grazing patterns; whether we use different grasses" (Q 129). He called for more R&D spend to address these issues—a call echoed by the Danish and German governments. Kirsten Holm Svendsen of the Danish Permanent Representation to the EU suggested that Article 69 of the 2003 CAP Regulation could be used to fund innovation and research in this area (Q 451).

168.  Natural England identified three ways of reducing emissions: "production methods with a lower greenhouse gas contribution; practices which encourage the retaining of carbon in soils; but, equally importantly, food prices that reflect the externalities" (Helen Phillips, Q 165). Dr Phillips suggested that improved management of peat soils in particular could be "a very cost effective way of going about carbon mitigation" (Q 164). Meanwhile Murray Sherwin of the New Zealand Government drew our attention to his country's intention to move to "a comprehensive emissions trading regime, which is all greenhouse gases in all sectors", including agriculture (Q 310). The agriculture sector, he explained, would be expected to start off "with an allocation of essentially free units, which will be scaled down over a period" (Q 312).

WITNESSES' VIEWS: ADAPTATION

169.  Many witnesses pointed out that while climate change presented a challenge for the agriculture industry, it could also create new business opportunities and income streams for farmers.[58] Helen Phillips of Natural England suggested that agriculture would have "an absolutely and utterly unique role" to play in adapting to climate change (Q 164). She emphasized the need for sustainable practices; "for instance less use of fertilizers, more sensible use of agricultural wastes", and for preventive measures, such as the establishment of wildlife corridors allowing species and habitats to migrate. The RSPB anticipated that the industry would have to move to new crops and new ways of farming (Q 92).

170.  Some of these could prove lucrative. Fiona Bryant of the English Regional Development Agencies suggested that climate change adaptation should be regarded as a "huge opportunity, whether that is reducing CO₂ emissions through waste management, through addressing diffuse pollution, through providing renewable energy and a number of other areas of activity"(Q 370). She pointed out that although it had been anticipated that agriculture could provide ecological services, this had thus far been interpreted in terms of biodiversity. A much wider interpretation was required, encompassing the efficient use of resources and the potential use of carbon capture storage and sequestration. NFU President Peter Kendall also saw "big potential" in renewable energy, notably in new technologies, by-products and waste (Q 124). Walter Duebner of the German Permanent Representation confirmed that renewable resources "provide new income possibilities for farmers" (Q 427). He suggested these could become a "new production line" for farmers, who "do not depend on food production alone any longer, they have another outlet." Ian Baker of the English Regional Development Agencies cautioned, however, that these opportunities would "only be fully realised if farmers themselves are talking to other people in those same supply chains, and the people who essentially manage the markets where their produce is going" (Q 381).

WITNESSES' VIEWS: BIOFUELS

171.  Commissioner Fischer Boel said that "we do not need the energy scheme that we have at present" (Q 727). She made the argument that "today we have a well-functioning market so I hope we can agree this will disappear and then maybe spend the money in innovation or the possibilities of developing the second generation of biofuels instead". Most of the evidence we received was implicitly supportive of the Commissioner's stance. Baroness Young of Old Scone, CEO of the Environment Agency, pointed out that "if we are moving away from funding production, we should not be helping fund biofuel production particularly" (Q 197). She went on to propose that the carbon market ought to fund biofuel production, by setting the right long-term price for carbon.

172.  Many witnesses called into question the net environmental impact of first-generation biofuels. Baroness Young suggested that the biofuels target for Europe "clearly cannot be achieved within the European arable area, unless we put the whole area under biofuels" (Q 195). The Environment Agency, she explained, was "pretty sniffy about biofuels anyway, because we think that certainly first-generation biofuels are not exactly the most effective way of reducing carbon and that we need to move to second-generation biofuels" (Q 195). Natural England emphasized the need to "avoid production subsidies for biofuels, because with that, we will see all the things that we do not want, such as very big monocultures of biofuels" (Q 166). Murray Sherwin pointed out that "there are very few biofuel opportunities or options out there right now which are both economically and environmentally positive" (Q 317).

173.  Some witnesses were equally concerned about biofuels imported from outside the EU to meet the biofuels target. The RSPB warned that "it would be bizarre if we cut down rainforest and create greenhouse gas emissions from doing that to create biofuels, some of which have a rather poor record themselves in saving greenhouse gas emissions, but that seems to be one direction we might be heading in" (Q 82). Baroness Young insisted that "if we are to have a biofuels market globally, we do need to see some sort of accreditation process or certification scheme" (Q 195)—a call echoed by Natural England.

174.  Sonia Phippard stressed the UK Government's "very firm view that as we look at the fuel alternatives, we need to be very, very clear both about looking for the most efficient sources of them, which may not be European, and at the environmental impacts of those sources" (Q 15). Baroness Young pointed out that if the aim was to identify the most environmentally effective and least environmentally damaging ways of impacting on carbon "the hierarchy would be energy from waste; energy from biomass; and biofuels coming quite a long way down after that—unless the second-generation biofuels really start to come through" (Q 197).

WITNESSES' VIEWS: RESOURCES

175.  The Agriculture Commissioner has presented the environmental challenges facing the agriculture sector as a justification for transferring resources from Pillar I to Pillar II. Mariann Fischer Boel pointed out to us that "the budget for agriculture will not be increasing after 2012. We will have lots of different challenges but we have not asked for more money. We will simply try to reallocate within our budget" (Q 731). Her Chef de Cabinet, Poul Christoffersen, likened this to an offer to fund climate change measures at no extra cost: "We are actually saying we are prepared to finance this by moving more money into the second pillar" (Q 729). "It would be difficult to find another financial donor", the Commissioner suggested (Q 729).

176.  Her colleague Dalia Grybauskaite, the Budget Commissioner, was more optimistic, anticipating that other financial donors were likely to come forward, albeit with mixed motives. With reference to environmental challenges, she stressed the need "to avoid duplication", pointing out that "we have these elements in separate policies and they all fight, [saying] 'I need to do it', because they want to keep their portfolio" (Q 653). She consequently warned that "the creative minds in this house and outside are working very hard to keep things [resources] in the same pockets" (Q 675).

CONCLUSIONS

177.  We support the Commission's intention to review whether the strategic guidelines for rural development in the period 2007-2013 offer appropriate incentives for farmers and land managers to address the challenges and exploit the opportunities posed by climate change, including research and development, sustainable water management and the protection of biodiversity. We note, however, that because rural development programmes are drawn up by the Member States themselves, the onus is also on them to review whether their rural development and climate change agendas are suitably aligned. The Commission's review should therefore be complemented by equivalent reviews at the national level. Particular attention should be given to whether the right measure of flexibility is available to support measures that cut across the EAFRD axes, notably where there is both a business development and an environmental aspect to a particular project.[59]

178.  We would not support moves to incorporate climate change and water management objectives in cross-compliance. This would in our view add to the administrative burden faced by farmers, while duplicating policy objectives that are already addressed in Pillar II and in the Water Framework Directive.

179.  We concur with the Agriculture Commissioner's verdict that market developments have removed the justification for subsidising biofuel production.[60] Production-linked subsidies run counter to the principle behind the 2003 CAP reform—support schemes for energy crops should be no exception.

180.  We support the Commission's call for funds to be transferred from Pillar I to Pillar II so that adequate resources are available to implement the climate change agenda for agriculture. We note, however, the risk that the climate change agenda may be seized upon to resist calls for cuts to the overall CAP budget—a position that may be implicit in the evidence given to us by the Agriculture Commissioner.

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49   Commission Communication on the Health Check, Para. 4.3. Back

50   See also Mike Rumbles MSP, Appendix 5, Para. 1; John Scott MSP, Appendix 5, Paras. 3 and 4; and Sarah Boyack MSP, Para.3. Back

51   Note however, that the Commission has proposed that in the EU-15, the current redistribution key for modulated funds will only apply to the first 5 per cent of additional modulation. For the remaining 3 per cent, and for the 3 per cent applied in the new Member States, all the funds obtained from modulation will remain with the Member State in which they were generated. Commission MEMO/07/476, p.10. Back

52   Commission Communication on the Health Check, Para. 4.1. Back

53   The 2007 reform of the fruit and vegetable regime (Council Regulation 1182/2007 EC) offers Community financial support to producer organisations, which may engage in crisis prevention and crisis management measures (such as harvest insurance, training, or support for the administrative costs of setting up mutual funds). These measures are financed with operational funds that may be co-financed by the EU. Back

54   Op. cit. Para. 4.2. Back

55   Commission Memo 07/476, p.8. Back

56   Op. cit. p.9. Back

57   Commission Communication on the Health Check, Para. 4.3. Back

58   See for example RSPB Q 56. Back

59   On this point, see Q 378 of the oral evidence given by England's Regional Development Agencies. Back

60   This Committee has recently analysed the EU Strategy on Biofuels in its 47^th Report of Session 2005-06, published on 20 November 2006. Back