Responding to price volatility: creating a more resilient agricultural sector Contents

Chapter 3: Resilience and the Common Agricultural Policy

78.This chapter looks at how farmers have traditionally sought to improve their levels of resilience. We outline the current options available under the CAP and put these in the context of how the Policy has evolved.

Types of risk facing farmers

79.Defra noted that farmers “face many risks manifesting as volatility in agricultural markets”, and that such risks differed in their probability and impact, implying different potential roles for the UK Government and farmers.55

80.According to the OECD different levels of intervention were required in different circumstances. Normal variations in production, prices and weather could be managed directly by farmers as part of their normal business strategy and did not require a specific policy response. At the other end of the spectrum, infrequent but catastrophic events affecting many farmers over a wide area, such as severe droughts or the outbreak and spread of a damaging disease, were usually beyond farmers’ and markets’ capacity to cope, and might mandate a government response. Finally, marketable risks lying between the normal and catastrophic, such as hail damage and some variations in market prices, could be handled through market tools or through cooperative arrangements among farmers.56

81.In addition, as has already been mentioned, climate change is expected to increasingly exacerbate the risk of weather shocks and changing production conditions in the agricultural sector. According to the European Commission, the EU farming sector will be in the frontline, coping with impacts such as changes in rainfall patterns and rising temperatures, as well as more frequent extreme weather events, including heatwaves, droughts, storms and floods.57

Defining resilience

82.Witnesses agreed that resilience encompassed the capacity of the agricultural sector to withstand the impacts of price volatility and low prices, and the ability to maintain competitiveness. Ian Hodge, Professor of Rural Economy at the University of Cambridge noted that resilience relied:

“on a series of different types of capital: financial reserves that can be drawn on when incomes are low, levels of machinery and other assets that give capacity to cope with unfavourable production conditions, human capital that provides knowledge and skills to understand and address changing and unfamiliar circumstances, natural capital that provides ecosystems services in support of production, and social capital that provides access to social networks and support for information and sharing resources”.58

83.Menter a Busnes, which implements Farming Connect, a Welsh advisory service for farming families and forestry businesses operated under the Welsh Rural Development Plan, stressed the link between resilience and competitiveness. It argued that both of these were associated with well-run businesses with improved levels of income and productivity, which were therefore better able to manage risk.59

84.According to Farm Europe, a think-tank focusing on EU rural economies, “A resilient agricultural sector is one which can respond to risk effectively and take steps to mitigate the wider effects of global price volatility.”60

The Common Agricultural Policy as a source of support

85.EU countries’ agricultural sectors are regulated by the CAP, which to a large extent provides the policy framework within which farmers manage risk. DG AGRI told us that EU agricultural policy had shifted “from strong market management with high support prices towards a flexible system consisting of direct payments [including the Basic Payment Scheme] complemented by a market safety net”. This set it apart as a “comprehensive tool to meet the challenge of market volatility in the short, medium and long term”.61

The evolution of the Common Agricultural Policy

86.The CAP is one of the oldest EU policies, having been launched in 1962 following the establishment of the European Economic Community. This necessitated transferring national state intervention—a prominent feature in the agricultural sectors of the founding member countries, but incompatible with the principle of free movement of goods—to the Community level.62

87.According to the European Commission, the policy was developed in the post-war years when agriculture in Western Europe had been crippled. It aimed to encourage better productivity in the food chain, thereby ensuring a fair standard of living for the agricultural community, stabilise the market and ensure the availability of food supplies to EU consumers at reasonable prices.63

88.At the point of its inception, the CAP offered high support prices to farmers, combined with border protection and export support to incentivise production. By the 1980s, however, the EU had permanent surpluses in many of the major farm commodities. The high budgetary cost of the measures and the distortion of some world markets led to the introduction of the milk quota in 1984, and a maximum ceiling for the CAP budget in 1988, as part of efforts to reform the policy without departing from its basic principles.64

89.The 1992 reform of the CAP started the shift from production support through market intervention (price support and border tariffs) towards what has become seen as income support. It introduced Direct Payments65 to farmers to compensate for the cut in price support.66 Subsequent reforms further de-coupled support payments from production, increased market orientation and included environmental requirements and reinforced support for rural development.67

90.The latest round of reform, covering the period 2014–2020, has continued along the same path, introducing the ‘green payment’ as a new policy instrument. This subjects 30% of Member State total Direct Payments to environmentally beneficial greening practices, such as the maintenance of permanent grassland, ecological focus areas and crop diversification.68

Increased market exposure

91.The evidence strongly suggested that the developments in the CAP from supporting production by intervention in markets towards providing direct forms of income support had exposed EU farmers to the dynamics of global agricultural commodity markets.

92.According to Defra, “the intensity of market intervention has declined significantly as a result of CAP reform” since the early 1990s, leaving EU markets more open to respond to fluctuations of supply and demand”.69

93.The AHDB told us that this greater exposure to global volatility presented increased challenges to farmers:

“De-regulation of the EU Agricultural markets has meant that farmers have to now actively manage their own price risk … Clearly this is a huge challenge for the industry, which requires a broader and new set of management skills, beyond the traditional physical skills.”70

94.Changes to the framework of the CAP have resulted in a greater exposure of production decisions to market forces. Direct Payments, however, provide income support which maintains a degree of financial stability for some farmers.

Market management tools

95.Despite the decline in market intervention, Defra pointed out that the EU still retained a number of market management tools, including intervention buying, emergency powers to address “serious market disturbance”, a crisis reserve, and a facility for export subsidies.71

96.As an example of an emergency measure, DG AGRI noted a temporary exceptional aid to milk producers in the Baltic countries and Finland which it introduced in the wake of the August 2014 Russian import embargo on most EU agricultural products.72

97.Defra also pointed to the €500 million package of measures announced by the Commission in September 2015, to “support European farmers after a prolonged period of low prices”.73 The largest part of the package consisted of targeted aid for all Member States to support the dairy sector. Additionally it advanced certain Rural Development payments and included plans to address market imbalance, including the extension of private storage aid.74

98.According to DG AGRI, market measures are now deployed only as a last resort, at times when market conditions become adverse and prices collapse: “Thus the policy has gradually shifted from the concept of a safety net based on targeting price signals towards one targeting farm income, and the recent measures in support of the dairy sector reflect this.75

99.It also stressed that a policy delivered through price support, as was previously the practice in the EU, would lead to a vicious cycle: such support effectively increases prices, providing incentives for overproduction, which again leads to collapsing prices, and eventually to demands for volume controls. It concluded: “This recipe may temporarily work for small or isolated countries, but it fails to stabilise income in more open economies.”76

100.The shift in the CAP towards income support and greening is likely to continue. Future policy decisions must focus on addressing the outcomes of price volatility and periods of prolonged low prices and help farmers to develop resilience mechanisms rather than controlling prices.

101.While we note the Commission’s ambition to simplify the CAP, the focus must be on reducing complexity for the farmers who use it.

The 2015 aid package

102.The Welsh and Northern Irish administrations welcomed the September 2015 package but argued that much more needed to be done to address the acute situation in the dairy sector. According to the Welsh Government, “EU Aid packages of this type do help but they are by no means the panacea.”77 The Northern Ireland Assembly Committee for Agriculture and Rural Development agreed that “much more is needed to assist farmers with the cash-flow difficulties they are experiencing [following a] sustained and sharp drop in milk prices”.78

103.There was, though, a difference of view over the usefulness of such emergency responses. The Welsh Government argued: “The dairy sector faces many challenges and a one-off relatively modest payment will only have a limited impact and could well entrench further attitudes within the industry that the Government will ‘bail us out’.” Instead, the focus should be on helping farm businesses and the industry become stronger so that they can cope with such challenges without government intervention.79

104.By contrast, the Northern Ireland Assembly Committee for Agriculture and Rural Development stated that farmers “need immediate assistance now or they will go out of business”. It added that the actions geared towards stabilising markets and addressing the functioning of the supply chain were focused on aiding recovery in the medium to long term.80

105.George Eustice MP, Minister for Farming, Food and Marine Environment, also noted that Member States could use the CAP’s Rural Development funding to “help farmers get back on their feet” after a natural disaster. This provision allowed Member States to grant farmers aid to restore agricultural production potential damaged by natural disasters, adverse climatic and other catastrophic events and to invest in preventive measures.81 The Minister told us that the UK Government used the funding to support farmers after floods in the Somerset Levels in 2014.82

106.One-off support packages can help to counter the impact of extreme natural disasters or catastrophic events that are beyond individual farmers’ control. Policy should, however, focus on building the sector’s resilience in the longer term.

107.We recommend that the UK Government clearly articulate the specific circumstances under which it will seek to access EU funding to provide emergency aid for farmers in the wake of an extreme natural disaster or a catastrophic event.

The Risk Management Toolkit

108.The latest round of CAP reform also introduced a new Risk Management Toolkit, which allows Member States to use Pillar 283 funding for Rural Development to finance three different types of risk management instruments:

(a)financial contributions to premiums for crop, animal and plant insurance against economic losses to farmers caused by adverse climatic events, animal or plant diseases, pest infestation, or an environmental incident;

(b)contributions to mutual funds to pay financial compensation to farmers, for losses caused by adverse climatic events or by the outbreak of an animal or plant disease or pest infestation or an environmental incident;

(c)an income stabilisation tool, in the form of financial contributions to mutual funds, providing compensation to farmers for a severe drop in their income.84

109.Some witnesses pointed out that the new risk management options under the CAP had so far not been very popular among Member States. According to DG AGRI, the uptake of the EU risk management tools in the programming period 2014–2020 had been “rather limited”. They told us that in some cases, Member States’ reluctance to include such instruments in their Rural Development Programmes (RDPs) appeared to be caused by a “cultural shift to more sector involvement in managing risks”.85

110.Defra added that some Member States had preferred to use national funds under the EU’s state aid rules to provide support for insurance, and were concerned about the potential expense of the income stabilisation tool in comparison with the size of their RDPs.86

Increasing farmers’ responsibility

111.According to DG AGRI, these new options encouraged farmers to “share responsibility in managing specific on-farm risks”.87 Indeed, some witnesses argued that farmers should take on greater responsibility for managing risk. The OECD said that producers were best placed to manage day-to-day business risks, while the EU and governments should target support towards more extreme, catastrophic risks.88

112.The NFU agreed that individual farmers should contribute to their own risk management, for example, by undertaking benchmarking comparisons of their costs with comparable businesses, or by considering ways to buy and sell inputs and outputs. It added:

“Farmers should have access to a range of measures to help them to manage volatility. These measures should be accessible and easily understood. There is a role for government to ensure this is the case.”89

113.DG AGRI noted that risks that were specific to certain countries or regions should be left to Member States to manage, including weather and diseases:

“How to address risk at the EU level should depend on the type of risk that is EU-wide, such as market risks (linked to the Common Market, with its internal and external dimensions) or broader environmental risks (with the best example being the impact from climate change).”90

We return to this issue in Chapter 7.

The role of Direct Payments

114.Direct Payments under Pillar 1 of the CAP provide a major source of income to some farmers. The evidence suggested that this income, while protecting these farmers during periods of low prices, could undermine the industry’s competitiveness and resilience in the longer term.

Direct Payments as a risk management tool

115.The NFU argued that Direct Payments provided an “effective risk management function”, complementing measures such as intervention and private storage aid. It also expressed concern that developing alternative risk management tools financed by the CAP would reduce the Direct Payments budget, consequently undermining the existing policy.

116.The AHDB said that Direct Payments were likely to contribute to resilience, but it highlighted the need for farmers to acquire the skills and tools needed in the market. It argued that the payments provided “passive volatility management”, while options such as insurance schemes could be used to manage volatility more actively.91

117.DG AGRI also noted that the switch towards Direct Payments allowed a “clear transmission of market signals”, which it said was a key element for the competitiveness of the agricultural sector.92

Direct Payments stifling innovation

118.Some witnesses, on the other hand, told us that Direct Payments reduced incentives to innovate and might artificially keep ineffective or unproductive farmers in business.

119.The Welsh Government noted that while income support provided a safety net for farm businesses, it might also be the reason why farm businesses “innovate and embrace change more slowly than they might otherwise do”—such a direct subsidy might stop individual businesses and the wider industry from addressing current challenges and realising a long term vision.93

120.Nick Tapp, a farmer, agreed that the current policy was delaying the pace of change to meet new demands from the marketplace, “with the result that inefficiency is rewarded, and technical innovation can be ignored”. 94

121.Professor Ian Hodge noted the important role of shocks in bringing about changes in the agricultural sector:

“When there are major shocks or stresses, as has occurred periodically in the past, it may require more radical changes in agricultural systems and structures that the existing population of farmers or the current structure of farm businesses is unwilling or unable to deliver. The restriction on this more radical adjustment option might have a substantial opportunity cost to society in preventing a shift towards more socially valuable enterprises or techniques. “95

He added that some businesses might resist changes “that could be beneficial at a more aggregate level” if they were committed to a particular production type or technology:

“In this context, the only way in which the industry can change more radically would be through a change in the population of businesses, some leaving the industry and new ones joining.”96

122.We also heard evidence suggesting that sectors that did not benefit from Direct Payments might be better prepared to operate in competitive markets. Barclays Agriculture and Allan Wilkinson, Head of Agriculture and Food at HSBC, noted that the pig and poultry sectors, along with the horticulture sector, were ahead of other sectors in terms of having the business knowledge and recording systems to understand their production costs.97 It is certainly the case that Direct Payments offer farmers a guaranteed income regardless of their actions to improve resilience.

123.Rural Business Research noted that the Direct Payment accounted for 56.4%, or £22,400, of the Farm Business Income (FBI) that English farmers achieved on average for the 2014/15 financial year. Only 5.3% (£2,100) was generated from agriculture and 23.4% (£9,300) from diversification, according to data from the English Farm Business Survey.98 It should be noted, however, that the Farm Business Survey only covers farms deemed to be ‘commercial’ and excludes the smaller businesses that make up half of UK farms99. In addition, while FBI can be equated with financial net profit, it is calculated using differing methods.100

124.Direct Payments provide farmers with important income support to withstand protracted periods of low prices. They can, however, reduce incentives for innovation and efficiency gains and hold back much needed structural change.

125.In the long term Direct Payments have a crucial role in supporting the provision of public goods. This is discussed in the context of the future shape of the CAP in Chapter 7.

Voluntary co-operation and diversification

126.Within the framework of the CAP, farmers have traditionally adopted strategies actively to increase the viability of their businesses, including through voluntary co-operation and diversification.

127.Sir John Marsh noted that farmers could co-operate among themselves, or with major customers or suppliers in the form of vertical coordination, potentially leading to vertical integration.101 Similarly, Menter a Busnes argued that farmers’ competitiveness could be increased by measures such as collaborative buying of inputs, which could have a significant impact on income. It added that cooperation could increase the negotiating power of farmers, who were traditionally perceived as price-takers whose production decisions did not affect the market price.102

128.The evidence suggested that other common risk management strategies employed by farmers include informal “self-insurance” through saving and borrowing,103 and increasing storage capacity to allow flexibility in deciding when to sell commodities.104

129.Farmers have also sought to reduce their exposure to risk through their choice and mix of farming enterprises (choosing combinations that contrast in ways such as vulnerability to weather shocks), by maintaining a degree of production flexibility, and by diversification. On-farm diversification involves farmers undertaking other income-generating farm activities, such as tourism and farm based retailing. In contrast, off-farm diversification involves farmers or other members of their families diversifying their incomes by taking up employment or business opportunities outside the farm.

130.Rural Business Research, a research consortium led by the University of Nottingham, noted:

“Although farms have typically become more specialised over time with respect to their agricultural activities, farmers have also engaged with additional income generating activities, including diversifying their business activities drawing on a range of farm and non-farm resources (including value-added to farm produce via on-farm retail, recreation activities drawing on land resources, accommodation provision, including tourism and agricultural contracting).”105

131.They added that renewable energy generation, using technologies such as solar, wind and anaerobic digestion, had more recently become a key on-farm diversification activity. Nevertheless, investment requirements and planning controls were significant barriers to large-scale renewable energy projects.106

132.Professor Morgan noted that the diversification of production helped farmers spread the risk by producing many different commodities rather than just having a monoculture.107 The All-Party Parliamentary Group on Agroecology for Sustainable Food and Farming agreed: “The diversification of outputs means that a fall in the price of one agricultural commodity will have less overall effect on the farm business.”108

133.Some witnesses noted, though, that there was a trade-off between efficiency gained through specialisation and improved resilience from diversification. According to Menter a Busnes increased competitiveness and efficiency through specialisation could increase exposure to risk, as income became ‘less diversified’.109

134.The Irish agriculture and food development authority, Teagasc, agreed that the downside of product diversification was that it was “likely to lead to a less efficient and productive agri-food sector as research has shown that more specialised farmers are more efficient”. They added that farmers seeking to control fluctuations in their total household income by taking up off-farm employment could also inadvertently reduce the efficiency of their farms.110

135.Mr Dunn, from the Tenant Farmers Association, pointed out that tenant farmers did not always have the option of diversifying beyond agricultural activities, because their tenancy agreements required them to be farmers with landlords reluctant to grant consent for it.111

136.The NFU noted that product differentiation and adding value to products were yet another way to mitigate the impact of risk, such as the production of organic milk, but they “may not suit every business and sector”.112

137.Farmers also have access to a growing number of market based instruments to manage price volatility. These are discussed in more detail in Chapter 5.

Supporting farmers to exit the sector

138.In view of the relatively large size of public subsidy compared with overall income, there is a risk that this support may be keeping less progressive farmers in business at the expense of new entrants. This suggests that there could be a case for government intervention to help farmers struggling to cope to retire, allowing new entrants in.

139.The Minister told us that Defra had no plans to encourage farmers to retire proactively, but it had started to consider ways to help farmers minded to do so:

“We have had some discussions on whether you could have mechanisms that enable people to retire with dignity, as it were, and maybe stay on the farm but make it possible to allow a new property to be built for a new farmer coming in and taking it on. We are keen to encourage such things as contract farming and shared farming agreements, which offer an opportunity for somebody to step back from the day-to-day running of the business while keeping an interest in it and staying in their home. We are seeing the development of some models that enable this transfer to take place.”113

140.We recommend that the UK Government works to identify the main barriers preventing farmers from exiting the sector and investigate ways to overcome these barriers. They should consider how Rural Development funding can be used to accelerate structural change and create opportunities for new entrants into farming.

55 Written evidence from Defra (RPV0009)

56 OECD, Risk Management in Agriculture: What Role for Governments? (November 2011). [accessed 5 May 2016]

57 European Commission, EU Agriculture and Climate Change factsheet (September 2015): [accessed 5 May 2016]

58 Written evidence from Professor Ian Hodge (RPV0016)

59 Written evidence from Menter a Busnes (RPV0030)

60 Written evidence from Farm Europe (RPV0015)

61 Written evidence from DG AGRI (RPV0027)

62 European Parliament, The common agricultural policy (CAP) and the Treaty, Fact Sheets on the European Union (January 2016) [accessed 5 May 2016]

63 European Commission, The early years: establishment of the CAP (22 April 2015): [accessed 5 May 2016]

64 European Commission, The crisis years II: the 1980s (22 April 2015): [accessed 5 May 2016]

65 Direct payments now comprise the Basic Payment Scheme, the Green Payment, the Small Farmers’ Scheme and the Voluntary Coupled Scheme. The term “Direct Payments” is used in this report to refer to this suite of schemes and those that preceded them (the Single Farm Payment).

66 European Commission, The 1992 reform (“MacSharry reform”) (22 April 2015): [accessed 5 May 2016]

67 European Commission, Overview of CAP Reform 2014–2020, Agricultural Policy Perspectives Brief, No (5 December 2013): [accessed 5 May 2016]

68 European Commission, Overview of CAP Reform 2014–2020, Agricultural Policy Perspectives Brief, No (5 December 2013): [accessed 5 May 2016]

69 Written evidence from Defra (RPV0009)

70 Written evidence from AHDB (RPV0020)

71 Written evidence from Defra (RPV0009)

72 Written evidence from DG AGRI (RPV0027)

73 Written evidence from Defra (RPV0009)

74 European Commission, Annex: Comprehensive package of measures, Fact Sheet (7 September 2015): [accessed 5 May 2016]

75 Written evidence from DG AGRI (RPV0027)

76 Written evidence from DG AGRI (RPV0027)

77 Written evidence from the Welsh Government (RPV0010)

78 Written evidence from Northern Ireland Assembly Committee for Agriculture and Rural Development (RPV0002)

79 Written evidence from the Welsh Government (RPV0010)

80 Written evidence from Northern Ireland Assembly Committee for Agriculture and Rural Development (RPV0002)

81 Regulation of the European Parliament and of the Council of 17 December 2013 on support for rural development by the European Agricultural Fund for Rural Development (EAFRD) and repealing Council Regulation (EC) No 1698/2005, Regulation (EU) No 1305/2013

82 Regulation of the European Parliament and of the Council of 17 December 2013 on support for rural development by the European Agricultural Fund for Rural Development (EAFRD) and repealing Council Regulation (EC) No 1698/2005, Regulation (EU) No 1305/2013

83 Pillar 2 refers to rural development policy, while Pillar 1 encompasses product and producer support. Pillar 1 is funded solely from the EU budget, while Pillar 2 is based on multi-annual programmes that require co-financing from Member States.

84 Regulation of the European Parliament and of the Council of 17 December 2013 on support for rural development by the European Agricultural Fund for Rural Development (EAFRD) and repealing Council Regulation (EC) No 1698/2005, Regulation (EU) No 1305/2013

85 Written evidence from DG AGRI (RPV0027)

86 Written evidence from Defra (RPV0009)

87 Written evidence from DG AGRI (RPV0027)

89 Written evidence from the National Farmers’ Union (NFU) (RPV0024)

90 Written evidence from DG AGRI (RPV0027)

91 Written evidence from AHDB (RPV0020)

92 Written evidence from DG AGRI (RPV0027)

93 Written evidence from the Welsh Government (RPV0010)

94 Written evidence from Nick Tapp (RPV0005)

95 Written evidence from Professor Ian Hodge (RPV0016)

96 Written evidence from Professor Ian Hodge (RPV0016)

98 Written evidence from Rural Business Research (RPV0008)

99 Farm Business Survey, ‘User Guide’:
[accessed 5 May 2016]

100 Farm Business Survey, ‘User Guide’:
[accessed 5 May 2016]

101 Written evidence from Sir John Marsh (RPV0006)

102 Written evidence from Menter a Busnes (RPV0030)

103 Written evidence from Defra (RPV0009)

104 Written evidence from Professor Lloyd, Professor McCorriston, and Professor Morgan ; Written evidence from Professor Ian Hodge (RPV0016)

105 Written evidence from Rural Business Research (RPV0008)

106 Written evidence from Rural Business Research (RPV0008)

108 Written evidence from the All-Party Parliamentary Group on Agroecology for Sustainable Food and Farming (RPV0031)

109 Written evidence from Menter a Busnes (RPV0030)

110 Written evidence from the Irish Food Development Authority Teagasc (RPV0013)

112 Written evidence from the NFU (RPV0024)

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