Summary

The negotiation on a new Multiannual Financial Framework (MFF) for 2020-2027 forces the EU to make some hard choices. New priorities on the protection of the EU external border, immigration and asylum policy, security and defence and student mobility through the Erasmus program etc need to be covered appropriately by the future budget.

With Brexit, revenues are set to fall unless compensated by higher contributions of Member States. The CAP with its large share of the budget needs a critical review.

A high budget for the CAP can only be justified if EU value added can be demonstrated. The criterion must be “Public money for Public Goods”. Direct Payments (DP’s) to farmers do not fulfil this criterion and need to be phased out. Since they represent an important part of farmers’ income, farmers must be given sufficient time to adapt.

More money should instead be spent on the protection of the environment with a long list of important issues: Maintaining biodiversity, soils and ecosystems; on reduction of air and atmospheric pollution; on mitigation and adaptation to climate change including action on energy efficiency and conservation, emission reductions and on water management; on maintenance of carbon sinks in the form of wetlands and forests with afforestation as an element and the protection of permanent habitats and grasslands.

Justified are also payments to farmers in Less Favoured Area (LFA’s) with natural handicaps-often areas facing a real risk of depopulation but important for environmental protection, maintaining rural communities and European landscape, infrastructure and economic activity. In other words, protection of European heritage and culture.

Nonetheless market orientation must remain the predominant principle for farmers’ decisions on production.

The phasing out of DP’s – combined with a possible national co-financing of DP’s – would liberate an increasing amount of money each year with some of it to be used in a modern CAP and some of it to be used for other political EU priorities.

 

A. Introduction

The upcoming discussions on the new Multiannual Financial Framework (MFF) 2020-2017 is about recalibrating the EU budget to accommodate for new priorities. To name a few: more money is needed for a common and strengthened control of the EU external border. Other areas of political priority are e.g. the EU immigration and asylum policy as well as a common security and steps toward a common defence policy. Also an enhanced EU financed Research and Development policy needs to be financed to deliver on Europe’s goals of becoming a leading innovation economy. A higher budget is also needed for Erasmus, Europe’s successful program on student mobility and exchange. Together with a loss of revenue from Brexit there is a need to look at the existing expenditure unless there is a (unlikely) chance of a significant increase in own resources and/or increase in Member States contributions to the EU Budget.

The CAP represents about 40% of the EU budget and is thus an obvious candidate for closer examination in light of the abovementioned priorities. Continued high CAP expenditure can only be justified provided there is added value for the EU as such, not just for farmers and the agricultural sector. Without public support and demonstration of real added value for European society, the CAP is not sustainable in the long run. Society must be convinced, that taxpayers money is spent in order to meet commonly accepted objectives which otherwise would not be met without support. Consequently, the overall guiding principle for a modern CAP post 2020 must be “Public money for Public Goods”. Market orientation of the CAP should continue to be the primary guiding mechanism for farmers’ decisions on production, but where market failures exist (externalities) public intervention is required.

 

B. CAP Objectives

Objectives for European agriculture and the CAP are many but the most important ones, and on which most, if not everybody, would agree, can be summarised as follows:

• To produce food efficiently, abundantly, safe and of high quality
• To produce Public Goods as caretaker of the countryside, undertake climate action mitigation and protect the environment in tandem with agricultural activity
• To help to occupy the countryside for demographic, economic, employment and infrastructure reasons
• To protect environmentally vulnerable areas, European heritage and culture
• To provide a certain degree of stability for farmers in light of market failures and increased volatility both on the side of inputs as well as outputs
• To be part and parcel of the Single Market based on high standards contributing to its consolidation and adaptation
• To participate in international trade as part of the globalised economy adding to global demand as well as to global food security
• To be part of the modern economy for 2020 and beyond, providing growth and innovation

 

C. Five Main Elements for a Modern CAP

1. Direct payments (DP’s)

The present CAP with the generalised decoupled direct payments in Pillar I (Basic and Green payments) take up 70 % of the CAP budget and 28 % of the overall EU Budget.

The DP’s were introduced originally to compensate for the cut in support prices. Today they cannot be justified since they are paid as income support to farmers even when market prices are high. In times of low prices, the income support has been insufficient requiring ad hoc crisis management measures and market support. The DP’s are paid with no obligation to produce but only on condition that the farmer keeps the land in Good agricultural and Environmental condition (GAEC) and respects Statutory Management Requirements (SMRs) so-called “Cross compliance”. In order to activate the DP (entitlement), the farmer needs a number of hectares corresponding to the number of entitlements he possesses. The Green Element was introduced in the 2013 reform to ensure a “greening of the CAP”. In reality the requirements are so loose and flexible that the Green payment does not result in any real value added in terms of biodiversity, environment, climate change, soil protection and so forth. The Court of Auditors report from February 2018 agrees with this evaluation (Greening: Special Report of the Court of Auditors -22-02-2018). I would go so far as to state that the present CAP in some respects is even less green than it was after the Fischler reform in 2003.

The value of the DP’s has been capitalised into higher land value prices to the advantage of older farmers and to the detriment of young farmers and the need for generational change. The DP’s are primarily paid to the bigger farmers with 80% of the budget for DP’s going to 20 % of the farmers in the EU. The 20 % however represent the bulk of production and land under production (close to 90 %). Consequently, the smaller farmers with up to 10 hectares have very little benefit. DP’s represent a very important share of farmer’s income from farming up to 40 to 50 % in some cases (off farm income not included).

DP’s do not fulfil the criterion of Public money for Public goods. Income support is a social not an economic policy.  Why agriculture and not fisheries or any other economic activity? DP’s need to be phased out. Farmers however need time to adjust. Phasing out could theoretically be done over the 7-year period corresponding to the Multiannual Financial Framework (MFF) timeframe. A longer phasing out period is more realistic depending on what could be agreed politically in the Council and the European Parliament. Important is the message: In the long run the payment of DP’s to farmers without proper justification are unsustainable hands out.

Phasing out could be put in operation by way of a “Green Bond” with the value of the bond corresponding to the total payments over the number of phasing out years. The value of the payment would be decreasing each year until payments are reduced to zero at the end of the validity of the bonds. The farmer holding the bond/deed could either keep the bond and receive annually the degressive payment until the deed runs out or sell it on the market. The price of the bond to be determined by the market. This would allow older farmers to retire quicker and provide the younger farmers with higher but temporary payments as a start-up. Alternatively, the farmer could use the proceeds to finance investments.

Phasing out of generalised DP’s linked to the land would lead to de capitalisation of land values and thus assist in the generational change. The idea of a green bond in different forms has been around for several years for example as described by former OECD director professor Stefan Tangermann in Tangermann, S et Al. (1991), “A bond scheme for supporting farm incomes” or by professor Alan Swinbank et Al.” The bond scheme.” Available at http://centaur.reading.ac.uk/4614/

There are different models to be considered-should bonds be kept exclusively by farmers or be allowed to be sold freely on the market? Cross compliance in Pillar I would probably disappear but could be maintained in an enhanced Pillar II. The important thing is to get agreement on the principle of phasing out DP’s with modalities to be negotiated.

 

2. Pillar I and II

The present CAP is divided into Pillar I with expenditure financed 100 % by the EU Budget and Pillar II co-financed by Member States (varying from 25 to 75% depending on the measures and region). Pillar II takes up the remaining 30 % of the CAP budget and relates to Rural Development regarding measures with respect to protection of the environment, climate change mitigation, modernisation of farms, development of alternative farm income, research and risk management amongst others. The system is based on multiannual programs and in the case of farmers based on an individual contract for delivery of services subject to controls.

The divide between Pillar I and II has over time changed considerably and begs the question whether it still makes sense to maintain this structure? Since Pillar II measures are co-financed, Member States (MS) are careful in selecting programs and beneficiaries.

The question is whether in the future combined with a phasing out, an element of co-financing of Direct Payments should be considered.  The element of co-financing is very controversial and seen as a risk of renationalising the first and oldest common EU policy. Were co-financing to be introduced it should however be on a voluntary basis for Member States as under Pillar II. If a Member States chooses not to co-finance the DP, the EU financed share would be lost. Co-financing should however be strictly limited (25-50 %?) in order to avoid the risk of distortion of competition and to secure a level playing field.

The degree of co-financing could vary according to the wealth of the Member State as is the case in relation to measures under Pillar II. Could co-financing trigger a renationalisation of agricultural policy? I think the risk is minimal.

Politically it would be sending the wrong signal when we need more Europe. The fact is that the CAP like the Cohesion Funds has always been not just a policy providing EU value added and support to the farming community, but also a demonstration of EU solidarity and worked as an element of “transfer union” so much despised in Germany and by other net budget contributing MS when discussing reform of the Euro and completing the banking union.

Economically, agricultural and food production is one of the most important sectors in the EU providing employment and supply of abundant and high-quality food to consumers in the EU and third countries. Production and trade in agricultural products and food is highly integrated as demonstrated by the discussion on Brexit. The CAP with its common standards is an integral part of the Single Market.  The Single Market would be put in serious jeopardy if agricultural policy where to be renationalised. Trade in goods not just for food and agriculture would break down.

DP’s represent some 40 Billion € annually. With a phasing out over 10 years that would reduce the budget for DP’s by 4 billion € annually.

An element of national co-financing would add to the budgetary resources made available. See a forceful analysis by Professor Alan Matthews, Trinity College Dublin in favour of introducing co-financing in the CAP and suggesting different models:
http://capreform.eu/why-national-co-financing-of-cap-pillar-1-payments-is-needed-in-the-mff/

The savings could be used if not wholly then partially to finance a revised and modern CAP consisting of the following elements and subject to the criteria of public goods:

 

Real Green payments

Direct payments can be justified as compensation for the lack of remuneration from the market for the production of public goods (Externalities). Activities like taking care of the country side or keeping the farm in good agricultural and environmental conditions are not remunerated by the market. The problem of externalities is a fundamental one where the market price does not cover the real cost of production. Such payments exist to a certain extent already under Pillar II but need to be generalised and substantially enhanced.

Consequently, direct payments (or “contract payments”) to farmers or a group of farmers (on a collective basis), should be introduced on a contractual basis for a range of actions/services delivered:

• Protection of the environment, of biodiversity, soils and ecosystems.
• Reduction of air and atmospheric pollution.
• Mitigation and adaptation to climate change with action on energy efficiency and conservation, emission reductions, water management.
• Maintenance of carbon sinks in the form of wetlands and forests with afforestation as an element and the protection of permanent habitats and grasslands.
• Promotion of renewables with due respect of land use, land use change and forestry (LULUCF).
• Support the transition to sustainable intensification of agricultural production i.e. producing more with less in an environmentally sustainable manner.
• Promotion of efficient agriculture relying on research and development, innovation, investment in climate friendly production methods, precision farming, optimizing pesticide and fertilizer and use of drones, robots and Big Data.

Payments should in principle be differentiated according to the level of services delivered i.e. the higher the income foregone or cost incurred-the higher the payment. This principle is hard to apply in practice and instead standard amounts per hectare depending on the delivery of services to be delivered could be envisaged. This would facilitate controls. So, payments should be related to the achievement of specific objectives within each of the different domains rather than provided as a general decoupled payment entitlement to farmers.

Member states should be obliged to offer such contracts but it would be voluntary for the farmer to participate. The engagement with the farmer on a positive basis with less emphasis on controls and sanctions but focused on delivery, should make such contracts more attractive for the farmer.

 

3. Less favoured area payments

In Less Favoured Area (LFA’s) with natural handicaps farmers receive direct payments under Pillar II. The LFA payments should however be much more limited to those areas which meet specific criteria. To-day they are paid out extensively in areas not in real need (Luxembourg f.ex.). At the same time, the payments probably need to be increased, in order to reach agreed objectives more efficiently, e.g. stem the trend of depopulation of rural communities and protect fragile culturally important landscapes.

The co-financing could be increased, where to-day the figure is 50 % in general and 75 % in so-called Cohesion areas. Higher co-financing rates may be necessary for member states with weak public budgets. Even 100 % EU financing might be considered in the poorest areas of the EU on a temporary basis.

Obviously, there is an element of distortion of competition by keeping farmers alive in such areas, which otherwise would leave agriculture. However, the effect on overall production is modest.

Maintaining farming in remote areas like mountains does not make sense from a purely economic, efficient allocation of resources point of view, but certainly from many other considerations: demographic, strategic, maintenance of rural communities, tourism, protection of environmentally fragile areas/regions, cultural heritage etc.

 

4. Crisis and Risk management

Agricultural production is by definition a risky economic activity due to its dependency on the weather, natural events and sanitary risks for animal and plant production. Agriculture is characterised by supply and demand functions that are highly price inelastic with consequent large price effects. Mitigation against risks can be undertaken at the individual farm level, in joint cooperation in the form of producer groups/cooperatives or at government level. Risks can be divided into weather/nature related or biological (animal/plant disease) risks and market related risks. Climate change and the increased interdependence of international markets adds to price volatility and weather-related risk.

 

US vs CAP approach

When looking at risk mitigation measures it is useful to look at the US approach. There are significant differences between the US and EU approach to risk management with very different weight of instruments:

US: 60% insurance, 40 % safety nets, 0 % income support with direct payments

EU: 1 % insurance, 39 % safety net, 60 % income support with direct payments.

Policies in the US are characterised as dynamic-integrated vs static-segmented in the EU. In the US insurance policies are largely subsidized in some cases maybe even excessively[1].

What to do about such risks?

Weather related or biological risks should normally be taken care of by way of individual farmer insurance. Major weather or natural events (earthquakes) or biological events (Foot and Mouth disease) may however require state intervention.

Market risks can also be covered by individual insurance but might be quite costly if income stability is the objective. Contracts between farmer and upstream supplier and downstream buyer is another way of market related risk mitigation. Forward contracts and futures market/hedging is a useful tool if it is available. In the EU, this is still relatively poorly developed and primarily relevant for cereals and protein crops. Risk management of this type is ex ante to the event

 

CAP crisis management

Market support in the form of intervention prices and intervention buying is ex ante but now only seldom in operation due to the low level of price guarantee/safety net. It was however used successfully in connection with the latest dairy crisis 2 years ago when prices dropped below the reduced safety net (intervention price).

Instead the CAP has provisions for crisis management under the Safeguard Clause in the Single CMO and in the newly adopted so-called Omnibus Agricultural Provisions Regulation (EU) 2017/2393. The Commission has basically an open-ended range of instruments which can be applied if the budget is available and the political will or pressure warrants intervention. It is preferable to keep it ad hoc i.e. ex post in order to avoid moral hazard with market operators becoming too sure that the Commission will intervene.

 

5. MFF and the CAP

In order to have the necessary flexibility and in light of previous experience, I would suggest that the necessary budget should be available to the Commission whenever there is a crisis. The CAP should have access to a budgetary reserve to be used in times of crisis. Therefore, the CAP budget for market support should be set within a maximum over a 3 or 5-year period. The result would be larger payments in years of crisis and negligible payments in normal times.

The problem is that this does not at all fit with the present annularity of the EU budget. Unspent money cannot be transferred or “saved” for next year. This was a deliberate decision to avoid providing the EU with too much budgetary flexibility.  In the upcoming discussions on the MFF for 2020-2027 this straightjacket should be done away with. Unfortunately, Germany and others will mostly likely oppose such increased flexibility. As we have seen with the influx of migrants and refugees, there is a general need for more flexibility in the EU budget.

 

Public Support for Insurance coverage and countercyclical payments?

The question is whether in addition to the Commission’s Safeguard clause a system of public support/subsidy should be introduced to cover a part of an insurance premium against income loss. Going further, should the EU participate in designing systems of countercyclical payments as applied in the US farm policy? The risk of subsidizing insurance premiums is that this may end up primarily benefitting the insurance companies given that the income risk is rather high. Countercyclical payments may have the beneficial effect of avoiding major farm bankruptcies and closures but entails potentially high budgetary costs and risk of moral hazard. Farmers may be kept in business who otherwise should leave the sector and make space for more efficient farmers.

The US policy approach is thus quite different from the EU policy. The question is whether the EU needs to go more in the direction of the US in terms of risk mitigation via subsidies to insurance schemes whilst abolishing the direct payments.

 

D. Conclusion

Market orientation of the CAP has to be continued with the phasing out of the decoupled Direct payments combined with possible co-financing of DP’s during the phasing out period.

Payments to farmers are well justified in case of market failure and the need to promote and protect Public Goods. Setting up contracts with individual farmers or a group of farmers delivering services to society is the way forward. We need to get away from a “sticks and carrots” approach in favour of a more constructive engagement with farmers. In practice this means much more of Pillar II type of measures and only residual use of Pillar I measures in the form of crisis management. Further the possibility of limited use by member states of coupled support could be allowed, to maintain farming in vulnerable and sensitive areas or in danger of depopulation, but subject to more strict selection criteria.

Unfortunately, this probably means more and not less administration-this will not serve the populist cry for simplification! It’s the price to be paid for real delivery of Public Goods for Public Money to European citizens.

The upcoming MFF discussions is a good opportunity to consider these ideas allowing more money to gradually be spent on other EU policy priorities whilst putting the CAP on a sound footing for the future.

 

 

Lars Hoelgaard, Partner at TRADE-UP
Former Deputy Director General in DG AGRI, EU Commission

 

 

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[1] Comparative analysis of Risk management tools supported by the 2014 Farm Bill and the CAP  2014-2020 Directorate General for Internal Studies, Policy department B, Dec 2014

 

 

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http://bruegel.org/2018/03/eu-budget-scope-to-reform-common-agricultural-policy/