Original publication: October 2016
Authors: Alan Matthews, Louis Pascal Mahé, Jean-Christophe Bureau, Thomas Dax and Andrew Copus
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This document was prepared for the Workshop on “‘Reflections on the agricultural challenges post-2020 in the EU: preparing the next CAP reform” of 8 November 2016, organised by the European Parliament’s Committee on Agriculture and Rural Development (COMAGRI) and its Policy Department (AGRI Research). It contains three studies: 1. The future of direct payments (by Alan Matthews). 2. The future of market measures and risk management schemes (by Louis-Pascal Mahé and Jean-Christophe Bureau). 3. The future of rural development (by Thomas Dax and Andrew Copus).

 

The Future of Direct Payments

This note responds to a request to provide policy recommendations to AGRI Committee Members on possible improvements of the current direct payments mechanisms in the light of future challenges for EU agriculture. The future of direct payments is central to the debate on a future CAP because of their importance both in the total support that farmers receive and in the CAP budget. Budget transfers are the single largest element of support to EU farm incomes. Direct payments accounted for around 72% of the CAP budget and for just less than 30% of the entire EU budget in the 2013-2015 period.

The note is a work of structuring and synthesis, attempting to assist AGRI Committee Members by systematically setting out the choices available to MEPs if they wish to consider further reforms of the CAP.

Chapter 2 describes the structure of direct payments following the 2013 CAP reform. Decoupled payments, in the form of the Basic Payment Scheme and the Single Area Payments Scheme, remain the single most important layer, but other layers have been added, including a greening payment and young farmer payment which are compulsory for Member States, as well as schemes for coupled support, small farmers and areas of natural constraints which are optional for Member States. The 2013 reform greatly increased the flexibility given to Member States with respect to how they could implement the direct payments regime.

The ‘external convergence’ formula brought about a limited but unprecedented redistribution of CAP Pillar 1 resources between Member States. However, it did not alter the relative ranking of countries, and there are still significant differences in payment levels per hectare particularly among the old Member States and between old and new Member States.

Twelve of the 18 countries applying the BPS will still use the partial convergence model in 2020. The area of eligible land has likely increased following the 2013 reform. The most popular of the voluntary measures chosen by Member States has been coupled support, which has been introduced by all except Germany. Fifteen Member States opted for the Small Farmers Scheme, covering 41% of the EU’s farmers and 5% of its agricultural land.

Member States have also made wide use of the flexibility granted to attach varying conditions to the greening payment.

Chapter 3 asks whether the new direct payments regime is achieving its objectives and whether it is fit for purpose. Farm incomes remain hugely dependent on these payments. Based on FADN data over the period 2004-2013, the contribution of direct payments to farm net income was 47%, other public transfers 15% and market income 38%. The average share of direct payments was as low as 7% on horticultural farms and as high as 101% on ‘other grazing livestock’ farms over this period.

The 2013 reform introduced various measures to try to even out the distribution of direct payments across farms. However, degressivity/capping has made hardly any impact on the distribution of payments between farms, although the redistributive payment can play a more important if still limited role. The great majority of direct payments in the current programming period will continue to flow to farms whose income from farming is above the median farm income.

Capitalisation effects reduce the benefits of direct payments for existing farmers and raise the costs of entry and growth for younger and expanding farmers. Direct payments have slowed the exit of some farmers from agriculture and the reallocation of land towards more efficient farms. Direct payments contribute to stabilising farm income. However, they are not well targeted because they are not specifically focused on those farms facing the highest levels of income variability. Direct payments generally have a negative relationship with farm productivity, although the move to decoupled payments has reduced the efficiency losses associated with the previous partially-coupled payments.

The available data cannot yet tell us anything directly about the environmental benefits from the greening practices. The fact that the maintenance of permanent grassland requirement and the crop diversification obligation have led to minimal changes in land use, and the fact that the great majority of the land enrolled in EFAs is used for productive options, are pointers that the additional environmental benefits, relative to the pregreening baseline, in return for the expenditure of €12 billion annually are likely to be low. The greening choices made by Member States and farmers do not suggest that the opportunities to deliver significant environmental value have been taken in most cases.

There are no specific challenges and no specific public goods for which the appropriate policy response is a uniform, fixed, decoupled payment per hectare. There is a need to restructure direct payments to a set of targeted payments focused on well-specified objectives.

Three different models are proposed to help to identify key decisions for AGRI Members regarding the future of direct payments.

  • Model 1 assumes that decision-makers prolong the current structure of direct payment into the next programming period but wish to make technical adjustments to the legislation to improve its effectiveness and to simplify its administration.
  • Model 2 follows the US example in which decoupled direct payments are eliminated and the savings used either to introduce counter-cyclical payments or a set of income stabilisation tools. No merit is seen in counter-cyclical payments. There is a case to shift resources to income stabilisation tools but these should be managed principally at the Member State level.
  • Model 3 revisits the greening payment and considers four different options to replace it. These include reverting the greening obligations to cross-compliance; replacing the greening obligations by a menu approach at the Member State/regional level; adopting ‘conditional greening’ whereby entitlement to the basic payment would be conditional on enrolling in a basic agriculture-environmentclimate measure (AECM) in Pillar 2; and transferring the greening payment for voluntary AECMs in Pillar 2.

The current system of direct payments is neither sustainable in the long run nor designed to address the challenges facing farmers and land managers in Europe today and in the future. Chapter 5 puts forward a recommended structure for the future of direct payments, based on the following set of principles.

  • Payments should be targeted on specific objectives with a clear results orientation.
  • Payments should be restructured within a one-pillar, programmed, multi-annual CAP.
  • National co-financing should be required for all CAP expenditure.
  • Decoupled direct payments should be gradually phased out over a pre-announced transition period.
  • Savings should be redirected to more spending on risk management, improving competitiveness, climate action and environmental public goods.
  • Payment entitlements should be replaced by a contractual framework between farmers and public authorities.
  • Cross-compliance and the greening payment should be replaced with ‘conditional greening’ whereby the receipt of public support would be conditional on enrolling in a basic (shallow) environmental scheme devised by the Member State.
  • The allocation of budget resources should be incentive-based so that budgets are allocated to Member States based on performance as well as needs.

An indicative CAP budget in 2025 is prepared to illustrate the effects of these various choices. All of the elements in the recommended structure for future direct payments to farmers are familiar in the current CAP. What is proposed is to redesign these payments so that they are more effective in achieving their objectives, more understandable to farmers, give greater flexibility to national authorities, and provide greater value-for-money to the taxpayer. Policy-makers can decide the pace at which the transition can take place. What is important is that individual reforms to any element of the direct payments regime are consistent with the proposed long-term direction of travel.

However, the gains from shifting to a more targeted approach are sufficiently compelling that it would be a pity to delay.

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The Future of Market Measures and Risk Management Schemes

Background

The CAP has deeply changed its approach to agricultural markets since 1993. Market orientation and direct payments instead of tight price or supply controls are the new principles. The changes in the EU budget structure clearly reflect this evolution and the 2013 reform confirmed this trend. Market measures were kept alive but nearly dormant for most commodities, available for activation in exceptional circumstances. A Reserve for crisis was installed. Assistance to insurances and Mutual Funds was made possible in the framework of the second pillar. Member states have made an uneven use of them and, in particular, a very limited implementation of the Income Stabilization Tool. In spite of these new risk management tools, recent booms and crises have shaken the farm sector strongly enough to question the adequacy of the new CAP to cope with market disturbances.

1. Market disturbances: new challenge for the CAP
Financial balance of farm operations is increasingly sensitive to price instability, first, because net incomes are a small fraction of turnover due to outsourcing of intermediate inputs, labour and capital, and because of specialisation; second, because EU farm prices are not only closer to world prices but they also move in parallel. The EU is a net exporter for most commodities. A large use of export refunds is now out of question, because of international commitments. Due to its world size, both as a producer and as an exporter, the EU now influences world prices, as well as it bears their influence.

Lessons from developed countries experiences: a mixed record
Countries in similar situations have adopted policies to mitigate the implications of world price instability. In developed countries instability is mostly a producers’ issue; and policies and politics focus on price drops, rarely on price booms. In net importing developing countries instability is a consumers’ issue; and policies focus on price booms hurting their population plagued by poverty. All attempts at international coordination to moderate commodity price volatility have so far failed to deliver significant results.

The US has now implemented a variety of payments that clearly protect farmers from most adverse conditions, including low yields and prices. The potential distortions of competition with respect to the EU are a source of worry. However, one must warn against the simple idea that “the US does it, Europe should follow”. Indeed, the US system is itself plagued by many undesirable aspects.

First, because of the countercyclical nature of marketing loans, insurance programs and shallow loss payments, the budgetary costs of the program vary a lot. The cost to the taxpayer of the crop insurance program can exceed $10 billion certain years, for example. It is hard to imagine how such a program could fit in the present EU Multiannual Financial Framework, which largely relies on fixed annual endowments.

Second, the cost efficiency of the US insurance program is poor. Analyses conclude that every time a US farmer receives one net dollar through the insurance system, it costs two dollars to the US taxpayer. The efficiency of shallow loss payments programmes is also questioned.

Third, because of this protection, even a risk-averse producer has an incentive to specialize and produce more. Hence, the US programmes make farms less resilient to adverse conditions and more dependent on payments. The environmental consequences are also negative: monoculture is something that the recent CAP reform aims to deter.

2. Market measures and crisis management: dairy as a study case
The EU dairy market works as a study case to illustrate the mechanics of a rather typical agricultural crisis. In the last two crises, price collapses in 2009 and 2015 occurred after price booms in 2007-8 and 2013-14. The magnitude of the last crisis can be sensed by the magnitude of the price drops from peak to trough over the 2013-15 period (-36% for monthly prices and -16% for yearly data, at farm gate).

The Commission took a few market measures and proposed to use temporarily the Reserve for crisis to cover the costs. This attempt was met with strong opposition from farm organisations, the Council and the Parliament. Although at this stage, the cause of the crisis was viewed as political (the Russian ban) rather than economic, it reveals an EU institutional problem. Political institutions (the Council, the Parliament and the Commission to some extent) are too closely involved in day-to-day policy implementation, and this does not always ensure it works in a time consistent manner and for the common good.

In reality, the main engine of the crisis soon appeared to be the fast growing production of milk in the EU, as a surge of deliveries of 4% in 2014 was under way, although quotas were still in place up to March 2015. That is, the downfall in 2014 was already work in progress when in August 2014 Russia declared an embargo on EU imports of dairy and other products. This precipitated the price fall because the Russian outlet accounted for about 1.6% of EU production, a significant shock in a tight market. These developments also show how difficult it is to implement financial solidarity within the farm sector, in general, and even in the midst of a crisis.

In September 2015 the Commission proposed new measures including a €500 million aid package, an increased aid to private storage to milk powder and a programme of private storage aid for cheese. Several other measures were of a qualitative nature or hindered by uncertain and delayed effects, such as aid to promotion or using Rural Development Programmes through advance payments and measures to promote product quality and competitiveness, developing financial instruments and Income Stabilisation Tools, encouraging the improvement of Producers Organisations and “improving an exchange of experiences regarding unfair trade practices”.

The measures did little to end or alleviate the crisis since production continued growing fast and prices stayed depressed. Two features of adopted measures in 2015 are worth pointing out as they illustrate the wrong signals given to producers regarding their expectations of future public policies. Indeed, 80% of the €420 million emergency aid was distributed in proportion to quota references; and previously in March the Commission had decided to postpone the collection of the “superlevy” (amounting to €409 million) on quota overshoot and to spread it over three years, thus alleviating the cash flow shortage of some dairy farms in eight Member States. With hindsight, this initiative appears as unfortunate since it gave the wrong signal to the Member States where milk supply was growing fast, particularly to Ireland and the Netherlands where production increased most in 2014 and 2015. This initiative is one illustration of a recurrent conflict in the CAP: in addressing adverse income situations, the short run approach is to cope with emergency, but at the cost of fuelling further long run or delayed disturbances. The philosophy of the package also conveyed the message that market orientation was the principle and that mitigation of market disturbances consequences was to be largely handed over to Member states in the new context of increased flexibility of National Rural Development Plans. But at present, income stabilisation tools are nearly absent of Member States Rural Development Plans.

The Council of 14 March 2016 decided to double the quantity ceilings admissible in public storage for skim milk power and butter, and to allow Producer Organisations to regulate production on a voluntary basis for a limited period with the help of special envelopes financed by Member States. This was an ill-conceived device since it created a noncooperative behaviour between Member States and a new budget externality between countries. We show that a “prisoner’s dilemma” (i.e. a non-cooperative equilibrium detrimental to everyone) is bound to emerge from this policy scheme.

The decisions of July 2016 partly corrected some of the flaws pointed above with an EU-wide scheme to finance directly production reductions when Member States do not have a scheme in their National plans, and to co-finance from the EU budget Member states plans of supply moderation. But a basic externality still persists, at least between producers; and the benefits from the inelastic demand and price effects will remain largely untapped, at the cost of taxpayers. The EU institutions failed to agree on clear economic or political criteria to define where production could expand, with or without public support. A stronger system of crisis prevention cross compliance between basic payments, market regulation and risk coping instruments is now required.

Lessons from simulations of alternative policies over the recent period.
To illustrate the working of the dairy market and simulate counterfactual policy scenarios, we built an ad hoc simplified model just calibrated on years 2013-15. Scenarios included the Russian ban, public storage defined as in March 2016 decisions and ex post supply reduction (both mandatory and voluntary-subsidised). The results support the capability of market measures such as public storage and supply reduction to offset part of the price collapse and its consequences. The main driving force is the implicit inelasticity of the aggregate demand for dairy products and therefore the vivid price response to a restoration of market balance. Because of this effect, subsidies to small supply reductions appear unjustified if the programme is enforced across the whole EU. Focusing on gross margin over feed cost reinforces this finding. Then, gross margin over feed cost is nearly the same in both mandatory supply containment and intervention scenarios. If the subsidy is granted, overcompensation is likely, because the price effect more than offsets volumes cuts.

The simulations also illustrate how intervention benefits our foreign competitors; and enlighten the new constraint on market measures due to these leakages. Results point out significant exports losses from price enhancing market measures.

Using an averaged benchmark as reference – i.e. a more normal market situation than 2013 – to evaluate simulations results, brings further light. The three market measures of our scenarios do bring gross revenues virtually to benchmark level. However, they cannot neutralize the gross margin losses from benchmark level, although they reduce the losses quite significantly. This exemplifies the depth of the crisis even in comparison to an “average” market situation. This also shows that, when inputs have been committed to surplus production that is bound to be later under-priced, market measures are coming late and stay off the mark. To illustrate the point, a crisis prevention limiting supply growth to 4% over 2014 and 2015, announced ex ante, appears to fare better than all curative ex post market measures considered. However, under the present institutional setting, stakeholders and political forces do not express any demand for public action in periods of price booms to limit the pace of future supply developments. Asymmetrical demand for public action along the price cycles is a major problem in designing well-conceived market policies.

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Selection of figures:

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The Future of Rural Development (by Thomas Dax and Andrew Copus)

Background
In the course of the start of discussions on preparation of the next CAP reform a workshop presentation and an ‘In-Depth Analysis’ on the subject of the future of the rural development policy was commissioned by the European Parliament Committee on Agriculture and Rural development (AGRI Committee). This has been prepared by the two authors from the Federal Institute for Less-Favoured and Mountainous Areas in Austria; and from NORDREGIO, Sweden/ The James Hutton Institute, UK. The aim is to highlight key points for the discussion on the future of rural development policy, and to reflect on challenges for the post-2020 policy reform.

The analysis is based on a review of studies and policy analyses, on the history of rural development policy, – including the first experiences from the start of the 2014-2020 programming period – and discussion with experts on the implementation of Rural Development Programmes.

The analysis of the evolution of European Rural Development Policy reveals that its emergence dates back almost three decades. With the formulation of the Second Pillar by the Agenda 2000 decisions rural development became a discrete structural part of the wider CAP. The subsequent evolution of Rural Development Policy implies a gradual increase in its political priority.

Due to the broad scope of non-agricultural policies impacting on rural areas the tensions between sectoral and territorial measures and the aspect of coherence between CAP and Cohesion Policy has remained crucial throughout all programming periods.

This led to repeated discussions about objectives, priorities, scales and organisational issues of Rural Development Policy, and to ambitions for a more strategic and integrated approach, focused on sustainable and balanced territorial development.

The challenges for the next reform are, in particular, concerned with adapting the regulatory framework to support more effective implementation, exploiting territorial assets and potentials at the regional level, and providing incentives for strategies that enhance innovation and shape the amenities of rural regions.

Rural Development in the European Union
Rural areas are increasingly characterised by integration into their wider spatial contexts. These developments have intensified over the last decades due to on-going socioeconomic and technological changes, impacts on ecological performance and, in general, a web of inter-relations transforming the challenges and opportunities of rural areas.

In particular, forces of globalisation and the strengthening of rural-urban interlinkages have placed ‘relational aspects’ of rural regions and ‘proximity’ relationships on top of the agenda. The multitude of drivers involved in this complex structure demand a perspective on rural areas that includes an assessment of policy action from a wide set of sectors and enhanced efforts for coherence of those actions.

Rural areas have been classified at the international level to enable comparative assessment of rural contexts and policy achievements. The first internationally agreed classification provided by OECD (1994) has been revised and refined by the European Commission/Eurostat, and subsequently re-adopted by the OECD. Many other typology studies have underlined the limitations of clear-cut spatial categories (for rural and urban areas), indicating large spheres of transition between them, and the relevance of rural-urban interrelations. What is even more important for future rural development policy is that among rural regions significantly different types can be discerned, which probably should be acknowledged in policy approaches.

The analysis of implementation of RDPs concentrates on the lessons learned at the start of the present programme period 2014-2020. Studies reveal that rather gradual changes of RDPs predominate, underpinning the assessment that CAP and rural development is a policy area of high path-dependency and inertia, when compared to needs assessment. The new structure of Pillar 2, with six priorities against formerly three (or four) ‘axes’ of programme activities, did not lead to significant changes in the allocation of financial resource to instruments.

There are some shifts of programmes (MS and regions) with regard to the previous period which were made possible through a fund-switching mechanism between the two pillars of CAP allowing increased funds for Pillar 2 in a number of countries, and leading to an increase in overall EAFRD financial resources of about 3%.

The most salient finding from assessing the current application of RDPs is that within the common policy structure significant national and regional variation in programme strategies and priority setting is accomplished. This high diversity of application is understood to reflect the divergent needs of rural regions, but also result of different strategic considerations.

There is little evidence that CAP Pillar 2 delivers significant beneficial impacts in terms of reducing territorial disparities. Rural development is an issue that is at the cross-roads of political discussion of the CAP and Cohesion Policy. Support for development of areas with natural constraints (ANC) and orientation towards sustainable agriculture will remain at the core of RDPs. In addition, aspects of policy coherence between CAP and other policies impacting on rural regions will gain in importance.

In this complex and contested policy arena it is not a simple task to distil key implications for the reform discussion. Diverse stakeholders perspectives and country strategies imply a range of distinct expectations on the future of rural development policy; from substantial continuity of RDP and the CAP architecture (with only minor revisions for Pillar 2), at one extreme, to a shift to a multi-sectoral “Rural Cohesion Policy”, focusing on endogenous development of the full range of territorial capital, at the other.

Guidance in the upcoming discussion will require a clarification of “rural” objectives, the discussion of relevant criteria to assess programme needs, a focus on options that reflect the various positions and development opportunities, intensive considerations on the future programme structure and framework to enhance targeted application and effective administration procedures, and a detailed analysis of revision of priorities of future RDPs.

Orientation for the post-2020 reform
From all the discussions and evidence available a high interest in continuation and future adaptation of RDPs emerges. A radical restructuring of the ESIF fund arrangement is probably not a realistic goal. Instead the pre-reform discussion should focus upon rebalancing the intervention logic within the current Pillar 2 structure. There is for example, increasing concern about lack of “targeting” and effectiveness of implementation. In particular, the following main issues are considered crucial for the future reform of Rural Development Policy:

The diversity of rural areas and the different needs and opportunities should be increasingly reflected in RDP programming. A “place-based” approach could enhance the relevance of actual contexts for the selection of priorities in RDPS.

Moreover, increased territorial focus in distribution of funds is required to address region-specific challenges, e.g. articulated through land abandonment, marginalization trends and rural regions of particularly high poverty risk. Such situations are above all relevant in “New” Member States, regions in Mediterranean Countries and ANCs as well as remote regions in other EU countries.

Besides the territorial aspects, RDPs need to show much clearer than until now that they are beneficial to all people in rural regions and impact the whole societies. This (ongoing) shift in the focus of beneficiaries should secure respective effects for the local economies and societies and provide significant (positive) impact on well-being in rural regions.

In order to enhance programme up-take, particularly in regions with gaps in participation, specific attention should be paid to capacity building, knowledge development and participatory local development action. These “soft” support measures need an increased priority in specific regions to overcome the “downward spiral” and outmigration tendencies.

A number of “social” measures have been included in RDPs already; to become more effective a considerable priority and share of funding as well as further elaboration of these measures is required to achieve (measurable and meaningful) effects for the various types of rural regions.

The LEADER and CLLD approach, and the cooperation measure represent tools of high potential for participation, local development strategy processes and identity creation. On-going consultation and learning processes of their application should feed into the future reform process.

Above all, rural areas should no longer be understood as only places of development problems and sub-ordinated to urban areas, but that they also have significant opportunities which should be continuously nurtured, in order to achieve desired impacts (see also discussions of Cork 2.0 conference). A wise and carefully adapted land management system that enables sustainable development and the focus on social innovation aspects are core to make use of these (place-specific) potentials.

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