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The Future EU Budget - The Agricultural Dimension

Introduction

This paper looks at the prospects for further reform of the CAP in the context of the forthcoming negotiations over the EU’s financial perspective for 2014-20. It is complementary to the Experts’ existing paper on the CAP, which covers the history of that policy in greater depth.

In 2006 the EU Member States agreed that there should be a review of the EU’s Budget. This would not be a review of the current financial perspective but prepare the ground for the discussions about the next financial perspective – that is the EU’s Budget over the years 2014-2020. Member States, businesses, pressure groups and the public were all invited to contribute to the debate.

The share of the EU’s Budget spent on the CAP has fallen considerably from its peak of 70 per cent in 1984, the large surpluses have been eliminated and the total cost of the CAP to Member States is around one per cent of all government expenditure within the EU (the whole EU budget accounting for around 2.5 per cent of public spending within the EU). But even so, around 40 per cent of the EU Budget is still spent on the Common Agricultural Policy, so scope for budgetary change without substantial adjustment to that area is limited - unless Member States wish to increase the overall budget, which is unlikely in the present fiscal climate. Thus CAP issues have been and will continue to be central to the review of the EU Budget for 2014-20.

The discussions stimulated by the review process highlighted – perhaps predictably – the differences of view between Member States. Some seek (in the words of the then Chancellor of the Exchequer Alistair Darling MP for the UK), "a radically reformed EU budget" in the "context of a shift away from agricultural support". Whilst others, such as France, agree on the value of "a bold assessment" of the Budget, "free from constraints of the standard budget negotiations" but find a fresh argument for supporting agriculture in the need to "ensure the food security of European consumers" [French submission to the Commission].

British debates about the EU Budget and the Common Agricultural Policy (CAP) often give the impression that further reform of the CAP is a relatively straightforward matter merely frustrated by the desire of some Member States to hold on to fat subsidies. This analysis ignores the political forces as powerful (if not more) in their arguments against change to the CAP in some Member States as those in the UK (and elsewhere) who argue for radical change to the CAP.

Agriculture & the European Economy

Agricultural subsidies are ubiquitous in the industrialised world, as prevalent in the United States, Japan, Norway and Switzerland as they are in the EU. This reflects historic experiences of food shortages, the need to ensure a reasonable (and consistent) level of income for producers and in some countries, the size and therefore political importance, of the rural economy. Although the long term trend is for agricultural employment to fall (currently only some 5% of the workforce in the EU, generating 1.6% of GDP), it is still high in some Member States (18% in Poland, for example, compared to two per cent in the UK) and farmers remain a powerful political force. The rural economy, which is much affected by the CAP, represents a higher population than these figures suggest.

CAP Reform to Date

Expenditure on the CAP peaked in the mid-1980s. The fact that agricultural support was taking up two-thirds of a growing EU Budget by that point made reform of the system essential. A series of reforms, beginning in the 1990s, reduced the overall level of support to around 40 per cent today, largely by removing the incentives to production that had been a feature of most agricultural support systems since World War Two.

Whilst cost was a key driver of reform, so was the external pressure generated by the world trade talks in the Kennedy, Tokyo and Uruguay rounds. The EU could not credibly maintain high agricultural subsidies, and high frontier protection on produce from non-EU countries, whilst simultaneously calling for greater free trade. The EU had to accept a reduction in export subsidies, not least because of the adverse consequences for the developing world, where cheap European foodstuffs were undermining domestic production.

The most important reform – carried forward significantly in 2003 - has been a shift of EU support from trade-distorting subsidies to ones which are not linked to production but support preservation of the countryside (70 per cent of the countryside in the EU is managed by farmers) and a better environment. There have also been a series of reform packages agreed for particular products, notably dairy products and sugar. These have been designed to reduce incentives to production and to enable a freer market to develop. The system of supporting the market price to help farmers – which led to the infamous "lakes" and "mountains" of surplus food and in some cases their destruction - was replaced with one of direct grants to farmers, resulting in lower prices to consumers.

The two main constituents of the current agricultural budget are the direct aids to farmers and the expenditure on rural development. It is the former that accounts for by far the largest share (over 70% in 2010) and offers both the greatest scope for savings and for criticism.

Future Agricultural Spending – the Problems

There is a tension between the desire to reduce the cost of the CAP and the strong support for it that exists in some Member States. This conundrum poses a difficult problem for Member States, not least because they are required to co-fund some CAP measures (those that support the countryside, environment and rural development) out of national budgets.

Recent enlargement of the EU has had a considerable impact on the CAP and will continue to do so. Extending the CAP immediately and in full to the countries of central and Eastern Europe (the EU12) when they joined in 2004 would have substantially increased CAP spending as they have a larger agricultural workforce than the E15 countries and also many small farms. To avoid this, they currently receive a reduced level of support for a transitional period. In the current EU Budget period, 2007-2013, CAP support to the EU15 is falling and that to the EU12 is rising, as the system gradually adapts to EU enlargement.

The current transitional provision expires in 2013 and the EU12 will argue strongly for equal treatment. (Romania and Bulgaria joined in 2007 and will not be eligible to join the full CAP until 2016.) This will increase pressure to reduce the level of payments to avoid costs rising even if some redistribution of CAP funds from the older Member States in the EU15 to the newer Member States in the EU12 will also be necessary, though it will meet with opposition from countries such as Spain (one of the largest recipients of agricultural support in the EU).

Whilst food security is important, it is not a compelling argument in difficult economic times for expanding agricultural production in the EU because Europe is a relatively high cost food producer compared with many other parts of the world. Nonetheless, some Member States will use the increasing demand for food because of population increases and changes in eating habits to defend the CAP. In reality, food shortages are in the developing world and it is there that production needs to increase.

International pressure on the EU to reform its agricultural policy, which played such a major part in achieving earlier reforms, is now likely to be less powerful, partly because world trade in agricultural products has been enjoying one of its periodic booms and also because of the difficulties (many of them non-agricultural) of bringing the Doha round of trade negotiations to a successful conclusion.

Predictably, divisions amongst Member States are already appearing. Countries, led by the UK, who argue for radical CAP reform are in a minority. The so-called G22 group of Member States (all except the UK, Sweden, Denmark, the Netherlands and Malta) want retention of the existing CAP budget post-2013. This bloc originally came together during the crisis in the dairy industry in 2009 when they argued for greater support for dairy farmers. Another group is of nine new Member States who also want retention of a strong CAP but want changes to make it "fairer" – i.e. to redistribute the budget from older Member States to newer ones. None of this will make the overall reduction of CAP expenditure easy.

An important unknown factor in this round of CAP negotiations is the new role of the European Parliament in agricultural questions. The Lisbon Treaty introduced co-decision for agricultural measures, meaning that CAP reform will now require agreement between the Council of Ministers and the Parliament before it can proceed. Some critics argue that existing CAP reforms would never have been agreed because of MEPs being hostile to reforms that their constituents object to. But with responsibility for the budget as a whole, the Parliament may now be less ready to listen to MEPs from rural areas.

Agriculture Ministers have recently included the prospect of reintroducing an approach based around "market management", with prices to farmers held up through long term supply contracts instead of through taxpayer-funded interventions. This approach has some similarities to the powers given the UK Milk Marketing Board between 1933 and 1993. It is attractive because it enables the farm subsidy budget to be cut whilst protecting farmers’ incomes. It would however be seen as a retrograde step (even in the UK) because it would reintroduce market distortions which the EU has largely eliminated, is unpredictable in terms of cost and would be complex to administer.

Future Agricultural Spending – the Possibilities

The Budget review comes at a difficult time for finance ministries across Europe. Although the EU budget is tiny by comparison with national budgets (accounting for less than two per cent of EU Member States’ gross national income), there will be opposition to allowing the EU Budget to rise. Finding room for other EU expenditure will put pressure on spending on the CAP. Moreover, with farm incomes on a rising trend there will be a good case for reducing the direct farm payments, which are in any case criticised, for example by the organic lobby who argue that the current single farm payment scheme does not reward those farmers who deliver most in environmental terms.

Since the current direct payment scheme does not differentiate between those farming in more difficult circumstances and those with high quality land, there could be scope for savings by tilting the programme in favour of the less favoured areas, such as hill farms, which are important to the countryside but more difficult to make economically viable. Such a change would be politically popular in many Member States but would work to the disadvantage of the UK which has a higher proportion of large efficient farms than the EU average.

Another form of land management – much derided – has been ‘set-aside’ with farmers paid not to use a part of their land. It came into its own when world food prices rose in 2008 and the EU could allow previously set aside land to be brought back into use, demonstrating the flexibility of this approach. Nonetheless, set-aside makes poor economic sense.

In the past, with so much of CAP expenditure linked to production, the Commission has always argued that, to avoid the risk of trade distortion, national aid must be rigidly controlled and support funded wholly by the EU. Now this is no longer the case, there has been much discussion about allowing some support to be provided nationally by Member States. Such an approach would enable Member States to design agricultural and rural community support schemes that better fit their particular needs but farmers might well object to the ending of a "level playing field" in terms of agricultural support across the EU. Any support schemes for farmers at national level would therefore need to be within the EU’s "state aids" rules in order to comply with competition law. Shifting more expenditure to national schemes, at a time of fiscal contraction, might also be a way of leading public opinion within Member States to support reductions in the overall level of agricultural support.

Most farmers, and many politicians, would like to see greater simplicity in the grant-making procedures, including a reduction in red tape, whilst maintaining anti-fraud checks. As the problems with the single farm payments in England over late payment have vividly demonstrated in recent years, this is harder to achieve in practice than first appears if one is to get the right balance between simplicity and fraud prevention.

Conclusion

Critics of the CAP persistently underestimate the improvements which have been made in the way the CAP operates and the difficulties of achieving radical or rapid reform. This paper shows that further reform of the CAP is nothing like as simple as some commentators in the UK suggest; there are big obstacles in many Member States. The current UK position of wanting to phase out all direct payments is unrealistic.

The fact that Poland will have the presidency during the period of the Budget/CAP negotiations will further complicate the situation in view of Poland’s desire to see the CAP budget protected but redistributed.

The UK’s position is particularly difficult. If the EU budget and CAP reform are inextricably mixed up together, so is the CAP and the UK rebate. The size and imbalance of the CAP has always been the major cause of Britain’s disproportionate net budget contribution. While changes in the CAP could reduce the problem, too aggressive promotion of such a strategy will only cause other Member States to target the UK Budget rebate, unpopular as it is already. It is only too easy to see how linkages could be made to the disadvantage of the UK.

The EU as a whole will need to consider the Budget and CAP reform in the context of the wider EU 2020 economic strategy, which seeks to enable EU Member States to grow their way out of the current economic difficulties. EU 2020 implies a greater emphasis on competitiveness and includes proposals for a climate change fund. There have been some suggestions that the climate change fund should be financed at least partly from the CAP budget.

It should be possible, if the reformers can stick together (and this implies eschewing unrealistically radical proposals), to achieve some progress. For example, further limited reform with some repatriation of CAP spending to Member States, could result in a further reduction in the percentage of the EU budget going to agriculture.

 

September 2010

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