EU Subsidy Reform: Options for Achieving Change

EU subsidy reform: options for achieving change

Teresa Cavero[1]

Introduction

The European Commission initiated,at the end of 2007, a process to review the reform of the Common Agricultural Policy (CAP) agreed in 2003 and which applies until 2014. These negotiations initiatedthe debate about the future of the European budget for the agricultural sector after 2014.

The present and future of the CAP cannot properly be understood without an appreciation of the World Trade Organisation (WTO) negotiations. The WTO’s Uruguay Round was supposed to reduce agricultural subsidies, but the 1994 Agreement on Agriculturenonetheless was sufficiently vague to allow rich countries, including the European Union, to pass reforms that would not end trade-distorting agricultural subsidies and hence would not stop dumping.Furthermore, the 2001 Doha Ministerial Declaration stated that WTO member states were committed to sustainable development, and that future progress in trade liberalisation would take into consideration and address the needs and vulnerabilities of developing countries.

A central problem is the assumption of the “minimally trade distorting” nature of Green Box measures, which is a very subjective concept. This ambiguity has allowed the European Union and United States, instead of complying with WTO requirements, simply to shift subsidies from the Amber and Blue Boxes and hide them in the Green Box, allowing them to maintain or even increase the high level of support these countries provide to agricultural production.[2]

The debate on green box reform, and CAP reform more broadly, should not be first and foremost a discussion about the scale of the budget allocated to agriculture. It is necessary first to recognise that agricultural production in Europe is, in general terms, marginally or not at all competitive, given the high costs of production (land, labour, inputs and transport). The challenge then is how to design a European policy that enhances social welfare: one that provides economic, social and environmental gains, targeted to small producers and less favoured areas in the European Union. The budget can only be determined once an appropriate policy has been designed, and if the policy fulfils the suggested objectives, it deserves a suitable budget, which may even be greater than the current one.

The objective of this chapteris to offer trade negotiators, policy makers and other interested readers with insights into strategies that could be pursued to promote reform of Green Box subsidies in the European Union,taking into account a series of policy change objectives that would enhance social welfare both for citizens in the EU and those in developing countries. An attempt has been made to identify the various actors that seek to influence CAP reform towards a sustainable and development-friendly agricultural policy framework for the 21st century.

This chapter first provides some initial background, explaining the history of CAP reform, the current state of Green Box subsidies, the context of the WTO Doha Round, and the calendar for CAP reform. It then analyses the main levers for achieving policy change in the CAP, and suggests five areas of policy reform which would have positive economic, social and environmental impacts in developed and developing countries. The third part of the paper analyses the main political forces in the European Union that play a role in the reform process. The fourth part of the paper elaborates further on five suggested reforms, and assesses the viability of achieving policy change in these areas, namely: promoting rural development, protecting and restoring the environment, mitigating the causes of climate change and adapting to its inevitable effects, and fulfilling European obligations towards developing countries. The chapter closes with a summary and a few final conclusions.

Background

Where the CAP comes from.

In the several reforms of the Common Agricultural Policy (CAP), a series of proposals hasbeen put forward and implemented which favour a change in the nature of CAP expenditure, moving away from price and production support (known as Pillar One payments, which are generally categorised in the WTO’s Amber and Blue Boxes) towards environmental protection, rural development, the preservation of the European agricultural landscape, and animal welfare (Pillar Two payments, which are generally notified in the Green Box). The MacSharry reform,proposed in 1992 and implemented from 1994 onwards, for the first time made a switch from market support to direct support for farmers’ incomes, linked to production limitations. In 1999, the Agenda 2000 agreement intensified the 1992 reforms.[3] In 2003, the Austrian commissary Franz Fischler pushed an ambitious reform towards a more competitive and market-responsive CAP, with higher environmental and animal welfare standards, and substantial but incomplete decoupling, which led to the modification of the Common Market Organisations of sugar, tobacco, olive oil and fruits and vegetables.[4]

Specific developing country concerns, such as the impact that green box subsidies have on European agricultural production and exports, as well as the trade and non-trade barriers to accessing European markets, still remain to be addressed in full. The measures introduced with the Fishler reforms in 2003 signal a marked shift in the European approach to agriculture. The reforms can be seen as resulting from several factors: first, pressure at the WTO from EU trading partners that demanded reduced support to farmers, including Green Box payments;[5]secondly, the difficulty of defending a system that absorbs 50% of the European budget,benefits roughly two percent of the population, and concentrates 80% of its support on 20% of all farmers[6];and thirdly, growing public concern that the abuse of natural resources is becoming ever more unsustainable.

There is a genuine concern that the EU is using green box measures to channel farm subsidies under the CAP to the same beneficiaries and in the same volumes as it did before the reforms, thereby maintaining a strong international trading position. This situation allows the EU to maintain a completely unbalanced subsidy distributionsystem,in which about 80% of subsidies are concentrated on 20% of the farms.[7]Direct support to farmers through the Single Payment Scheme violates some of the basic principles of the WTO, but permissive interpretation of these principles has allowed a continuation of agricultural subsidies worldwide. The main principle that decoupled payments violate is the non-trade distorting requirement, since direct payments affect production in various ways, as Oxfam has identified:[8]

Wealth effects: A guaranteed stream of direct income may increase producers’ willingness to plant. For instance, decoupled payments can help farmers cover fixed costs and stay in business when they would otherwise go bust.[9] This is particularly true in the case of large, fairly competitive farms, where fixed costs are reduced to a minimum. Due to the highly regressive nature of European subsidy distribution, this is the type of farm that attracts most subsidies.
Risk/insurance effects: Direct payments create insurance effects, changing the producer’s perception of risk. At higher levels of wealth, farmers may be willing to take more risks, including expanding agricultural production. Guaranteed support based on land ownership also strengthens land value, and hence the capacity to borrow and invest in land, equipment or inputs.
Land allocation effects: As farmers know the payment reference year may be updated, they may want to keep up production levels.[10]If updating today leads farmers to anticipate that future legislation will again update base acreage and yields, there is a clear incentive to build acreage for future assessments. In Europe, the requirement to keep the land in good agricultural condition may cause farmers to continue to cultivate land that would otherwise be left fallow.
Accumulation effects: The distorting effects of decoupled payments are multiplied when such payments are given to farmers already benefiting from insurance or price support mechanisms. A farmer that receives a decoupled direct payment on a commodity crop that is also eligible for a loan rate (in the US, for example) will have an incentive to keep both payments, thereby undermining the decoupling effect. Concerns relating to this accumulation have been consistently raised by G20 countries.

Also, when domestic support is very high, it effectively acts as a hidden export subsidy, because it allows production to take place more cheaply, and so effectively lowers export price and allows dumping to happen.

Moreover, the discussion on the distorting nature of direct payments will remain inconclusive until the price difference between the cost of production and market prices is completely transparent. Even in the absence of this information, it is easy to appreciate that financial support received by any farmer for any reason is going to influence his or her production decisions. Direct payments in any particular year are related to the land area at a farmer’s disposal that year, which implies that the recipient has to have farmed before; and the amount of the payment is based on the factors of production used.[11] These conditions imply a necessary predisposition to produce, which is related to the direct payment incentive.

For all the reasons stated above, decoupled income support payments currently allocated via the Green Box should be a likely target to be removed in the Doha negotiations or, failing that, a future round.

Where the CAP is now: Green Box contents.

The text of the WTO Agreement on Agriculture defines in its Annex 2 the basis for exemption from reduction commitments for certain domestic support measures, namely the Green Box measures. Besides direct payments and payments that are decoupled from the scale of production andnumber of farm animals, the green box also includes measures addressing environmental protection. The EU also allows a limited percentage (5%) of Green Box support to be allocated by its Member States to cover additional environmental incentives to farmers under certain conditions (mainly alignment with national environmental policies).

The EU’s December 2006 subsidy notification to the WTO covers the 2003/2004 period, in which Green Box payments account for €22bn. This amount does not reflect the impact of the Single Payment Scheme introduced with the 2003 reform. Oxfam has estimated that, once the 2003 CAP reform has been fully implemented in 2006/2007, European green box payments would amount to €50bn, much of which would be a simple shift from the Amber and Blue Boxes under the reforms introduced in the 2003 CAP review.[12]

No measures currently in the Green Box have been designed specifically to promote agriculture or food security in developing countries. Developing countries’ concerns have been addressed in part through special and differential treatment. Hidden barriers to the successful export of developing countries’ agricultural produce persist in the form of technical limitations to sanitation, quality control, transport and traceability. Reforms of the Green Boxwhich support, regulate and normalizeagricultural exportsfrom developing nations would be a viable and fair initiative.

WTO Doha round context: developing countries and the external agenda

The ultimate aim of WTO negotiations is a worldwide zone of free trade, which implies the elimination of domestic support and export support, and the elimination of trade barriers to facilitate access to markets. Complete attainment of this goal may not be desired by some of the negotiating parties. Powerful groups of agricultural producers, such as those in the EU, would like to keep the support they have received until now. Developing countries would also like to keep some policy space in order to decide the necessary speed and scope of liberalisation in order to achieve comprehensive economic and social development.

After several years of inconclusive negotiations,and nearly four years after governments failed to conclude the Round in Hong Kong in 2005, WTO Members again failed to achieve an agreement in June 2008. The negotiations do require a change in position from the EU, as EU trading partners demand more equitable trade in agricultural products,[13]and the EU itself desires greater access for industrial products and services. If the EU chooses to pursue further the shift in its agricultural policy that has already been initiated - towards a sustainable, environmentally friendly, and flexible approach to developing countries - this will allow itto take a viable position in the WTO negotiations while at the same time maintaining a vibrant agricultural community and contributing to counteracting global climate change and local environmental degradation.

3. Green Box reform: objectives and main interest groups

The reform of the CAP should ensure that Green Box payments promote economic, social and environmental sustainabledevelopment, both in developed and developing countries, so that spending in this area genuinely supports the provision of public goods.The challenge is to tailor the reform so that different stakeholder parties, together, achieve a net benefit in both the short and long term. For this, interested groups must assess how they see their role and position in the future.The fundamental debate is not about the amount of money in the pot, but about guaranteeing that the CAP budget supports policies that enhance social welfare in the European Union. If this objective is tackledproperly, it should generate a virtuous cycle of positive externalities that have a positive impact in developing countries.

In the author’s view, the reform should address objectives that, in the first instance, deliver public services for European citizens. These include the promotion of sustainable rural development, the protection and restoration of the environment, mitigation of the causes of climate change and adaptation to its unavoidable effects. These objectives are elaborated on further in the next section. A policy reform with these objectives should generate beneficial impacts for developing countries. For developing countries to capitalise on the gains of this reform, the European Union should guarantee policies that are coherent with its agreements with developing countries in other areas, such as international (including regional and bilateral) trade and development aid.

At the moment, interests are to a large extent polarised. The EuropeanParliament would like to rationalize agricultural spending, so that other imminent needs in the European Union can be addressed with the existing limited funding.In fact, the European Parliament has been active in making proposals through non-binding resolutions, which are far more progressive than those of the Council. This has been possible because the power of influence of the strong protectionist lobbies is more diluted at the Parliament level.

For individual member states, conditions are very different depending on the current internal structure of agricultural support: for example, Luxembourg and Finland already provide almost all their agricultural support in the form of agri-environmental subsidies, under Pillar Two; Sweden and Austria have over 80 percent of their support in this category; while others, such as France, have under 40 percent.[14] Some states such as the UK and Germanywouldlike to re-nationalise agricultural spending, in particular in view of the possible expansion of the EU to include new countries with significant agricultural sectors, such as Croatia, Macedonia and Turkey.Spain has recently taken a more progressive position towards agriculture through the approval of the Rural Development Law in 2006. Norway (which is not a European Union member state but is an interesting example to consider) would like to keep some level of support coupled to production, arguing that the country’s producershave to bear higher production costs.[15] Interestingly, countries’ political stances on agricultural issues appearhistorically to be fairly stable, and relatively immune from the agendas of different political parties at the national level.

Consumers in general demand fresh food all year round, and, to the extent possible, for it to be cheap. Those that become organisedin consumers’ groups are primarily concerned with food safety. Some such groups support a wider CAP reform based on the belief that this would bring better quality food. The consumers association Which? has calculated that the CAP has inflated the cost of food in the European Union to be amongst the highest in the world.

Farmers’ organizations have for many years been highly influential and have played an important part in shaping the CAP. But it is worth drawing attention to the fact that not all farmers are in the same situation, as large scale producers have very different objectives to small scale farmers. The latter have systematically been made worse off by the various CAP reforms. For this reason, they have tended to associate with large producers, in order to preserve their existing privileges. A good example of these differences is illustrated by the COPA-COGECA (Committee of Professional Agriculture Organisations – General Confederation of Agricultural Co-operatives in the European Union) as the union of big producers, and the CPE (Coordination Paysanne Européenne) representing small scale farmers. Small farmers might thus support CAP reform if it is truly focussed on supporting small scale, family based production. Currently, these farmers stronglyresist any proposal to expand the list of Statutory Management Requirements or broaden the scope of Good Agricultural and Environmental Conditions. There is growing demand from some of these organisations for some kind of safety net against low prices, in view of further reductions in intervention support and export subsidies. Many producers, be they individual farms and food-processors or agri-businesses, are currently benefiting from the high prices induced by recentincreases in global demand for cereals, although livestock producers have expressed concern over the higher feed prices they face as a consequence.