How can direct payments be justified after 2013?
Stefan Tangermann (retired OECD Director for Trade and Agriculture, and Professor Emeritus, University of Göttingen) has written a powerful critique of the Single Farm Payment in Agra Europe. He concludes that 'Targeted payments to farmers providing specific public goods where they are needed are a much more convincing policy than general payments arguably justified by cross-compliance.'
"With the arrival of the EU's new farm Commissioner, the process of working towards the CAP for the post-2013 period enters into a crucial phase. All sorts of things will have to be decided, ranging from the overall budget available for the CAP to the details of individual measures in the rural development policy.
However, the biggest question by far is the future of direct payments. For the time being, they make up for nearly three-quarters of EU expenditure on the CAP, equivalent to about one-third of the Union's total budget. For many farmers, direct aids are a large share of their revenues (not to be confused with their income - see below). Whether one likes it or not, direct payments have become the linchpin of the CAP.
Direct payments were introduced into the CAP when fundamental reform began under Commissioner MacSharry in 1992. Support prices for major products were reduced, and direct payments were granted as compensation.
Under Commissioner Fischler, the process of decoupling the payments from production was initiated in 2003, while Commissioner Fischer Boel continued the reform process. As a result, direct payments have come to play a pivotal role in Europe's agricultural policy regime.
Overall, these reforms were a major achievement. Heavy-handed government interference with agricultural markets was reduced when price support was cut. Farmers were not left out in the cold as compensation was granted.
This approach was not only politically necessary in order to allow farm price reform to go ahead. It was also socially and economically wise: over a long period of time, farmers had been led to believe that the old support policy was going to be continued. On that basis they had made investments, possibly even decided to become farmers. The CAP could not turn away from its past overnight, it had to provide the economic conditions under which producers could adjust to the new situation. Decoupling the payments from production was another great step as it helped to reduce market and trade distortions even further.
No end-point for direct aids
One big question, though, was left unanswered from the beginning. What was the future of the payments going to be? Would they be granted forever? After all, at some point farmers could be expected to have adjusted to the policy reform. The political, social and economic justification of compensation for past price cuts fades away as time goes on.
Farmers are clever people. They are aware that the history of economic policy-making is full of examples where compensation for a reform was granted, but only for a given period of time. As a result, there is now rapidly growing uncertainty about the future of the instrument that forms the biggest part of the CAP.
The new farm Commissioner Dacian Ciolos is on record of having stated his belief in the need to maintain direct payments. He, and the whole agricultural policy establishment in Europe, will then have to come up with a credible justification for that part of the payments that is to be maintained in the future.
Unless this justification is fully credible, it will not be politically sustainable. And if it is not politically sustainable, it will not stick, and then the uncertainty among farmers will persist. But policy uncertainty is just about the worst thing one can inflict on a sector whose health so much depends on long-term planning.
What could be the justification of any remaining future direct payments? Direct payments in this sense are general payments made on a per-hectare basis to (essentially) all farmers – different from targeted payments which are directly conditional on the delivery of specific public goods and based on the value and costs of providing those goods.
Which incomes need support?
As argued above, compensation for past reforms cannot provide such justification. As adjustments can be expected to take place, such compensation can be gradually reduced to zero over time.
But what about income support to farmers? After all, the belief is widely held - though not necessarily substantiated - that farm incomes lag behind incomes in other parts of the economy. In order for this justification to be credible, payments would have to be in line with criteria used for income support policies in other sectors of society.
One central criterion there is that support needs to be means-tested. Farmers whose families have high incomes would then receive less than poor farm families. Per-hectare payments can hardly be justified on such grounds.
Moreover, payments would then have to be higher where there is a larger gap between farm-family incomes and other incomes in the country concerned – hardly politically acceptable in a European Union where all farmers are expected to compete on an equal footing.
What about the desire to safeguard a viable agriculture in Europe? Would agriculture not disappear from large parts of the EU if the payments were eliminated?
In order to stress this argument, the point is often made that direct payments now constitute a large part of farm incomes in Europe. But much care is needed with this type of statement.
Farm income is calculated as revenue minus costs, where costs include, among others, rent and interest payments. It is a well established fact, confirmed in many empirical studies, that farm support is largely capitalized in land values. Where land is rented, as is the case in large parts of Europe's agriculture, most, if not all, of the direct payments flow to landlords. Where producers have bought the land they farm, they have essentially forwarded the expected future stream of payments to the previous owner of the land, and may now pay equivalent interest for the credit they have taken to finance the purchase of their land.
In both cases we cannot expect the direct payments to contribute to the operator's income, and hence it is not helpful to look at statistics on the share of direct payments in farm incomes.
At the same time, where direct payments are capitalized in the value of rented land, eliminating the payments does not undermine the long-term economic viability of the farm because the operator already farms the land essentially without economic benefit from the payment. Land rents will adjust, and farming continues.
Where farming is indeed endangered without payments, aids may be necessary if society wants that land to be farmed – but that cannot possibly justify payments to all farmers in all parts of Europe. Something like measures for less-favoured areas is the answer - not a general payment for the whole of Europe's agriculture.
Are direct payments justified by a desire to enhance competitiveness of farming in the EU? That depends on the meaning of 'competitiveness'.
Clearly, government support can help any farmer to stand in competition with any other farmer in the world. But would we really call the government-supported farmer competitive? Competitiveness in the market place depends on productivity, know-how, product quality and other similar factors. Policy can do a lot to enhance such 'true' competitiveness, and the whole array of measures that the EU subsumed under the Lisbon agenda are relevant in that context. Education, training, extension services, research and development all belong to that arsenal of policies – per-hectare payments do not.
But what about the variant of the competitiveness argument focusing on the view that environmental and other standards are more demanding in Europe than in other parts of the world? Are direct payments not justified in order to compensate EU farmers for the extra costs resulting from such more demanding standards?
To some part this depends on the empirical question of the magnitude of any such extra costs. Research has shown that they differ very much from sector to sector within the farming industry, but also from farm to farm. Overall, though, any such extra costs are relatively small, certainly much smaller than the level of payments currently granted to EU farmers.
This takes us directly to the issue of cross-compliance, the argument most frequently used in political debates about the justification of current direct payments in the EU. The payments were introduced for a completely different reason, i.e. compensation for policy reform, and cross-compliance was then invented in order to provide a political underpinning for the new payments. Most of the requirements under cross-compliance would have to be respected anyhow. Justifying payments on these grounds is akin to granting payments to all car drivers, which are then claimed back from drivers exceeding speed limits. Cross-compliance is hardly politically credible in the long term.
Targeted payments to farmers providing specific public goods where they are needed are a much more convincing policy than general payments arguably justified by cross-compliance.
With all this said, it will be interesting to see whether any really credible justification can be developed for that part of the direct payments which politicians feel should be maintained for the post-2013 CAP. Europe's taxpayers are keen to know why they are expected to finance such payments – but farmers will want to be reassured that the justification of any payments they receive is politically sustainable beyond any doubt."
Copyright Informa UK 2010. This article was originally published in Agra Europe. For details on how to subscribe please go to www.agraeurope.com