Basic Direct Payments for EU Farmers: The Proposal of the Commission of the EU

Direct payments are the most important budget outlay

EU expenditure on Agriculture and Rural Development makes up a high share of total EU expenditure. The share was – according to official information – 41 per cent of total EU expenditure in 2011 and amounted to €55.269 billion. The position ‘Direct Payments’ was the most important budget outlay during the present Financial Framework with €39.771 billion in 2011; it made up a share of 72 per cent of the total expenditure on Agriculture and Rural Development.

This budget item came into existence in 1993 as the Council of Agricultural Ministers had decided in 1992 to reduce the intervention prices for grain by about 33 per cent and to also reduce the support price for oilseeds. It was a widely held agreement in 1992 that farmers should be fully compensated for the income loss incurred from the price cut. This item grew over time as institutional prices for other agricultural products had to be reduced due to international pressure. However, the income loss incurred by farmers due to these additional price cuts was only partly compensated by additional direct payments. Thus, the first group of farmers was treated better than the following groups.

Direct payments were originally justified with the compensation argument

Even if there was agreement that farmers had to be compensated, there was a widely held understanding that a) it was compensation for the income loss due to reduced institutional prices and b) the compensation had to be tapered off petered out over time. The importance of the development of market prices can be illustrated for the case of wheat. Figure 1 shows the development of intervention and market prices for wheat and the attributed direct payments. It is obvious that market prices did not decline as much as intervention prices; but the latter had been taken for the quantification of the income loss.

Wheat prices in the EU

Moreover, market prices in recent years have even been higher than the prices prior to the price cut. Most likely, prices will stay above the former price level in the coming years . Moreover, independent of the development of market prices, direct payments cannot be justified anymore by the need of adjustment aid. That part of EU agriculture (the Old Member States) which suffered from price reduction has had nearly 20 years for adjustment and thus, sufficient time to adjust. It has to be noted that a large part of EU agriculture (the New Member States) has never been hit by a price cut. In contrast, farmers in the New Member States generally enjoyed a higher income due to EU membership for 10 New Member states in 2004 and the other two in 2007.

The original justification does not hold any more; a new rationale has been proposed by the Commission

One may wonder why the EU Commission, in spite of the evidence, still sticks to the continuation of direct payments. Official statements clearly convey that the Commission is trying to put forward a new justification. It is amazing that the budget request for expenditure based on the new justification is practically identical with the past actual expenditure. The Commission seems to know that exactly the same amo unt of money is needed even if used to serve different purposes.

The Commission proposes two payment parts:

a)    Basic income support through granting basic decoupled direct payments, providing a uniform level of obligatory support to all farmers in the Member States (or in a region) based on transferable entitlements that need to be activated by matching them with eligible agricultural land, plus fulfilment of cross-compliance requirements.
b)    A mandatory “greening” component to support environmental measures applicable across the whole of the EU territory.

It is stated: “The necessary adaptations of the direct payment system relate to the redistribution, redesign and better targeting of support, to add value and quality in spending. There is widespread agreement that the distribution of direct payments should be reviewed and made more understandable to the taxpayer. The criteria should be both economic, in order to fulfil the basic income function of direct payments, and environmental, so as to support for the provision of public goods.”

The statement clearly supports the suspicion that the change is not primarily based on a diagnosis of the present situation and on the identification of market or policy failure. Instead, it is trying to convince the taxpayer that the exact amount of money which has been used to serve one purpose has to be used to deal with another supposed problem. Nevertheless, the new concept pretends to be able to improve the targeting of support. In the following we limit the discussion to the rationale provided for basic payments.

The rationale of basic direct payments is in conflict with social support in the member countries

The Commission argues that the income of farmers is on average lower than the average income of other sectors (see Figures 2 and 3) and, hence, income support is needed. The taxpayer – even with little education in economics – may ask the following questions:

1. Is it the task of the EU to provide for income support of specific sectors?
2. Can the need for social support be based only on a comparison of average incomes?
3. Are there adequate data available for efficient policy measures?

Trends in agricultural income

Relative agricultural income

Is it the task of the EU to provide for income support for specific sectors?

The Treaty of Rome and all the other following Treaties did not mention that the EU has to provide income support for farmers. The Treaties only state as the first two objectives: “The objectives of the common agricultural policy shall be:

a)    to increase agricultural productivity by promoting technical progress, the rational development of agricultural production and the optimum utilisation of the factors of production, in particular labour,
b)    thus to ensure a fair standard of living for the agricultural community, in particular by increasing the individual earnings of persons engaged in agriculture.”

It should be noted, that the EU has – according to the Treaty – first of all to contribute to higher agricultural productivity and second, the increase in productivity should ensure a fair standard of living ….The ranking of the objectives is pronounced by the word ‘thus’. Clearly, the Treaties do not mention that the EU should be in charge of securing a ‘basic income’ for farmers.

Indeed, it seems strange that the Community should be responsible for of securing a basic income for a specific sector in the member countries. A policy which aims at securing a minimum (basic) income is obviously part of social policy. But social policy is generally in the realm of the member countries and not of the EU. Nevertheless, the EU Commission is putting forward a recommendation to implement social measures at the EU level. This proposal is not in line with the principle of subsidiarity.

It should also be noted that the proposed payments will slow down structural change and an increase in productivity as compared to a situation without any payments. The marginal producers, i.e. those who are going out of production if revenue declines, will stay in production for longer, leading to inefficient use of resources. Disguised inefficient use of resources in the agricultural sector will continue.

Can the need for support be justified by a comparison of average incomes?

The individual member countries of the EU have established social security policies. These policies do not provide support for specific sectors, but for people who suffer from poverty. In general, applicants for social assistance have to provide information about their household income and, in addition, on the value of their property. Applicants who own property which can be sold are not considered poor.

The EU proposes a completely new criterion for social assistance. All farmers qualify for basic payments, independently of their income. As the payment is related to the area of land cultivated by the individual farmer, owners of large estates will be entitled to higher payments than farmers who cultivate smaller estates. Hence, basic payments increase disparities within the agricultural sector. It is absurd to justify the basic income payments by a comparison of average incomes of sectors and to even support farmers who are considered to be well off by the societies in the member countries.

The proposal for basic payments contradicts the proposal to align payments across the EU member countries

The proposed gradual alignment of direct payments across the EU member countries is even more questionable, based on the new justification of the direct payments. If these payments should provide a minimum income for farmers, as argued by the Commission, the amount of money transferred to farmers in the individual countries should differ, as overall income and social assistance differs across the countries. Therefore, basic income support contradicts the gradual alignment of basic payments across member countries.

Do we actually have information on total labour income of the farming population as compared to that of people working in other sectors of the economy?

The Commission presented information comparing average incomes in agriculture with average incomes in other sectors (see Figures 2 and 3). Such comparisons are highly misleading. First, we do not have exact information on agricultural labour income, as most farmers do not have to submit a tax declaration . We have on the EU level only information on agricultural value added, including the income of all factors of production, i.e. labour, capital and land. EUROSTAT calls the value added per work unit as labour income.

However, not all of total factor income accrues to farm households. Tenants may have to pay rents to non-farmers and farmers may have to pay interest to non-farmers. Calculating this income one may derive a low income for labour, but the farm household may be well-off due to income from capital and land employed outside the agricultural sector. Hence, the calculated income does not inform about the income of farmers and, thus, on the need for financial assistance from the point of view of society at large.

It has to be added that even accurate data on the income of farmers do not inform about the living standard of farmers as compared to the non-farming population. Farmers pay fewer taxes than non-farmers for the same amount of nominal income. Moreover, farmers generally own houses and do not have to pay rent. Finally, many of them own land and capital. Consequently, most farmers do not qualify for social security in their home country due to their income and due to the value of their property. What a strange situation: If the Commission’s proposal is accepted, persons who are not qualified for income support (social security) in their home country will be qualified to receive basic income support from the EU. Can that really be? Is that acceptable?

Do we have information on agricultural labour input?

Calculating income per Work Unit as done by EUROSTAT and accepted by the Commission to support their reasoning, raises some additional problems. EUROSTAT provides information on value added at factor cost and agricultural labour input. Labour input is measured in work units where part-time and seasonal labour is aggregated in full time equivalents .  Even if EUROSTAT had fairly accurate information on agricultural value added, it has no such accurate information on the actual labour force and on that part of the labour force which relies on income from agriculture only. It is known that the share of part-time farming is fairly high in some countries; hence, the information on labour income per person employed is highly misleading.

Take for example the case of a full-time off-farm worker who owns a small farm cultivated by his wife. He may have a high income, but she may have a low income, even if much above the opportunity costs part-time farmers which work with one third of their time on the farm. According to the methodology of EUROSTAT the income of the husband is neglected and the income generated by the wife is multiplied by one third. Consequently, according to this methodology the wife earns an income below that in other sectors. Obviously, the derived information does not inform on the living standard of the family. Needless to say, that this household would not qualify for social security in any of the EU member countries.

Moreover, it is misleading to compare average income if the variance of income in the sectors compared is very high as in agriculture. According to the Commission’s data, 20 per cent of farmers in the EU receive 80 per cent of the present direct payments. Obviously, internal disparity is very high. How can the Commission propose providing for a basic income support for all farmers if some – or even many – have an income which is much higher than the income of the average person in our societies? One should recall that these payments have to be financed by the ordinary taxpayer. The Commission stated that the policy should become more targeted than in the past. The new proposal leads to high conflicts with this objective.

Is the CAP too expensive?

The EU Commission answers this question clearly. ‘No, CAP expenditure on the EU level is only a small share of GDP. The CAP is the only supranationalised policy and the value generated for the money spent is high’ . Whether a policy is too costly or not depends, first of all, on how policy measures are targeted; the less targeted they are the less efficient they are. A policy is well targeted if it heals a market or policy failure more efficiently than any other policy measure.

If the original justification of a policy has become obsolete, a continuation of the same policy is too costly. It is a widely held agreement that a continuation of the present direct payments system cannot be justified with the original arguments. Hence, this policy is too costly. The new justification of changing direct income payments to basic direct income payments clearly shows that a) there is no justification of such a policy measure and b) the justification presented by the EU Commission is based on inadequate information. Is the European taxpayer really willing to pay the high salaries of Commission staff in exchange for such a dubious proposal?

Summing up

The EU Commission’s proposal to introduce changes in direct payments is based on the perception that a new rationale for these payments is needed. The new justification for direct payments proposed by the Commission is not convincing. This new instrument would not contribute to the officially stated agricultural objectives laid down in the Treaty of Rome and which have not been changed; just the opposite, the effects of the new payments would hold back growth in productivity which is the first objective mentioned in the Treaty.

The Commission justifies the proposed basic income payments with the need to secure a basic income. Hence, the instrument could be part of social policy. However, so far the individual member countries of the EU have been in charge of social policy. The introduction of the new instrument would not be in line with the principle of subsidiarity.

The new instrument would be in strong conflict with the principles of social policy in the member countries. Social policy is generally based on information about household income and also takes into account the value of the property. In contrast, the proposal aims at providing basic support to all farmers independently of their actual income and their wealth. As the transfer is proposed to be related to the area used by the individual farms, the transfer to well-off farmers would be higher than for farmers with little land endowment. Disparity in agriculture would be higher than without these transfers.

The new justification put forward by the Commission is based on a comparison of average labour income in agriculture with labour income in the overall economy or in other sectors. Such a comparison can hardly be accepted for justifying socially motivated transfers. Such a policy has to be based on information about household income. Moreover, there is no accurate information on labour income of farmers in the Member Sates

Moreover, the Commission does not have adequate information about the labour income of full-time farmers in the EU.

The conclusion is that the present Commission’s proposal cannot be accepted.

Picture at head of post © Copyright Nigel Mykura and licensed for reuse under this Creative Commons Licence.

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6 Responses to “Basic Direct Payments for EU Farmers: The Proposal of the Commission of the EU”

  1. The court jester →
    March 16, 2012 at 10:33 #

    These arguments are very convincing, but there is a big problem.

    It is called “politics”.

    The European Commission is not operating in a vacuum. It is working in a political environment.

    The author is free to write from an academic perspective and ignore the politics. That is a choice.

    The result is very theoretical, but still interesting.

  2. Ulrich Koester →
    March 16, 2012 at 12:26 #

    Dear court jester,
    Thank you for accpeting my reasoning. I think it is the task of professional economists to act as advocate for the society at large.
    I wonder whether politcal arguments can neglect economic reasoning. Can a decision by good on politcal grounds if it is’bad’ on economic grounds?
    Ulrich Koester

  3. wolfram koester →
    March 18, 2012 at 20:40 #

    very good article! it seems EU agricultural policy stays in a never ending loop of consistently ignoring fundamental economic principles.

  4. Eckart Guth →
    March 21, 2012 at 17:13 #

    Prof. Koester´s reasoning is very convincing from an economist and common sense point of view.It was always understood that direct payments are necessary to allow farmers to adjust over time to the reduction of institutional prices resulting from sucessive CAP-reforms. There was however no agreement on how long the transtion should be.It might therefore be more promising to argue that the Commission proposals are lacking a clear policy of the phasing out of the direct payments. Koester´s analysis provides good arguments to support a progresseive phasing out. The lack of rational for the direct payments can perhaps best be demonstrated in the case of Greece, where all policies are put under scrutiny except direct payments for farmers,with the result that poeple could be tempted for trhat reason to move back into agriculture. This is certainly not an objective of the CAP.

  5. Arne Henningsen
    April 6, 2012 at 21:41 #

    Thanks a lot for the interesting analysis!

    …and if the justification of the subsidies is changed to “basic income support” and “greening”, it is harder to argue that the direct payments should (automatically) fade out over time…

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