The provocative title of this post was prompted by a tweet in my Twitter timeline (@xAlan_Matthews) which told how a farm speaker at a meeting the tweeter had attended had said he/she was frustrated by how many farmers do not manage their farms as businesses and that the Basic Payment makes some lazy.
I do not want to make moral judgements about anyone’s conduct but it is, indeed, an interesting question to ask how the CAP support system affects farmers’ individual behaviour. It is, of course, well known that farmers’ decision-making is often motivated by reasons other than rational profit-maximising behaviour. Society often benefits from the multiple goals of farm decision-makers, as when farmers are prepared to undertake environmental stewardship even where it might not be the most economically efficient thing to do.
Translating the value-laden terms ‘lazy’ and ‘hard-working’ into more neutral language, the question might be rephrased in terms of ‘technical efficiency’. Is there any evidence that the Basic Payment (or the preceding direct payments which it replaced) has an effect on the technical efficiency with which farmers use their resources? I examined the evidence on this issue together with co-authors Luca Salvatici and Margherita Scoppola in a recent paper for the International Agricultural Trade Research Consortium. This post expands on the relevant section of that paper (see Section 3.3.4 of the paper here).
Focus on technical efficiency
Technical efficiency is one of the factors that can help to explain differences in productivity between farms. The most comprehensive measure of productivity is Total Factor Productivity (TFP), defined as the ratio of all outputs to all inputs. At a point in time, in a cross-section of farms, a firm can have a higher TFP in comparison with other farms because of a higher level of technical efficiency and/or because it has a more optimal scale of operation. Technical efficiency refers to the degree to which a farmer is making optimal use of existing technologies, while the scale factor refers to whether the farm is fully exploiting economies of scale.
Over time, a farm can improve its TFP by adopting new technologies which come on the market. Thus, an individual farm can improve its TFP over time either by adopting the new technologies, by improving its technical efficiency (relative to the technological frontier), or by exploiting economies of scale. Assuming that all farms have the same access to the new technology, then if some farms adopt but some farms do not, this will show up in cross-section data as deteriorating technical efficiency of the non-adopting farms.
At farm level, subsidies may give rise to technical inefficiency if higher profits lead to slack, a lack of effort and disinclination to seek cost-reducing methods. These negative effects might arise if farmers are less motivated to perform well because of the higher income due to subsidies. Subsidies also lead to a soft budget constraint, meaning that farmers might be inclined to over-invest, for example in machinery, which can also lead to an inefficient use of resources.
However, direct payments may also have positive effects on efficiency and productivity through this income effect. Positive effects might arise if direct payments provide farmers with the necessary financial means to keep technologies up to date, or make it easier for them to access credit to invest in efficiency-improving farm assets.
Because of these offsetting effects, the impact of direct payments on on-farm technical efficiency is an empirical matter.
The empirical evidence
Latruffe provides a summary of the literature that examined the impact of farm subsidies on technical efficiency up to 2010 in this OECD report (see p. 39) and concludes that “the impact on technical efficiency is almost consistently negative across the literature.” This conclusion was further substantiated in the meta-analysis of the impact of agricultural subsidies on farm technical efficiency by Minviel and Latruffe (2014).
For example, Zhu and Lansink (2010) quantified the impacts of CAP subsidies on technical efficiency, using a sample of German, Dutch and Swedish arable farms over the period 1995-2004 when the partially-coupled subsidies (MacSharry payments) were in effect. They concluded that the share of total subsidies in total farm revenues (i.e. degree of subsidy dependence) had a significantly negative impact on the technical efficiency of crop farms in all three countries investigated. Also, the share of subsidies in farm income had a significantly negative effect on the change in technical efficiency in their sample. (unfortunately, the journal references in this post may be behind a paywall for some readers).
In a study of French cereal farms using data from 1996 to 2003, Mary (2013) also found a negative relationship between CAP Pillar 1 subsidies and TFP growth over the period.
Both of these studies cover a relatively short time period. They also refer to the partially-coupled MacSharry payments. Poor efficiency and TFP performance during this period may be due to the conditions associated with receipt of these payments and to the fact that they were partially-coupled payments (thus distorting farmers’ production choices) rather than due to the income effect described above. For example, set-aside of arable land was a compulsory requirement in place for larger cereal farms during the sample periods for both studies. The conditions associated with the payment rather than the payment itself might be responsible for the observed results.
Two studies have examined the relationship during the period when decoupled payments have been in force. Rizov, Pokrivcak, and Ciaian (2013) investigate the impact of CAP direct payments on farm productivity (both level and growth) in the EU-15 Member States (the absence of sufficiently long data time series precluded covering the new Member States). Their study addressed a number of econometric problems present in earlier studies, and they are able to test for the impact of direct payments both before and after decoupling was introduced in the period 2005-06.
They find evidence that the partially-coupled payments (prior to 2005) had a clear negative effect on both productivity levels and growth in most EU-15 Member States (the finding is statistically significant for productivity levels in seven of the 15 countries even if economically the magnitude of the effect is not great – a doubling of subsidies leads to a reduction of between zero and 3.7% in TFP depending on the country – and statistically significant for ten of the 15 countries for productivity growth).
However, for the period when subsidies were decoupled, a more varied pattern of results is found. For ten of the EU-15 countries there is a positive relationship between subsidies and productivity, although this relationship is statistically significant for only six countries for both productivity level and growth. Overall, they conclude that decoupled subsidies after 2005 either have no effect or a small positive effect on productivity in the majority of EU-15 countries.
These findings are consistent with the study by Kazukauskas, Newman, and Sauer (2014) of Danish, Dutch and Irish farms using a similar methodology but with a uniform production function for each of the Member States (the Rizov et al. study estimated separate regressions by farm type in each Member State). They also found that decoupling had a positive and significant effect on productivity.
However, their study compared the impact of decoupled payments with coupled payments, rather than the impact of decoupled payments with the absence of payments. It thus only provides indirect evidence on whether the income effect of decoupled payments per se has a negative or positive effect on technical efficiency.
The results in both studies are net effects; the methodology they employ does not distinguish between the individual effects of the technical inefficiency losses and the investment-induced productivity gains. What they suggest is that, with decoupling, the technical inefficiency losses are reduced, and/or the positive investment effects due to the interaction of the subsidy with market imperfections are increased.
Thus, the studies do not exclude the possibility that some farmers may use their Basic Payment to opt for a quiet life, that the Basic Payment may influence the choice of production in favour of less-demanding enterprises, or that the Basic Payment may allow farmers to farm without having to push their efficiency to its limits. However, the most recent evidence suggests that, at the sector level, the impact on overall output is more than offset by the fact that, for other farmers, the receipt of direct payments may make it easier to negotiate bank credits which allow them to undertake productivity-enhancing investments.
This is not to say that direct payments are a particularly effective way to stimulate on-farm investment. In all cases, the economic importance of the effects identified in the two studies is very small.
This post was written by Alan Matthews
Photo credit: © Copyright Oast House Archive and licensed for reuse under a Creative Commons Licence.