We are pleased to publish this guest post by David Blandford (Penn State University) and Berkeley Hill (Imperial College London).
The President of the National Farmers Union (NFU) of England and Wales told the Food Manufacture Group’s Business Leaders’ Forum (Feb 14, 2017) that the NFU is currently actively lobbying the UK government to ensure that British farmers are not disadvantaged with respect to their main competitors in Europe following Brexit. The fear seems to be that cuts in the £3 billion of direct aid, which seem highly likely when Britain leaves the EU and its CAP, will result in a non-level playing field in which UK farmers are put at a competitive disadvantage. Thus, there will be a claim for government support to address the issue. This claim is of obvious importance to the shape of future national agricultural policy in the UK and should therefore be examined closely. In this post we investigate the validity of this claim.
First, it is necessary to clarify what it means to be competitive. This often-used term is surprisingly difficult to pin down. In its simplest form, being competitive implies the ability of a firm to continue in business indefinitely given prevailing market conditions. In turn this means that the firm’s costs of production are such that, when deducted from revenue, the residual profit is adequate to compensate for the risks involved (that is, ‘normal’ profits will be earned on the assets owned by the firm). Anything less will cause production to be cut back or terminated, and eventually the firm will exit the market.
Changes in costs or revenues will affect the ability to remain competitive. Typically farms produce more than one commodity, so remaining competitive also involves the ability to switch and rebalance among these. In the longer term it also reflects the ability of the firm to increase efficiency, e.g., by adopting new technology, in order to reduce costs per unit of output.
Because of differences in cost structure, management ability and other factors, the agricultural industry at any given time will comprise a mix of farms, some of which are not competitive under prevailing conditions, some which are, and yet others who earn profits large enough to enable them to expand. Discussions of Brexit and competitiveness have to be capable of considering all these aspects (and more).
Second, which direct aid is being considered for cuts? According to Agriculture in the United Kingdom 2015 (Defra, 2016) direct payments in 2015 totalled some £2,841 million, of which the largest component (£2,176 million) was Basic Payments.
The remainder largely comprised support under agri-environment schemes that deliver environmental services. Most of these services (e.g., protection of wildlife habitat) are public goods without market prices, and a market-failure rationale can be applied for their continuation post-Brexit, providing that the payments are actually targeted to the provision of the public goods. Another component is special payments for farming in disadvantaged (hill) areas, though these are confined to Scotland and Northern Ireland and claim to be justified on environmental and social grounds.
It is the Basic Payments component that is most likely to be culled, most of which go to farmers in England (£1,400 million) with much smaller total amounts going to farmers in Wales (£190 million), Scotland (£348 million) and Northern Ireland (£238 million). The Basic Payments have been criticised for generating little if any public benefit in exchange for their cost. If their aim is to alleviate any persistent poverty found among UK farmers , the lack of targeting based on income means that they are a highly inefficient way of achieving this.
The Basic Payments Scheme and competitiveness
To put the threatened Basic Payments in context, in 2015 they represented about 8.2% of all the money accruing to the UK agricultural industry from selling marketed output plus all subsidies (figures from Defra (2016)); the market accounted for the overwhelming majority. The Basic Payments’ percentage would be somewhat lower if earnings from other gainful activities (such as jobs taken outside the farm), investment earnings and pensions were taken into account (currently not part of the Economic Accounts for Agriculture).
It is worth recalling the following:
• Basic Payments are the latest manifestation of a process that introduced direct payments for farmers in 1992 as compensation for a switch away from supporting incomes by intervening in commodity markets to support prices, increasingly recognised as having many negative characteristics (impact on trade, on consumers etc.). For political reasons, the compensation was not time-limited. Consequently, direct payments later became interpreted as a permanent form of income support to the farming sector.
• Direct payments (from 2005 the Single Payment and from 2015 the Basic Payment) were designed to be decoupled from agricultural production. Though linked to parcels of agricultural land and historical entitlements, it has not been necessary to produce any actual farm commodities to receive them. In theory, therefore, they should not affect production decisions including those that determine competitiveness, which are intended to be based solely on market conditions.
• Before Brexit, the wide differences between Member States in their levels of direct payments were not raised as a substantive issue affecting national competitiveness in the Single Market applying throughout the EU. Rather, the case for reducing these differences (‘external convergence’) was based primarily on equity rather than considerations of economic efficiency.
It follows that, if Basic Payments are truly decoupled, their removal should have no impact on the competitiveness of British farmers – their presence or absence should be irrelevant.
There are, however, reasons to think that Basic Payments (and their immediate predecessors) have had an indirect or secondary impact on production decisions and competitiveness:
• Because Basic Payments have been linked to land occupancy/ownership, they have influenced land prices, probably increasing these compared to a situation in which this link did not exist. Largely because of the land link, Basic Payments are likely to have impeded structural change, reducing the international competitiveness of UK agriculture by limiting gains in efficiency associated with increases in farm size.
• By providing producers with a zero-risk income stream, there will have been a change in attitudes towards risk mitigation that, in turn, will have been influenced production patterns and, indirectly, competitiveness.
• Farmers have engaged to some degree in self-subsidisation of their production activities. This last point needs some amplification.
Impact on the farm household unit
Farm households, the form of economic institution that is numerically dominant in UK agriculture, combine the roles of units of production and units of consumption (unlike corporations). When faced with circumstances that indicate that production is no longer competitive, some farmers may have chosen to use their Basic Payments to subsidise their agricultural production. As a result, they continue to generate output that market conditions alone could not justify; without this self-subsidy, they may be forced eventually to exit the industry.
The cessation of Basic Payments would bring such self-subsidisation to an end. While farm output would be expected to decline (at least in the short-run) this would really be the result of the exposure of production that was essentially non-competitive to market realities.
Whether or not self-subsidisation takes place, any loss of Basic Payments as a resource flowing to the household would obviously be unwelcome to the individuals involved, and potentially more painful to living standards for some households than others. These losses represent private costs of a benefit withdrawn, and in this respect would be little different from a cut in pensions or any other welfare payment.
The issue is to facilitate change in an equitable way, which may justify the use of transitional mechanisms to reduce the short-term impact, such as by the provision of advice on business restructuring, tax concessions, or even time-limited income payments. However, history shows that farmers as a group have remarkable abilities to absorb policy changes (such as by altering cost structures and production patterns and embracing diversification into non-agricultural activities) if adequate notice is given (and even if it is not). This ability has often been under estimated by policymakers.
If, as expected, land prices declined after the cessation of Basic Payments, this would result in a capital loss to farm households that owned land. It would probably push some households with heavy borrowing into leaving farming. However, a reduction in the cost of land could facilitate structural adjustment by allowing expansion by the most competitive farmers. It could also impact the costs of farming, as rents would be expected to fall and the interest charges on loans for the purchase of (cheaper) land to decline.
Competitiveness post-Brexit and the national interest
After this discussion we now return to the level playing field issue. The nub of the matter is whether, post-Brexit, it would be to the UK’s benefit for the government to step in on a permanent basis to address any apparent disadvantage to UK farmers from leaving the CAP. While UK farmers would be operating without Direct Payments, competitor farmers in the rest of the EU would, presumably, still be in receipt of them.
We are concerned not with transitional aid to facilitate resulting adjustment (which may take a variety of forms, can be justified on market-failure grounds, and to which UK ministers seem already to have agreed) but with the justification for longer-term support, implied by the NFU.
In this context, a distinction must be made between the national interest and that of the UK agricultural sector. Basic Payments in the rest of the EU would enable farmers there, if they so chose, to self-subsidise their production, which could undercut UK farmers. The playing field is not level, in the sense that imports will be produced with a cost structure not available in the UK.
However, this will not necessarily be against the national interest, as commodity prices in the UK will be lower than otherwise, and consumers and other users will benefit, in particular through lower food prices. In effect, resources would be transferred from EU taxpayers and farmers to UK consumers.
As long as this is a sustained process (that is, the arrangement is long-term and not just a disruptive short-period phenomenon), then it is in the interest of the UK economy as a whole to profit from this. True, there would be some private cost to UK farmers through selling less to the market, but this would be difficult to distinguish from the fall in their household income resulting from the cessation of Basic Payments; any poverty resulting from either could be addressed by welfare policy. UK farmers should be encouraged, even assisted, to adapt to the new commercial environment, in the same way that they would to the opening up of trade with a new competitor that has comparative advantage on their side.
If, as seems likely, the UK will eventually enter into trade agreements with major agricultural producing countries outside the EU, the resulting competitive pressure could be intense. It makes sense for the adjustment process to be working well before UK agriculture comes under a more severe competitive test in a post-Brexit economic environment.
This post was written by David Blandford and Berkeley Hill.
Photo credit: © Copyright P L Chadwick and licensed for reuse under a Creative Commons Licence.