More on who benefits from farm subsidies

Jack Thurston reviews some recent academic studies, including a recent paper by Stefan Kilian and Klaus Salhofer from the Technische Universität Munich, which make the point that much of the benefit of agricultural support policies does not end up in the hands of farmers who are its intended beneficiaries, but rather benefits landowners. However, my reading of the Kilian/Salhofer paper is that we need to be careful in applying this conclusion to the EU’s Single Farm Payment.

Kilian and Salhofer highlight the requirement in the EU Single Payment Scheme that a farmer must possess an entitlement in order to qualify for the payment. It turns out that this creation of a new ‘factor of production’ can modify significantly the conventional conclusion that landowners benefit from agricultural support.

Economic theory shows that agricultural subsidies tend to be capitalised into the purchase and the rental price of agricultural land. The reason for this has to do with the relative responsiveness of the supply and demand for land to changes in its price (what economists refer to as the supply and demand elasticity of land).

Take the extreme case where the supply of land is fixed. An increase in agricultural support will increase the profitability of farm production. Because of higher incomes farmers are prepared to bid more to rent in or purchase extra land. But given that the overall supply of land is fixed, farmers will bid against each other up to the point where the entire increase in profitability is dissipated by the higher cost of land. Thus, it is landowners rather the farm operators who are the main beneficiaries of farm support policies.

However, in the EU Single Payment Scheme a farmer must possess an entitlement in order to qualify for the payment. Farmers were granted the number of entitlements equal to the average eligible hectares they planted in the reference period. These entitlements can be sold with and without land and they can also be leased out with land. However, for each entitlement to be activated in any year the farmer has to have one hectare of eligible land (either owned or leased). Effectively, there is a market for entitlements which is quite separate to the market for land.

The question is whether the value of the entitlement stays with the farmer (we can think of him as a tenant) or is passed back to the land owner (the landlord) and capitalised into the value of the land. It turns out that whether the value of the Single Payment is capitalised into the value of land depends crucially on the ratio of the number of entitlements to the number of hectares of agricultural land, as well as on the payment model (historic, regional or hybrid) in place.

Specifically, for all three payment models, as long as the number of eligible hectares exceeds the number of entitlements the Single Payments are not capitalised into land prices. If there is a surplus demand, entitlements have their own value decoupled from land.

Kilian and Salhofer, however, assume that the more usual situation is that there are more entitlements than land. They defend this assumption by pointing out that governments can issue more entitlements than hectares right from the beginning, since they are allowed to allocate entitlements to farmers who otherwise would not have them, such as newcomers. Also, over time, they point out that the agricultural area is decreasing every year due to such factors as road-building and urbanisation.

In these circumstances, some of the payments in countries using the historic model are capitalised into land values, while all of the payments in countries using the regional model will be capitalised, with the hybrid model somewhere in between. Thus, they conclude that the move to decoupling is unlikely to lead to significant decreases in land prices in the EU and could even push prices higher to the extent that the previous coupled subsidies for animal production may not have been capitalised into land values before.

The question is whether Kilian and Salhofer are right in their assumption. The key variable in their analysis which determines whether capitalisation of the Single Farm Payment into land values occurs is whether there is agricultural land without entitlements in a Member State. This is much more likely in countries which have adopted the historic model than the regional or hybrid models. However, even in countries which have adopted the regional model, the Kilian and Salhofer scenario in which there are more entitlements than land is not totally convincing.

The entitlements given to newcomers and other farmers without entitlements come from a national reserve which is established by reducing other farmers’ entitlements by up to 3%, so there is no net creation of entitlements in this process.

Where farmers are forced to sell land to public bodies for road building or similar purposes, or where they afforest this land, they are entitled to consolidate their entitlements.

It is only where a farmer voluntarily sells land for non-agricultural use such as housing that the entitlement will be lost. In this case, a sensible farmer would first seek a buyer for his surplus entitlements. The anecdotal evidence I am aware of suggests there are still ‘naked’ acres around to ensure buyers for these entitlements (see the WebbPaton website offering to match entitlement buyers and sellers in England which has adopted the dynamic hybrid model). In any case, the disappearance of agricultural land is a long-term process and is unlikely to influence the market for entitlements at the initiation of this scheme.

I am therefore inclined to the view that the usual situation in EU Member States is that there is agricultural land without entitlements, and thus that the value of the Single Farm Payment is not capitalised into land values. However, the implication of this is that land rents should have fallen across the EU when the Single Farm Payment was introduced, and I am not aware of any evidence to this effect, leaving us with an apparent puzzle. Is there any other information out there which might throw light on this question? This conclusion does not apply, of course, to other forms of agricultural support in the EU, such as market price support or biofuels subsidies to which Jack refers.

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2 Responses to “More on who benefits from farm subsidies”

  1. Jack Thurston
    October 15, 2007 at 09:00 #

    Does not some of the conclusion depend on the price at which entitlements are bought and sold?

    If – as we are observing empirically – entitlements are being offered for sale at a price which means they offer the chance of a rate of return higher than other paper investments, there will be an additional incentive to acquire land in order to claim the benefit. This will bid up the price of agricultural land since an entitlement is valueless unless it is accompanied by a piece of eligible land in ‘good agricultural and environmental condition’.

    So the question must be: why are entitlements being offered for sale at a price which looks to be on the low side, given the rate of return? First, perhaps it is because it is a buyers market – more entitlement holders are looking to make a lump sum windfall gain than there are new farmers wishing to enter the business of farming subsidies.

    Second, could it be that the talk about ‘everything changing after 2013′ has given SFP entitlements a fairly short shelf life, which could be curtailed even more if member states agree more modulation, or the CAP’s financial discipline mechanism kicks in.

    I wonder what the evidence is from farm land sales – is land being sold parceled up ‘with entitlements’ most of the time, or are land and entitlements being sold in separate transactions? This French farm offered for sale explicitly states that “DPU’s(single farm payment rights) are included in the price”. Has an entitlement-only market sprung up in other member states? In other words, the theory gets us only so far. What is actually going on, and why?

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