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.