Production effects of moving to flatter structure of direct payments

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What might be the production, consumption and trade effects of the Commission’s proposals to redistribute direct payments by moving to a flat(ter) structure of direct payments across the Member States, and to redistribute payments within Member States by moving from the historic basis of farm payments (in the majority of Member States which operate this system) to a regional flat rate system?

A silly question, some might respond, for are not the EU’s direct payments decoupled (leaving aside the continued existence of a share of coupled payments) and thus not meant to have an effect on farm production? If a direct payment is truly decoupled, then moving payments from one farm to another, or from one country to another, will affect relative incomes but not output.

But there is widespread agreement that even decoupled direct payments do have an effect on production, even if there is less agreement on how strong this effect is in practice. There are now a number of studies which attempt to quantify these effects.

These include the yet-to-be-released Commission draft impact assessment of changes to the direct payments regime, as well as studies using the CAPRI and AGMEMOD models. The general message from these studies is that the production (and thus trade) effects are likely to be small, but that the distributional effects across and within countries could be significant.

Commission AIDS7K model

One approach is illustrated by the Commission’s farm income impact modelling using its AIDS7K model based on FADN data. Because this is a static model with no behavioural structure, it cannot directly calculate possible changes in the structure of production.

However, the Commission reports possible income changes by farm type. If the assumption is made that higher incomes on some farm types will be associated with increased production, and vice versa, then some inferences can be made on the likely direction of production changes.

As a general rule, a uniform flat rate would reduce support in more productive regions and sectors in favour of more marginal regions. In any move towards a flat-rate payment either between or within Member States, grazing livestock (beef and sheep) farms are the main beneficiaries (along with wine and horticultural farms). According to the Commission, moving to a uniform flat rate per hectare of potentially eligible area (PEA) across the EU as a whole (note that in the scenario it models farmers in several Member States continue to receive a limited amount of coupled direct payments (suckler cows, sheep and goat, cotton, Article 68, Posei)) would see farm net value added per Agricultural Work Unit increase by 10% on beef and sheep farms. Farm net value added would fall marginally on milk and arable farms.

(If account were taken of the greening component in Pillar 1, which means farmers must incur additional costs to become eligible for the payment, then the income gain to grazing livestock is reduced and the income losses on milk and arable farms but also pig and poultry farms are exacerbated).

AGMEMOD study

These production effects are more formally modelled in two well-known sector models AGMEMOD and CAPRI. In each case the results are, in part, determined by the modellers’ assumptions about how direct payments impact on production as well as by the policy scenarios that they assume.

The AGMEMOD 2020 combined model is an econometric, dynamic and partial equilibrium model representing each of the 27 Member States. Direct payments are incorporated as add-ons to the relevant producer price to form a reaction price (livestock, livestock products) or expected gross returns (crops).

Coefficients are applied to these add-ons to determine their production effect. For example, a coefficient of 1 would imply that farmers perceive direct payments as equivalent to a similar price increase, while a coefficient of 0 would imply that they treat them as totally decoupled.

The coefficients used in AGMEMOD vary across countries and commodities, for example, to reflect differences between the historic and regional SPS systems. For historical payments the coefficients vary between 0.3 and 0.6 and for regional payments between 0.1 and 0.5. The coefficients for coupled payments lie between 0.5 and 1.0.

Results of moving to a uniform flat-rate payment across the EU as a whole are reported in a recently-published AGMEMOD simulation [access to ScienceDirect required] for wheat, barley, maize, beef, pork and milk. Unfortunately, the consequences of moving to a uniform EU flat-rate payment are conflated with an overall reduction in the CAP budget for direct payments (by around 54% in the final year of implementation). Another important difference with the Commission analysis is that coupled payments are assumed to be decoupled in this analysis, which has particular consequences for the beef results. Despite these more severe assumptions, the production effects are estimated to be very marginal (ranging from 0% to -0.8% of commodity production in 2020) apart from beef where production is estimated to fall by -3.3%.

The AGMEMOD study does not report the expected commodity market price changes although these are presumably correspondingly small. AGMEMOD assumes exogenous world prices which are not affected by the EU net trade balance. To the extent that world prices respond to a reduction in EU production, then the AGMEMOD results, small as they are, also represent upper-bound estimates.

CAPRI study

A second study published by the EU’s Joint Research Centre uses the partial equilibrium CAPRI model together with a specially tailored farm group component called CAPRI farm type (CAPRI FT) to analyse the impact of a flat rate for direct payments at NUTS 1, MS and EU levels (with the level of redistribution and potential impacts increasing in moving to an EU flat rate). The farm models are behavioural programming models in which production and land use (but not farm structure) change in response to changes in relative profitability of different enterprises.

In the CAPRI model direct payments have an impact on production through their partial capitalisation in the returns to land. As direct payments change, so does the cost of land. Thus a reduction in direct payments will favour land-intensive production and vice versa. Land has an elastic supply curve in the model and, at the margin, is in competition with non-agricultural uses such as forest, recreation or nature reserve. So if direct payments fall sufficiently, land moves out of agricultural production and overall production will fall.

The study assumes that if land moves out of production the equivalent direct payment is lost and so overall expenditure on direct payments falls slightly in the scenarios modelled. The scenarios also assume that payments which are coupled in the baseline are decoupled in the scenarios, which will particularly affect beef and sheep as noted earlier.

This study also shows relatively small production and price impacts. In the EU flat rate scenario, which represents the most radical redistribution of direct payments, production generally falls (by -1.3% and -1.9% for cereals, by -1.7% and -0.8% for oilseeds, and by -0.6% and -0.2% for meat in the EU-15 and EU-10 respectively). The maximum price increase was for cereals of 1.5% for the EU-15 and 2.9% for the EU-10, while for meats prices are projected to increase by 1.1% in the EU-15 and 1.2% in the EU-10. The small magnitude of the impacts is due in part to the role of entitlements in limiting land use expansion while allowing for some substitution between grassland and arable land.

Given the small price and production changes, income effects are mainly driven by the redistribution of decoupled payments and to a lesser extent by land use changes. As regards farm types, large and medium size farms and dairies, mixed crops and livestock, general field and mixed cropping, olives, cereals and oilseeds and permanent crops are particularly negatively affected. Small farms tend to be less affected. On the other hand, the most extensive production systems, such as sheep, goats and grazing, the residual farm category and mixed livestock farms, realized higher premiums and incomes. These income changes correspond closely to those projected in the Commission’s AIDS47 model. They are aggregate changes, and there can also be redistribution within farm type groups with some farms gaining income and others losing. These distributional effects are analysed in detail in the study.

Conclusion

The Commission’s 2013 legislative proposals to be released next month will contain a number of measures likely to affect the level of EU domestic production and thus the impact of EU agricultural policy on third countries. The most significant will be the market measures confirming the elimination of milk and sugar quotas. But changes in the design of direct payments, including the overall budget for these payments, redistribution across farmers and member states, the introduction of the greening component, and the extent to which payments can be coupled or not, can also potentially have market effects.

Redistribution of direct payments (moving from the historic payment for entitlement payments to a regional flat-rate system in the EU-15 Member States plus Malta and Slovenia, and moving to greater convergence in the value of payment entitlements across Member States) will tend to shift payments from more productive to less productive Member States, and from more intensive to less intensive farms within Member States.

Redistribution of payments on its own would thus be expected to have a negative effect on EU production. Recent studies support this intuition but suggest that the effects will be very marginal, in most cases less than 1-2%. The effects are somewhat larger for cereals than for livestock but still rather small. Overall, therefore, the studies support the view that the EU’s direct payments are rather decoupled in practice.

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