What is the likely cost of greening Pillar 1?

The Commission’s proposals for the design of direct payments after 2013 include a greening component which, according to the draft legislative proposal (yet to be released on 12 October next and thus subject to change) will be mandatory for farmers in receipt of the basic income payment – thus becoming what I called in an earlier post a form of super-cross-conditionality.

In the impact assessment to be released with the legislative proposal the Commission has made some estimates of the cost of implementing these green measures. In this post, I examine these costs using information in the draft version of the impact assessment (Annex 12 Impact of Scenarios on the Distribution of Direct Payments and Farm Income).

This version was completed before June 2011 and the favoured proposal in the draft regulation now differs somewhat from the version examined in June. In particular, the obligation to maintain a green cover during winter has been dropped, but on the other hand the area to be setaside under the ecological focus requirement has been increased from 5% to 7% (see this post for a summary of the draft direct payments regulation).

The effect on farm income in 2020 of greening direct payments is determined by two factors. First, the implementation of the green measures increases the costs of farming either directly or in the form of loss in income. Second, various of the green measures (the requirement to maintain the 2014 level of permanent pasture, the requirement for crop diversification and, particularly, the ecological set-aside) will have an impact on supply and thus market prices. Thus, the greening leads to an increase of agricultural prices which tends to counterbalance the impact of the measures on cost.

The study concludes that the cost of greening will amount to €33/ha of potentially eligible area (PEA) in 2020. Just half of this figure is the cost of maintaining permanent grassland (€17/ha PEA). I have not been able to find any IACS figures on the size of the EU eligible area (if anyone knows where these can be found, please let me know). But the Commission estimates that the average direct payment will be €267 per ha PEA and, assuming a budget for direct payments of around €40 billion, this works out at a PEA of 151 million ha in 2020 (this compares to a utilised agricultural area of 178 million ha in EU-27 today). Using this figure, the cost of greening would amount to approximately €5 billion. This compares to the value of the green payment (30% of €40 bn) of around €12 billion.

Costs for the maintenance of permanent grassland and the ecological set-aside are in general the highest. For instance, among regions, the cost of maintaining permanent grassland in areas where an alternative use of land exists varies between €5 and €620/ha, with an EU average of €216/ha of grassland. With 5% of set-aside, the average cost per ha of land to be set-aside is €260/ha, but in some regions the costs per ha are more than €1,000. When the cost of greening is brought back to the total PEA, the amounts are lower. It is estimated that 29% of farms would have a cost between €15 and €30/ha of PEA, 4% would have a cost higher than € 200/ha of PEA, and about 21% of farms would not experience any cost.

In general, the costs are estimated to be highest in the Member States where maintaining large areas of permanent grassland is economically challenging due to pressure to substitute grassland by fodder crops (the Netherlands, Slovenia and Belgium).

It is interesting to speculate what is the value of the environmental benefit to be gained from incurring this cost? The Commission study cannot answer this question because of a lack of data on the environmental impact of the green measures. Instead, it quotes some figures on the land area likely to be affected by these measures.

Overall, for the EU-27, it estimates that 25% of the PEA will be affected. The risk of ploughing permanent grassland is reduced on about 13 million ha. On about 1.7 million ha of land, farmers receive incentives to cultivate alternative crops, mitigating the negative effects of monoculture, while about 3.6 million ha of arable land are set aside for ecological purposes. [It also estimated that an additional 20 million ha of arable land green cover is applied during winter time but, as noted above, this measure seems to have been dropped from the draft regulation].

But, in themselves, these figures do not give any insight into the size of the environmental benefits to be gained on these areas. Given this, it will be hard to answer the question posed at the beginning of this post whether incurring a €5 billion cost in this way is the most effective way of increasing the production of environmental public goods by farming.

Commission methodology

At a technical level, the credibility of the Commission estimates can be assessed by examining the methodology used. The Commission methodology is sophisticated and appears well suited to the task. My main criticism would be with the estimate of the cost of maintaining permanent pasture, which seems to me to be over-estimated. This is because the Commission methodology seems to assume that all permanent pasture that could be converted into arable cropland would be by 2020 in the status quo scenario. Its model does not have the capacity to estimate the proportion of permanent grassland that would actually be under threat in 2020, given the configuration of relative profitability (gross margins) between grazing livestock and other enterprises at that time.

The Commission’s analysis is carried out with FADN data at farm level using the AIDS7K model which covers 81,000 farms in 27 Member States. Expected prices and yield estimates in the scenario year 2020 are based on results taken from the Commission’s AGLINK-COSIMO model. Additionally, the labour input has been adjusted according to observed trends. The following steps are involved.

Crop diversification: This measure requires farms to cultivate at least 3 different crops, with no crop allowed to cover more than a 70% of the total arable land. It is assumed that the profitability of the additional crops corresponds to the average regional gross margin of field crop farms with diversified arable crops. Therefore, the costs are assumed to be equal to the difference between the farm’s individual gross margin of arable land and this average regional gross margin. In the cases where the farm individual gross margin is lower than this regional average it is assumed that there are no additional costs.

Ecological set aside: 5% of arable land has to be taken out of production. Costs for the implementation of the measure arise if the amount of fallow land on the farm is lower than the area to be set-aside. For each hectare to be additionally set aside it is assumed that the costs equal 2/3 of the farm individual gross margin of arable land. The idea is that farmers will set aside the less productive areas first (with the assumption that their gross margin is 2/3 of the farm average).

Preservation of grassland: Farmers have to maintain their permanent grassland. The cost of the implementation of this measure would be an opportunity cost. To estimate this cost, it was necessary to assess on each farm whether there is an opportunity to convert grassland to arable land or not and to quantify the magnitude of the opportunity cost.

There will be little or no opportunity to convert grassland in farms with poor soil quality. For the simulation it is assumed that this is the case on farms with a low share of arable land (less than 5%) and on farms where sheep and goats represent more than 70% of grazing livestock units. Furthermore, it is assumed that rough grazing and 10% of the remaining permanent pastures cannot be converted.

For the remaining permanent pasture it is assumed that the opportunity costs are 2/3 of the difference in gross margins between permanent grassland based dairy and beef production systems and alternative systems at regional level. Only a fraction of the difference is kept in order to take into account that the newly converted grassland would probably not have the same level of productivity as land already in fodder crops (the most productive areas have been converted into arable crops before).

For the calculation of the difference in gross margins at regional level, it is considered that there are no opportunity costs in regions where permanent grassland is not relevant or where there is no alternative identified (no cattle production). Otherwise, in regions where grass-based and forage crops based feeding systems co-exist in specialised farms, it is assumed that the first alternative to cattle production based on grass is to intensify production adapting the feeding system by ploughing the grassland to produce forage crops. Finally, in the remaining regions, where cattle production takes place in mixed cropping-livestock farms, the farm gross margins per hectare of utilised agricultural area in mixed and specialised cropping farms are used.

Green cover: I include this because it is included in the draft Commission study even if it appears to have been dropped from the draft legislative proposal. During winter, farms have to apply green cover on 70% of their arable land and the area covered by permanent crops, excluding the area of ecological set-aside The costs of the implementation of green cover are estimated based on assumptions on the affected area and the costs per ha. As there is no information on green cover available at farm level several assumptions had to be made: first, it was assumed that a large part of the area covered by cereals is covered during the winter, as in most cases a large share of the cereals are winter crops. As in the FADN it is not differentiated between winter and summer crops it was assumed that on each farm the share is equal to the national shares of winter and summer varieties published by EUROSTAT. Furthermore, it was assumed that 30% of the area of permanent crops is already covered. The costs per ha of land to be additionally covered in order to meet the requirement are assumed to be equal to 50€.

Market effects: These gross costs of implementing the green measures are the appropriate measure to compare with the value of the environmental benefits to be achieved. However, in terms of the impact on farm income, these gross costs will be offset by a transfer from consumers through higher commodity prices. These are reported in the Commission study by farm type rather than by commodity. The income effect over all farms is reported to be an increase of +0.6%, with more positive effects on crop farms (2.6%) and grazing drystock farms (+1.2%), while enterprises using grain as a feed are worse off (income on milk farms would fall -0.2% and on pig/poultry farms by -8.4%).

Overall, farm income falls by -2.8% on average in the Integration scenario (which includes the greening option, but also includes the effect of capping, where the money saved by capping and diverted to rural development is assumed lost to farmers). It seems that the positive impact of the market effects from reduced supply do not compensate farmers for the increased cost of implementing green measures in Pillar 1.

Overall, these results are probably quite a good guide to the likely outcomes of the proposals in the draft legislative proposal because, although the green cover requirement is removed (thus reducing costs), the ecological focus area requirement is increased from 5% to 7% (thus raising costs).

Photo downloaded from http://www.flickr.com/photos/13847552@N03/3906560447/ under Creative Commons licence

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