The challenges of the next Cap: doing more with less

Abstract

The European Commission has initiated a review to simplify and modernise the Cap in the coming decade. This paper identifies the challenges that future agricultural policy must address. It highlights that, in addition to the traditional concerns of agricultural policy focused on the needs of farmers, the future Cap must also address a wider range of issues and concerns raised by consumers and citizens. Given the hints that the future Cap budget in the Multi-annual Financial Framework (Mff) after 2020 may be lower than in the current Mff, there is an urgent need to focus spending on those priorities with the greatest European value added and effectiveness. From this perspective, the high share of the Cap and EU budget devoted to general, area-based direct payments can no longer be justified. The next Cap must begin the process of phasing out direct payments, instead introducing and building on a more targeted set of policies designed to better equip farmers to face the challenges of the future.

Future challenges

The European Commission announced in its 2017 Annual Work Programme that it would “take forward work and consult widely on simplification and modernisation of the Common Agricultural Policy to maximise its contribution to the Commission's ten priorities and to the Sustainable Development Goals. This will focus on specific policy priorities for the future, taking account of the opinion of the Refit Platform, and without prejudice to the Commission proposal to revise the Multiannual Financial Framework” (European Commission 2016).
As the first part of this exercise, DG Agri conducted a public consultation in early 2017 which attracted over 320,000 online responses as well as over 1,400 position papers. At the same time, the Commission services are conducting an impact assessment of alternative scenarios for the future Common Agricultural Policy (Cap). The outcome will be presented in a Communication before the end of 2017 which will include conclusions on current performance and an evaluation of future policy options.
There are three motivations for proceeding with this evaluation of the Cap even though the previous reform only fully entered into force at the beginning of 2015. The first is the widespread sense that the last Cap reform added greatly to the complexity of managing the Cap for both farmers and paying agencies. The current Commissioner for Agriculture and Rural Development, Phil Hogan, has made simplification of the Cap a priority, but only a limited amount can be achieved through changes in Commission implementing and delegated acts. This justifies the focus on simplification of the basic acts in the current review.
The second motivation is a view that the last Cap reform did not fully equip EU agriculture with the tools needed to address the challenges of the future. Some of these challenges are long-standing but have come into sharper focus given recent trends on agricultural markets and in the external environment. Some of these challenges arise from new commitments which the EU has entered into since the last Cap reform, notably adherence to the UN 2030 Agenda for Sustainable Development and its 17 Sustainable Development Goals as well as the Paris Agreement on climate change.
Recent trends on agricultural markets have underlined that EU market prices are now closely linked to world market prices. They are also more influenced by external events such as trade embargos, meaning that producers are now more exposed to price volatility. Agricultural markets have always been cyclical in nature, but the low income gearing and growing indebtedness of many farms mean that promoting greater resilience in periods of low prices has become more important. There is thus now a greater interest in providing a more extensive risk management toolkit to enable farmers to better weather periods of low prices.
Uneven bargaining power in the food chain has long been a concern among producers (being one factor behind the growth of agricultural co-operatives, for example), but the increasing concentration of input supply, processing and retail distribution firms has raised the question whether farm prices and incomes are being squeezed by abuses of market power.  The report of the Agricultural Markets Task Force made a number of recommendations in this regard (Veerman 2016). The Commission proposes to carry out an impact assessment of these recommendations with a view to introducing legislation in the course of 2018.
After a number of decades of steady growth, more recently the increase in EU agricultural production shows signs of levelling off and productivity growth may be slowing down (DG Agri 2016). Various factors may be responsible, such as the move from price support to decoupled payments, the erosion of natural capital, deliberate policy incentives towards extensification, restrictions on the use of chemical inputs, and the impact of climate change on yields (Moore and Lobell 2015). The EU has the ambition to secure free trade agreements with a wide range of trading partners, many of whom are significant agricultural exporters, and which are likely to increase competition on EU agricultural markets. With trade barriers falling, European farmers must compete with producers in countries with more favourable land endowments, emphasising the importance of encouraging the use of scarce European land resources to produce quality products with a premium value rather than focusing on commodity production.
There is also a growing focus on problems of generational renewal in the face of a gradually ageing farm workforce. New support instruments were introduced in the 2013 Cap reform but difficulties in accessing land and credit remain major impediments for new entrants (Hogan, 2016). High land prices and the increasing capital intensity of agricultural production lead to worries over high levels of farm indebtedness in some countries as well as the impact of the concentration of agricultural land in the hands of large non-agricultural investors. Loss of population in many rural regions continues, although the role of agricultural production even in remote rural regions is now rarely significant enough that encouraging agricultural production alone can reverse these trends.
Characteristic for these issues is that they revolve around producer concerns that have been the traditional focus of agricultural policy. However, in addition, a wider set of concerns about the nature of the food system as a whole is increasingly articulated by consumers and citizens. Agricultural production often leads to the loss of environmental natural capital (water quality, biodiversity, soil fertility, air emissions). There is an urgent need to mitigate the impact of climate change by reducing emissions of greenhouse gases from agriculture, while also ensuring that agriculture in different EU regions can adapt to the expected impacts of climate change. There is widespread concern about inappropriate diets high in processed foods and meat products leading to growing levels of obesity and associated health problems. There is increasing attention to the problem of food waste and the unnecessary strain this puts on resource use. Within the EU, food poverty has again become a significant policy concern, with growing use of food banks and an increasing need for food assistance. There is a growing movement in favour of ‘localisation’ of the food supply, with an emphasis on short supply chains, country of origin labels and buying local. On top of these issues, there is a debate on the appropriateness of using agricultural resources to produce bioenergy (whether in the form of biofuels or biomass).
At the same time, there is widespread suspicion, warranted or not, regarding the dependence of conventional agriculture on chemical and pharmaceutical inputs and opposition to the potential use of biotechnology in helping to improve the productivity and sustainability of agriculture. Agriculture structure issues remain important in the policy debate, with some concerned that small/family farms continue to lose out to larger, industrialised production units particularly in livestock production. Large intensive animal operations are also criticised on animal welfare grounds, including issues relating to overuse of antibiotics. These problems have fuelled growing calls for greater attention to the sustainability of agricultural practices and production (resource efficiency, sustainable intensification, circular economy). As well as reflecting the growing interest of citizens and consumers in the food system and the way food is produced, another characteristic of these issues is that many involve ethical norms and value judgements which are difficult to adjudicate on the basis of evidence alone.
The search for a narrative which might help to maintain a high level of Cap spending in the next EU Multi-annual Financial Framework (Mff) is a third motivation for the current review. A Commission proposal on the size and composition of the next Mff had been expected before the end of 2017 but this may now be delayed until 2018 because of the uncertainty created by the UK exit from the EU. The UK is the second largest net contributor to the EU budget so its departure, depending on the terms agreed in any financial settlement, will make it even more difficult to agree on the size and composition of the next Mff. It is already clear that new resources must be found within the MFF to enable the EU to deal with the challenges of migration, enhanced security, and youth unemployment. The Commission, in a reflection paper on the future of the EU finances, has indicated that in this battle over resources the Cap budget looks particularly vulnerable (European Commission 2017).
This review shows that the range of policy issues which the Cap is expected to address in the future is becoming ever broader even if it is the case that, at least for some of these issues, policy instruments other than agricultural policy per se will be found more appropriate and more effective. At the same time, EU farmers may be asked to address these challenges with fewer resources. This means it becomes even more urgent to assess whether the current resources available to the Cap are being spent most effectively, and to ask how these resources should be deployed in the future.

The need for reform of direct payments

Over the past two decades, the Cap has evolved from supporting producer prices to supporting producer income. EU farmers now produce at more-or-less world market prices, while their incomes are heavily supported by the system of direct payments. Pillar 1 direct payments, including the Basic Payment, the greening payment, the Single Area Payment Scheme, coupled payments and other area-based payments, make up 70% of the Cap budget and 28% of the entire EU budget. However, this system of direct payments lacks any real legitimacy or justification (Matthews 2016, 2017).
It was originally introduced to compensate farmers for the reduction in income due to lower market price support when producer prices were largely determined by the administered prices set under the Cap. However, compensation can only be justified as a temporary measure. It is hard to rationalise direct payments as compensation for price reductions which took place twenty-five years ago, not least because they have been extended to farmers in the new member states which never experienced those price reductions and where prices generally rose on accession to the EU.
The Commission defends direct payments as a basic income support for farmers. But the very skewed distribution of this support, with the main beneficiaries being farms with relatively high incomes, undermines this justification (Matthews, 2017). Also, because eligibility for direct payments depends on control over land, these payments are capitalised into the value of land1. For tenant farms or farmers renting land, this means that much of the value of the direct payment is dissipated in the form of higher rents, so that the ultimate beneficiary is the landlord rather than the actual farmer. Also, as farmers acquire additional land over time to expand, the value of the direct payments is offset by the higher purchase cost of the land they buy. Thus, there is a high leakage of the benefits of the direct payments to non-farm groups and this leakage increases over time.
Capping direct payments is often suggested as a way to limit direct payments to those in need of income support. However, using agricultural policy as a form of social policy is inevitably going to be poorly targeted on those farm households with low incomes. Merely shifting a higher share of direct payments to smaller farms (for example, through capping or by building on the redistributive payment) does not necessarily lead to a more equitable policy. Many small farm occupiers have off-farm income so there is no necessary correlation with low household income. Heavily subsidising small farms may also result in an increasingly uncompetitive agricultural structure which will require increasing levels of support over time merely to survive.
The Commission also highlights the important role of direct payments in stabilising overall farm income. Certainly, the availability of a steady stream of income from direct payments enhances the creditworthiness of farmers and reduces the volatility of total farm income including the payments. However, direct payments are not well designed for stabilisation purposes. Some of the more risky farm enterprises, such as horticulture, receive relatively little in the form of direct payments because they use relatively little land. Also, direct payments are paid regardless of the level of farm prices both in good years and bad. If the sole objective of public transfers is to stabilise farm income, an income stabilisation tool is a more efficient use of public funds (Castañeda-Vera and Garrido 2017).
Of course, the stabilising role of public intervention may simply crowd out alternative choices farmers could make to smooth their incomes (Oecd, 2009). Private sector risk management instruments may find it more difficult to get established and compete because the public transfers make use of these alternatives less attractive. Reducing the adverse consequences of risk may also encourage farmers to take on greater risk. With the backstop of a steady stream of direct payments, farmers may be more willing to specialise in monocultures because there is less need to diversity.
Direct payments are sometimes justified because farmers in the EU must meet higher standards, in terms of the environment, food safety and animal welfare, than farmers in other countries. This is not a convincing justification, for many reasons. To the extent that high standards correct for the negative externalities imposed by farming on other groups in society, this is not an argument for compensation. Without the standards, overall EU social welfare would be reduced: the standards raise overall EU welfare and do not call for compensation. High standards are often used as a selling point and contribute to the premium prices that EU products obtain, so the additional costs are sometimes compensated by higher market prices2.  Often, the standards demanded by the private sector are higher than those required by legislation and set the bar which producers must meet.
While EU farmers compete with producers in other countries, they also compete with other enterprises within the EU for the use of resources, particularly labour and capital. Other enterprises in the EU are also subject to high regulatory standards, and there is no evidence that farming is necessarily discriminated against in this respect and, therefore, again no case for compensation. More generally, competitiveness cannot be reduced to comparisons based on a single factor. Producers in other countries look with envy at the innovation system in the EU, the well-functioning credit markets, stable legal systems and property rights. There is no reason to pick out just one of the factors which determine competitiveness in which EU farmers may be at a disadvantage and to argue that compensation is justified on that basis alone. When standards are raised, it may be appropriate to offer transitional aid to producers to help them adjust to these higher standards (e.g. investment grants for improved buildings) but this is not a justification for area payments on a continuing basis.
The final argument which is used to justify direct payments is that they are important to ensure the provision of public goods, whether this is the continuation of farming in marginal farming regions or the provision of ecosystem services. This justification is partly based on the link between the basic payment/single area payment and cross-compliance conditions, as well as the conditions attached to the greening payment. However, the links between these payments and the provision of public goods is very indirect. There is no link between the size of the payment received by a farmer and the size of the provided public good, nor are the payments designed to encourage the management of agricultural land in such a way which maximises the output of public goods. Environmental public goods (and bads) are spatially heterogeneous and uniform area payments fail to reflect this fact. The environmental literature also emphasises the superiority of results-based schemes over schemes which reward farmers on the basis of inputs such as undertaking specific farm practices. For all these reasons, uniform area-based direct payments are a very inefficient way to incentivise farmers to provide more public goods (Oecd, 2010). Some public goods need to be provided by farmers co-operatively and here specific targeted measures to encourage collective action may be needed (Oecd, 2013).

Designing the future Cap

There is an important role for payments which compensate farmers for doing things which society values but for which markets do not exist. Underlying the previous criticisms of the current system of direct payments is the fact that they are not targeted. All farmers are entitled to receive a basic payment, regardless of income, their contribution to the environment or to the provision of ecosystem services, provided only that they comply with a basic list of good farming practices and statutory regulations.
As well as paying farmers to provide public goods and positive externalities (where these are insufficiently produced relying on market forces alone)3, agricultural policy should also ensure that the social costs of all negative externalities are fully internalised. Studies show that the costs imposed on society by these negative externalities, including water pollution, loss of excess nitrogen, soil erosion, pesticide use, air pollution and greenhouse gas emissions, can be substantial (Jongeneel, Polman, and van Kooten 2016).
These two basic principles, the “polluter pays” and the “provider gets”, give plenty of guidance for the future direction of the Cap, but are not in themselves sufficient to answer all relevant policy questions. There can still be debate over the design of the most effective policy instruments to achieve these objectives. Are market-based incentives sufficient, or are regulatory instruments also required? How to balance the higher administrative costs of more targeted policies with the likely social benefits? How to choose the most efficient policies which ensure the greatest provision of public goods (or the greatest reduction in health or environmental damage) for the minimum expenditure of public funds (or at minimum cost)?
Also, this distinction between polluters and providers assumes that we know where to draw the baseline (presumably based on good farming practice) to allow us to distinguish cases where farmers are providing a genuine public good and not just being subsidised to stop a polluting activity. Establishing this baseline revolves around who holds the original property rights and is an inherently political question. For example, buffer strips along water margins are effective at reducing excess nitrogen run-off and water pollution. Should farmers be required to adopt this practice or should society compensate farmers for the loss of cultivable land tied up in these buffer strips? Should farmers be subsidised for taking measures which reduce greenhouse gas emissions, or is this a case of ‘the polluter pays’ and emissions should be appropriately taxed? Future agricultural policy will be, in large part, a debate over where to draw the property rights baseline.
Within the Cap, targeted payments are largely the domain of Pillar 2. The perspective outlined above would see a sharply diminished role for Pillar 1 and a larger role for Pillar 2, buttressed by a complementary tax and regulatory regime to ensure the full cost of producing agricultural products is reflected in market prices. Clearly, direct payments cannot be removed overnight; given the capitalisation of payments into asset values and farmers’ expectations, such a step would wreak havoc. But an end date should be set within, say, a period of two Mff’s, giving farmers a reasonable time to adjust.
Such a policy perspective would also need to address the future role of cross-compliance. Cross-compliance, as its name implies, is directly linked to the continuation of direct payments in Pillar 1. The incentive to comply is the sanction of losing part or all of the Pillar 1 payment4. Many cross-compliance requirements are already legislative requirements. The argument for linking them to a farmer’s eligibility for direct payments was to create a "better awareness on the part of beneficiaries of the need to respect those basic standards."5 If there is no longer a Pillar 1 payment, some other way of ensuring the benefits of cross-compliance must be found.
Cross-compliance requires respect for a series of Statutory Management Requirements as well as national standards of good agricultural and environmental condition which include rules to better address water, soil, carbon stock, biodiversity and landscape issues as well as minimum level of maintenance of the land. After more than a decade, one should imagine that farmers are now very aware of their statutory responsibilities so the argument that cross-compliance is necessary to create that awareness is growing weak. For the non-statutory standards of good agricultural and environmental practice, consideration will need to be given as to whether these should also be given a statutory basis or be included in a simplified agri-environment-climate measure (Aecm) (which will require an adjudication of the property right allocation in each individual case).
Under the perspective advocated in this paper, the budget for Pillar 2 payments would be increased. The focus of the agricultural elements of Pillar 2 should be on encouraging innovation, including through the encouragement of operational groups under the European Innovation Partnership for Agricultural Productivity and Sustainability, supporting risk management, and incentivising land management for the production of public goods. A shift within Cap spending from direct payments which are 100% financed by the EU to Pillar 2 payments which are partially co-financed by Member States will not necessarily be welcomed by Member States and farmers. Member States argue that the requirement to come up with national co-financing makes it more difficult to draw down Pillar 2 funding, while farmers worry that while some governments may be willing and able to provide the matching finance, others may be less able or more reluctant, thus distorting the level playing field inside the single market.
On the other side, environmentalists might fear that the coverage of EU farmland farmed to higher environmental standards may be lower under a voluntary Aecm funded under Pillar 2 than is achieved by the greening measure and cross-compliance as part of Pillar 1 direct payments. In response to this criticism, where justified, some cross-compliance standards designed to prevent negative externalities can be made statutory standards. Alternatively, in areas with particularly valuable ecosystem services to be protected, enrolment in an Aecm in return for compensation could be made mandatory (as is the case of Natura 2000 areas at present). Further, programmes which have a high EU significance could receive EU financing up to 100% of total costs, while national co-financing would be introduced for other programmes with lesser EU significance. Co-financing rates can also be differentiated by a region’s Gdp per capita as is currently the case. If a member state is unwilling to co-finance a Pillar 2 programme, it suggests the programme does not have a very high value and probably should not be provided anyway. Greater fungibility could also be introduced to allow shifting between Pillar 2 spending and other structural funds when deciding on national allocations under the Mff as another incentive to ensure EU funds are taken up.

Conclusions

European citizens have high expectations and high demands for future EU agricultural policy (Ecorys 2017). In contrast to the past, when the policy largely focused on support to farm incomes (either through guaranteed minimum market intervention prices or through direct payments), the future agenda for agricultural policy will be driven at least as much by consumer and citizen concerns with the way food is produced. Market forces alone will not ensure the necessary transformation; there will continue to be a need for a strong policy framework to address risk and bargaining power, to internalise both the positive and negative externalities of agricultural production, while encouraging the adjustments necessary to move towards a more sustainable agriculture and food system which also contributes to Europe’s ambitious climate targets.
While the budget available for future agricultural policy is not yet known, there are strong hints that it will be smaller than in the current Mff period. Asking agriculture to do more with fewer resources will require a much greater focus on how the Cap budget is spent. In this context, devoting such a high proportion of the EU and Cap budget to general area-based direct payments with minimal environmental conditionality can no longer be defended. The next Cap must begin the process of phasing out direct payments, instead introducing and building on a more targeted set of policies designed to better equip farmers to face the challenges of the future.

References

• Castañeda-Vera A., and A. Garrido (2017), “Evaluation of Risk Management Tools for Stabilising Farm Income under Cap 2014-2020.” Economía Agraria y Recursos Naturales 17 (1): 3–23

• Ciaian P., Kancs D’A. and Swinnen J. (2008), Static and Dynamic Distributional Effects of Decoupled Payments: Single Farm Payments in the European Union, Licos Discussion Paper Series No. 207/2008, Katholieke Universiteit Leuven

• DG Agri (2016), Productivity in EU Agriculture - Slowly but Steadily Growing. EU Agricultural Markets Briefs No. 19. Brussels: European Commission, Directorate-General for Agriculture and Rural Development

• Ecorys (2017), Modernising & Simplifying the Cap: Summary of the Results of the Public Consultation. Brussels: European Commission Directorate-General for Agriculture and Rural Development

• European Commission (2016), Commission Work Programme 2017: Delivering a Europe That Protects, Empowers and Defends. Swd (2016) 400. Brussels

• European Commission (2017), Reflection Paper on the Future of EU Finances. Brussels

• Hogan P. (2016), "Access to land and credit for young farmers in a bid to secure the future of the European farming sector," Speech to Ceja General Assembly, 19 July 2016, Brussels. Jongeneel, R., N. Polman, and G. van Kooten (2016), How Important Are Agricultural Externalities? A Framework for Analysis and Application to Dutch Agriculture. Working Paper 2016-04. University of Victoria: Department of Economics

• Matthews A. (2016), The Future of Direct Payments. Paper Prepared for Workshop on ‘Reflections on the Agricultural Challenges Post 2020 in the EU: Preparing the next Cap Reform. Brussels: European Parliament, Directorate General for Internal Policies

• Matthews A. (2017), “Why Further Reform? Appendix 1.” In Cap - Thinking out of the Box. Brussels: Rise Foundation

• Matthews A., L. Salvatici, and M. Scoppola (2016), Trade Impacts of the Common Agricultural Policy. Iatrc Commissioned Paper 19. Minneapolis: International Agricultural Trade Research Consortium

• Moore F., and D. B. Lobell (2015), “The Fingerprint of Climate Trends on European Crop Yields.” Proceedings of the National Academy of Sciences 112 (9): 2670–2675

• Oecd (2009), Managing Risk in Agriculture: a Holistic Approach, Oecd Publishing: Paris

• Oecd (2010), Guidelines for Cost-effective Agri-environmental Policy Measures, Oecd Publishing, Paris

• Oecd (2013), Providing Agri-environmental Public Goods through Collective Action, Oecd Publishing: Paris

• Veerman, C., ed. (2016), Report of the Agricultural Markets Task Force: Enhancing the Position of Farmers in the Supply Chain. Brussels: European Commission

• 1. The mechanism is complicated because the payments are not linked directly to use of land but to entitlements. Entitlements are not attached to land but are allocated to a person and become the property of that person and can be traded. But there is still an indirect link to land, as entitlements must be activated, and a farmer cannot activate more entitlements than he or she has hectares of eligible land. Whether and to what extent the value of the payment is capitalised into the value of the entitlement or the value of the underlying land depends on whether there is a surplus of entitlements relative to eligible hectares or vice versa, the tradability of the entitlements, the treatment of new entrants and the extent to which productivity growth is different across farms (Ciaian, Kancs and Swinnen, 2008). See Matthews, Salvatici, and Scoppola (2016) for a discussion of the empirical literature on the extent of capitalisation of direct payments in the EU.
• 2. Alternatively, high standards when imposed by processing firms or supermarkets in the context of global value chains may act as a barrier to entry to low-cost producers elsewhere, wi th the same effect.
• 3. The mere fact that an agricultural activity produces a positive externality is not, in itself, an argument for government support. Often, positive externalities are a joint product with the marketed output or may be supplied as a side-benefit of production decisions made for reasons of productivity and profit (e.g. zero tillage reducing soil erosion) and the market outcome may be sufficient to ensure an adequate supply of the positive externality also. Government intervention is justified when there is clear under-supply of the positive externality relative to society’s preferences.
• 4. Participants under the small farm scheme introduced in the 2013 Cap reform as a voluntary option for member states are, for reasons of simplification, exempted from the cross-compliance system of inspections and risk of penalties.
• 5. Also, the administrative penalty of withholding part or all of the basic and green payments was seen as a cheaper way for the state to enforce compliance rather than resort to the court system.