Common Agricultural Policy (CAP)
- The Features of the CAP at the Time of Inception
- The Evolution of the CAP
- 1992 to 2003
- CAP Reform in 2003 and Thereafter
- The Future of the CAP
The Common Agricultural Policy (CAP) of the European Union (EU) is called ‘‘common’’ because themain agricultural policy decisions aremade at the EU level, and these agricultural programs are financed for the most part from the EU’s common budget. The functioning of the agricultural sectors in the member countries of the EU is widely determined by decisions at the Community level. Consequently, agriculture is perceived as one of themost integrated sectors in theEUand is sometimes viewed as a possible model for other sectors. Although the EU’s agriculture sectors are politically integrated, however, they are less integrated economically than other sectors.
The creation of the CAP in 1962 was vital for the European Economic Community (EEC), the forerunner of the EU. The six founding countries Belgium, France, Germany, Luxembourg, the Netherlands, and Italy had their own national agricultural policies, which differed vastly. The individual countries were reluctant to remove their intervention in agricultural markets, or allow for free trade among member countries and to follow the rules of a customs union. It did not make sense to exclude one sector from market integration, however, and politically the stakes were high: France wanted access to the large German market for its agricultural products if it were to allow for German industrial products to enter the French market. Hence, it became necessary to establish the organizational and institutional framework for agricultural policy at the Community level.
The institutional framework set up at the inception of the Common Agricultural Policy was a compromise to satisfy the heterogeneous interests of the member countries. Under German pressure, the EEC decided on a common price level for agricultural products significantly higher than world market levels and introduced border regulations that completely disconnected EEC prices from those on the world market. The evolution of the CAP has proven that this initial framework constrained the CAP in adapting to changing conditions in the EEC and on the world market.
The Features of the CAP at the Time of Inception
Common market organizations regulated the Common Agricultural Policy for the main agricultural products. These market organizations are Community law and include the legal framework needed to administer the markets. The aim was to keep domestic farm prices above the level of worldmarket prices. Variable levies were implemented as border measures to cover the gap between the domestic farm prices and the corresponding world market prices. The levies varied with the world price since the commonly agreedupon prices were the lowest prices at which foreign supply was allowed to enter the European domestic market. Fromthe start, the CAP provided for export subsidies in the event that domestic production was to surpass domestic use at domestic prices. The export subsidies were termed ‘‘export restitutions.’’ Under the General Agreement on Tariffs and Trade (GATT) and later the World Trade Organization (WTO), export subsidies for industrial products were eliminated and import tariffs rates were bound by a ceiling rate negotiated by member countries. Thus the trading regime for agricultural products remained very different from that of industrial products.
In addition, market organizations included domestic measures of protection. The most important ones were guaranteed purchases by state agencies of selected products such as butter, skimmed milk powder, grains, and sugar at intervention prices, and facultative purchases for some other products if some additional conditions prevailed. The protection regime for sugar was exceptional as it included intervention prices for sugar, minimum purchase prices for sugar beets, and production quotas. For quantities above their allocated quotas, farmers received the worldmarket price.The sugarmarket regimewas the least in line with free market principles; it was more comparable to instruments used in centrally planned economies.
The Evolution of the CAP
The institutional prices were the main instruments of the market regimes that constituted the Community law. The Community law or any changes to the law were generally proposed by the EuropeanCommission; in the case of agricultural law the decisions were made by the Council of Ministers, which is composed of agricultural ministers from member countries. The most important decision by the Council ofMinisters was to make the agreed changes to the institutional prices. These changes were made annually up to the 1990s. Since no objective criteria guided the setting or changing of institutional prices, political considerations dominated these decisions. National interests diverged widely between member countries, partly because of differences in their national conditions such as inflation, overall growth in the economy, and productivity changes in agriculture. Moreover, the framework that was instituted to finance these policies accentuated the differences in national interests among themember countries. The EU had adapted the principle of financial solidarity, which stipulated that policies implemented at the Community level should be financed from a common budget. As the EU did not generate revenues, the contribution to the common budget came either fromthemember countries’ budgets or fromimport tariff revenues, that is, member countries would deliberately forgo their own tariff revenue in favor of the Community budget. Not all countries benefited from these policies. For example, the Netherlands was traditionally a huge exporter of dairy products so decisions that resulted in higher dairy prices increased the income of Dutch dairy farmers much more than it taxed its consumers. For the United Kingdom (UK), which was a huge importer of dairy products, an increase in dairy prices had the reverse effect. Hence, it is understandable that national interests diverged significantly.
The voting proceduremade it evenmore difficult formember countries to come to an agreement. The Treaty ofRome (1957), fromwhich theCommunity emerged, provided for majority voting for most decisions. The six founding members agreed in 1966, before the first market organization came into existence in 1967/68, to apply unanimity voting whenever there were vital interests at stake for any individual country. Thus agreements could be reached only ifmember countries forwhich common policies conflicted with national interests were compensated. The result was that an increase in the domestic price level was decided year after year, even in times where world market prices for agricultural products declined and the exportable surplus of theEUrose.The increase in agricultural protection, the enlargement of theEU, and unprecedented technological progress in EU agriculture contributed to a faster growth in EU agricultural production than consumption. For the Community, which had started as an importer of agricultural products, the changes in supply and demand reduced the import gap gradually over time and by the end of the 1970s generated export surpluses. Increasing exports and falling world market prices put pressure on the EU budget as outlays for export restitutions rose strongly. A new phase of the Common Agricultural Policy began with even more governmental interference in themarket. Themilk market presented the most urgent problem. Milk production in the EU grew strongly as imports of concentrated feed could be imported free of duties due to the GATT. At the inception of the CAP, the EU had set its bound tariffs at zero or a very low level at a time when imports of these products were negligible. In return, the EU was allowed to introduce the variable levy system. The import regulation for concentrated feed became the Achilles’ heel of the CAP. Low prices for feed, which were partly due to significant declines in transatlantic transport costs, and high support prices for CAP products, led to high effective rates of protection for meat and milk and increases of production. On the demand side, imported feed was substituted for domestically produced grain, and because of cheap imports of vegetable oil, margarine was substituted for butter. The consequence was the accumulation of stocks in the EU and accelerating budget outlays. The latter seemed to have been themain constraint for the Common Agricultural Policy during this period.
In 1984, the council agreed on a quota systemfor milk. Farmers received a right to sell under the quota at guaranteed prices. Sales above the quotawere taxed with a superlevy, which for many years was higher than the price paid for sales within the quota. Hence, production was curtailed and growth of production was stopped.Moreover, a set-aside program was offered to farmers in 1986. Grain farmers were offered a premium if they voluntarily took arable land out of production.
The first 25 years of the CAP were characterized by increases in border and domestic EU protection for agricultural products. The EUreacted to changes in the economic environment mainly by introducing newinstruments to limit budgetary expenditure.The concerns of the trading partners were for the most part neglected.
1992 to 2003
The Uruguay Round (1986 94), the last round under the GATT, focused on agricultural trade. The EU had to reform the CAP in order to comply with the rules of the new round. The council decided to first reform the EU grain market in 1992. For the first time, the Common Agricultural Policy prices of specific commodities were cut, some significantly: the council agreed to cut institutional prices for grain by 30 percent. Farmers were compensated entirely for their prospective income loss by direct payments. These payments were linked to the use of land for grain. In addition, farmers would qualify for payments if they set aside at least a politically determined percentage of their land. Although the effect on grain production was minimal, domestically produced grain became competitive against imported concentrated feed and, thus, the grain surplus vanished.
The decision on the grain sector contributed to a final agreement in the Uruguay Round. The agreement required further changes to the CAP, however. The EU’s export subsidies were now constrained in two ways:
- the quantity of well-defined products or product groups that was allowed to be subsidized was reduced by 21 percent (from their 1986–88 level ); and
- the amount of export subsidies had to be cut by 36 percent (from their 1986–88 level).
Moreover, like other GATT/WTO members, the EU had to accept concessions on the import side. Each country was to allow imports of specific products up to 5 percent of domestic consumption in the base period 1986 88; variable levies and other nontariff trademeasures had to be converted to tariff equivalents (tariffication), and the tariff equivalents had to be reduced by 36 percent on average fromthe base period 1986 88, and by at least 15 percent for individual products. Thus, the EU was not allowed to apply the variable levy systemanymore and had to take into account changes in world prices when setting domestic institutional prices. It was this international agreement that forced the EU to change its market organizations. Finally the EU reformed the CAP drastically in 2003, aiming atmaking a positive contribution to the Doha Round of trade negotiations, which was launched in November 2001. One of the reforms was of domestic support. The CAP direct payments were included in the ‘‘Blue Box.’’ These are direct payments under productionlimiting programs and hence they were exempted fromreduction.This concessionwas given to theEU in return for price cuts and the realization that aid to the farmers was needed during the adjustment period. But the EU would have to give up these exemptions by the end of the Doha Round as adjustment compensations cannot be paid permanently, and the EU would have to look for alternatives for providing aid to farmers.
CAP Reform in 2003 and Thereafter
The Common Agricultural Policy reform of 2003 was a change in the paradigm of agricultural protection. Previously, support to agriculture took the form of price support to output and factors of production; and in the livestock sector, some kind of payments were made by head of animals. This support stimulated production and taxed consumption. Hence trading partners opposed this system and pressed for a change. The council decided in 2003 to reduce price support even more (for the main products from 2004 onward and for some products such as sugar, olive oil, tobacco, and cotton at a later time) and to decouple in principle all types of direct payments. The general proposal of the European Commission combined all income losses due to price cuts made until 2003 and all types of direct payments granted up to 2003 in one type of payment, the Single Farm Payment, to be made to individual farms based on historical levels. Entitlements to farm payments were made tradable and, thus, became decoupled completely from production, at least in principle. But the council allowed member countries a lot of flexibility. For example, countrieswere allowed to link part of the payments to production or to the use of factors of production during the transition period and to link them again to production in the future if regional or domestic production in a country fell too strongly. Payments could also be linked completely to land, either by granting a flat rate across the country or by differentiating between regions or between arable land and grassland. Finally, some payments were tied to environmental standards that farmers needed to meet, a process known as cross-compliance. Cross-compliance links payments to farmers to their respect of environmental and other requirements (such as animal and plant health and animal welfare) set at EU and national levels.
The 2003 reform also introduced a new classification of the CAP instruments: Pillar I for market and price support measures and Pillar II for rural development. In the reforms, a decline was imposed on Pillar I spending, while Pillar II spending was allowed to go up.
The distinction between the two types of measures may sound economically reasonable, but what justification could there be for increasing Pillar II’s budget by about the same amount that Pillar I’s decreases, given that in principle the two pillars have different purposes? Rural development should not focus mainly on agriculture. Rural development needs differ across regions and countries and they are not related to past agricultural support, so it is questionable that the changes in budget needs for rural development of each region and country (Pillar II) match widely the reduction made in agricultural support (Pillar I).
Hence critics suspect that Pillar II is a way for policymakers to continue providing support to farmers when they can no longer justify direct payments as adjustment compensation for price cuts that occurredmore than a decade earlier. The framework of Pillar II seems suitable for hiding subsidies for agriculture. Pillar IImeasures require a higher quality of governance than Pillar I measures, but unfortunately, due to the enlargement of the EU from15 to 25 member countries in 2004, and the further enlargement on the inclusion of Romania and Bulgaria in 2007, the competence to monitor and to enforce Pillar II measures has declined on average. The European Court of Auditors regularly finds irregularities and fraud in Pillar II measures.
The Future of the CAP
The CAP has changed significantly over time. Changes have been driven by budgetary concerns rather than economic rationale, however. Up to the 1990s, budget constraints led to reforms, but they resulted in even more protective and trade-distorting policies. Finally, under the GATT/WTO multilateral trade negotiations, the Common Agricultural Policy abandoned most of its border protection. Some products such as sugar andmilk continue tobe highly protected, however. Changes in the EU and other countries’ policies and rising oil prices may result in higher world prices andmaymake further reforms of EU border measures unnecessary. But if these changes do not happen, the EU will need to cut its agriculturalprices further in order to complywith the constraints imposed by the WTO.
The role of the CAP has becomemore important for the world food system over time as the EU has grown from 6 to 27 members as of 2007. The reduction in the CAP’s external rate of protection contributes to less distorted agriculture. Two major concerns remain, however: first, as long as EU prices for food products are not completely linked to world market prices, the CAP does not buffer fluctuations in world market prices to the maximum possible extent. Thus further complete coupling of EU and worldmarket prices is needed. Second, Pillar II of the CAP allows for hidden farm subsidies and causes distortions across EU member countries and worldwide. Hence, Pillar II measures have to be reconsidered and scrutinized with respect to distortive effects. See also agricultural trade negotiations; agriculture; common market; distortions to agricultural incentives; European Union; political economy of trade policy