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In what ways can the CAP be argued to be both inefficient and inequitable? Why is so difficult to reform it?
The Common Agricultural Policy (CAP) is a set of policies within the European Union intended to raise farm incomes. It accounts for around half of the EU budget and is the source of many disputes between EU member nations and between the EU and third nations. It has proved to be notoriously difficult to reform and is subject of many criticisms. In this essay I will give a brief history of the common Agricultural Policy followed by its critiques and why reform is so complex.
The Common Agricultural Policy emerged in the late 50’s and early 60’s after the founding EC members had sustained a period of food shortage during the Second World War. In order to create a common market, tariffs on agricultural products would first have to be removed. However, due to the substation political influence of farmers, coupled with the sensitivity of the issue, it took an extended period of time before CAP became fully implemented. The creation of CAP was first proposed by the European Commission in 1960 following the Treaty of Rome (1957) which established the common market. In the treaty of Rome the general objectives of a common agricultural policy were defined and in July 1958 the principles of the common agricultural policy (CAP) were laid out at the Stresa Conference. In 1960 the CAP mechanisms were agreed upon by the six member nations and in 1962 CAP came into effect. As such, three principles were established to guide CAP: market unity, community preference and financial solidarity.
One f the first major policies of CAP was to keep agricultural prices high and stable which was sustained by implementing a ‘domestic price support’, also known as a price floor. This policy proved to cause a multitude of problems which led to a series of reforms. You see, The EU would set price floors for all of the foremost agricultural products such as dairy, beef, veal and sugar which were anywhere from 50 to 100 percent of the world price. They enforced these price floors by becoming a ‘buyer of last resort’, guaranteeing unlimited purchases of agricultural goods at the price floor level. In the early days of CAP the EU was a net exporter of most agricultural products so the EU was able to make sure that supply and demand matched at these high prices by limiting the amount foreign food that entered the market, which was done by imposing import tariffs. However, higher food prices encouraged farmers to produce more and discouraged food consumption. This meant that the result of the tariff was a fall in imports as the EU became more self-sufficient, eventually leading to the EU becoming a net exporter of agricultural goods.
One of CAP’s key concerns in regard to equity refers to the distribution of support it provides farmers with. The issue here is that in some parts of Europe (such as the Parisian Plain) farms tend to be very large and very ‘high-tech’. Farmers may use disease resistant seeds, large quantities of pesticides and chemical fertilizers along with huge labour-saving machines all to increase their yield (food produced per hector). Other places (such as the Greek Islands) adhere to a more traditional form of farming. This means smaller farms and simpler agricultural equipment. As a result, the French farms tend to not only be more efficient but also much larger and are often run by cooperation’s. The smaller, simpler farms on the other hand are often family owned farms, employing less intensive and therefore less efficient farming techniques. The differences between these farms have significant implications with regard to the distribution of equity created by price floors, illustrated by the following diagram:
The diagram above presumes that there are on two types of farm in the EU; large commercial farms and small family owned farms. The supply curve of the family farm is shown on the left and the supply curve of the commercial farm is shown in the middle. The right hand panel shows the combined supply curves i.e. total supply. The family owned farm’s supply curve is above that of the commercial farm because as discussed before, the commercial farms are much more efficient. The world price is labelled as Pw, which would also be the price in Europe if there were free trade. At this price the small farm would produce nothing as it is lower than the small farms marginal cost of producing. However, at the floor price of Pw+T both farms produce (the small farms produce Zsmall and the large firms produce Zlarge). As we can see from the diagram, the consumer surplus created by the price floor is quite unevenly distributed. The smaller more traditional farms earn only Asmall but the large technologically advanced firms earn Alarge. Therefore large producers stand to gain more from the price floor as it helps producers in proportion to their production. The issue with equity is that although the floor price does help all farmers it tends help the already wealthy, large farm owners a lot more whereas the more traditional smaller farms see a much lower welfare gains.
Another important equity concern is that the artificially high prices created by the price floor are mainly felt by the lower income consumers. Food, for obvious reasons is considered a necessity and will therefore come first in a person’s weekly budget. Although wealthier consumers can afford to buy higher quality food, the actual amount of food consumed by different people will tend to be similar regardless of income (apart from the very poor). Evidently the fraction of ones income spent on food is likely to be much lower if you are very wealthy. For this reason, the CAP could be seen as being ‘unfair’ in the sense that it acts as a form of regressive taxation. That is the food tax as a fraction of poor people’s incomes is higher than that of the wealthy. For example, figures release by the United States Department of agriculture show that the poorer countries allocate larger share of expenditures to food consumed at Home.
A final problem of inequity is the impact CAP has on the world market through the supply surplus it creates. This surplus stems from the advancement in agricultural technology that occurred after the Second World War known as ‘The Green Revolution’. This technology included superior strains of wheat and other crops as well as the kind of equipment and farming techniques used by the ‘commercial farms’ I discussed earlier. Seeing that CAP would reward output, farmers tended to switch to these more intensive farming techniques. The result was a rapid increase in agricultural production. For example, in the first ten years of CAP wheat production rose rapidly despite the area planted remaining unchanged. The reason for this was an increase in yield by fifty per cent. This rise in productivity may first be seen as a good thing, after all the first objective of Article 39 in The Treaty of Roam aimed to “increase agricultural productivity by promoting technical progress”. Nonetheless this rise in productivity has proved to be a persistent cause for problems in CAP.
The source of this problem is the fact that food demand is relatively unresponsive with regard to price. People tend to buy only what they need when it comes to food, just because the price of bread halves it doesn’t mean you’re going to want to eat twice as much bread. That is, demand for food is price inelastic as it is a necessity (as discussed earlier). If left to the free market this unresponsiveness would usually mean that the rise in productivity will result in sharply falling prices. However, for obvious reasons the political leaders of the EU did not want to see their farmer’s produce rapidly decline in price. Nonetheless, supply continued to rise and eventually the EU went from being a net importer of agricultural goods to a net exporter because this rise in supply was not met by an equal rise in consumption demand.
The obvious solution to this dilemma was simply to export the surplus in food (rather than store it). However, because EU prices were above world prices, exporters would have to sell at a lower price internationally than what they paid for the goods domestically. In order to persuade traders to do this the EU would pay them ‘export funds’ to make up the difference between EU prices and world prices, which is known as ‘dumping’. The angered exporters based outside the EU because dumping would cause world food prices to fall. The CAP price floor had always had a negative impact on nations outside the EU. For example, it reduced the world price of food as well as the volume of non-members exports by shutting off the EU market to the exports of outside nations. However, by subsidising its exports the EU stood to ham its international trading partners even further. The diagram below explains how:
The lines labelled MD (no CAP) and MS (no dumping) show world import demand and supply without the CAP’s tariff or dumping. At this equilibrium there would be Pw, o and total world exports would be xo. After the tariff was introduced the demand for world imports fell which is shown by the inward shift of the MD curve. This resulted in lower export prices for non EU members shown by the fall in price from Pw, o to P’w. Exports also fell from Xo to X’. When the CAP started to subsidize EU exports the MS curve shifted outward causing a further fall in price to P”w and a further reduction in non-member exports to X”.
The CAP has always been notoriously difficult to reform. The problem started in the 1960’s and still (to some extent) prevails today. The main decision-making body for CAP affairs is the Agricultural council and for most proposed CAP reforms, unanimity is required so change is usually rare and gradual. In recent years however, change has been more forthcoming. This is because of intrusions in CAP affairs by other parts of the EU framework (such as the environmental departments of the EU) as well as external trade demands. Furthermore, Euroscepticism by states such as Denmark and the UK is largely due to CAP which such nations consider harmful to their economies. Nevertheless, proponents of CAP
Maintain that it protects the rural way of life even though it is recognised that it has an impact on world poverty.
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