The Common Agricultural Policy Distorts World Trade Economics Essay

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The Common Agricultural Policy (CAP) is a costly inflexible policy that distorts world trade. Economically, the CAP transfers wealth within the European nations and narrows the income gap between farmers and consumers. Socially, the CAP is a mechanism that protects inefficient farmers in the European Union. This essay will address and explain the foundation and operation, winners and losers, reforms and future of the CAP.

Foundation for the CAP (Treaty of Rome):

In 1957, twelve years after the end of the Second World War, the CAP was proposed by the European Commission in the Treaty of Rome. Since then, it has been the largest expenditure in the European Union's budget. Basically, the CAP eliminates the trading barriers within the EEC by providing a free market without tariffs on agricultural products traded inside the EEC.

However, it creates barriers for non-European nations to trade their agricultural products in Europe.

The three founding principles of the CAP are market unity, community preference, and financial solidarity. The six founding states wanted Europe to become self-sufficient in food as result of post-war food shortages. Realizing that the supply of many agricultural commodities was sensitive to economic shocks caused by outside circumstances such as weather conditions, politicians wanted to create stability in the agricultural markets.

Moreover, they aimed to shrink the income disparity between farmers and non-farming workers as well as create employment in the agriculture sector.

In the Treaty of Rome, the main objectives of CAP were to increase agricultural productivity by promoting technological advancement, to guarantee a fair price for consumers, to ensure a fair standard of living for all, to increase the income of workers in the agricultural community, to stabilize European food markets, and to ensure adequate availability of food.

Along with the five main objectives listed above, the broader principles focused on improving economic and social issues in the agricultural community, including social benefit and protection for workers in the agriculture sector. The CAP ensures that the children of farmers will have the same opportunities to succeed as children elsewhere. In addition, the CAP aids those wishing to establish independent farms. It facilitates retirement pensions and improves rural housing for farmers.

History of the Reforms:

Since the Treaty of Rome, the CAP has caused controversies among the European consumers, EU member states and non-European countries. The WTO firmly stresses that CAP distorts the market and prevents free trade. In chronological order, several major reforms have been instituted in an attempt to improve the CAP.

1) The Mansholt Plan

Sicco Mansholt, the European Commissioner for Agriculture from 1958 to 1972, noticed that farmers' standards of living were not improving significantly despite the massive increase in agricultural spending. In 1968, Mansholt encouraged over five million farmers to give up farming and move to a different industry.

By doing this, the government could consolidate these farms into larger, more modernized farms. Furthermore, his plans included training and early retirement programs for those five million farmers. Unfortunately, he was faced with strong opposition from the outraged farmers, which consequently prevented the full adoption of his plan.

As a result, his plan was reduced to only modernization of agricultural farming, the retraining of farmers, and the abandonment of farming. Due to its drastic downscaling, Mansholt's reform was largely unsuccessful.

2) Uruguay Round:

Due to the severe trade distortions in the world created by the CAP, external pressures from outside of EU brought about a reform of the CAP. In the Uruguay round of the GATT, European and non-European representatives met to discuss the agricultural subsidies. In the negotiation, the United States demanded to eliminate trade-distorting subsidies and NTBs as well as to increase European market access.

The Uruguay round agreement required a 20% reduction in the aggregated measures support. Lastly, the 1986 Uruguay round brought about the concept of decoupling and helped introduced the Macsharry Reforms.

3) MacSharry Reforms:

Due to the increase in productivity from subsidies of the CAP, the EU moved from being a net importer to a net exporter. The overproduction of produce outstripped the domestic demand and caused a surplus of produces. These produces were either purchased by the EU or exported. This increased the EU's agricultural spending from 10 billion Euros to 30 billion Euros between 1980 and 1990.

In 1992, Ray MacSharry, then European Commissioner for Agriculture, proposed to limit rising production from farmers and adjust to a freer agricultural market. MacSharry's reforms lowered intervention prices but increased direct payment to farmers. For instance, the intervention price for cereal and beef were cut 15% and 20%, respectively.

The MacSharry reforms also provided direct income payments to farmers growing livestock and arable land. Producers received payment for the land they "set-aside". The payment is usually based on historical payment received in each farm. Farmers can, in effect, be paid to maintain rural landscapes. Because of this reform, farmers had a choice of whether to use all the land and receive the market price or comply with the set-aside policy and obtain subsidies.

This method proved to be very counterproductive, as farmers chose to set aside lands that were difficult to farm in the first place, thus enabling them to receive subsidies for otherwise unprofitable land. Lastly, the MacSharry reforms established greater measures to encourage forestry, farmer retirement, and the environment.

4) Agenda 2000

With the enlargement of the EU, the Agenda 2000 wanted to strengthen community policies by creating a new financial framework for 2000 to 2006. It took into account of European competitiveness, environmental considerations, rural development, simplification and decentralization of legislations.

Similar to the MacSharry reforms, Agenda 2000 reduced the market intervention prices for milk, beef, and veal. It ended farmers' payments based on levels of production and set the maximum payment to any farm capped at 30000 Euros. The Agenda 2000 modified the CAP to incorporate the new members of the EU.

5) Doha Round:

In 2001, another trade negotiation organized by the WTO occurred in Doha, Qatar. In this round, developing members argued that production quotas, storage aids, export refunds, and output/area payments should be abolished. In addition, the participants in the Doha Development Round discussed that the Single Farm Payment should be phased out since it had not provided any societal benefits.

Lastly, European members claimed that agricultural subsidies should be financed by the individual nations rather than by the EU. This reform would force each country to finance its own projects as well as prevent nations with small agricultural sectors from bearing a disproportionate economic burden.

6) European Commission Report 2003

Belgian economist Andre Sapire led the 2003-2004 reform. This reform resulted in a significant decrease in intervention price for dairy products. The reform stated that intervention price had to be reduced 25% by 2008, an additional price cut of 10% compared to the Agenda 2000. By 2007, the invention price for skimmed milk powder had to be reduced by 15%. The 2003 reform continued the ongoing discussion about giving individual countries more control over administering the farm aid.

7) Decoupling Reform

In 2003, decoupling reform removed the direct payments to farmer based on production of a certain commodity. Prior to the reform, farmers' profits were determined by the direct payment associated with the commodity rather than by profit the commodity can be sold in the market price.

The goal of decoupling was to change the agricultural sector to a more free market system, in which farmers choose levels of production base on the market demand. Moreover, this reform introduced the SFP to the farmers. Farmers who receive the SFP have to maintain their land in good agricultural and environmental condition. However, they are prohibited from producing fruit, vegetables and table potatoes.

8) Sugar regime reform (2005-2006)

The CAP's subsidies caused the sugar beet to be overproduced in EU. However, the price of sugar in Europe is more expensive than the world's market price for sugar. In 2005, the EU's agriculture ministers declared to cut the support price of the sugar beet by 40% by 2010. With a lower price barrier, more sugar producing countries are able to gain access to the European market. This reform benefited not only the emerging countries but also European consumers.

The Operations of the CAP

Europe's agricultural products, such as beef and butter, are protected from external competitions. The CAP provides internal agricultural supports through several market interventions.

1) Intervention Price

If the world/market price falls below the intervention price level, the EU will buy up any European product offered for sale at that invention price. To ensure the price stays at the intervention level, intervention buying had to take place to purchase the excess supply, which artificially increase the demand. Since the Macsharry reforms, the intervention price has been consistently reduced in the EU.

2) Import Levy

Many agricultural goods are charged with an import levy before entering the EU. (VIL) raises the (Pm) of a specific good to the EU's (MIP). This would insulate the EU from international price changes. Producers gain A while consumers lose A+B+C+D. Import levy creates a deadweight loss of B+D. Along with the intervention price, MIP has been consistently reduced since the Machsharry reforms.

3) Tariffs

The EU can impose tariffs on specific produce imported to Europe. These tariffs increase the world market price to the EU's target price, above intervention price. Producers gain H+I+J, while consumers lose H+I. The budgetary cost is I+J+K. Tariffs create a deadweight loss of I+K. Due to the GATT meetings such as Uruguay round, tariffs have been significantly reduced and no longer serve as a major barrier for trade as they once were.

4) Import Quotas

The EU can also impose import quotas by restricting the quantity of agricultural goods to enter the European market. It creates an increase in price due to increase in demand. The price of goods increases from pw to Pd. Consumers lose A+B+D+C and the producer gain A. The government or quota holder gets D. Import quotas creates a deadweight loss of B+C. Unfortunately, import quotas hasn't been significantly changed since the inception of the CAP.

5) Subsidies

In the 1980's, the EU gave export subsidies to farmers for them to cover the gap between the EU price and the world price. With the export subsidies, these farmers overproduced their goods to export them abroad. The overproduction caused harm for the environment. Farmers tried to grow as much goods as possible by using toxic chemical, fertilizers, while simultaneous cutting down forests by creating more land for farming.

The dark rectangle on the right diagram shows the export subsidies given to the farmers. In Macsharry reform, export subsidies were largely replaced by direct subsidies, which distributed to farmers' base on the area of land producing a particular crop rather than total quantity of crop produced. In 2003, the SFP replaced direct subsidies.

6) Non-tariff barrier:

Finding it difficult to impose tariff due to the international pressure, the EU has been using (NTBs) to block agricultural imports from non-European countries since the mid-1990s. These NTBs include technical measures, customs rules and procedures, transport regulations, product origin, and standards. For instance, the EU blocked the import of US-grown beef because the American cattle are injected with growth hormones.

Even though no research has found any adverse effect of these hormones to either the animals or the consumers, European officials were wary of cheaper competition from abroad and took this measure to protect European producers. The NTBs prevent many other agricultural goods such as genetically-modified corn and soybeans to enter the European Market. Pressured by the WTO, the NTBs have started to phase out through Uruguay and Doha rounds.

Protecting these European farmers doesn't come cheaply for the CAP. The program is the largest expenditure in the EU, comprising approximately 50% of the EU's annual budget. In 1962, the (EAGGF was established to finance the CAP. Managed by the European Commission, the EAGGF finances direct payments to farmers and regulate agricultural markets through intervention and export refunds.

According to the principle ofÂ shared management, every member state has to contribute capital to this fund proportional to the size of the state's economy through value added tax. In other words, countries with large economies contribute more than countries with small economies. The United Kingdom, however, wasn't satisfied with the way CAP was funded. Although the UK had a large economy in the 1980s, it was the third poorest of the ten European Economic Community members.

The United Kingdom received less benefit from CAP than other member states because it had a relatively small farming sector as a proportion of GDP. Thereby, the UK demanded a rebate at the Dublin European council in November 1979. In 1984, the Thatcher Rebate amounted to two-third of the difference between Britain's EU contribution and receipts. Consequently, other countries, such as Germany, Sweden, Austria, and the Netherlands, are forced to make up for this rebate capped to 25% of the figure which would otherwise apply.

Major winners and losers of the CAP:

The CAP transfers economic surplus from European consumers to farmers throughout the European member nations. Overall, the CAP creates a deadweight loss due to its inefficiency.

Landowners and Farmers vs Consumers and Non-European Farmers

Non-farming landowners gain from the CAP as they are able to rent their lands to farmers at a higher rate. According to OCED in 2003, they gain 13% of the CAP benefit, which amount to 6.5 billion. Farming landowners also gain from the CAP as they receive government subsidies for their jobs as well as lands they set aside. They receive 28% of the CAP benefit, which amount to 14 billion.

Working farmers gain from the CAP as they receive payments for employment. In countries such as Denmark, Germany, and Ireland, the farming household income is much higher than the non-farming household income. They receive 10% of the CAP benefit, which is around 5 billion. If it wasn't for the CAP subsidies, these agricultural jobs wouldn't exist as European farmers wouldn't be able to compete with non-European farmers on a price basis.

As a result of the CAP, the EU's consumers are the biggest losers. Only 5% of the EU's populations work on farms. The remaining 95% of the EU's populations suffer from purchasing agricultural goods at a much higher price. In 2003, the CAP cost EU's consumers 50 billion Euros in tax and 50 billion Euros from higher food prices.

Due to the EU's market interventions, the non-European farmers who are more efficient in farming lose out because of CAP. It is especially unfair when the EU dumps their excess produce into the emerging market, which ultimately harms non-European farmers by reducing the world market price.

For instance, African farmers cannot compete with the overproduced European food imported at heavily discounted prices. Their homemade grains grown only a few miles away end up being more expensive than European grain shipped halfway around the world. As a result, these African farmers are often driven out of business. Thus, the CAP has devastated the poorer parts of the world by dumping unwanted goods outside of the EU.

Agricultural states vs Non-Agricultural states

The EU member states with a large agricultural sector such as France and Spain benefit from the CAP in expense of other states such as UK and Germany, which have small agricultural sectors in proportion to their GDP. UK and Germany contribute more money to fund the CAP than they receive benefits from the CAP.

Farming related industry vs Non-farming related industries

Farmers need to purchase machineries, pesticides, and fertilizer, which ultimately increase the demand for farming supplies. Companies that supply farming equipment, pesticides, and fertilizer to the European farmers gain from the CAP. According to OECD in 2003, input suppliers receive 37% of the CAP benefit, which is about 18.5 billion.

There is a significant opportunity cost for using the CAP. The CAP budget is about 50 billion Euros per year, of which 40 billion are spent on direct payments. This money can be spent in other industries such as healthcare. As more European workers are heading towards retirement, investing in healthcare would have a substantial benefit for many Europeans in the future. The non-farming industries in EU suffer from this opportunity cost.

Future for the Common Agricultural Policy:

In 2008, the EU agriculture ministers reached a political agreement in the CAP Health Check review. Their goal was to reach two main objectives by 2015.

1) Reduction of the CAP budget

The next long-term EU budget will start from 2014. In order to lower the CAP budget, the EU will need to phase out the Single Farm Payment, eliminate arable set-aside, and reduce subsidies that give farmers incentives to overproduce.

2) Subsidize public goods that fight climate change and improve public health

Bioenergy production such as biofuels can help fight global warming. These biofuels can be made from genetically-modified (GM) corns, which can be made into ethanol. The CAP may follow US agricultural subsidy for corn. However, these GM crops are still prohibited from entering the European market, and it will most likely be a long time before the EU starts producing GM crops.

The public health community demands health to be taken into account in the CAP. A growing number of people in EU suffer from major food-related health issues, such as obesity and heart disease. The CAP currently does not support healthy foods, such as fruits and vegetables, because these foods are not affordable to lower income people. In the future, the CAP may subsidize healthy food and bioenergy production.

Throughout the past decades, reforms in the CAP have radically transformed the agricultural industry. Farming, believed in the 1960's to be a crucial part of the European economy, has lost its past importance with the rise of globalization. The CAP has proven to be extremely expensive to operate and difficult to change.

The original CAP, which aims for European nations to be self-sufficient in food, has overall harmed the European and global economy. Although farming is still largely subsidized by the EU, each reform has led the CAP of a path of freedom with less market interventions.