AEF372: CLASS NOTES 2

Key Points:

There are two major issues or features highlighted by the Economic and economical consideration of the CAP:
  1. the evolutionary progress of agricultural support policies in Europe
  2. the meaning of the economic representation of the transfers and effects generated by these policies.

1.    Evolution of European Policy  (inevitable - with benefit of 20/20 hindsight?)

2.    Meaning and Implication of Economic Analysis - the illustrative case of elimination of EU Dairy Quotas

Question 1.    If quotas are a 'bad thing', (as outlined last week, and further explored below) why were they introduced in the first place?
Quotas were introduced (April 1st. 1984) in response to the growing surpluses and increasing taxpayer costs of the previous policy - unlimited support (in effect - aside from some co-repsonsibility levies, which were largely ineffective - see full notes) at price Pm.  The quota involved a small reduction from previous production levels, which were then fixed.  Hence, the EU taxpayer gained, both by the initial reduction, as shown here, and also by the fact that committment to support was now limited, and no longer open ended.  Consumers were not affected at all by the change, while producers only suffered relatively minor losses as shown - clearly quotas were economically a good thing compared with the previous open-ended support - a step in the right direction?

Incidentally, as shown in the full notes, the alternative to quotas - an equivalent reduction in the support price (to generate the new excess supply of EUx) - would have generated a slight increase in net gain (because of the consumers' gain), but a major reduction in producers surplus - hence was dismissed by the Council of Agricultural Ministers as being impractical politically, at that time.
 
 
 
 
 
 

Question 2:    Just how bad a thing are quotas?

First, there are very considerable practical problems in calibrating the principles illustrated in this diagram with realistic representations of the real world - especially the supply and demand responses both within the EU and in the rest of the world, and equilibrium quota rents.  Even, in the case of milk, identifying Pm and Pwa causes problems, since both are only known with certainty for butter and SMP, not for raw milk.  However, we can leave these issues on one side, and hope that accidentally unrealistic estimates of these nearly unknowable points (footnote) will either be unimportant or cancel out.  Nevertheless, next week's material, on the mechanics of the world market, is important in making sensible judgements about the slope of the RoWxd curve (as it passes through 'known' point X, and, subsequently, what it might look like if and when the EU adopts a free trade policy.

Whatever judgements we might make about these practical analytical issues, the diagram suggests a clear social gain - the Tax gain is clearly larger than the net loss in surplus (the difference between the consunmer gain and the producer loss).  This will always be true so long as demand curves slope downwards and supply curves slope upwards.  That is the way the world is - this diagram is simply the partial analogue of the gains from trade logic outlined last week (Class Notes 1).  Any set of economic models representing this industry will necessarily come to this conclusion that free trade is a good thing, so long as they obey the principles of economics.

The conventional explanations of what consumers and producers surplus measures mean and how they are to be explained is contained in the policy primer notes.  However, recalling the general equilibrium gains from trade of last week - the long run gains all accrue as consumer gains (or, alternatively, as additional producer incomes earned through additional trade).  How are these related to the apparent partial gains shown above?  A sensible question, and not one addressed in the text books (or any of the literature that I am presently aware of).  A practical and provisional answer is as follows.

The annual consumer surplus gain from the policy reform is a measure of the potential for a perpetual stream of annual gains forever into the future.  The producer surplus loss, however, is a measure of the (negative) incentive for the production adjustment - the shift round the production possibility frontier.  Once this adjustment is achieved, there is no further loss.  The producers surplus measure is, in effect, the annual equivalent of the extent to which the present policy has increased the capital value of the fixed and specialised assets employed in the dairy sector, which would otherwise be employed elsewhere.  This capital value is a finite sum, not an infinite stream - it is part of the present fixed costs of the industry, which would be reduced if the policy were to be reformed (eliminated). The producers' loss is temporary, the potential gain is permanent. The partial welfare arithmetic (the conventional measure of the costs/benefits of policy change) seriously confuse these by treating them as exactly comensurate.

The key, therefore, to policy reform is to design (and then market and sell to the interested parties) a sensible transition policy which, at least partially, compensates the present owners of these assets for their capital loss.  Convincing people of the sense of policy elimination becomes the most critical part of policy analysis -  the specific estimates are largely beside the point - though the relative sizes of gains and (temporary) losses are clearly important in illustrating the case for reform.  Here, there are several additional considerations which are important - as illustrated in the analysis of eliminating quota:
 

This Table, in bn. euros, shows the conventional measures of producers' and  consumers' surplus changes, and changes in taxpayer costs.  Producers' lose 9.9bn. per year (about 75bn. in total, capitalised over ten years at a real interst rate of 5%).  Consumers and taxpayers combined stand to gain 10.3bn. per year without the policy in place (enough to completely compensate producers' loss over 9 years, if the latter is converted to an annual annuity payment at 3% real interest rate (reflecting the lower risk associated with public funds compared with private commerical risks).

However, there is also a significant cost associated with implementing and policing the present policy (and raising the necessary tax revenues to finance it).  This would also be saved if the policy were to be eliminated - shown here at 10% of the transfer to producers - a conservative estimate.

This estimate is partial - it takes no account of the general equilibrium effects of the reform - which would effectively inject the static gain (0.71bn.) into the circular flow of income - generating second round additional gains according to the value of the multiplier - another 0.14bn as estimated here.

There are also dynamic gains, resulting from the increased market incentives for continual productivity improvements and matching productive potentials to emerging market demands,  adding a further 1.4bn, to the potential gains from policy reform.

Overall, the EU stands to gain 2.3bn. (net of the produecers' loss) from the policy reform.  Once producers' had been fully compensated for their loss, the gain would be an estimated 12.5bn. per year, indefinitely, as the gain to consumers and taxpayers plus the net gain to the economy.  See here for an executive summary of this report, and consult the DEFRA web site for the full report on this study.

Question 3.    So why doesn't this change happen?

The short, and perhaps glib, answer is that the time is not yet right - the context and circumstance of the policy has not yet reached its breaking point, at least not realtive to the alternatives being talked of (e.g. the Curry Commission made not mention at all of reforming the dairy sector - only of making adjustments to area and headage payments!)

Consider the history of the CAP - policy was introduced, and then changed, in repsonse to changing circumstances and contexts, opportunities and threats, as represented in the political market place (where both votes and political support are traded).  It is a mistake to think that political decisions are all made on the basis of 'one person, one vote'.  The votes (and associated political pressure and political party support) of the producers for support (although smaller in number) will be more strongly expressed because of their gains per head than the opposition of consumers.

It has also been argued that political support for farm subsidies (however implemented) can also be expected from the consumers and taxpayers, so long as these groupd believe that farmers would be unjustly treated without such support - i.e. that altruism counts in political decisions.  Indeed, we had better hope this to be true - otherwise, the political system is merely a system for producers to exert their power over the market, since it is in their apparent interests to control the market, if at all possible.  Monopoly is the natural ambition of business.  Competition is its only countervail.  Businesses seek to eliminate or subdue competition whenever they can get away with it.  If government can be persuaded to assist in this, then so much the better.

So, Question 4.    when might the time be right?  Several pressures can be identified against the present policy, which are building all the time:

Notwithstanding all these rather pragmatic arguements - there is no solid analytical framework available for assessing the 'right' conditions (contexts and circumstances) for policy change.  We could easily spend the rest of this course talking about why this is the case, and what sorts of frameworks we might think of developing.

For the current position of the CAP - the European Commission's Agenda 2000 Mid Term Review (MTR) Reform, introduced in June 2003, and still being developed - see the EU Commission DG VI web site. Quoting from the outline paper: "The key elements of the reform in a nutshell: In effect, these proposals are for the conversion of commodity related support (including area and headage payments) to payments to look after animals, food quality and the countryside.  Farmers will only get these annual fixed payments (based on historic entitlements) if the comply with good practice in caring for the countryside, for food production and for animal welfare.  Furthermore, the 20% of farmers who currently recieve 80% of the support can expect that their future streams of payments will be reduced - with the support diverted towards rural development.

This generally makes quite good sense, though will encounter substantial resistance from the member states. Major Problems?


Question 5:    what critical problems remain? There are at least two (which your tutor has thought of or come across in the literature):

See the recent UK Government's (Defra and HM Treasury) "Vision for the CAP", which is about to be subject to a House of Commons Select Committee Inquiry - to which I have contributed a pair of memoranda:  a critique of the "vision" and an 'alternative'.  The CRE (Professors Ward and Lowe) have also submitted their own CRE view, concentrating on rural development aspects (Pillar 2 of the CAP).

Footnote:  Unknowable?  It is worth remembering a fundamental principle of physics:  the Heisenburg Uncertainty Principle:  which roughly says: The more accurate is the determination of the position of a particle (an event or observation), the less accurate will be the associated information on the speed and direction of travel of the particle.  There is an irreducable zone of uncertainty surrounding all events and observations.  If we know their place (circumstance), we cannot know their status in time (context), and vice versa.

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