EUROPEAN ECONOMICS: THE

COMMON AGRICULTURAL
POLICY
CAP
 Objectives:
 I – Increase Agricultural Efficiency/Productivity
 II – Ensure Fair Standards of Living for Agricultural Workers.
 III – Stabilise Agricultural Markets
 IV – Ensure Supply Availability
 V – Ensure reasonable prices for Consumers.

 Principles:
 I – EC Preference (i.e., a CET)
 II – A single Product Market
 III – Financial Solidarity.

 Conflicts between Objectives + principles:

 Implication of regional specialisation from Objective I and principle
II. However, no evidence of this occurring in times of exchange rate
volatility.
CAP Price
D S S’ S’’
 Why was it needed?
 Demand side:
 Low Income Elasticity of Demand for food
(Engel’s Law)
 Thus supplies depended on rise on
population rather than income.
 Low PeD at higher income levels.
P
 Supply Side:
 Low PeS in the short-run due to lags
 Low labour mobility (farming as a way of
life)
 Low lab. Mobility lead to excess labour
P’
supply – to be remedied by fast urban growth
(Lewis Model).
 Tech. Progress disproportionately fast,
leading to structural excess of supply.
 Evident environmental stochastic problems. P’’
 Farmers may respond to falling prices by
increasing supply – further depressing prices.
 The diagram shows the problem: Low Price
elasticities exaggerate the effect of increasing
supply due to tech. Progress, and Demand will
shift much slower the supply due to population Q Q’ Q’’ Quantity
growing at a slower pace than technology.
CAP – TYPES OF INSTRUMENT (FREE
TRADE USED AS THE BENCHMARK)
 Variable Levy with Price Support Price SEU
 No Import Competition DEU
 Target Price – upper limit of prices. PT
 Intervention Price – lower limit of
prices. Pi
 Threshold Price – Target Price +
transport costs. c
 The EU will buy the excess supply
to ensure Pi is achieved.
 Therefore a b d
 0 – Q1 is purchased by domestic
consumers. e
 Q1 – Q2 is purchased by the EU at
Pi. PW
 Consumers LOSE (a + b + e). g
 Domestic producers GAIN (a + b +c) f
 Community LOSES (pays) (b + c + d Quantity
+e)
 NET LOSS OF (b + d + 2e) Q1 Q2
CAP – TYPES OF INSTRUMENT
DEU SEU
 With Import Competition:
 Same as standard Tariff diagram w/ DWL
triangles.

 Deficiency Payment Scheme (DPS):

 Similar to standard Tariff Diagram, except it
makes up the difference between the market
price and a price agreed ex-ante.
 Thus, it doesn’t alter the supply schedule.
 Hence, whilst the deadweight welfare loss PEU
under the former would be the yellow and red
triangle, under the latter only 0 – Q1 units are
sold and thus the EU only has to reimburse up
to Q1.
 Therefore, DWL from DPS = red triangle.
 The DPS is VISIBLE in it’s redistribution from
consumers to producers, whilst the VLS is
invisible, and is therefore more politically
PW
tractable.
 In addition, only a narrow band of goods it can
be used for as farmers are both producers and
consumers of goods.
Q1 Q2
CAP – TYPES OF INSTRUMENT
 Supply Quota
 Similar to the DPS – except it sets an ex-ante limit on the
quantity – so it would agree on Q1.

 Direct Income Payment (DIP):

 Optimal vector for redistribution – doesn’t work through
the market like taxes and subsidies, so there are no market-
distorting effects and price distortions.
 Deficiency Payments per
 Units of Land (BAD)
 Animal

 Negative income tax for farmers

CAP: TYPES OF INSTRUMENT
 In Sum (Pre – 1992 Mac Sherry reforms):
 The CAP can largely be characterised by the VLS with
price supports (about 70%).
 This is very costly in terms of welfare, provides perverse
incentives (encourages structural excess of supply and
encourages continual shifting of Supply outward due to
guaranteed intervention price), and lowers World price due
to dumping.
 Being an exporter is also bad for the terms of trade.
 DIP are good but when tied to output + resources lead to
gains for the big farmers (that do not need the support) –
about 80% of the transfers go to large producers, who,
cumulatively, are only 20% of the sector.
CAP – SUCCESS?
 Has the CAP been a Success?
 Has it met it’s 5 Objectives?
 1 – Increase Agri. Efficiency (productivity)
 Has increased, but more about tech. Progress and capital investment than regional
specialisation, so the role of the CAP is unclear.
 2 – Fair income for Agri. Workers
 Agri. Workers’ income has actually declined relative to other industries. Yet net income
is higher than average and can be explained by Agri. workers having multiple income
streams – about 25% of total income.
 3 – Market Stabilisation
 It has worked in the short-term due to heavy price controls. But due to rigidity of
system, the longer term is marred by structural excess supply.
 4 – Security of Supply
 It has lead to self-sufficiency with many self-sufficiency ratios over 100%; but it is
unclear whether this objective is as pertinent as it was at the conception of the CAP.
 5 – Reasonable consumer prices
 Difficult to gauge. Whilst EU prices are higher than World Prices:
 Dumping has lowered World Price.

 There has been declining consumer prices.

 Conclusion is that it’s probably higher than it needs to be.

CAP – SUCCESS?
 Additional points:
 Costs to taxpayers/consumers has been high and
redistribution sub-optimal.
 CAP DOMINATES the EU budget, making it economically
and politically unsustainable as the funds are being directed
from other causes.
 CAP has also lead to trade wars – ‘chicken wars’ with the
USA.
 The agricultural market has been swamped by TRADE
DIVERSION in terms of trade flows (Thorbecke et al.), in
contrast to the rest of the EU which has seen high levels of
Trade creation.
 Admittedly it HAS LEAD TO A SINGLE INTERNAL
MARKET.
CAP - REFORM
 Therefore, the CAP needs reform in the following areas:
 Welfare Costs
 Trade Conflicts
 Budgetary Pressures
 Positive regulatory Failures
 Inefficient Market Support
 Sub Optimal Redistribution

 No steady labour exit

 Complex administration

 CAP inappropriate tool to consult the wider rural problems

 Adverse effects on the environment (set-aside).

 Supply surplus – still high.

CAP – REFORM + PROSPECTS
 1992 Reforms (Mac Sherry):
 Focuses on PRICE SUPPORT  INCOME SUPORT.
 Lowered intervention price for cereals (significant proportion of the
industry) by 1/3 - although the threshold price is still high to
prevent imports, dumping is less prevalent.
 SET – ASIDE: Compensation for leaving areas of production fallow.
Acts as a form of DIP, moves burden from EU Consumers  EU
Taxpayers and doesn’t affect international trade.
 However, leads to over-intensive production on remaining areas which is
environmentally risky.

 Prospects:
 Although positive regulatory failures still remain (and are
increasing in severity), steps are being taken in the right direction.
 DIP could be devolved to individual member states, which would
lower barriers to entry.