The impact of GATT and CAP reform on E.U. cereals

by Teresa Acklin
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This first of two articles analyzes European production prospects after CAP reform and GATT.

   The main aim of the 1992 reform of the European Union's Common Agricultural Policy was to shift support from markets to landholders. It was believed this step not only would achieve the objective of adequately supporting farmers' incomes, but also would solve the problem of continuing growth of surpluses and the escalating budgetary cost of agricultural support.

   Since the late 1970s, the European Union's expenditure on agricultural support has increased threefold in nominal terms and close to double in real terms. The bulk of this expenditure has been for the subsidized dumping of a large part of excessive current output on world markets and the buying, storage and cut-price disposal of surpluses on both internal and external markets.

   The 1992 reform of the Common Agricultural Policy was intended to play a large part in at least stabilizing, if not actually reducing, agricultural support expenditure.

   The growth in production and subsidized exports has been a major source of tension between the E.U. and other agricultural exporting countries. As production has exceeded domestic self-sufficiency, so the E.U.'s share of exports and the displacement of imports have increased.

   This conflict was at the root of the original intention to make agriculture a major feature of the Uruguay Round of the General Agreement on Tariffs and Trade, which began in 1986. It is also the reason negotiation became increasingly focused on measures to limit and reduce the level of subsidized exports.

   The most important elements of the GATT accord are a 36% cut in budgetary expenditure on export subsidies, a 21% reduction in the volume of subsidized exports and a 20% scaling down of domestic supports. The new rules will apply from the beginning of 1995 and be implemented over the following six crop years to 2000.

   But settlement of the GATT dispute will add further burdens to the E.U. agricultural sector, in addition to those imposed by the CAP reforms.

      CAP reform effects and implications

   The CAP reform's emphasis is on cereals because of their central role as human and animal food. The assumption is that reduction in grain prices will force an overall moderation of E.U. farm prices, since grain forms the raw material for most livestock production and sets relative profitability for the arable farming sector.

   It is expected that reduction of cereal support levels to a point closer to the world price will provide an overall movement of food prices toward a more realistic market-clearing level. Thus, cereal support prices will be cut to 110 Ecus per tonne by the 1996-97 marketing year from 155 Ecus in 1992-93.

   The new system involves fundamental change, not only of cereal price levels, but also of the market price support and external protection structures. Small farmers who produce fewer than 92 tonnes a year and farmers who sign on to set aside 15% of their arable land will receive crop compensation payments. This direct subsidy is equal to the difference between the old intervention price of 155 Ecus and the final reformed target price of 110 Ecus.

   But the subsidy is paid only on the basis of the average regional yield during the 1990-92 period. If a farmer produces more than the region's basic “reference yield,” he will receive no subsidy on the additional amount, effectively earning only the new, reduced market price for the excess.

   The European Commission believes that its current nominal 15% arable set-aside will result in an effective set-aside of cereal producing land of 9% or slightly more, after taking into account the small-producer exemption. But the effect on cereal production will be substantially less than the Commission's expected figure.

   The tendency of farmers is to concentrate their set-aside on oilseeds and proteins rather than cereals; in the U.K.'s major East Anglian grain-production area, for example, the actual setting aside of wheat growing land in the first year of CAP reform was no more than 4%. Farmers also tend to concentrate their resources on the land remaining in production.

   The Commission's assumptions about the effectiveness of set-aside are likely to be proved to be highly over-optimistic when the effect is averaged over the reform period. The problem is that set-aside is likely to become less, rather than more, effective with each passing year. Seen in both a GATT and an E.U. budget context, the biggest danger in the development of set-aside policy is the scope it is giving to maximizing the area and production of wheat at the expense of other crops.

   Conclusions of a 1993 on-farm survey, shown at right, of E.U. farmers' response to set-aside shows quite clearly that farmers are likely to maximize wheat area within the set-aside limit because it is most profitable to do so. They will select high yielding varieties, maintain wheat on the best land and seek to minimize the proportion of the best land that is actually set aside.

   The survey concludes that the overall effective set-aside rate will be close to 7%, implying production slippage of approximately 50%.

   The crucial question in assessing the effectiveness of reform and the impact of GATT is the profitability of E.U. cereal production in relation to likely future market price levels.

   The CAP reforms are likely to result in an E.U. internal market price of 95 to 110 green Ecus per tonne by the end of the 1996-97 year. By the end of the “GATT period” in 2000, it is likely the E.U.'s cereals producers would expect an average price of 85 to 95 green Ecus. This level assumes the E.U. will seek to avoid GATT export limitations by eliminating export subsidies through reduced E.U. price levels that equal the post-GATT world price.

   How many cereal growers would survive at that price level and what would their aggregate level of production be? The question can only be answered by postulating scenarios that would arise from varying productivity levels.

   It would be reasonable to postulate that productivity will not increase, that it will increase at a modest 1.5% per year between now and 2000 or that it could increase by 2% per year in the same period. The important question is: will production increase, decline or remain the same under these scenarios?

   In 1992, Commission economists sought to partially answer this question by grouping samples of “professional” cereal growers — excluding small, mixed farms — according to their profitability and share of production. The assessment used long-run fixed costs as well as variable costs to present not only a long-run cost of production but the price at or above which any given group would remain in production. The study used production, cost, area and yield data for the 1989-90 marketing year.

   The original Commission analysis indicated professional growers would be likely to produce only around 100 million tonnes at a per-tonne price equivalent to 103 green Ecus — less than the final 110-Ecu target price but close to the likely post-reform market price. Small farms would produce 30 million tonnes.

   Using the Commission's analysis updated to 1992 area, cost and yield data, professional cereals production would be about 130 million tonnes, plus output of 30 million from the smaller farms. Application of an effective 5% set-aside for cereals reduces professional production to 126 million tonnes.

   Adjusting profitability and production to reflect possible productivity increases indicates the production that could be expected at post-CAP reform price levels and at price levels expected by the end of the GATT period.

   In the unlikely case of no area compensatory subsidies, the adjustments show that with an annual 1.5% increase in productivity among professional farmers, plus small-farmer output, production in 1999-2000 would be about 165 million tonnes. Because it is probable that compensation payments will be maintained, the actual output would be 20 million to 30 million tonnes higher.

   If it is assumed the most likely productivity increase is 1.5%, these figures would suggest the E.U. could limit production to 172 million tonnes, the level needed to meet the GATT-required export subsidy limit — but only if compensation payments are discontinued in 1996, a highly unlikely circumstance. In practice, it is more likely that production will exceed the limit by some 15 million to 25 million tonnes.

   The most important conclusion is that even with compensation payments, efficient E.U. cereal growers have everything to gain by maximizing output and a great deal to lose by not doing so. The gains from maximizing yield, rather than sustaining output at reference yield levels, are substantial.

   The difference in profitability between the reference yield and the quite feasible yield of 8.5 tonnes to 9.5 tonnes per hectare is close to 100%. These calculations are based on costs of efficient growers and assume that maximizing output will involve a significant increase in variable costs at around the 7.5 tonne per ha output level.

   The gains from productivity are also likely to be substantial; an increase of 1.5% a year is likely to result in an increase in profitability of more than 20% — a further indication that farmers are likely to maximize output rather than stabilizing output at their reference yield levels.

   The most efficient producers would be able to remain in production, even if there were no compensation payments. The “shock” effect of CAP reforms and the GATT also may make farmers look more closely at their cost structures to reduce costs. This would tend to sustain profitability at lower prices.

   Taken together, all these factors suggest that the E.U.'s cereal sector is more likely to expand its output from the 1992 set-aside adjusted level than to contract or even stabilize.

   Brian Gardner is a Brussels-based writer, commentator and consultant on E.U. agricultural and food policies. This article is based on his June presentation to the National Association of British and Irish Millers.

1993 on-farm survey conclusions of E.U. farmers' response to set-aside

   • Because participating farmers will tend to idle their least productive land, average yield will be higher on the land remaining in production.

   • Production on the remaining land will be intensified, allowing farmers to maintain or increase yield;

   • Yields will increase because of set-aside itself, as idling for one year increases productivity through retention of higher levels of moisture and nutrients.