24 Nov 2015

A brief review of the new CAP reform in Germany

Cajus writes*

The idea of distributing money to poorer people to help them improve their standard of living has been proven to be a successful way to fight poverty. The organisation “GiveDirectly” claims on their webpage that they have increased earnings by 34%, assets by 58% and defeated 42% of hunger by applying this method in Kenya.

Also the EU seems to have gotten caught up on this Idea recently. The Common Agricultural Policy was introduced in 1962 to help European farmers sustain their business. This was important to secure food production and especially in this time as due to other new economic possibilities (industrialisation as a driver for example), being a farmer doesn't seem attractive for most people. (Witzke; Noleppa, 2007) The CAP has since its creation been revised many times. It is often argued, that the CAP is rather unsuccessful, especially compared to the money invested (40% of the EU budget). The EU increased incentives for higher food production, which led to a overproduction of food in the 1970-80s. Therefore, the CAP shifted from market to producer support, where price support is replaced with direct aid payments, similar to the aid payments by GiveDirectly. The European Commission claims [pdf] that this led to an “increased emphasis on food quality, protecting traditional and regional foods and caring for the environment.”

In Germany this method keeps many farmers in business. The revenue of most farmers in Germany consists of such aid payments by more then 50%. Therefore, this system does not punish inefficient farms. Also, this method leads to inequality of benefits received under German farmers and creates unnecessary incentives. Aid received correlates with farm size, while smaller farms gain less benefits, larger farms gain more. This seems reasonable as incorporated farms (and therefore larger) tend to have lower profits.

A slightly newer adjustment of the CAP introduces a budged limit to direct payments. This budged limit is at €300,000. Since smaller farms receive less benefits, this will not have an effect on smaller farms, but larger incorporated farms will partially suffer and possibly forced out of business.It creates an incentive to split up larger farms into smaller farms. (Witzke; Noleppa, 2007)

Bottom Line: Using direct payments to help farmers in Germany has its ups and downs. On the one hand, it secures food production and local farmers, but on the other it promotes an unnecessary shift from incorporated farms into smaller farms. Also it does not incentivise farmers to be productive. Since more then 50% of German farmers revenue comes from the CAP, actual performance does not make a big difference in total revenue for farmers. Therefore, this method needs adjustment to create incentives for farmers to be productive, as well as giving them an economic surplus. This surplus however may also be created in other ways such as cheaper land for example. Higher food prices in Germany would also be an option, especially as inflation German food inflation rates are the lowest in Europe. However, to prevent overproduction as already occurred during 1970-80s due to high incentives to be productive, a limit of food production for each farm maybe helpful to allocate production efficiently.

* Please comment on these posts from my growth & development economics students, to help them with unclear analysis, other perspectives, data sources, etc.


NM said...

Cajus raises some of the intriguing difficulties of designing support structures. It’s a pity his idealism should be dented so young!! J

I would be interested in the source of his assertion that incorporated (larger) farms tend to have lower profits. It seems counter to a lot of other things I read.
I had thought that one of the main purposes of the single farm payment scheme is to keep farmers in their communities, so that the rural towns, and the traditional cultures they support and maintain, don’t get hollowed out by industrialised farming and consolidation of small holdings into large, broad acre, mechanised farms. So, measuring the effectiveness of subsidies is a difficult art, involving lots of different motivations and desired results. Also, the larger number of outcomes which are selected for in design of a subsidy the lower the pressure the subsidy applies to any individual factor. Even if farm efficiency was an intended outcome of the subsidies, the fact that a number of other outcomes are desired, means that the influence on farm efficiency would be reduced.

Cajus seems to disapprove of subsidies which are capped, due to the incentive to split farms to maximise subsidies. In fact, that may be a desired outcome of the policy designers.

I disagree with his conclusion that the current subsidy has no incentive for efficiency because only half farmers’ income comes from market payments. 50% of payments is still a large incentive to improve efficiency.

Cajus goes on to describe some alternative regimes, but I worry that they become more complex and fragmented. Having to implement a number of complex subsidy regimes has made me wary of complex regimes.

Overall it was an interesting way to think about the CAP

Cajus Mellin said...

Hello NM,
Thank you for your reply.
The source can be found here:https://www.agrar.hu-berlin.de/de/institut/departments/daoe/ihe/Veroeff/WP79.pdf "However, the vast majority of incorporated farms would make negative profits in the absence of direct payments" (page 11).
Larger farms may not be less efficient, but they have obviously higher costs then small farms. If these costs outweigh any profits they make, there total revenue depends less on productivity and I think that increasing food price and cutting some of the aid money would therefore be a more efficient way to pursue the CAPs goals.

Some large incorporated farms receive around 1 million euros subsidy money (also according to the source above). If new policies cut the subsidy money to only 300 000, such farms will potentially be driven out of business. At the same time, other large incorporated farms will split up into smaller farms. I didn't mention this in the post, but the new CAP regulation is also a lot about cutting qoutas and about increasing trade and specialisation. For such purposes large incorporated farms have an advantage over small farms, because they for example use less tractors per hectare and therefor have a lower input cost relative to farm size. This causes them to be able to produce at lower costs and therefore be more competitive. Small farms will suffer by the increased competition, and this is a reason why I don't understand Germanys policies incentivising large farms to split up.


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