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Economic Prosperity

What old-style CAP defenders claim

It seems that even arduous CAP defenders do not pretend that, overall, the CAP enhances Europe's economic prosperity. However, they hold that subsidies for farm modernization serve economic growth. More generally, they like to credit the CAP with the EU’s vibrant export-oriented sectors that produce farm inputs and process food. So the economic effects of the CAP are said to be mixed and not disturbing in the light of the CAP’s multifunctional benefits.

Strongly distorting subsidies

The CAP consists of diverse subsidies that affect economic wealth in different ways. Among the most problematic subsidies are those that reward production (e.g. payments per suckler cow) and the use of land for production (e.g. payments per hectare of rice). Other subsidies stimulate production by raising prices. Export subsidies, for instance, reduce supply and thus drive up prices on the EU market.

Such subsidies vitiate market-driven resource allocation and slow down structural change. The result is that European agriculture is not aligned with its comparative advantage but skewed in favor of those products that receive disproportional protection. For instance, Europe is producing too much meat and not enough vegetables. More importantly, support to the agricultural sector comes at the cost of the manufacturing and service sectors. By driving up wages and other input prices throughout the economy, it acts like an invisible tax on all non-farmers.

Direct income support

Direct income support has no evident linkages to production (that is why it is also called ‘decoupled’). The main example is the Single Farm Payment (SFP), which is based on historic entitlements. Though formally decoupled from production, direct income support still prevents market signals from directing the economy’s resources to their most productive uses:

  • Farmers can use the payments to finance additional production which they could otherwise not afford.
  • Farms that would not be viable in a free market may stay in business if part of their costs can be financed through support programs. This distorts the structure of production (in favor of less efficient producers, whether small or large) and keeps an excessive share of labor in agriculture.
  • Young farmers who do not inherit farm land find it harder to set up a farm as the SFP drives up land values.
  • The SFP obliges farmers to maintain their land in good agricultural and environmental conditions. Some of these conditions, such as avoiding the encroachment of unwanted vegetation, are easiest to fulfill by farming. The SFP thus pushes farmers indirectly to produce.

Second pillar programs

Many productivity-enhancing programs subsidize measures on the farm level, such as investment in machinery and buildings or in farming and management training. To the extent that these expenses are geared at increasing productivity – and not, for instance, environmentally responsible farming that benefits society – they should be borne by the farmers themselves. Individual farmers know best what kind of investment they need, and paying special subsidies to farmers again distorts the economy to the detriment of non-farm sectors.

Administrative and financing costs

Doling out farm payments is costly. Ministries and agencies have to set detailed rules, verify entitlements and compliance, decide on individual claims, and process payments. Farmers need to inform themselves, engage consultants, file applications, and cooperate in official controls. These costs – for farmers alone – have been estimated to be 6.7 % of CAP payments disbursed in France, while farmers' administration costs amount to 8.5% in Italy and 9.3% in Germany. Germany also stands out with € 28 of administration costs for farmers per hectare of farm land.

Costs arise not only from distributing but also from raising public money. Some of these costs are evident, such as the cost of running finance ministries and filling in tax declarations. The more insidious distortions brought about by taxes are less visible: citizens work less, save less, and invest less in their education if taxes are high. Companies also invest less in high tax countries.

Damage to EU trade interests

Still another detriment of the EU’s agricultural policies is that it fosters protectionism abroad. The EU offers a welcome justification to its trading partners for keeping their tariffs and subsidies as a legitimate self-defense of their farmers. This is a problem for the EU because the EU - together with the US - is the world’s leading agricultural exporter. Liberalization of world food trade would create significant new business opportunities for European producers, processors and traders.

The spillover effects of EU agricultural protectionism reach even further. EU agricultural policy is routinely lambasted as hypocrisy by developing countries. It discredits the free-trade argument and serves as a pretext for maintaining barriers to trade in all kinds of goods and services. If the EU took the lead and dismantled its protectionism in agriculture, this would lend lasting support to free-traders around the world.

Conclusion

Subsidies come with multiple costs. They distort competition among farmers, they bias the economy in favor of agriculture, they involve administration and financing costs, and they are an impediment to freer trade around the world. Subsidies should therefore be used with great care. To be acceptable, subsidies have to deliver non-economic value to society that more than outweighs their often hidden economic costs.

Still, the EU has a role to play to promote the productivity and competitiveness of European agriculture: through support to research and development. Companies that invest in research and development often do not reap all the benefits of their investments. So it is broadly acknowledged that governments should help out with subsidies. And since many of the benefits of research and development spill across borders, EU action can create value. Such subsidies should not be part of the CAP but be integrated into the EU’s Directorate-General for Research which has the requisite procedures and competences.

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