Una mirada al interior de la caja negra : El espectador como

Embedding entitlements into the CAP

Direct payments have long become the major budgetary item in the CAP. The pressure to maintain a high level of expenditures arose from farm’ organisations. They have never been fond of the conditions and the programming imposed in order to receive Pillar II payments, and cherish entitlements and payments ‘rights’, a designation which was most unfortunate for a down payment that

9 _{ECA (2011) supplies anecdotes of the unsuppressed vagaries of the Single} Payment System. Although the arguments essentially refer to European law and have little economic content, the report obviates a faulty system of tradable entitlements.

was supposed to offset a once and for all support price cut. The pressure also arose from member states anxious to maintain net budgetary returns. MEPs followed suit. Such pressure has been surprisingly successful: while the Commission seemed open to significant budget reallocations, the Pillar I budget remained practically untouched, neutering any major reform along the ‘public money for public goods’ line.

The choice of the Commission itself was to stick to the concept of entitlements to direct payments instead of embarking on the contractual approach. It was also to dodge planning a gradual reduction of the Pillar I payments, which have barely any connection with public goods and are still a tool for income support. A reason why the Commission fell short of planning the phasing out of the single payments, but maintained a significant flat ‘basic’ payment, is that farm incomes depend greatly on direct payments. Static simulations using the Farm Accountancy Data Network and more sophisticated studies such as “Scenar 2020” (Nowicki et al., 2010) were used to back the idea that any sharp decrease in the direct payment budget would result in a large number of farms going bankrupt. This outcome was foreseen not only in member states where farm structures are lagging, but also in the ones where farms are highly modernised but also heavily indebted, such as Denmark and the Netherlands. The Commission’s impact assessment stressed this point and warned against the risk of “unbalanced territorial development”, should direct payments be reduced. Whether this assessment reflects economic reality is debatable. Clearly, direct payments account for a major share of net farm incomes. In the livestock sector and in several countries, these payments account for a large part of apparent added value, and an even larger part of net income (Matthews, 2014). However, farms depending most on direct payments, e.g. the extensive livestock sector, would easily qualify for forms of support other than basic payments, such as Pillar II measures more targeted towards public goods. Provided that the valuation of such environmental and territorial services by society is high enough to justify payments suitable to make a living, marginal areas can avoid further loss of farm population. In large arable crop farms, many international examples show that a gradual adjustment to a well-planned and announced reform involves large cost reductions, in particular

through the cost of primary factors (New Zealand and Canadian agriculture have successfully phased out large subsidies).

The fact that large farms, otherwise technically efficient, seemed to be on the brink of failure without the Single Payment Scheme (SPS) is about much more than the widely perceived distribution issue; it is also a problem of resource allocation and inefficiency of the agricultural system as a whole. It is a vexing paradox that the CAP payments have generated a modernised and capitalised farm sub-sector, assisted under the argument of improving competitiveness, which at first glance would be unable to thrive without huge amounts of public funds. Such farms should be viable after dynamic adjustments are allowed to occur. Policy- makers should be more aware of the long-term implications of buying time and short-term peace from the lobbies through granting rents that capitalise on farm equity and become ‘drawing rights’ on the EU budget, becoming so entrenched that they undermine much needed reforms.

A better architecture for Pillar I, but weakened by loopholes The Commission proposal for a new architecture of direct payments survived the negotiation process with the Council and the Parliament. The multiple layer payments may appear in line with similar proposals from some think tanks (for examples, see SER, 2008; Bureau & Mahé, 2008). However, a number of key characteristics of think tank proposals were dropped along the way. So were the ideas of gradually phasing out the basic payment; of making payments contractual and not transferable; and of attaching a new set of green payments to designated public goods rather than submitting current payments to extra cross-compliance. In the end, the cost-effectiveness of the payments to deliver public goods has

been curtailed, at least in comparison with a more focused scheme.10

10 _{To illustrate the point, taking a crop farm of 100 ha with a gross margin} of €400/ha and assuming the worst case of 5% EFA condition requiring to set aside arable land, focused ‘green’ payments would cost €2,000 while 30% of the entitlements to direct payments (assume €25,000) amount to €7,500. On these aspects, see the analyses of Mahé (2012), Matthews (2013b), and Hart (2015) in chapter 10 of this volume.

The link between payments and the opportunity cost of effective upgraded practices was abandoned.

The misuse of public funds was exacerbated by relaxing the requirements for counterparts for the green payments. Furthermore, in widespread situations where the conditions for green payments require no or minimal adjustment of practices and land use, the cost of compliance will be null or nearly so and the green payments clearly a windfall gain – in which case ‘greenwashing’ is an appropriate qualification. It is a paradox that Article 28 of the Direct Payment Regulation requires that, in the context of transmission of entitlements, any windfall gain due to an increase of the value of entitlements “is to revert to the national reserve” and that the pervasive likelihood of windfall gain due to ‘green’ payments is overlooked.

One conspicuous diversion of the previous SPS, pointed out by the European Court of Auditors, was the de facto admitted eligibility of non-farm entities. The new regulations call for efforts to narrow down the ‘active farmer’ condition for receiving payments. Designated non-farm activities such as recreational activities are now explicitly excluded. No payment should be given to areas “naturally kept apt to grazing or cultivation” (Art. 9, R1307) even though the exclusion criteria as written in the delegated acts

seem rather lax.11 _{Eventually, the primary objective of the ‘active}

farmer’ provision is to allow exclusion of the most publicised leakages, e.g. payments to airports and golf courses. In spite of

potential loopholes that make12 _{this objective conditional on the}

national implementation of the measure, the active farmer argument is perhaps a double-edged sword, since it enshrines the notion that only farmers should be paid for the delivery of environmental services on agricultural land, while the debate on this issue deserves to be open since the economic and legal bases for

11 _{Exclusion from payments would result if more than 50% of the declared} area is natural. It will be tempting to adjust the claims so that the threshold is not passed.

12 _{These exclusions can be easily nullified due to an explicit exception when} direct payments are at least 5% of the non-agricultural receipts, which is not a dire demand (see item 2(a) of Art. 9 R1307). Again, member states’ adaptation of the regulation will prove determinant.

this privileged right granted to farmers are questionable. This measure, with its weakness and judicial complexity, is the result of the choice to stick to cross-compliance and entitlements instead of deploying contractual payments focused on services in which compensation and cost of services could be made more equal. Were green payments adjusted to the costs suffered by economic agents, this issue and many other perverse effects of direct payments would vanish.

Overall, the new architecture of direct payments states legitimate objectives but the maintained status of ‘entitlement cum cross-compliance’ suffers from three weaknesses: 1) it is far from a targeted measure either on environmental services or on any other public good; 2) it does not respond to the major criticism that, in many member states, those who benefit more from these transfers are often wealthier than the average taxpayer who funds them; and 3) tradability of entitlements and rent capitalisation feeds the political demand for perpetuation of the basic payments.

Capping, redistribution and convergence

The capping of payments initially proposed by the Commission was modest, but that which results from the regulation’s final adoption will, in practice, be almost completely ineffective, particularly for the largest beneficiaries in member states choosing the 5% reduction of the basic payments. The topping up of payment ceilings by the outlays of hired labour costs for the larger farm units, already in the proposals, is a strange way to foster employment in rural areas, as was argued for. The wage rate being overwhelmingly set by the national labour market, this allowance is a biased transfer in favour of capital and land rather than labour, contrary to what is alleged. It had been suggested that such an exception for capping would be restricted to farm cooperatives or similar arrangements where farm income is shared by workers, but high stakes for the few large beneficiaries and national biases have managed to influence the

decision process. The first evaluation by the Commission of the

product of the reduction of payments mechanism for the period 2015-19 is €558 million or €110 million per year, which translates

into only 0.2% of the Pillar I budget.13 _{It appears that the impact of}

capping and degressivity is unlikely to match the redistribution that took place under the former modulation schemes.

However, the possibility left to member states to implement redistributive payments, i.e. to provide higher per hectare payments for the first hectares (up to 65% of the average payments on the first 30 ha or the average farm size) can have significant distributional consequences. Eight member states took this option and accordingly most of them chose not to apply the reduction mechanism. This means, as for capping, that the largest beneficiaries will not be particularly penalised. In the case of France, the main promoter of this provision, this measure is such that the degree of progressivity of CAP payments involves redistributions going much further than the previous ones. While this measure has a compelling social legitimacy, it raises the question of its longer-term impact on maintaining small structures in place. The smaller size of EU farms is a significant explanation of the limited competitiveness of the EU beef and sheep production compared to third-country producers. This privileged treatment of smaller farmers would be even more justifiable if the top-ups were conditioned on verifiable upgraded practices regarding the environment or on territorial objectives, i.e. on joint public goods provision.

Convergence of payment rates was widely accepted in the name of equity. However, convergence of the level of payment per hectare hardly makes the overall distribution of payments more equal due to the farm size effect. The redistributive payments have the merit of alleviating the inequality bias built into the system, since basic payments are proportional to area and entail small compliance costs. One more feature of uncapped payments has been overlooked. Being unlimited, the payments boost the net income of farmers whose acreage is large and hence saving propensity high enough to buy additional land or to invest in even larger farms, either in EU-15 or in new member states, or in both, or in residential

13 _{Nine member states have declared their intention to cap basic payments} at maximum amounts ranging from €150,000 to €600,000. Ten member states opted for applying only the minimum reduction of 5% on amounts of basic payments above €150,000. Eight member states plan on subtracting the salaries actually paid by farmers from the payments before applying the reduction of payments’ mechanism (European Commission, 2014).

properties. Moreover, owners of largest farms benefiting primarily from CAP payments reach higher tranches of income tax rates, which make the use of marginal purchased inputs cheaper than their marginal products, a mechanism which further exacerbates intensification.

The compulsory shift towards a more uniform payment per hectare can be seen as progress, in the sense that such payments should be less directed towards the most productive areas than the historical entitlements based on compensations for old price cuts. However, the rationale for a uniform payment rate is weak, since a single rate per hectare it is a poor indicator that this payment is ‘fair’, especially when the public goods supplied and their production costs are heterogeneous. As simulations for the Parliament had pointed out, the impact of such a shift in terms of global inequality (as measured by Gini coefficients) is limited, unless this redistribution is conditioned on a capping of payments per capita (Bureau & Witzke, 2010). In addition, the compulsory shift to a uniform rate per hectare is hardly a revolution: member states already had the possibility to get away from the historical individual references under the previous Regulation 2009/73, and many of them had done so. The innovation is that this shift to a per hectare basic payment symbolically closes a period where direct payments had the legitimacy of the ‘compensatory payments’. Whether this lifts a major psychological obstacle to designing a genuinely new CAP in the future remains to be seen.

While the flexibility left to the member states keen to make different choices between pursuing social objectives and boosting production capacity has proved useful to avoiding endless negotiations, the embodiment of a permanent entitlement to the basic payment per hectare remains at the core of the economic and political problems of the CAP and precludes the emergence of a policy based on public sector economics. A crucial clause remains missing in EU texts, which is that no individual should receive EU payments above what can be considered the minimum wage in his/her country, unless these payments are laden with obligations to deliver public goods or services and require specific costs. This issue was not even discussed, even though Farm Accountancy Data Network figures show that the average transfer to a farmer reaches

a very high level in some member states.14 _{Ten member states (often}

with a high proportion of large farms) are not going to apply a real capping but will use the flat 5% reduction of basic payments instead, even though they are now assured to keep the proceeds in the country. As most member states using redistributive payments did not go as far as also applying the payment reduction mechanism, the general picture is of the reluctance to implement an effective capping of support. This fact reveals that ‘national preferences’ for (non-) redistribution of support, or national politics rather, are a key explanation for why capping was so hard and contentious to phase

in. It also suggests that diverging national interests15 _{and the}

heterogeneous proportions of large farms across member states were not enough to explain the aborted attempts to cap large payments in 1993.

Full harmonisation of the per hectare payments throughout the EU is clearly not achieved, but this criterion made little sense if strictly enforced: the per hectare payment is not a particularly legitimate indicator; and homogenisation of a per hectare payment does not ensure that equity is achieved when structures, economic and regulatory conditions differ. Were the convergence conducted more swiftly than GNP/capita, further rents would be generated in new member states, making later reforms more painful and primary factor market adjustments toward efficiency slower. Demands for more convergence from new member states were often a smokescreen for plain bargaining on a larger share of the EU budget. On this issue the Commission proposal was reasonable and the reform probably went as far as it was politically possible. Payments to young farmers and for natural constraints, simplification

The new CAP gives member states latitude for subsidies to young farmers entering the profession (programmes already existed at the member state level as well as under rural development funding). However, the mere fact that such policies are seen as necessary to

14 _{According to these data, the average farmer in Luxembourg receives} €63,000 from the taxpayer, see Matthews (2014).

15 _{In the initial attempts to reduce the largest payments by a levy, the} proceeds were not to be kept by member states.

make it possible for newcomers to enter the sector illustrates the barriers caused by the pass-through of payments to asset and equity

prices.16 _{From that point of view, the young farmer payment can be}

seen as a patch to alleviate a problem created by the CAP in the first place. As it is neither targeted to identified public goods nor restricted to designated areas stricken by rural decay or dereliction, and granted in areas where farming has too many candidates, it thus inflates the various hidden payments to retiring farmers or fuels the bidding up of land prices.

The reform makes it possible for member states to provide larger amounts of aid to farmers in areas with natural constraints (ANC). The experience with past programmes of Pillar II suggests that they address some important objectives and do so at a limited cost. The Commission also successfully introduced a definition of these areas based on agronomic and biophysical characteristics, rather than the former (absurd) definition which led some very fertile land to be classified as less-favoured. This voluntary measure did not succeed since only one country decided to use it. Applying a flatter rate to direct payments, which favours less privileged areas, and the simultaneous availability of measures with similar purposes in Pillar II, without merging the two schemes, may be the explanation.

One drawback of extended targeting of Pillar I payments is that the new measures contribute to the blurring of the distinction between Pillar I and Pillar II and the coordination of different

measures having the same objectives.17 _{This hardly contributes to}

making the CAP simpler. The regime for small farmers makes good sense and even more so for the new possibility of replacing annual

calculation of payments by a lump-sum annual amount.18 _This

16 _{The capitalisation of payments into land prices is a controversial issue} that needs to be explored further. Swinnen et al. (2013) noticed that the capitalisation mechanism is observed in many empirical studies but with