THE IMPACT OF PRICE SUPPORT SYSTEM ON COMMON AGRICULTURAL POLICY OF THE EUROPEAN UNIONPresented by Ergin Akalpler

Crucial QuestionWhat is the impact of the price support system of the CAP on free trade?

Which support instrument (such as export subsidies import levies etc.) better fits into the CAP to reduce the trade distortion and destabilizing effects on the market with respect to the welfare of consumers and to distribution effect?

What is researched:

The impact of the price support system of the CAP for cereal products are taken into consideration as sample products in EU-15. The impact of the support measures on cereals are researched.

Method:Producer Subsidy Estimate is used to estimate the impact of support measures and Supply demand curve is used to illustrate the effects of support measures in the CAP. Theoretical and empirical researches are considered. Time series and linear regression technique are used for better forecasting.

The CAP

In 1968, 11 Years after the foundation of the EU CAP came into effect 1987 single European ACT removedTechnical fiscal and Physical barreirs1993 Maastricht agreement:Economic and Politic Union, Monetary Union, EU citizenship,

Objectives of the CAP (Article 39)

Increasing productivityFair living standards for producers. Market stability Reasonable price for consumers andMaintenance of employment

Principles of the CAP

Community preferencesMarket UnityFinancial Solidarity

Protection in the CAP

Strong Protection %75 external protection with intervention(cereals, butter, milk, beef, some fruit and vegetablesWeak protection %25 external protection without interventionEgg polutry wine, flowers some fruit and vegetables

Support measures of the CAP

-Tariff Measures-Non tariff measures: Export import subsidies and quotas, Monetary compensatory payment, production quotas, interventions

Reforms of the CAP

Mansholt Plan in 1968Replaced 5 million small scale producer with large scale producers1988 Reforms, radical measures:Introduced set aside measures, early retirement of age 55, extensification of production type.

1992 Mac Sharry reforms:

Direct payments instead of support measures Support prices for cerelas and cattle reduced 15%Beef support prices reduced 29%Set aside reduced 15%

1994 Uruguay round

agricultural support would be reduced 20% over a 6 year period.

A reduction of 36% in budget spending on export subsidies

21% cut in the quantity of subsidized export.

Agenda 2000

, A new policy for rural developmentThe integration of the environmentThe involvement of local peopleThe creation of different development programs to assist farm sectors in CEEC Further reduction in prices.

The function of the CAP

The theoretical perspective of International trade

Ricardo Smith modelHeckshir Ohlin ModelIntra Industry trade modelStrategic trade Model

The Smith Ricardo Model

Smith based on Absolute costs- threats labor only factor-countries with lower REAL cost of production has advantage on trade.Ricardo based on Comparative cost-countries with lower RELATIVE costs has the advantage on trade

Ricardo based his theory on a number of assumptions

-two nations and- two commodities - free trade, -   perfect mobility of labour within each nation, but immobility between the two nations,- constant cost of production,- no transportation cost,- the labour theory of value

Amount of trade between US and UK

US UK

_____________________________Wheat (bushels / man-hour) 6 1  Cloth (yards / man- hour) 4 2 _____________________________

Price of trade between US and UK

US UK_______________________________________Price of 1 bushels of Wheat $1.00 $2.00Price of 1 yard of cloth 1.501.00________________________________________

  The H- O-Samuelson model 

HO focus on international differences in factor endowment. Comparative advantages is explained by the abundance of factors-countries with abundance factors will export, with scarce will import.Inter industry trade depend on different type of products trade

Intra Industry Trade

IIT entails lower income of factor and market adjustment than Inter ind. Trade.Horizontal IIT- vertical IIT IIT beneficial it increase competition,Firms grow rapidlyIIT similar product trade create preasure on price reduction

Strategic trade

In imperfectly competitive market trade policy promote firms with unilateral protection such as:Indirect export promotionExport subsidies to deter competitors entering market.

Ex: aircraft ind. in political interest

Boing Produce Dont Prod.______________________________Airbus Prod. -5, -5 100, 0 Dont Prod 0, 100 0, 0________________________________

Effects of subsidies

Boing Produce Dont Prod.______________________________Airbus Prod. 20, -5 125, 0 Dont Prod 0, 100 0, 0________________________________

PSS and Cobweb theorem

Simplest model to illustrate the danger of price fluctuation in econ.Demand decreasing function of current priceSupply increasing function of last year (Time leg behind)

Impact of elasticity on S/D

P p p

P1 P1

P2 P0

Po P2

Q 0 Q1 Q2 Q Q

Figure1-1: Demand is more elastic Figure 1-2: Supply is more elastic Figure 1-3: Both have the same elasticity

Impact of intervention on cobweb

p P

P2 P2 P1

p p P1

0 Q1 Q Q2 Q 0 Q1 Q Q Figure 1-4: intervention price is below Figure 1-5: Intervention price is above the market price market price (p)

Methodology of PSE in the CAP

PSE = Q (Pp –Pr.X) + D + I

 Where; Q = quantity produced

Pp = producer price in domestic currency units.

Pr = world price in world currency unitX = exchange conversion factorD = Direct government payments

I = Indirect transfers through policies  

Estimation of MPS for PSE

MPS = (Pp-Pr). Q

The unit PSE is the total PSE per tonne or unit of production. Unit PSE= PSE/ Q Percentage PSE= PSE/ Q.Pp +D  

PSE for Exported products

S D b f c Pp Pr a g e d S1 S2 D2 D1

Tariff-Non Tariff Trade Measures -Tariff Trade Measure - Non Tariff Trade measures:Price Support systemDirect payments Intervention Export SubsidiesExport/ Import QuotasVER

Tariff Trade Measure

Specific tariff is a fixed charge per unit of importP = P1+ t

Advalorem percentage of estimated market value of good is taxed  P= (1+t) P1= P1+ t P1

Impact of Tariff on input /output

nominal rate of protection (NRP)NRP = P1+ P1. t - P1/ P1 Thus NRP = t effective rate of protection (ERP)ERP = t P1– Σ tj .Pj.Xj / V

Three cases of ERP on input

1-inputs subject less tariff than output ERP> NRP 2- inputs subject equal tariff as output ERP= NRP 3- inputs subject more tariff than output ERP>NRP

Tariff Escalation

May be present when tariffs on input more than final products because ERP calculation is higher than the NRP-

This increase the profit of producer or reduce tariff expenditure

Impact of the trariff on the Market

: Effects of the tariff

NTM: The market Price Support

P D S P D S S1

PEU

W W

Px Q1 Q2 Q Q3 Q4 Q

CAP Payments

-Based on Limited area Set aside aid per Hectare

-Based on Unlimited areaDirect paymentsIntervention

Direct payments

Pw(1+S

) Pw

S

S’’’

a b

P

q1 q2 C1 Q

The impact of direct payment on PSE

Year Common Wheat Barley Oats Maize

MPS PSE MPS PSE MPS PSE MPS PSE

1993 4.069 5365 3.071 3962 205 326 1.927 2329

1994 3.299 4829 2.561 3627 173 318 1.264 1716

1995 1.589 3052 1.653 2784 207 415 1.706 2164

1996 -1.834 528 136 1339 233 457 727 1237

1997 6 1417 442 1583 165 390 915 1394

1998 2.329 3742 2.215 3348 233 473 1.168 1639

1999 2.809 4520 1.645 2991 304 584 1.435 2017

2000 1.041 2904 122 1480 286 586 940 1536

2001 251 1980 0 1379 181 493 550 1203

Impact of direct payments on PSEPSE befor and after direct payments

0

1.000

2.000

3.000

4.000

5.000

6.000

7.000

8.000

9.000

1 2 3 4 5 6 7 8 9

year

€- m

n/t

PSE for W

PSE-DP(w)

PSE for B

PSE-DP(B)

PSE for O

PSE-DP(O)

PSE for M

PSE-DP(M)

Impact of the Export subsidy

Year Wheat Barley Oats Maize

1994 748 579 31 122

1995 241 161 9 57

1996 210 24 22 37

1997 983 42 25 38

1998 384 440 33 64

1999 625 485 35 85

2000 150 25 36 48

The Export subsidy amount for cereal products in EU (Euro mn /t)

 

Impact of Export Subsidy on PSE

Year Common Wheat Barley Oats Maize

MPS PSE MPS PSE MPS PSE MPS PSE

1994 3.299 4.047 2.561 3.140 173 204 1.264 1.321

1995 1.589 1.830 1.653 1.812 207 420 1.706 1.743

1996 -1.834 -1.624 136 160 233 255 727 765

1997 6 989 442 484 165 190 915 953

1998 2.329 2.713 2.215 2.655 233 266 1.168 1.232

1999 2.809 3.434 1.645 2.130 304 339 1.435 1.520

2000 1.041 1.191 122 147 286 322 940 988

Impact of Export subsidiesThe PSE Export subsidies

-3.000

-2.000

-1.000

0

1.000

2.000

3.000

4.000

5.000

1 2 3 4 5 6 7

year

Eu

ro m

n/t

w-mps

w-pse

b-mps

pse

o-mps

o-pse

m-mps

m-pse

Impact on the Export subsidy world market

S2 S1 D1 D2 D1 D2 S2 S1 D1 D2

a b c

h g f e d

D

S D subsid

y

S2

S1

Pw1

w1

Ps

Pw

Import Quotas P p’ p

quota domestic P with quota world P Dm Q1 Q2 Q

Impact of Support Measures

Trade measures for EU Consumer Producers Community Agency

Tariff for importing country Loss Gain Gain

Direct payments on limited area

Loss Gain Loss

Direct payments on Unlimited area support- with set aside

Gain Gain Loss

Intervention purchase Loss Gain Loss

Only Set aside Intact Loss Loss

Product Price cut Gain Loss Gain

Subsidy for exporting country Loss Gain

Loss

Import Quotas Loss

Gain Loss (License owner gain rent)1

Export Quotas Loss

Gain

Loss (License owner gain rent) 1

VER Loss

Gain

Loss (License owner gain rent) 1

Impact of Support Measures Positive effects;        Subsidy protect producers and rural welfare,        Support insufficient producers to maintain their production,        Subvention redistributes income from domestic consumer who pays a higher price to domestic producers of the commodity (who receives the higher price)        Price support or intervention price, prevent the fluctuation in the market,

        Increase competition change of domestic producers,         Subsidies is a trade creation between member countries,        Subsidies contribute indirectly imported product amount where there is a less output,        Increase producer surplus,        Subsidy is more preferable than tariff, subsidy is a direct form of aid         Increase export of commodity,

Negative effects,         Subsidy cause an over-production,        Because of subvention some efficient production of exportable commodity in the third country replaced by the insufficient production in the EU,        Subsidy is a trade distortion for non-member countries, and reduce the welfare of the world economics,        Subsidies cause an unfair competition and it is inconsistent with the comparative advantages theory,

        Subsidies reduce the welfare of the consumer if there is an over-production,         It is difficult to estimate which producer get subvention, and once it is given it is difficult to remove, (protective tariffs may have the same effect)         Reduce consumer surplus or cost,        Increase product price,        Subsidies cause a producer and consumer cost or deadweight,        Reduce competition of third country producers,Subsidy is used for political purposes, such as work place guarantee