Digest Paper - CAP reform: implications for beef and dairy

Key elements to CAP reform

From its original design to the latest reform, the CAP has moved from a policy focused on supporting production to a policy aimed at supporting farm incomes. Policy tools have changed from export subsidies and coupled payments linked to production, to a policy dominated by area-based payments and support for rural development, as shown in Figure 2. In its current structure, the CAP is based on a two pillar system. Pillar 1 is used to provide income support for farmers, while Pillar 2 supports rural development.

The latest reform will see the CAP keep its two pillar system, but will allow for increased flexibility in its implementation at national level. This flexibility is in two main guises:

The ability to move money between pillars: boosting direct support at the expense of rural development or vice versa.
The option to introduce ‘targeted’ support, allowing countries to focus a proportion of their budget towards certain industries (such as through coupled support) or specific groups of farmers (such as small farmers).

The CAP has also introduced the concept of ‘greening’ to direct payments. Farmers will have to meet certain environmental requirements in order to receive the full level of support. These include crop diversification measures, permanent pasture maintenance and leaving an Ecological Focus Area of (initially) 5% for farms with at least 15ha of arable land. Farmers who do not comply with these will lose their greening payments and (from 2018) face further sanctions.

Initial EU Commission estimates for the cost of implementing greening regulations in the UK at around €33/ha on average, although it is important to note that the cost will vary between farms depending on the type of production and their specific situation1. Moving forward, farmers will have to evaluate whether the greening element of direct payments outweigh any additional costs to production.

The impact of inter-pillar transfers

The new CAP aims to reduce the gap in average payments between countries, while giving Member States the flexibility to orientate the CAP towards their own specific needs.

Under the new regulation, national governments will be able to shift up to 15% of direct aid (Pillar 1) to rural development (Pillar 2), and vice versa. This is often referred to as ‘modulation’ and ‘reverse modulation’, respectively. In countries receiving less than 90% of the EU average, national governments are able to transfer up to 25% of Pillar 2 funds into Pillar 12.

The ability to transfer money between pillars has implications on competitiveness as governments have the ability to boost direct payments at the expense of rural development. Alternatively, governments have the ability to support rural development at the expense of direct payments to farmers. This issue could be particularly important to farms located in areas with similar topography, land type and climatic conditions, but situated on different sides of a border and subsequently receiving different payment levels.

In its CAP implementation document, Defra announced its intention to shift 12% from direct payments to rural development in England, with the possibility to increase to 15% for the final two years of the CAP period. The Welsh government have revealed that they will shift 15% from direct payments to rural development, while the Scottish government will shift 9.5% from Pillar 1 to Pillar 2. Within the UK, Northern Ireland is the only devolved state that will not shift money between Pillars.

The impact of targeting support

The latest reform will also allow national governments the ability to introduce programmes to target support to specific groups or industries. As shown in Figure 3, funding for each of these programmes is taken directly from the Basic Payment Scheme. This has the effect of reducing the funding available to non-targeted farms.

The implications from this ability to target support towards specific groups or industries is the risk that CAP reform could distort market competitiveness, both within and between industries. This issue is explored in the next section.

Farm level analysis

In this section, we consider the effect of implementing CAP reform on farm businesses in the UK and in Member States that are in direct competition with UK agriculture. To do this we explore the impact on a model farm in each sector. Each farm is examined based on several scenarios, exploring the movement of funds between pillars and possible introduction of programmes for targeted support through coupled payments.

The analysis also examines a set of ‘estimated direct support payments’, looking at how CAP may be implemented within each country.

The analysis is based on the latest information available as at 14 January 2014, using records available on government intentions to shift money between pillars3 and the possible use of coupled support. It is important to note that the consultation process is ongoing in many countries. As such, the use of targeted support remains open for debate. Readers may have their own opinions on the use of coupled support in each country.

The analysis is based on standardised farms for beef (both cow-calf and finishing farms systems) and dairy farms. This allows for a direct comparison of support payments by country/region. This analysis only considers one farm type for each sector in order to illustrate the potential impact from the implementation of CAP reform at national level. Details of each farm are outlined in the Table 2.

Farms in England, Scotland and Wales were examined on a regional basis, ie different hectares are paid at different rates depending on region (such as upland and lowland). Scotland and Wales will be gradually undertaking a shift from a historic to regional system for CAP payments. Our results look at payment rates under a full shift to a regional system. Other Member States will also be moving from a historic to an area-based funding system. This will see funding redistributed from high historic recipients (such as intensive beef finishers) to other recipients. The analysis below examines funding under a flat rate for non-UK (and Northern Ireland) countries due to the difficulties and complexities involved in examining a shift to an area-based regional system in each country. As such, results for these farms represent a national average.

Beef producers

Compared with other agricultural sectors, livestock producers show some of the greatest possible variation in support payments in the model4. Tables 3(a) and 3(b) illustrate the differences in support payments for a selection of beef farms (for both cow-calf and beef finishing enterprises). The tables show the range in direct support payments for each farm from decisions made by national governments to shift money between pillars and the use of targeted support (coupled payments). For the farm types examined, the difference in support payments under certain scenarios can be more than double payments received under less favourable situations.

Unsurprisingly, the highest returns to all farms involve the use of coupled support, combined with boosting direct support payments at the expense of rural development (reverse modulation). The smallest payments are based under scenarios where Member States reduce direct support payments in favour of rural development, with no targeted support.

As well as showing the range in payments for individual countries, Table 3 highlights the risk of changes in relative competitiveness between countries and the risk of market distortion from differences in payment rates. For the countries identified, the model suggests that direct returns to lowland cow-calf farms could theoretically vary by as much as €170/ha and by €145/ha for extensive beef finishers. It is important to note that the estimated results are based on the model farms presented above and the various assumptions used in the model itself. There remains uncertainty on whether coupling will be applied, as well as the possible rates that might be set.

For beef producers in the UK, English farms could be at a competitive disadvantage to producers in Scotland and Northern Ireland. Scottish beef producers could benefit from coupled support and a lower

level of modulation, while farms in Northern Ireland benefit from budgets based on initial allocations (ie no inter-pillar transfers). In comparison, with no coupled support in England and with 12% transferred from direct payments to rural development, English beef producers could be at a relative disadvantage.

English beef producers could also be at risk from increased competition from Ireland; a key supplier of beef to the UK. In our model, with a lower level of modulation and under the assumption that Ireland re-introduces coupled support to the beef sector, beef producers in England could receive direct support payments approximately 25–30% less than their Irish counterparts.

Although the analysis above only considers a lowland cow-calf farm and an extensive beef finisher, it is important to note that significant differences in payments will exist within a country depending on region and whether the farm examined is an intensive or extensive producer. Intensive units, for instance, tend to benefit from higher payments (measured in €/ha) from coupled payments than farms with large areas of land but fewer animals.

Dairy producers

In contrast to beef producers, due to the assumed absence of coupled support for dairy producers, dairy farms in this study show lower levels variation in payment levels between scenarios.

As the dairy sector has not previously been eligible for coupled support (such as through suckler cow premiums), the analysis assumes that they will not receive coupled support under any scenario. The introduction of coupled support as a national policy comes at a relative cost to the dairy sector, as money is moved from the Basic Payment Scheme to provide the coupled support. For dairy producers in England, the impact of government support for the livestock sector (beef and lamb) through coupled support could cost as much as €37/ha.

Within the UK, the model shows that Scottish dairy producers could receive some of the lowest payments per hectare. This is due to the cost of supporting coupled payments to the beef sector, reducing the budget available for area-based payments. In comparison, dairy farmers in Northern Ireland could receive some of the highest payment levels. This is partly due to the absence of any inter-pillar transfers and the decision not to introduce targeted support to the livestock sector, which would come as a relative cost to dairy producers.

It is important to note that, in addition to possible changes in income, the dairy sector also faces the end of the quota system. EU milk quotas – the system of supply management for the EU dairy industry – have been in place since 1983, but will cease to exist by end-March 2015. The final removal will bring to an end the period of transition that started in 2003 to realign the industry to become more market focused.

While production in the UK is not currently restricted by the quota, with production averaging 11% under quota over the last five years9, a number of EU countries consistently hit their respective allocations. The end of the quota system has been forecast with an increase in EU milk production by 7–8% between 2015 and 2020, resulting in an extra 10 million tonnes of milk by 2020, with the bulk of dairy expansion coming from Germany, France, Ireland and Poland10. Ireland, in particular, has already announced its intentions to increase milk production by 50% by 202011. This additional milk production will have to find a market, which could result in increased competition to UK dairy.

It is important to note that this increase in milk production could also result in an increase in (processing) beef entering the market as dairy herds increase. This knock-on effect could potentially impact on the UK’s beef industry, particularly product from Ireland, the UK’s largest supplier of beef.

Conclusion

There is a risk of the CAP becoming less ‘common’ driven by the increased flexibility to tailor CAP to the individual needs of Member States. The ability to transfer funds between Pillars, either boosting direct payments at the expense of rural development or vice versa, could result in an increase in the payments gap between countries, depending on the level and direction of transfer taken by different governments.

The additional ability to target support towards particular industries or groups could lead to market distortions in the beef industry. This sector is shown to have the highest levels of support and the greatest variation in support levels within our model. The possible introduction of coupled support to the livestock sector, for example, could impact on competitiveness between Member States as some governments choose to buoy support to their livestock industry. The extent of this will be dependent on decisions made by Member States, such as coupled payments rates as well as the possible introduction of other targeted support programmes.

As a result of increased flexibility, there could be a direct impact on the relative competitiveness of farms across the EU. The effects could be particularly felt among farms located in areas with similar conditions (such as topography, land type and climate), but situated on different sides of a border, potentially receiving very different payment rates.

Going forward, it is going to be crucial to carefully monitor the implementation of reforms in other countries that are in direct competition with UK farms. The decisions made by each country could have direct consequences not only for farms in that Member State, but to the competitiveness of different sectors and producers across the EU.

1 European Commission, ‘CAP towards 2020 Impact Assessment’, 2011. Analysis based on Option 1, whereby crop diversification refers to a minimum 3 crops, with no crop covering more than 70% of the arable area; 5% Ecological Focus Area; and the maintenance of permanent pasture.

2 Member States receiving less than 90% of the EU average are: Finland, Sweden, Spain, UK, Portugal, Lithuania, Estonia, Latvia, Bulgaria, Poland, Romania, Slovakia.

3 National governments were required to submit intentions to shift money between Pillars by 31/12/13.

4 See AHDB’s CAP reform analysis paper, accessible through the AHDB website for more detail.

5 The analysis is based on average returns over the period 2015–2020, and expressed in current prices. The results are expressed in €/ha, as this is the most commonly used unit of output.

6 Estimated returns are based on possible outcomes that may be implemented in each country, including the possible introduction of coupled payments and the rates at which coupled payments are set.

7 Estimated returns are based on possible outcomes that may be implemented in each country, including the possible introduction of coupled payments and the rates at which coupled payments are set.

8 Estimated returns are based on possible outcomes that may be implemented in each country, including the possible introduction of coupled payments and the rates at which coupled payments are set.

9 Source: Rural Payments Agency.

10 Source: Rabobank.

11 Department of Agriculture, Food and the Marine, ‘Implementation of Food Harvest 2020 in the Dairy Sector’.

David Swales

Head of Research and Industry, AHDB Market Intelligence, Stoneleigh Park, Kenilworth, Warwickshire, CV8 2TL

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