Instruments of market intervention in the European agricultural market and their impacts on supply

Table of content

1 Reasons for the common agricultural policy in the EU

2 Evolution of the European market intervention
2.1 Post-war-period till 1992 : price support, import levy and export
subsidy
2.2 1992 till 2004: coupled direct payments and rural development
2.3 2004 till 2013: decoupled direct payments
2.4 The GAP after 2013

3 Conclusion

1 Reasons for the common agricultural policy in the EU

With the foundation of the European Economic Community in 1957, which later became the European Union (EU), all member states agreed on an integration of their individual market in a common market which guarantees the free movement of goods, capital, services, and people. Right at the beginning of this process called European Integration, a common agricultural policy which supports, regulates and protects the European agricultural market was introduced.

The ancient reason for its establishment was the desolate food supply situation in Europe after the Second World War. As society and economy has been damaged by years of wars, the agriculture had been crippled^[1] and nearly all European states were dependant of food imports^[2]. In open competition, countrymen suffered huge changes in quantity and prices, which yield to an unsteady and under average income^[3] as well as an unsecure food supply for consumers^[4]. The agrarian market was supposed to failure without governmental intervention^[5]. In order to achieve a stable self-supply of affordable food and a better agricultural productivity^[6], the European agriculture was taken out of the regulation system of a free market economy and the common agricultural policy (CAP) came into force 1962.

The CAP was not meant to be a permanent form of market intervention^[7], but despite all endeavor for a free common market in the following years, the (modified) CAP it is still in force^[8]. As a supply-side economic policy, the CAP uses different instruments which are presented and evaluated in the following chapters. Figure 1 illustrates the evolution of the subsidies, their mixture and the percentage of the EU household which is spent on intervention in the European agricultural market. We can clearly distinguish three stages of the CAP, starting with the initial CAP in the post-war-period.

illustration not visible in this excerpt

Figure 1: Evolution of the CAP

Reference: http://ec.europa.eu/agriculture/cap-post-2013/graphs/graph2_en.pdf

2 Evolution of the European market intervention

2.1 Post-war-period till 1992: price support, import levy and export

subsidy

In order to offer incentives for farmers to produce more, CAP provided subsidies and systems guaranteeing high prices for agrarian products after the Second World War^[9]. The primary instrument to stable the common agricultural market was the price support by intervention pricing.

Figure 2 (on page 3) illustrates the mechanism of intervention pricing. In a free market, the market equilibrium settles down at the price p* and quantity Q* (point A). Now, the annual agrarian price circle of the EU^[10] sets the intervention price pI of certain agricultural products^[11] above the market price p*, which leads to a floor at pI. As the quantity demanded at the higher price pI is less than the supply at pI, there is an excess in supply (distance between QDI and QSI). To avoid the market price to be driven down to p* due to the missing demand, national intervention agencies occur as an additional consumer and, supposed the excess reaches exactly specified quality standards^[12], they are forced to buy out the excess^[13] at the price pI. This shifts the demand curve to the right to QD’ and market equilibrium at pI can be sustained.

illustration not visible in this excerpt

Figure 2: Intervention pricing and death weight loss, with respect to Eisen (2006), p. 2.

This approach increases the producer surplus from the triangle COA to FOE. As the pI > p*, the consumer surplus decreased from the triangle BCA to BFD. Although the increase in producers exceeds the decrease in consumers surplus (additional triangle DAE), there is a death weight loss whose which height depends on how the intervention agencies use the excess bought^[14]. They could sell the excess on the world market for the lower world market price, store or destroy it^[15]. In case of destroying, costs of DQDIQSIE plus the cost for the destruction process occur and are opposite to no net gain^[16]. Then the DWL would be DQDIQSIEA (red and purple area). If the excess can instead be sold at the world market at a price pW, the death weight loss decreases at the rectangle GQDIQSIH (purple area). But at the same time, the export revenue for the intervention firms lowers the producer surplus of farmers outside the EU^[17]. However, the negative allocation losses of intervention pricing are undeniable.

Instead of buy-in, Farmers can export the excess supply to the world market as well. This export does not seem profitable as the farmers revenue on the world market pW is lower than the intervention price pI guaranteed in the single market. To equal the export of the excess with the buy-ins ensured by the national intervention agencies, farmers receive an export subsidy raising their export revenues from pW to pI (see figure 3). This procedure downsizes the food stocks of the EU but causes negative pecuniary externalities to pW, given that the export amount is big^[18].

illustration not visible in this excerpt

Figure 3: Export subsidy (ES) and import levy (IL), with respect to Eisen (2006), p. 4.

[...]

^[1] Cp. Directorate-General for Agriculture and Rural Development of the European Commission (no year), p. 6.

^[2] Cp. at the same place, p. 7.

^[3] Cp. at the same place, p. 5.

^[4] Cp. Fehr (2009), p. 21.

^[5] Cp. Fehr (2009), p. 21.

^[6] Cp. Directorate-General for Agriculture and Rural Development of the European Commission (no year), p. 7.

^[7] Cp. Directorate-General for Agriculture and Rural Development of the European Commission (2009), p. 4.

^[8] For recent reasons for the CAP please refer to Directorate-General for Agriculture and Rural

Development of the European Commission (2009), p. 1-5.

^[9] Cp. Directorate-General for Agriculture and Rural Development of the European Commission (no year), p. 6.

^[10] Cp. Koester (1996), p. 12.

^[11] The CAP covered 90% of the agrarian end products under which are the most important are wheat, milk products, different kinds of meat, eggs, and fodder. Cp. Fehr (2009), p. 22.

^[12] Cp. Koester (1996), p. 17.

^[13] Cp. Eisen (2006), p. 2.

^[14] Cp. at the same place, p. 3.

^[15] Cp. at the same place.

^[16] Cp. at the same place.

^[17] Cp. Eisen (2006), p. 3.

^[18] Cp. Koester (1996), p. 14.