Norton Rose: predicting the impact of the CAP

The Common Agricultural Policy (CAP) started as a price support mechanism to improve food security after World War II, but has moved on significantly since then, most recently with the new 2014-2020 Policy. Paul Vine, partner in the Amsterdam office of global legal practice at Norton Rose Fulbright, takes a brief look back at the history of the CAP and provides some thoughts on its impact on agricultural investment.

As a mechanism to improve food security after World War II, the CAP led to significant oversupply in the 1970s and 80s. Product quotas were introduced to try to align production to demand and then, in the 1990s, the European Union (EU) reduced price support and increased direct payments to farmers. The direct payments were still made in connection with the production of certain products (so-called “coupled support”) but farmers had to meet food quality and sustainability requirements.

In 2000, the idea of Rural Development Support (RDS) was introduced; policies and payments to support rural Europe more generally.

The CAP is now based on two pillars: direct subsidies for food production and good agricultural practices, and RDS.

The main effect is to reduce income volatility. The policy does not protect against market failure or price volatility, except for a few emergency measures.

The 2014-2020 CAP 

Under the previous CAP (2007-2013), the direct subsidies ‘pillar’ gave farmers one direct payment, the Single Payment Scheme (SPS), depending on the type of land owned. This has been replaced by three payments:

• Basic Payment Scheme (BPS), which is similar to the SPS except that all BPS payments will be based on the area of farmed land which means CAP is fully de-coupled from production.

• Greening payment. There are specific incentives for greening practices for the first time.  One of the most hotly debated aspects of the 2014-2020 CAP, the result is arguably less ambitious than the green lobby had hoped, but still includes a concrete requirement and a penalty (up to 30 per cent of the direct payment) for failure to comply.

• Young farmer payment. Two thirds of EU farmers are now older than 55, meaning that the future of the rural community is in question. The young farmer payment is one tool to try to reverse this trend.

The second pillar, of Rural Development Support, should be less prescriptive in the 2014-2020 period. Member states will have flexibility to develop their own programmes within six broad areas – agricultural competitiveness, food chain organisation, ecosystems, resource efficiency and the low carbon economy, and social inclusion and poverty reduction.

One of the key discussion points here was around the flexibility that member states have to move up to 15 per cent of the funds available for payments to RDS 2.   In simple – and somewhat polarising – terms, this forces a choice between supporting agriculture and the rural environment.

When you start to consider CAP’s effect on agricultural investment, it is still relatively early on in the cycle to predict.  However, the EC Joint Research Centre (JRC) survey in 2014 polled a number of producers on investment intentions through the period.  Some of the key findings were:

• The average size of agri investment will be small (EUR 100,000s). Most of it will be in replacing/upgrading machinery and equipment which is not surprising given the short depreciation period of these assets

• Large scale investment by producers (i.e. increasing acreage by more than 50 hectares) will be relatively limited (JRC 2014 indicates only around 6% of activity at this level)

• Recipients of CAP payments are more likely to invest, but there is no significant difference in the CAP payments received by those who do and do not invest (JRC 2014). This means that it is hard to tell whether CAP affects investment at all, let alone the specific areas that it stimulates

• In fact, farmers tend to report that investments will be funded by a mix of own capital and bank debt with CAP subsidies only forming a small (less than 5%) of the investment price. There is some evidence that uncertain returns have more of an influence on investment decisions. So any policy initiative to reduce investment risk might increase investment more than CAP subsidies

• Other factors might have a bigger effect on investment. For example, the relevant country (e.g. more than 67% of the market surveyed in Germany and France intends to invest as opposed to  30% in Italy); and size of producer (e.g. those with more than 100 UAA are more likely to invest).

Beyond this, CAP’s effect on investment in EU agriculture is hard to predict for a number of reasons.

First, we are early in the CAP cycle and geo-political issues in Russia and Ukraine need to play out.

Secondly, there is relatively little quantitative data across the EU.

Third, the agri sector is hugely diverse (see for example the research by Swinnen & Knops 2013 – Land, Labour and Capital Markets in European Agriculture) in factors like land (consider for example that less than 20% of agricultural land is leased in Ireland but more than 80% in France); labour (in the context of a general outflow of agricultural labour, there are large regional differences); and rural capital markets (commonly inefficient because of transaction costs and information imperfections). These factors and the local investment climate play a significant role in investment decisions in addition to the isolated effect of the CAP.

That said, it is reasonably likely that overall the current CAP will have a relatively neutral or maybe slightly negative impact on external investment into agriculture overall.  The negative drivers are the smaller overall CAP budget in real terms; increased greening requirement; and (assuming that investors are focused on larger UAA) the new limits on CAP payments. Balancing elements in some cases will be the final transition to full CAP payments in new member states (for example, Bulgaria and Romania); and, in certain jurisdictions, an investor-friendly implementation of Pillar 2.