lsird

The James Hutton Institute

This page is no longer updated. The Macaulay Land Use Research Institute joined forces with SCRI on 1 April 2011 to create The James Hutton Institute.

Please visit the James Hutton Institute website.

The influence of the WTO negotiations on future policy development

David Legg

Whereas the major reason for change during the 1980s. when milk quotas were introduced, was the increasing cost of the budget, the overriding pressure for fundamental reform of the CAP in the 1990's has been the need for the European Union to comply with the commitments made within the Uruguay Round of GATT. This need will be extended further for negotiated settlements within the WTO in the years ahead. Enlargement of the EU to the East also poses problems for the CAP, however, these must be seen within the context of future WTO agreements.

Internal pressures for change within the European Union also exist but are secondary in driving fundamental reform when compared to external trade pressures. Internal EU issues include budgetary pressure, environmental concerns, animal welfare concerns and, especially in the light of the BSE crisis, the demands and concerns of consumers within the EU. These concerns will influence policy changes, however, the WTO is likely to be the most significant factor in driving policy change in the agricultural industry.

The aim of the 1992 reform of the CAP was to pave the way for a successful conclusion to the Uruguay round negotiations on trade liberalisation. It had become clear that European production of price supported commodities, most significantly cereals, milk and beef, was on a rising trend while internal consumption was at best static. In order to meet the demands for reductions in the volume and value of EU export refunds it was necessary to implement policies that at the same time as limiting EU production would realign support prices closer to world levels. The cereals sector experienced the most radical reduction in price with offsetting compensation in the form of direct payments and supply control via set aside being implemented. However, cereal support price cuts of the order of 30% drastically alter the comparative costs of production of intensive and extensive livestock. Hence simultaneously beef support prices were cut with offsetting increases in direct payments on suckler cows and male beef animals. Supply control in the beef sector was indirect via limits on the number of claims under the Suckler Cow premium and Beef Special premium being put in place. The dairy and sheep sectors were left relatively unscathed by the 1992 CAP reform with milk quotas being retained as the method for controlling production.

The most important factor that will influence livestock farming in less favoured areas in any future WTO round will be changes in the CAP to the beef, sheep and dairy regimes. However, it is likely that there will be less pressure to change the sheep regime, since this is based on deficiency payments and therefore not as heavily dependent on price support as the beef and dairy regimes. It would be fair to assume that the next WTO Round will continue in the same direction as the first, that is that it will be based on the same three areas; domestic support; export subsidies and tarrification. Further cuts in tariffs are likely to form a central part of the WTO round, this means that in some cases, depending on the size of the tariff reduction and the gap between European and world prices, EU support prices will have to be cut in order to prevent import penetration.

It is likely that as the next round of multi-lateral discussions over further trade liberalisation are due to commence within the WTO, the EU will begin to experience a re-emergence of significant surplus of stocks of cereals, dairy products and beef. Indeed, the recent market reports produced by the Commission (DGVI) suggest that if the CAP remains unchanged for the next 8 years the EU will end up with intervention stocks of nearly 80 million tonnes of cereals and 1.5 million tonnes of beef by the year 2005. This forecast is made on the basis that there is no change in our GATT commitments over this period. If a new WTO round leads to futher cuts in export subsidies, then the surpluses would be even higher by 2005.

Given the GATT commitments which progressively reduce the volume of EU exports, the long term choice is a relatively straight forward one. Either effective supply controls will have to be introduced which cut production in response to a shrinking export market. This strategy would have the advantage of enabling internal EU prices to be maintained at a higher level but would require significant and progressive cuts in volume produced and would directly lead to a loss in world market share for EU agricultural products. Indeed, if further tariff cuts lead to a greater volume of imports Europe would even risk losing a share of its own internal market. The alternative is to develop methods of agricultural support which do not distort prices and international trade and allow EU agricultural production to expand. This approach would essentially mean reducing or even removing price support and abolishing supply control.

A factor that will undoubtedly influence the next WTO round of negotiations is the change in direction of policy that occurred during the 1996 US Farm Bill. This significantly reduced the level of support in the US and decoupled it from production. A greater proportion of US policy instruments will now be eligible for the "green box" and will be protected from future cuts in support. The US will therefore have no interest in prolonging "blue box" measures into the next WTO round. The US are therefore expected to seek further significant cuts in the overall level of agricultural support within the WTO. Thus, either the EU will have to itself consider switching to more decoupled payments or it will have to make substantial concessions elsewhere to buy the prolongation of the "blue box".

The recent Commission document "Long term prospects" suggests that beef stocks will rise to 1.5 million tonnes by 2005. The problem for the EU beef regime is that the option of disposing of this surplus onto world markets with subsidies has been closed off by the GATT agreement. If beef consumption fails to recover and resumes its downward trend then against a background of GATT dictated cuts in exports and increases in carcase weights by 1998/99 the regime will be in crisis. While the short term measures adopted so far could enable the regime to survive over the next three years longer term radical reform of the beef regime is inevitable.

While the mechanisms that could be used to attain the solution are myriad in practice there are two possible basic routes that can be taken. The first involves rebalancing the internal market by ensuring that the supply of beef contracts to enable price support to be maintained and existing GATT commitments met. The second more radical option is to continue reform along the lines of the 1992 CAP Reform which began to switch agricultural support from price support to direct payments to producers. This second route would attempt to realign internal beef prices with world market prices and could well involve substantial price cuts.

The introduction of supply controls have enabled internal EU beef prices to be maintained significantly above prices obtained by farmers outside the EU. As a reform strategy, lower prices unaccompanied by compensation will never be the preferred option of beef producers as they are clearly made worse off. Further rounds of supply management to prolong the current regime will always seem superficially attractive, especially to those whose main concerns are short term. The benefits of price support are immediate whereas the alternative strategy would be fraught with uncertainty.

A policy of fully compensated price cuts would, in theory, be an ideal solution to the problems facing the beef sector. By reducing internal beef prices towards world levels the requirement to subsidise EU beef exports would be obviated. Such a policy would remove the GATT constraints on exports. Hence existing controls on production could be lifted and further cuts in production avoided. At the same time full compensation would protect the current levels of income within the sector. The question marks over this policy would be whether full compensation is politically achievable and the modalities of paying this compensation.

The compensation would be subject to a challenge at the World Trade Organisation were it not demonstrably non-trade distorting. The ideal policy would therefore be one in which not only were the price cut fully compensated but that this compensation were delivered in a manner compatible with the inclusion of these payments within the Green Box. This would not be the case if compensation for further price cuts simply added to the existing headage payment system. Hence the interest in developing decoupled support policies in the extensive livestock sector along the lines of those pursued in the arable sector.

Whether full compensation for radical price cuts in the beef regime could be funded under the existing CAP budgetary guidelines is a key question. Full compensation, even offset by reduced expenditure on storage of intervention beef and export refunds, would increase expenditure on the beef regime considerably and would therefore not be budgetary neutral.

Conceivably compensation payments for beef could be related to any of the following:-

There could be scope to attach environmental conditions to receipt of these payments although the cut in output prices ought to reduce the incentive to intensify grazing. However were these environmental conditions to impose additional costs on producers then the compensation paid would no longer be sufficient to maintain pre-reform income levels and the additional costs could well hamper the international competitiveness of the European beef industry.

Some commentators, and this would certainly reflect the view of the OECD and UK government, see decoupled support as a mechanism to allow supported European agriculture to achieve a transition to a more competitive world in which trade barriers would be lower, export subsidies abolished and agriculture less dependent on subsidy. At the end of the transition period agriculture in Europe would be operating at much lower levels of public support, would in all probability produce substantially less overall output, would be characterised by larger production units and would take place at a much reduced level in more marginal upland areas in the absence of specific policies designed to counter this effect.

Over the course of the GATT Agreement and certainly over the course of the next WTO round cuts in tariff levels will put the current EU dairy policy under considerable strain. If tariffs were cut by a further 36 per cent for butter in the next WTO round (a cumulative cut of 59 per cent between 1995 and 2009) landed prices of butter in the EU would be some 20 per cent below current EU intervention prices even if prices remained at the average level seen between 1993 and 1995.

It is recognised that milk quotas have helped to both improve and stabilize dairy farm incomes over the past 12 years. However cuts in tariffs and subsidized exports will force milk prices to fall and quota to contract in the years ahead. Three options can be identified to resolve this problem:-

Further cuts in the level of subsidised exports might be dealt with by a quota cut of say a further 2 per cent but if combined with declining domestic consumption then much larger cuts might be required to maintain market balance.

A policy of steep price cuts, similar to the 1992 cereal reform, accompanied by the removal of quota, would not require a cut in prices as great as 50 per cent, which is the average gap between EU and world prices. This is both because prices may be higher in the future and because even with a price differential some higher value-added products may be exported without subsidy.

B-Quotas would enable the dairy industry to maintain its current size in the face of tightening constraints under the GATT. However there are several major draw-backs to such a policy. These include its complexity, its compatibility with the GATT, its longevity given reduced tariffs and its uneven effect between Member States.

The decision as to which policy option is the best will differ between individual producers. The age of an individual producer, his financial situation and any plans he may have for the future of his dairy enterprise are all important considerations. Those producers who have no plans to expand and only hope to remain in the industry for another 5-10 years are more likely to be attracted by the stability and relative security provided by a milk quota system. However a producer with long-term plans within the dairy industry and who may have the ability to expand and develop his business is more likely to be attracted to other options. The same is probably the case for new entrants.

During the Uruguay Round of negotiations the European Union negotiators gave notice that they were determined to resist imposed cuts in Hill Livestock Compensatory Allowances (HLCAs) paid in Europe's disadvantaged areas. These, they declared, would have to be regarded as Green Box measures, as they were essentially social in nature.

In the event, this argument was never put to the test because the final Agreement in Agriculture specifies that internal support cuts could be made on an aggregate basis rather than commodity by commodity and programme by programme. The support price cuts in cereals and beef in the EU effectively met the 20% cut in total support which the EU was required to make.

This argument may resurface in the next WTO Round. Although some may argue that payments in disadvantaged areas are social or environmental, in practice they are paid on individual livestock units and would certainly not fit into the Green Box as currently defined. Indeed, some environmentalists in Europe argue that because they are paid per livestock unit that they encourage over stocking which can result in actual environmental damage.

There may therefore be some pressure to change the nature of HLCA payments to ensure that they are exempt from WTO cuts. This could be done in a variety of ways: