EU’s Common Agricultural Policy

(CAP) and its Impact on Inclusive

Growth

Initial findings

Not for quotation

For comments only

June 2017

Why is the World Bank interested in

contributing to the mid-term review of the

CAP? World Bank has a long history of supporting agricultural and rural

development all over the world

International experience could provide insights

World Bank has supported agricultural development in some of the New

Member States (viz. Bulgaria, Romania, Croatia, Cyprus, Latvia, Slovakia)

Regular Economic Report Series addresses EU-wide policy issues:

– RER 2: Sustaining Recovery, Improving Living Standards (Fall 2015)

– RER 3: Growth, Jobs and Integration: Services to the Rescue (Fall 2016)

– Planned RER 4: the EU’s CAP and its Impact on Inclusive Growth (Fall 2017)

Inclusive growth: successful structural transformation, which starts in agriculture

Before economic transformation takes off, agriculture:

– large shares in economic output and the labor force

– but the share in economic output less than its share in the labor force,

– lower productivity of labor than in industry and services.

Industrial growth takes off:

– industry, and in particular manufacturing, increases its share in the economy

– pulls labor out of agriculture more or less rapidly.

Services takes over…

However, there are no shortcuts to getting it right:

– moving people from farms to factories to offices is difficult

– poverty reduction starts in agriculture, which then allows people to accumulate

the resources needed to successfully move out of agriculture (see for instance

China, next slide)

– in middle income countries, agriculture remains important for jobs and poverty

reduction

Sources: Kuznets and Chenery, and Timmer, 2009; Stiglitz, 2016; WDR 2008

Structural transformation: China lifted 600 million people out of poverty.

Agriculture is first poverty “responder”: 300 million lifted out of poverty due to higher

incomes in rural areas, not through migration

Manufacturing is the second: 300 million people migrated from farms to factories.

Source: Urban China 2014

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Marginal product of labor in relation to total across sectors in China

Agriculture Industry Services

2nd industry

to services

The 1st transformation

from agriculture to

industry

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GDP growth originating in agriculture is more

inclusive

Source: Ligon and Sadoulet, 2007. Background paper to the WDR 2008 (see website)

Based on data from 42 countries (1983-2003)

How does agriculture support

inclusive growth? On farm, by raising agricultural profits and labor incomes

– With agricultural wages often the reservation wage for unskilled laborers economy-wide

Locally, by raising non-farm profits and labor income via strong multipliers: – Local agricultural growth multipliers generally vary from around 1.5 to

2.0

– Local consumption linkages even larger than production linkages

– Non-farm component of the rural economy is most dynamic and productive when farming is thriving (Datt and Ravallion, 1996)

– Farm households themselves diversify income sources to manage risk and seasonality

– Few industries locate to rural areas due to lack of economies of scope

Sources: Johnston and Mellor (1961), Delgado and Alfano (1994), WDR 2008, Delgado et al.

(1998), Block and Timmer (1994)

Agriculture in the EU Agriculture (narrowly defined as primary production):

– 1.4 percent of GDP

– 4 percent of total employment\

In 2010, in terms of numbers, 97 percent of all holdings were family farms:

– only 16 percent of total agricultural labor was performed by non-family workers

– Family farm households diversify their income sources (see next slide)

– Share of corporate farming in terms of area can be high in some NMS

Agriculture and agri-food businesses:

– 6 percent of GDP

– nearly 25 percent of total employment

Important social protection function for poor or vulnerable rural households:

– even in high-income countries, e.g. Greece after economic crisis

Contributes to rich variety of landscapes and habitats.

Farming is only part of farm

household income

Period Farming Off-farm

Investment and

property Transfers Others Total

Austria 2004-6 54 30 17 100

Denmark 2004-6 42 43 7 7 0 100

Finland 2003-5 27 42 18 13 0 100

France 2003 53 31 9 8 100

Germany 2003/4-5/6 80 20 100

Ireland 2004/5 32 45 2 19 2 100

Netherlands 2004/6 74 11 15 100

Poland 2003/6 67 8 21 3 100

UK 2002/3-4/5 40 28 21 11 0 100

average 52 30 11 13 7 100

Source: OECD, 2009

Farm Family Income (FFI) in Euro per Family Work Unit (FWU)

The European Model of

Agriculture

Competitiveness Sustainability Multifunctionality Across all regions

• Increase productivity

• Stabilize markets

• Availability of supply with affordable prices

• Improving rural livelihoods

Pillar I • Direct Payments – decoupled and coupled to

production

• Common Market Organizations

Pillar II Rural Development

Policy

Common Agricultural Policy (CAP) Shared Values, Common Objectives, 2 Financial Instruments

The Early

Years – 60s

Over

production

Exploding

expenditure

International

friction

Structural

measures

CAP in the

80s

Reduced

surpluses

Income

stabilisation

Budget

stabilization

Environment

and rural

measures

1992

Reform

Deepening

the reform

process

Food safety

and quality

Rural

development

as a 2nd Pillar

Reduction of

couples

payments

Consumer

concerns

Enhanced rural

development

WTO

compatibility

2003

Reform

Greening

Producer

organizations

Young farmers

Innovation &

research

Stability funds

2013

Reform

Food supply

Improving

productivity

Market-

stabilisation

Product

support

Agenda 2000 Agenda 2000

Market support

Enhancing production

capacity

Market orientation &

limiting public spending Diversity, competitiveness,

sustainability

Reforms of the CAP

CAP Pillar 1: decoupled payments

largely replaced coupled payments

Source: EC, staff calculations

Result: less distortions EU agricultural commodity prices

no longer very much above international prices

Source: EC, staff calculations, 2017.

7/5/2017 14

World Bank study on role of the CAP Assessing past impact on inclusive growth to distill policy

suggestions for the future on:

– Poverty

– Agricultural productivity

– Agricultural employment (including family labor)

– Local economic growth and rural employment

Methodology:

– Overall approach: time series of countries and regions (NUTS 1, 2 and 3)

– with the “treatment” (CAP programs) coming in at different years, and at

different intensities and mixes

– Not a “snapshot”, not a simulation

Methodology

Heterogeneity—in local conditions and how CAP is implemented—is a blessing and a curse:

– Correlation patterns need stakeholder and local knowledge to interpret and draw policy lessons

– Attribution and causality will be impossible to establish…

Data on farm and non-farm income are incomplete, while definitions vary by country

Poverty in the EU:

absolute poverty levels differ starkly

Note: (1) Data source: EU-SILC 2011, Eurostat; (2) Absolute poverty line: $21.7 PPP2011; (3)

Relative poverty line: 60% of national median

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Pove

rty

(per

cen

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Population at risk of poverty NUTS 3 regions

Agriculture and poverty are not

correlated…

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mb

er o

f p

oo

r

0 20 40 60 80 100Agriculture share of area

Number of poor Fitted values

Number of poor and agriculture share of area (zoomed)

Very small farms are in areas of high

poverty…

but so are very large farms

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25

30

35

Pover

ty r

ate

0 100 200 300Average plot size (hectare)

Predictive Margins with 95% CIs

Agricultural jobs and income reduced poverty (2009 to 2013; in percentage points of changes in poverty)

20 Note: (1) Data source: EU SILC, Eurostat 2010-2014 (Survey years); Shapley Decomposition, author’s own calculation.

Anchored poverty to 2009 relative threshold (income year)

In contrast to non-agricultural jobs and average earnings (2009 to 2013; results in percentage points of changes in poverty)

21

Note: (1) Data source: EU SILC, Eurostat 2010-2014 (Survey years); Shapley Decomposition, author’s own calculation.

Anchored poverty to 2009 relative threshold (income year)

Regions with higher household diversification

have greater poverty reduction

22

Notes:

(1) Panel Fixed Effects; All regressions include year fixed effects; (2) Anchored Relative Poverty line (60% of

median at 2011); (3) Data Source: EU-SILC, Eurostat; (4) Symbols: ** P<0.01, * P<0.05, +P<0.1

(1) (2) (3)

Poverty rate Poverty rate Poverty rate

Share of individuals living in agriculture households 0.64+ 0.18 0.50+

Household diversification index -1.71* -0.96+

GDP per inhabitant -0.01** -0.01**

Share of inhabitants with secondary education 0.06 0.05

Share of inhabitants with tertiary education -0.00 -0.01

Unemployment rate

R-Squared:

Within 0.38 0.44 0.45

Between 0.18 0.14 0.16

Overall 0.25 0.14 0.17

Observations 928 928 928

CAP payments go to areas of absolute

poverty

23

(3.1.1) (3.1.2) (3.1.3) (3.1.4) (3.1.5) (3.1.6) (3.1.7) (3.1.8) (3.1.9) (3.1.10)

LABELS Poverty rate Poverty rate Poverty rate Poverty rate Poverty rate Poverty rate Poverty rate Poverty rate Poverty rate Poverty rate

Total CAP payments 1.40e-08 1.60e-08*

Pillar 1 CAP payments 7.92e-09 1.12e-08+

Pillar 2 CAP payments 1.07e-07** 1.01e-07**

Pillar 1 coupled CAP payments -6.55e-08 -4.78e-08

Pillar 1 decoupled CAP payments 1.30e-08 1.43e-08

Population density(Inhabitants per hectare); 0.0970* 0.0944* 0.0965+ 0.0814* 0.107*

Gross Domestic Product(Purchasing power

standard (PPS) per inhabitant)

-0.000144+ -0.000147+ -0.000139* -0.000146* -0.000150*

Poverty line -0.000378* -0.000347* -0.000844** -0.000358* -0.000489*

Number of zero-beneficiaries 1.214+ 1.240+ 2.993 1.320+ -1.323

Constant 13.22** 22.12** 13.58** 22.09** 12.01** 28.83** 13.94** 22.60** 13.51** 25.12**

Country fixed effects Y Y Y Y Y Y Y Y Y Y

Observations 1,150 1,150 1,150 1,150 1,150 1,150 1,150 1,150 1,150 1,150

Adj R-squared 0.261 0.322 0.257 0.318 0.281 0.326 0.260 0.320 0.259 0.306

Note:

(1) Data source: EU 2011 Poverty Map (DG-REGIO and World Bank), 2010 Farm Structure Survey (Eurostat), and EU National Statistic

Institutes (Eurostat);

(2) Symbols: ** p<0.01, * p<0.05, + p<0.1;

(3) Missing observations in agricultural indicators are treated as zero;

(4) Luxemburg, Cyprus Republic, Croatia and Estonia are not being analyzed here

Note: All regressions include year fixed effects

CAP payments are associated with areas in

which poverty has fallen the fastest

24

(1) (2) (3) (4) (5) (6) (7) (8)

Poverty rate Poverty rate Poverty rate Poverty rate Poverty rate Poverty rate Poverty rate

Poverty rate

Total payments -0.05+ -0.05* -0.05** -0.05** -0.04 -0.04

Payments to pillar1 -0.02 -0.08+ -0.02 -0.10* -0.03

Payments to pillar2 -0.02 -0.08+ -0.02 -0.10* -0.03

Coupled payments -0.02 0.03 -0.01

Decoupled payments 0.01 0.05 0.01

Agricultural employees 0.02 0.02 0.02 0.02 0.02 0.02 0.02 0.02

GDP per inhabitant -0.01* -0.01* -0.01* -0.01* -0.01* -0.01* -0.01* -0.01*

Share of inhabitants with secondary education

0.14+ 0.14* 0.14* 0.14* 0.14* 0.14* 0.14* 0.14*

Share of inhabitants with tertiary education

0.05 0.05 0.04 0.04 0.06 0.05 0.05 0.05

Unemployment rate 0.18 0.18 0.18 0.18 0.19 0.18 0.18 0.18

R-Squared:

Within 0.47 0.47 0.47 0.47 0.47 0.47 0.47 0.47

Between 0.40 0.39 0.40 0.40 0.40 0.39 0.40 0.39

Overall 0.41 0.40 0.41 0.41 0.41 0.40 0.41 0.41

Observations 803 803 803 803 803 803 803 803

Literature Review on CAP impact

Growth: little to mixed impact

– Studies using simulation, mathematical and/or partial equilibrium modelling: mixed impact

– Survey data based methods: little impact

Productivity: negative impact

– Overall, negative; coupled: negative, but decoupled more positive

Employment:

– Pillar 1: negative impact

– Pillar 2: mixed impact

Gender, youth:

– CAP drives up land prices, which constrains access for these groups

CAP direct payments are biased towards large land holdings:

– About 80 percent of payments (70 percent of the CAP or 28 percent of the total EU budget),

go to only 20 percent of the farmers

Growth, productivity and jobs:

preliminary results

Panel regression at NUTS 2 regional level (EU28; 1989-2013)

CAP components:

– Pillar I payments (coupled and decoupled subsidies)

– Pillar II

Impact on:

– regional GDP growth;

– agricultural productivity, as measured by agricultural VA per worker; and

– the share of agricultural labor as a share of total labor

In Old Member States (OMS) and New Member States (NMS)

Regional GDP Growth CAP expenditures are positively correlated with regional GDP growth,

– findings measure “gross effects”, without taking into account the negative

effects of taxation for financing of these expenditures

Regional GDP is lower in regions with a high share of agricultural

employment

– because of lower productivity in agriculture compared to other sectors

– are CAP payments keeping resources in low-productive activities?

Growth effect is stronger for “non-distortionary” CAP support (which

includes both pillar 2 payments and decoupled pillar 1 payments)

– In OMS, where Pillar 1 historically was mostly coupled payments

(“distortionary”), Pillar 2 effects are stronger

– In NMS, where Pillar 1 is mostly decoupled, little difference between Pillars

Agricultural Productivity

In theory, effects of CAP payments on agricultural productivity:

– Negative by distorting optimal resource allocation—especially for coupled

payments

– Positive by reducing credit constraints—especially for decoupled and in regions

with strong credit constraints, like NMS

– Positive by mitigating risk—especially for decoupled

OMS: we find no significant impact of CAP payments on productivity

– Do the negative effects offset the positive effects?

NMS: strong positive impact of CAP payments on productivity

– Possibly because NMS has most payments are decoupled (Pillar 1 and 2) and

thus less distortionary)

Hypothesis: decoupling of CAP contributed to positive effect on

agricultural productivity

Agricultural Employment

In OMS: CAP payments tend to reduce outflow of labor of agriculture

– Only non-distortionary subsidies (Pillar 1 decoupled and Pillar 2) have a

significant effect

– Do decoupled, non-distortionary payments stimulate higher productivity

agriculture, in contrast to the coupled payments which keep farmers in low

productivity agriculture?

In NMS: no impact of CAP payments on agricultural employment

– Is increased productivity effect offset by shift from labor to other inputs (land

and capital), as payments were linked to land?

– Is there a bias of CAP payments to larger, less labor-intensive farms?

Growth, productivity and jobs: preliminary CAP policy suggestions

Three indicators of “jobs and growth”: regional GDP, agricultural labor

productivity and agricultural employment

Hypothesis:

– Non-distortionary policies (decoupled payments in Pillar 1 and investment

support in Pillar 2) performed better than coupled payments.

Policy implications:

– continue reform shift from coupled payments to decoupled payments (in Pillar

1) and to rural development and other measures (in Pillar 2)

– target payments better to poverty reduction and job creation

7/5/2017 31

Overall strategic agenda To meet the challenge of inclusive growth:

– Rural and agricultural growth is needed

– As part of successful structural transformation

Macro agenda:

– Reduce urban bias in basic services, e.g. health, education (including life-long learning), internet.

Sector agenda:

– Rural roads, electricity and communications, including internet

– Rural finance, savings and insurance, risk management

– Agricultural extension and technology transfer

– Support environmental services more efficiently by better targeting CAP payments

– Add value to basic farm products through quality labels, short supply chains, on-farm diversification, producer organizations, etc.

Timeline

Further analysis (July, 2017)

Field visits and revised analysis (August, 2017)

Draft report for comments (early September, 2017)

Review workshop (mid September, 2017)

Final report (mid October, 2017)

Team Rogier van den Brink, Hans Kordik and Joao Pedro Wagner De Azevedo (co-

Task Team Leaders, World Bank)

Team members: Jo Swinnen, Maria Garrone, Dorien Emmers (University of

Leuven), Attila Jambor (Corvinus University, Budapest), Alessandro Olper

(University of Milan), Matija Laco, Marianne Grosclaude, Paul Andres Corral

Rodas, Emilia Skrok and others (World Bank)

Reviewers: Tassos Haniotis, Director for Strategy, Simplification and Policy

Analysis of DG AGRI (European Commission), Holger Kray (Lead Agriculture

Economist, World Bank), Csaba Csaki (Professor at Corvinus University), Hans

Binswanger (University of Pretoria) and Alan Mathews (Department of

Economics, Trinity College Dublin)

Advisor: Dacian Julien Cioloș (former European Commissioner for Agriculture

and Rural Development and Prime Minister of Romania)