Reform of the European Union’s Common Agricultural Policy:...

ELSEVIER European Economic Review 42 (1998) 375411

Reform of the European Union’s Common Agricultural Policy:

How to reach GATT-compatibility?

Silvia Weyerbrock *

Department of Food and Resource Economics, Delaware Agricultural Experiment Station,

University of Delaware. 233 Townsend Hall, Newark, DE 19717. USA

Received 1 January 1996; accepted 1 December 1996

Abstract

This paper studies the reform of the European Union’s Common Agricultural Policy (CAP). It examines three questions: (I) do current reforms meet the targets specified in the Uruguay Round Agreement? (2) what additional reforms are needed to make CAP GATT-compatible? and (3) does CAP reform alleviate the EU’s budgetary problem? To investigate these issues, we use a six-region, 13-sector computable general equilibrium model with explicitly modeled policies. We find that CAP reform worsens the EU’s budgetary situation and does not meet the GATT targets. We quantify support price reductions and quota increases needed to reach the targets. 6 1998 Elsevier Science B.V. All rights reserved.

Keywords: Agricultural and trade policy reform; Explicit policy modeling; Uruguay Round Agree-

ment; European Union; Common Agricultural Policy

1. Introduction

This paper studies the reform of the European Union (EU)‘s Common

Agricultural Policy (CAP). It examines three questions: (1) do the reforms that

the EU is currently implementing meet the targets specified in the Uruguay

*Tel.: (302) 831-1323; hx: (302) 831-3651; e-mail: [email protected]. Published as Paper No. 1617

in the Journal Series of the Delaware Experiment Station.

0014.2921/98/$19.00 Copyright $2 1998 Elsevier Science B.V. All rights reserved

PII SOO14-2921(97)00066-4

376 S. Weyerhrock / European Economic Review 42 (I 998) 3 75-41 I

Round Agreement? (2) what additional reforms are needed to make CAP compatible with the GATT agreement? and (3) does CAP reform eliminate the EU’s persistent budgetary problem? To investigate these three questions, we use

a six-region, 13-sector computable general equilibrium (CGE) model. This model includes the EU, the European Free Trade Area (EFTA), Eastern Europe, the former Soviet Union, and the US. We model agricultural and trade policies explicitly, i.e., as endogenous and coupled instruments, wherever applicable. In

contrast, most existing work approximates policies as exogenous price wedges. The Treaty of Rome, establishing the European Union in 1958, singled out

agricultural policy as a cornerstone of the Union. Whereas policies for industrial

sectors remained largely in the domain of member states, the EU adopted a Common Agricultural Policy based on a common market, common policies, and financial solidarity. Since the 1980s the CAP ~ characterized by high price supports for most agricultural products, isolation of domestic from world markets, and large public expenditure - has caused budgetary crises, trade wars, and deadlocked GATT negotiations. Nowadays, it complicates integration between Eastern and Western Europe.

The CAP’s principal policy instruments are variable import levies and export subsidies. Internal market support measures such as intervention purchases supplement border measures. To limit budgetary cost, the EU restricts quantities eligible for support, imposes levies on producers, and offers voluntary land set-aside schemes. In this paper we first examine how a step-by-step change in two of the CAP’s major policy instruments ~ intervention prices and set-aside rates ~ influences the Union’s agricultural and macroeconomic indicators. Then we examine the budgetary, trade, and production implications of the CAP reform package adopted by the EU Council in 1992. This reform partially replaces price supports with headage and hectarage payments and introduces mandatory set-asides for large farmers. We examine whether it is compatible with the GATT agreement. The 1993 GATT agreement requires the tariffication of all nontariff barriers, minimum market access, and reductions in internal support, the volume of subsidized exports, and export subsidy expenditure. Because we find that some agricultural sectors do not meet the export competition targets after reform, we quantify by how much the EU has to increase its land set-asides and production quotas or to decrease its intervention prices to achieve these targets. ’

’ We note that many economists have advocated CAP elimination as the only “true” reform. This

would certainly make the CAP compatible with GATT. Studies suggest that it may also lead to real

income gains in the European Union between 0.1% and 3.7% (Harrison et al., 1995b; Parikh et al.,

1988; Folmer et al., 1995; Tyers and Anderson, 1992; Martin et al., 1990; Goldin and Knudsen, 1990; Burniaux, 1989). These estimates differ because of differences in model structures, time and policy

coverage, and extent of liberalization assumed.

However, a complete ehmination of the CAP appears unlikely for political reasons and, therefore, will not be studied in this paper.

S. Weyerhrock,l European Economic Recirw 42 (IYYN) 375-411 317

To investigate the economic effects of agricultural policy reform, we use a six-region, 13-sector CGE model including the EU, EFTA, Eastern Europe, the former Soviet Union, and the US. We choose a CGE model over other empirical models because it captures the intersectoral, factor-market, budgetary, and macroeconomic implications of agricultural policy reform. In the EU, such policy reform has large budgetary and sizable intersectoral effects despite a small share of agriculture in EU GDP, employment, and trade. Some existing general equilibrium models of Europe have addressed EU agricultural protection and policy reform (Frohberg et al., 1989; Burniaux, 1989; Burniaux and Waelbroeck, 1989; Burniaux et al., 1990a, b; Stoeckel and Breckling, 1989; Harrison et al., 1989, 1990, 1995b; Hertel et al., 1991; Folmer et al., 1995; Centraal Planbureau, 1993). Other CGE models have examined the economic implications of the Uruguay Round Agreement (Goldin and van der Mensbrugghe. 1995; Francois et al., 1995; Harrison et al., 1995a; Hertel et al., 1995). Our model improves on these models by providing a detailed coverage of agricultural sectors central to the CAP and by explicitly representing most CAP instruments. In addition. we quantify policy

changes needed to satisfy the GATT agreement. The outline of this paper is as follows. Section 2 discusses principles underly-

ing the CAP, and its policy and commodity coverage. We also describe a typical policy regime. In Section 3 we summarize factors that prompted CAP crises. Section 4 discusses the 1992 CAP reform package and the 1993 GATT Agree- ment on Agriculture. We explain our model, policy modeling approach, and data sources in Sections 5-7. Section 8 describes the reform experiments. Our results and concluding remarks follow in Sections 9 and 10.

2. Characteristics of the Common Agricultural Policy ’

Principles and policy cocerage: The CAP is based on four principles: market unity, community preference, joint financial responsibility, and producer co- responsibility. Market unity implies that products circulate freely among EU

member states. It requires the common organization of markets, common prices, currency stability, and harmonization of administrative, health, and sanitary regulations. On the EU market, community farm products have prior- ity for sale over imports; imports are subject to tariffs, quotas, or variable levies. EU member countries finance the CAP jointly. Because agricultural expenditure exhausted the EU’s budget repeatedly, grain, milk, and sugar producers pay

a small part of CAP expenditure since the 1980s. CAP mainly includes market and price policies (Table 1). Such policies

apply to most agricultural commodities produced within the EU. National

‘This section is based on K6ster and Tangermann (1990) and CAP Monitor (various years)

378

Table I

S. We_verbrock / Europeun Economic Reriew 42 (1998) 3 75-411

CAP policy instruments by sector before reform

Commodity Import regulation Internal support Export regulation

Grains Variable levies

Rice Variable levies

Oilseeds Tariffs

Sugar Variable levies,

import quotas

Fruits and

vegetables

Beef and veal

Mutton and

lamb

Pork

Poultrymeat

and eggs

Dairy products

Tariffs, countervailing

duties, quotas.

tariff- quotas

Tariffs, quotas.

variable levies, special

trade arrangements

Tariffs, voluntary restraint

agreements with major

suppliers

Variable levies,

supplementary levies

Variable levies,

supplementary levies

Variable levies

Intervention purchases. Variable refunds

production subsidy for durum

wheat, production refund for

wheat and maize starch for

non-food uses,

co- responsibility levy

Intervention purchases, Variable refunds

production subsidies

Milling subsidies, Variable refunds

co- responsibility levy

Common prices for specified Variable refunds

quantities, production quotas,

intervention purchases for

sugar purchased within quota,

various levies

Intervention by producer

organizations.

market withdrawal,

compensations

Variable refunds

Optional intervention

purchases,

private storage aids,

headage premiums

Variable refunds

Variable premiums,

annual premiums,

optional intervention

purchases,

private storage aids

Variable refunds

Intervention purchases in

exceptional circumstances,

private storage aids

Variable refunds

Variable refunds

Production quotas, Variable refunds intervention purchases for

butter and skim milk powder,

private storage aids,

subsidies for disposal,

special sales schemes,

co-responsibility levy

Note: Intervention purchases are mandatory if not otherwise mentioned. Sources: Koster and Tangermann (1990) and CAP Monitor (various issues).

S. Weyerbvock / European Economic Review 42 (1998) 375~- 411 319

agricultural policies of EU member states anchor on structural and social policies. The Union expanded structural and social programs targeted at its less developed regions only recently.

Design of a typical regime: An elaborate system of price supports applies to many agricultural products. It builds on three prices: the target price, the threshold price, and the intervention price. The target price defines the indica- tive market price for EU producers and represents (theoretically) the upper end of a range in which producer prices fluctuate. Imports enter the EU at the threshold price. The intervention price provides a floor below which market prices should not fall. Intervention agencies buy agricultural commodities at the intervention price. Each year the EU Council of Agricultural Ministers sets the

target, threshold, and intervention prices at a common level for all member states in European Currency Units (ECUs). The support prices - usually set in response to political and financial pressures - are converted into national currencies at green rates of exchange. 3

Despite modifications of the price-support system over time, the intervention price remains largely the minimum price guaranteed to producers. To limit budgetary expenditure, co-responsibility and producer levies for milk, cereals and sugar, and output quotas for sugar and milk were introduced. The EU also offers an optional acreage set-aside scheme.

Various trade barriers protect the EU’s agricultural markets from foreign competition. Variable levies, that bridge the gap between the threshold price and the world market price, apply to most agricultural imports. The EU does not apply variable import levies and quotas to imports of oilseeds

and cereal substitutes. Former colonies of Union members in Africa, the Caribbean, and the Pacific obtained preferential import quotas for sugar and

beef. To dispose its excess production on world markets, the EU uses variable export subsidies that bridge the gap between the price on the Union market and the world market price. It may target such refunds according to country of destination. Moreover, monetary compensatory amounts (MCAs), internal tariffs and subsidies, apply to intra- and extra-EU trade in many agricultural

products. The most frequently used non-price support instruments are storage

subsidies (beef, pork, poultry), deficiency payments (oilseeds), and production premiums (beef, sheep). Non-price support measures also include structural

measures such as support of irrigation schemes, R&D, and reforestation

projects.

3 The Council of Agricultural Ministers consists of the secretaries of agriculture of ELI member

states. Green exchange rates are used for agricultural transactions, and differ from conversion rates

applying to industrial goods and services. They limit the impact of exchange rate fluctuations on

national agricultural prices.

380 S. Weyerbrock 111 Europeun Economic Reriew 42 (IYYX) 375 41 I

3. The Common Agricultural Policy in crises

Since the early 1980s the CAP has caused budgetary crises, trade wars, and has deadlocked GATT negotiations. According to Kiister and Tangermann (1990) the following factors prompted CAP crises: (1) a change in the EU’s net trade position from being the world’s largest importer of temperate-zone agricultural products to being the world’s second largest exporter; (2) exploding agricultural expenses leading the EU repeatedly into near-bankruptcy (Table 2): (3) failure to meet CAP objectives such as income parity between rural and

urban workers and harmonization of rural living standards among regions; (4) sensitivity of the price support scheme to exchange rate realignments; (5) dif- ficulties in policy formation; (6) international pressure (GATT, agricultural exporters) to eliminate or change basic CAP mechanisms; and (7) opposition from environmental groups. Among these factors, budgetary and international pressures have given the strongest impetus for reform.

4. CAP reform and the GATT agreement

4.1. The 1992 CAP rgfoorm 4

Although the debate on CAP reform started in the early 1970s major reform packages were adopted only in 1984 and 1988. They temporarily alleviated but did not eliminate CAP problems. In May 1992 the EU adopted the thus far most radical CAP reform package. This package reduces or eliminates support prices, and introduces direct compensation payments and mandatory set-asides for large farmers. It covers cereals, protein crops, oilseeds, beef, mutton and lamb, dairy, and tobacco, and will be implemented between 1993 and 1996. Table 3 details the annual policy changes; this section summarizes the final policy amendments.

CAP reform will be most drastic in the cereal, protein crop, and oilseed sectors. By 1997 the cereal intervention and target prices will fall by 33%, the threshold price will exceed the target price by ECU 45. Support prices in the oilseed sector were eliminated. The Union compensates farmers for price reductions through hectarage payments based on regional historical yields and actual farm size. To qualify for such payments, farmers must plant the crop. In addition, farmers producing more than 92 tons of cereals a year must set-aside 12% of their cereal, oilseed, protein crop, and previously set-aside acreage under

4This section is based on OECD (various years), Commission of the European Communities (various years). Normile (I 993), and Made11 (1992, 1993).

Tab

le

2

EU

bu

dget

an

d C

AP

reve

nue

and

expe

nditu

re

1983

19

85

1987

19

89

1990

19

91

1992

19

93

1994

19

95

EU

bu

dget

EA

GG

F

Gua

rant

ee

Gui

danc

e

CA

P ch

arge

s C

AP

net

cost

Tot

al

%

of G

DP

24,8

07

28,0

85

35,4

69

40.9

17

44,3

80

52,9

69

61,0

97

65,2

69

68,3

25

76,5

26

16,5

39

20,4

63

23,8

75

27,2

25

28,3

01

33,3

06

35,8

29

38,1

34

37,4

06

39,8

00

15,8

11

19,7

44

22,9

67

25,8

72

26,4

54

31.1

95

32.9

34

34,7

48

34,7

87

36,9

73

728

719

907

1352

18

47

2111

28

95

3386

26

19

2827

2295

21

79

3097

26

64

2084

24

30

2589

21

44

2305

21

82

14,2

44

18,2

84

20,7

77

24,5

60

26,3

18

30,8

75

33,5

39

38,3

38

37,5

32

39,9

47

0.55

0.

61

0.56

0.

56

0.56

0.

61

0.62

0.

7 0.

6 0.

6

Nor

es:

All

figu

res

in m

illio

n E

CU

; 19

94,/S

pre

limin

ary

budg

et

data

, 19

95 d

ata

for

EU

-12,

E

AG

GF

is t

he

Eur

opea

n A

gric

ultu

ral

Gua

rant

ee

and

Gui

danc

e

Fund

. w

hich

la

rgel

y fi

nanc

es

CA

P:

it ha

s tw

o se

ctio

n:

the

guar

ante

e se

ctio

n fi

nanc

es

mar

ket

polic

ies

and

the

guid

ance

se

ctio

n st

ruct

ural

po

licie

s.

CA

P

char

ges

subs

ume

inco

me

from

ag

ricu

ltura

l ta

riff

s,

vari

able

im

port

an

d pr

oduc

tion

levi

es.

Sour

ce:

Com

mis

sion

of

the

E

urop

ean

Com

mun

ities

(v

ario

us

year

s).

382 S. Weyerbrock / European Economic Remew 42 (I 998) 3 75-411

Table 3 Main parameters of the Common Agricultural Policy reform

Product Units 1991192 1992193 1993194 1994/95 1995/96

Cereals Target price

Intervention price

Threshold price

Co-responsibility levy

Direct payment

Set-aside compensation

PI-orrirn plunts

Direct payments


Oilseeds b

Direct payment ’


Milk and milk products

Milk target price

Butter intervention price

Co-responsibility levy

Total quota

BeeJ and wni d

Intervention price

Intervention purchase

ceiling

Male animals’ premium

Veal processing premium

Suckler cow premium

Livestock density

ECU/t 223”

ECU/t 155”

ECU/t 218”

ECU/t 8.4

ECU/ha ~

ECU/ha

ECU/ha _ 299 299 299 ECU/ha _ 207 207 207

ECU/ha 384 359 359 359 ECU/ha _ 207 207 207

ECUit 268.1 264.7 261.3 261.3 261.3 ECU/t 2927.8 2927.8 2854.6 278 1.4 2781.4

ECU/t 6.7 6.7 0.0 0.0 0.0 mio t 106.9 106.9 106.4 105.4 105.4

ECU/t 3430 3259 3087 2916 2916

1000 t 0 750 650 550 450 (350)

ECU/h 40 60 75 90 90 ECU/h 0 100 100 100 100 ECU/h 50 70 95 120 120 UGB/ha 0 3.5 3.0 2.5 2.0

216

150

211

0

130 120 110 117 108 100

175 165 155

0 0 0

115 161 207

207 207 207

‘Average excluding durum wheat.

b The reference price is the intervention price for cereals in 1991192 and 1992/93.

’ Per hectare payments are averages calculated on the base of the average EU yields shown in the

table.

’ Beef and Wdl parameters apply to calendar years; they are equal in 1996 and 1997 unless otherwise

indicated (Madell, 1993); t, ha, and mio denote tons, hectares, and millions.

Sources: OECD (various years), Commission of the European Communities (various years).

a rotational scheme and 20% under a non-rotational scheme. Farmers receive compensation payments for the set-aside at the rate for cereal price cuts. The EU eliminated co-responsibility levies and stabilizer penalties.

In the beef and sheep sectors CAP reform will be less comprehensive. Policy- makers will reduce the beef intervention price by 15% and will introduce

S. Weyerbrock / European Economic Review 42 (I 998) 375-41 I 383

a ceiling on intervention buying of 350,000 tons a year in 1996. Intervention purchases made when the market price is less than 60% of the intervention price will not count against this ceiling. Beef producers will profit from lower cereal prices and (more significantly) direct payments such as suckler cow, male bovine animal, de-seasonality, and calf slaughter premiums. For sheepmeat, ewe premiums will be extended but limited by ceilings related to the past herd size and a state limit. To qualify for livestock premiums producers must follow stocking rate limitations.

Changes in EU’s dairy policies are negligible, they include a 2.5% cut in the target price for milk and a 5% cut in the intervention price for butter. EU policy-makers removed co-responsibility levies but did not implement a planned 2% cut in the milk quota. ’

4.2. The GATT agreement 6

Disputes on agricultural issues have been a major obstacle to the conclusion of the Uruguay Round of GATT negotiations. The final agricultural reform

package of 15 December, 1993, addresses tariffication, minimum market access, export competition, internal support, and sanitary and phytosanitary measures. Moreover, it contains a US-EU bilateral agreement on rebalancing and a peace clause. The new arrangements will be phased in over six years. This section describes changes important to the EU.

TariJ&ation: GATT members will convert non-tariff import barriers into tariffs and will reduce the unweighted average of those tariffs by 36% compared to a 1986-1988 base. Each tariff equivalent must be reduced by at least 15%. The new tariff equivalents will be bound in GATT. The EU may invoke a special

safeguard clause and add a variable element to its import measures exceeding the bound rate if imports surge or world market prices fall drastically below their 198661988 average.

Minimum market access: Countries will establish minimum market access for imports corresponding to 5% of domestic consumption in 1986-1988. Where

imports exceed 5% of domestic consumption owing to import quotas and voluntary export restraint agreements, current access will be maintained. Tariff quotas will guarantee market access.

Export competition: Spending on export subsidies (excluding spending on food aid) will be cut by 36% and the export volume by 21% compared to a 1986-1990 base. Expenditure and quantity cuts apply on a product-by- product basis. The volume commitment does not apply to processed products.

5 In addition to commodity-related measures, CAP reform encompasses an agri-environmental

action program, early retirement and reforestation schemes. ‘This section is based on Hathaway and Ingco (1995) Swinbank (1993), and IATRC (1994).

384 S. Weyerhrock J European Economic Review 42 (I 998) 375-41 I

Internal support: EU internal price supports will be reduced by an average of 16.8% compared to a 1986-1990 base. Countries that reduced internal support after 1986 will receive a credit. Internal support will be

measured by the aggregate measure of support (AMS) and bound in GATT. The total AMS corresponds to the sum of all commodity-specific AMS. The AMS will not cover non-trade distorting “green box” policies such as crop insurance, disaster assistance, and income payments not tied to current production. ’

4.3. Reform assessment and compatibility

Whether CAP reform meets the GATT commitments is a disputed issue. MacSharry and Steichen, agricultural commissioners of the EU, emphasized that the GATT deal is within the commitments of CAP reform (Agra Europe, 09.27.1992; CAP Monitor, 1993). Others suggested that the GATT deal will require further reforms (Swinbank, 1993; Josling and Tangermann, 1992). This section assesses qualitative aspects of both plans.

Researchers expect the EU to meet the new rules on import competition and internal support. Although the Agreement on Agriculture seems to foster a major reform of import policies, it will lead to little liberalization. During the 1986-1988 base period for tariffication world prices were the lowest in decades; the new tariffs therefore provide for a high degree of protection. The EU reduced initially high tariffs on sensitive products by 15% and reached the 36% overall reduction by reducing or eliminating already low tariffs on non-sensitive products. Moreover, it entered tariff equivalents in its country schedule that exceed tariff equivalents in the base period. Hathaway and Ingco (1995) find that the EU used ‘dirty tariffication’ in eight out of nine agricultural commodity groups. In addition, the special safeguard clause is widely considered a major potential move away from liberalization (Swinbank, 1993; Hathaway and Ingco, 1995; IATRC, 1994). The EU must transform its import quotas and voluntary export restraint agreements into tariff quotas. But it can continue using (non-discrimi- natory) variable levies if they fall below the bound rate. Hathaway and Ingco (1995) conclude that the new access rules will provide little additional access to

‘TWO other clauses, the rebalancing and the peace clause, are important to the EU. Because of past GATT commitments, oilseeds and non-grain feeds enter the EU duty-free or at low tariffs, The

EU proposed to trade reductions in support for grains for increased protection on non-grain feed

imports. The US rejected this offer but agreed to consult with the EU, if EU imports of US non-grain

feeds undermine CAP reform (Herlihy et al., 1993). According to the peace clause, non-trade

distorting policies will be exempt from countervailing duties and GATT challenges for eight years. In

addition, direct payments and other domestic support cannot be challenged in GATT if support does not rise above levels agreed to in 1992.

S. Wqwrbrock / European Economic ReCrw 42 (199X) 375-41 I 385

the EU. The EU was able to aggregate individual tariff lines into product groups and count existing special trade arrangements as part of its access commitments. Moreover, the EU’s import shares have traditionally been high. Besides changes in import competition, researchers expect an AMS reduction of 20% to be a by-product of CAP reform (Swinbank, 1993; Herlihy et al., 1993). The EU meets this commitment because its hectarage and headage premiums - although not fully decoupled - qualify as ‘green box’ policies. It also receives credits for reforms undertaken between 1986 and 1992. 8

Whether CAP reform meets the GATT’s export competition targets, however, is questionable. Reforms in the cereal and oilseed sectors will reduce the EU’s export surplus: owing to set-asides domestic production will decline; the switch from price supports to hectarage payments will influence yields; lower pork and poultry prices caused by lower feed cost will stimulate consumption; and because of lower cereal prices EU feedgrains will partially displace imported cereal substitutes in feed rations (Swinbank, 1993). Expenditure on export subsidies will decline because of a reduction in the EU’s export volume and intervention prices and an increase in world market prices. Yet, it is unclear whether the reductions in export volume and subsidy expenditure will reach the required 21% and 36%. Finally, CAP reform is sector-specific. To meet the GATT commitments the EU will probably have to change policies in sectors not or barely affected by reform such as the dairy, sugar, fruit and

vegetable sectors. Only a quantitative analysis can determine whether CAP reform is GATT-

compatible. Empirical evidence thus far is inconclusive. Using single-market

models, Josling and Tangermann (1992) find that the EU meets the internal support constraint for all commodities but sugar and the export volume and subsidy expenditure constraints for cereals and sugar but not for beef. Re- searchers at the Dutch Centraal Planbureau ~ using ECAM, an applied general equilibrium model of EU agriculture - find that CAP reform is largely compatible with the GATT agreement (Centraal Planbureau, 1993). ’ But Goldin and van der Mensbrugghe (1995) conclude that the export subsidy targets will require additional reforms in the EU in their study of the Uruguay Round Agreement on Agriculture based on the Rural Urban North South (RUNS) model. Existing studies do not quantify CAP policy changes needed to fulfill the GATT targets.

*In addition, a reduction in the protection for one commodity can compensate for an increase in

the protection for another. A cut in supply also reduces the AMS. ’ ECAM covers 9 EU countries, 20 agricultural and 2 non-agricultural sectors. Each national

model has a consumer demand and agricultural supply module. Producers compete with foreign

traders to satisfy total EU demand.

386 S. Weyerbrock J European Economic Review 42 (I 998) 375-411

5. The CGE model

We examine CAP reform and its compatibility with the 1993 GATT agreement in a six-region, 13-sector CGE model. lo This CGE mode1 combines five single-region models of the US, the EU, EFTA, small Eastern European economies, and the former Soviet Union. Each region model encompasses eight agricultural sectors central to CAP (wheat, other grains, sugar, meat, dairy, oilseeds, other food, and non-food), four industrial sectors (manufactures, en- ergy, equipment, and fertilizers), and one service sector. In addition, each region model includes five primary factors of production. Industrial sectors and the service sector employ urban labor and urban capital; agricultural sectors use land, rural labor, and rural capital. Trade flows link the five single-region CGE models. The rest of the world is modeled as a supplier of imports to, and a demander of exports from, these five regions mostly at fixed world prices. The US, the EU, and the former Soviet Union have market power on a few agricultural world markets. The US is modeled as a large exporter of wheat and a large importer of sugar, the EU as a large exporter of wheat, sugar, and dairy products, and the former Soviet Union as a large importer of wheat and sugar.

A region CGE model simulates a market economy in which prices or quantities adjust to clear markets. l1 It captures all transactions in the circular flow of income among economic factors within a region. Each sector produces a composite commodity that can be transformed into a commodity sold on the domestic market or into an export according to a constant-elasticity-of-transformation (CET) function. Output is produced according to a constant-elasticity-of-substitution (CES) production function in primary factors. The region models feature constant returns to scale in all sectors. Input-output coefficients for intermediate inputs are fixed. Sectoral input demands are derived from first-order conditions for profit maximization.

In factor markets, a CGE model can reflect different assumptions about wage flexibility, factor mobility, and the integration of rural and urban labor markets. A flexible wage CGE model features full employment; aggregate factor supplies are set exogenously and factor prices adjust to clear markets. A fixed wage

model, on the other hand, may accommodate unemployment: we fix the average wage and solve for aggregate employment. Moreover, a CGE mode1 can include

“The model is described in Weyerbrock (1994) and implemented in GAMS software (Brooke et al., 1992). It represents an extension of a USMexico CGE model by Robinson et al. (1993).

r1 Because this paper focuses on the EU, we model Eastern Europe and the former Soviet Union

largely as market economies. To capture the slower response of producers in transition economies to

changes in relative prices, we use low agricultural export transformation elasticities. Export trans-

formation elasticities reflect the ease with which a firm can move its factors of production between

producing output for the domestic and the export market given a change in relative prices.

S. Weyerbrock / Europeon Economic Review 42 I1 998) 375-411 387

different assumptions about factor mobility. If factors are intersectorally mobile, average factor returns adjust among sectors. If they are fixed, the final equilibrium has sectorally differentiated rental rates. Finally, our model can accommodate different assumptions regarding the link between the rural and urban labor market. If the two labor markets are linked, rural-urban labor migration may occur: it depends on the wage differential between the rural and urban wage. I2 Such migration is impossible, if the labor markets are segmented. To capture the short-, medium-, and the long-run impact of a policy change or external shock we establish three model variants featuring different factor market closures (see Section 8). In all variants land and rural capital are immobile.

The four components of domestic demand are consumption, intermediate demand, government demand, and investment. Consumer demand is based on Cobb-Douglas utility functions, generating fixed expenditure shares. House- holds pay income taxes to the government and save a fixed proportion of their income. Fixed input-output coefficients give intermediate demand. The govern-

ment is modeled as an explicit, non-optimizing agent. Real investment and real government expenditure are fixed.

Each region model has three macroeconomic balances: the government deficit, aggregate investment and savings, and the balance of trade. Government savings is the difference between government revenue and spending. Govern- ment savings is fixed and government revenue depends on many tax instruments. Real investment is set exogenously, and aggregate savings is determined residually to achieve a savings-investment balance. Enterprise savings rates

adjust to achieve the necessary level of aggregate savings. The balance of trade for each region (valued in world prices) is set exogenously.

Each region model solves for relative prices and factor returns that clear the product and factor markets. Moreover, each region model solves for an equilibrium real exchange rate given the exogenous aggregate balance of trade in each region (measured in prices of the rest of the world). An index of domestic prices of ‘semi-tradables’ defines the numeraire in each region model, and the currency of the rest of the world defines the international numeraire. The model determines five equilibrium real exchange rates, one for each region, which are measured with respect to the rest of the world. An arbitrage condition implicitly determines the cross rates.

The region models in our multiregion CGE model are linked by trade flows. A multiregion model includes sectoral export-supply and import-demand functions for each region, and solves for a set of world prices that achieve

I2 In equilibrium, migration maintains a specified ratio of real wages between the rural and urban

parts of the economy. The domestic labor supply of a labor category in each region is adjusted by the

migrant flows.

388 S. Wqerhrock / European Economic Reoiew 42 (1998) 3 75-41 I

equilibrium in world commodity markets. We assume that demanders in each region differentiate goods by region of origin and exporters differentiate goods

by region of destination. l3 Owing to imp erfect substitutability and transformability of the domestic and traded goods, the link between domestic prices and trade policy is weaker in our model than in models assuming perfect substitutability and transformability. On the import side, we use import-demand equations based on the almost ideal demand system (AIDS) instead of the commonly used CES import-aggregation function. I4 The AIDS function is a flexible functional form in that it can generate arbitrary values of substitution and expenditure elasticities at a given set of prices. The expenditure shares, S,,h,cl, on imports of good i into region k from region cl depend both on aggregate expenditure and on relative prices and are given by Is

Ci,k is nominal expenditure, Pi,k is a translog price index of the composite good as proposed by Deaton and Muelbauer (1980) and PTk,cl is the domestic price of imports. Symmetry, homogeneity, adding up, and local concavity restrictions are placed on the parameters so that the system satisfies standard properties of expenditure functions. On the export side, our model includes CET

13Trade theory frequently assumes that all goods are tradable and that all tradables are perfect

substitutes, These assumptions lead to results that are at odds with empirical observations: (1) given

commodity arbitrage, the domestic price of tradables are set by world prices. changes in world prices

are completely and immediately transmitted to the domestic market. and trade policy has a very

powerful impact on the domestic price system, (2) countries should specialize in accordance with

their comparative advantage, (3) there should be no two-way trade, and (4) sectoral trade shares do

not determine how responsive a domestic sector is to changes in world markets. We assume product

differentiation between the domestic and traded goods to capture stylized facts such as the imperfect

transmission of world price changes to domestic prices, incomplete specializatjon, and two-way

t radc.

14The CES import-aggregation functions in multiregion models with imperfect substitution

between domestic goods and imports cause empirical problems. Brown (1987) argues that the

monopoly power implicit in national product differentiation is the source of strong terms-of-trade

effects. Moreover, the CES formulation forces the import-demand equations to have an expenditure elasticity of one and does not capture the direct income effect of a shock on the demand for traded

goods. The AIDS formulation. on the other hand, may feature non-unitary expenditure elasticities.

Robinson et al. (1991) discuss the AIDS specification and the computation of various elasticities in

the AIDS system.

“We use the following notation: parameters and variables are presented by letters and sets by subscripts. We refer to three main sets. these are sectors, i orj, regions, cl or c2. and factors,& Many

sets have subsets: k, a subset of cl, includes the five explicitly modeled regions but not the rest of the

world. For example, the variable E,.,.,, denotes exports of good i from region k to region cl. And

FQ.l.n represents the demand for factor fin sector i 01” region k.

S. Weyerhrock / European Economic Review 42 (I 998) 375-41 I 389

export-transformation functions. l6 Given the first-order conditions, the export- supply equations are functions of relative prices and the elasticities of transformation between goods sold on the home and export markets.

6. Modeling policies

Our approach to policy modeling is to represent the EU’s Common Agricul- tural Policy and many other farm policies explicitly. Explicit modeling of policies means that policies are modeled as closely as possible how they work. CAP reform implies a partial liberalization and re-instrumentation of the CAP. The GATT deal involves a substitution of coupled policies, i.e., policies that distort domestic production and consumption, with decoupled policies. By modeling policies explicitly rather than approximating them by a tariff or producer subsidy equivalent (PSE) we can differentiate between (1) exogenous

and endogenous and (2) coupled and decoupled policies. Tariff equivalents and PSEs, on the other hand, measure aggregate support but not the incentive impact of government intervention.

Work on explicitly modeling the Common Agricultural Policy in CGE models is scarce. Harrison et al. (1989, 1990, 1995b) and Hertel et al. (1991) mode1 variable import levies or export subsidies. To the best of our knowledge,

other CAP policies and policies of other European blocks have not been modeled explicitly. Our approach to explicitly modeling policies relies on work by Kilkenny and Robinson (1988) Kilkenny (1991) and Burfisher et al. (1992) on modeling US and Mexican policies. Table 4 assembles agricultural policies included in our model and Table 5 summarizes our policy modeling approach. This section explains how we model policies central to the CAP.

6. I. Trade policies

Our model includes ad valorem and variable export subsidies, ad valorem and specific tariffs, tariff equivalents of non-tariff barriers in industrial sectors, variable import levies, and import quotas. We mode1 all trade policies as exogenous or endogenous price wedges.

I6 Many multiregion models with perfect competition in product markets feature product differ-

entiation on the export side. We extend this assumption to agricultural sectors because we find a considerable amount of product differentiation in such sectors at the high aggregation level of our

model. In sectors with relatively homogeneous outputs (sugar, wheat, and other grains) we use large

export transformation elasticities. Generally, the more homogeneous the product, the larger the

value of the elasticity. We test whether our results are robust with respect to large changes in CET elasticities.

Tab

le

4

Agr

icul

tura

l po

licie

s in

the

C

GE

m

odel

Sect

or

EU

E

FTA

C

EE

FS

U

us

Whe

at

Var

iabl

e im

port

le

vy,

vari

able

ex

port

re

fund

,

inte

rven

tion

purc

hase

s,

co-r

espo

nsib

ility

le

vy

Pric

e su

bsid

y,

inco

me

tran

sfer

Prod

ucer

su

bsid

y,

cons

umer

su

bsid

y,

inpu

t su

bsid

ies

Prod

ucer

ta

x,

cons

umer

su

bsid

y,

inpu

t su

bsid

ies

inco

me

tran

sfer

EE

P,

defi

cien

cy

paym

ents

Oth

er

grai

ns

Var

iabl

e im

port

le

vy,

Pric

e su

bsid

y,

Prod

ucer

su

bsid

y,

Prod

ucer

su

bsid

y,

EE

P,

vari

able

ex

port

re

fund

, in

com

e tr

ansf

er

cons

umer

su

bsid

y,

cons

umer

su

bsid

y,

defi

cien

cy

inte

rven

tion

purc

hase

s,

inpu

t su

bsid

ies

inpu

t su

bsid

ies,

pa

ymen

ts

co-r

espo

nsib

ility

le

vy

inco

me

tran

sfer

Suga

r

Mea

t

Impo

rt

quot

a,

vari

able

ex

port

re

fund

,

outp

ut

quot

a,

prod

ucer

le

vies

Pric

e su

bsid

y,

inco

me

tran

sfer

,

outp

ut

quot

a

Prod

ucer

su

bsid

y,

cons

umer

su

bsid

y,

inpu

t su

bsid

ies

Prod

ucer

su

bsid

y,

cons

umer

ta

x,

inpu

t su

bsid

ies,

inco

me

tran

sfer

Impo

rt

quot

a,

vari

able

im

port

le

vy,

vari

able

ex

port

re

fund

,

inte

rven

tion

purc

hase

s,

prem

ium

s

Pric

e su

bsid

y.

inco

me

tran

sfer

Prod

ucer

ta

x,

cons

umer

su

bsid

y,

inpu

t su

bsid

ies

Prod

ucer

su

bsid

y,

cons

umer

su

bsid

y.

inpu

t su

bsid

ies,

inco

me

tran

sfer

EE

P

Dai

ry

impo

rt

quot

a,

vari

able

ex

port

re

fund

,

prod

uctio

n qu

otas

,

inte

rven

tion

purc

hase

s,

co-r

espo

nsib

ility

le

vy

Oils

eeds

E

xpor

t re

fund

,

prod

ucer

su

bsid

y,

cons

umer

su

bsid

y

Oth

er

food

E

xpor

t re

fund

,

NT

Bs,

m

arke

t w

ithdr

awal

.

pric

e su

bsid

y

Non

-foo

d E

xpor

t re

fund

,

NT

Bs,

st

orag

e,

pric

e su

bsid

y

Pric

e su

bsid

y,

inco

me

tran

sfer

,

outp

ut

quot

a

Pric

e su

bsid

y,

inco

me

tran

sfer

NT

Bs

Prod

ucer

su

bsid

y,

cons

umer

su

bsid

y,

inpu

t su

bsid

ies

NT

Bs

Prod

ucer

su

bsid

y,

cons

umer

su

bsid

y,

inpu

t su

bsid

ies,

inco

me

tran

sfer

Prod

ucer

ta

x,

cons

umer

su

bsid

y,

inpu

t su

bsid

y,

inco

me

tran

sfer

NT

Bs

NT

Bs

Prod

ucer

ta

x,

cons

umer

su

bsid

ies,

inpu

t su

bsid

ies,

inco

me

tran

sfer

EE

P

* 2:

NT

Bs

-1

3 a b E

Not

es:

EU

ag

ricu

ltura

l po

licie

s ar

e pr

e-re

form

po

iicic

s.

EE

P

is t

he

US

expo

rt

enha

ncem

ent

prog

ram

. N

TB

s ar

e no

n-ta

riff

im

port

ba

rrie

rs.

392

Table 5

S. Weyerhrock J Europem Economic Reriew 42 (I 998) 375-41 I

How agricultural programs are modeled

Exogenous Endogcnous Programs

instruments instruments

Price wedyes Pck -~ output price

Pf,t domestic sales price rt, <I

&,k

CL, import price tm LP.rl r’““’ ,.k,‘i

p:,.,, export price rr ,.k.c,

T?Wlsf&5 All households

AlI enterprises

Rural households

Acreage payments

hrrl, General household transfer

rtr, Enterprise transfers

it7cslrbk Rural household transfers

dec0~lp,., Headage premiums

Prcon*P,,,//,k Compensation for price reduction

sacoW&.,//.k Compensation for set-aside

Other instrwnents Government infrastructure yin&

investment

Government intervention yib,,,

buying

Set-aside requirements ~~ur,,,rJ,k

Government infrastructure investment

Government intervention buying

Set-aside rate

PIE,,,, Deficiency payments

Producer levies

Output price subsidies

Intermediate input price subsidies

Indirect taxes

Subsidies to millers

Consumer subsidies

Import tariffs

Non-tariff barriers

Import quotas

Variable levies

TLl Export enhancement program

Var-iable refunds

Notes: PIE,,I, refers to ‘producer incentive equivalent’, which equals the sum of all price wedge

instruments that affect the output price, Pck. The tariff equivalent of a quota, ryX.,r. is a variable determined endogenously, given the fixed import quota. The tariff equivalent of variable import

levies. T$.CIr is a variable determined endogenously, given the gap between the domestic sales price

and the world import price. The tariff equivalent of variable export refunds, T;,,,,, is a variable

determined endogenously given the gap between the domestic sales price and the world price of exports. Indirect taxes, tcx, price subsidies to processors, consumer price subsidies. &, tariffs, tG., ,, ad valorem export subsidies, t:k.,l, value added taxes, &, income transfers and compensation

payments, and other instruments are fixed parameters.

S. Weyerhrock / European Economic Review 42 (IYYH) 375-41 I 393

Variable exports subsidies: The EU uses variable export subsidies to dispose its exports of many agricultural commodities on world markets. Variable export

refunds, Tr,k,cl, bridge the gap between the actual price of a commodity in the Union, P& and its world market price, PWF.,k,cl. The exogenous policy instru- ment is the domestic price of exports, PF.k,cl, which is equal to the domestic producer price, Pilk,

where Rk is the exchange rate. l7 The long- and medium-run variants of our model include an inequality constraint that ensures that variable export subsi-

dies are positive if the EU’s intervention price exceeds the world market price and zero otherwise. We implement this constraint for two reasons. First, the objective of the CAP reform is to reduce the EU internal prices to - but not below ~ world market levels. Second, we believe that the EU will not be able to defend export taxes over an extended period. Our short-run model allows

agricultural export taxes. Variable import lecies: Many EU imports are subject to variable import levies,

Tyk.k.cl, that bridge the gap between the threshold price, an exogenous price of imports, pyk,cI, and the world market price for imports, PW$cl. TTk,cl is determined endogenously, so that the levy’s ad valorem equivalent varies with the price gap,

Pyk.cl = 71?k,c1(1 + T:kk,cl + t:k.cdRk,

where t$_l is an ad valorem tariff. l8

6.2. Domestic policies

Among the domestic policies included in our model are many subsidies and taxes, input and output quotas, and transfers to rural or urban households. We model such policies as price wedges, restrictions on factor supply or output, or lump-sum income transfers.

Price subsidies, lez;ies, and indirect taxes: The model includes output price subsidies and levies, intermediate input subsidies, direct subsidies, and deficiency payments. Reflecting their effect on the producer’s output decision, we combine them into a producer incentive equivalent, PIE,,,. The producer incentive equivalent variable equals the sum of all per-unit, price-wedge instruments

” Hertel et al. (1991) represent variable export subsidies as preserving a specific ratio of output to

input prices. ‘*In Hertel et al. (1991) the variable import levy maintains a constant ratio of domestic to import

prices. In Harrison et al.. 1995b the variable levy bridges the gap between the target and the import price.

394 S. Weyerbrock / European Economic Review 42 (I 998) 375-41 I

that affect the output price of good l’&. I9 Given fixed input-output coefficients, i~~,~,~, the value-added price, P$, is used in the profit maximization problem to compute the marginal revenue product. The value-added price is the price received by producers, Ptk, minus the cost of intermediate inputs, plus the producer incentive equivalent, PIE,,,:

PI:k = Ptk - C (ioj,i,k P7.k) + PZEi,k,

where P4,k is the price of the composite commodityj in region k. If the producer incentive equivalent increases the producer’s value-added price rises. Factor

returns increase pulling factors toward the subsidized sector and causing output

in this sector to expand. Znferoention buying: Official intervention agencies in the EU buy agricultural

commodities at the intervention price that have not been exported or sold on the domestic market. We model intervention buying as a separate government demand component. For simplicity, we represent it as an exogenous supply shifter. Intervention buying influences the product market equilibrium, real GDP, and government savings. ”

Input and output quotas: To qualify for compensation payments, large EU farmers must set-aside land. We model set-aside provisions as an exogenous restriction on sectoral land demand. The demand for land for production of crop i is constrained by the total land demand in the base, FD0i.land.k minus the area that has to be set-aside:

FDi.bnd,k = FDOi,land,k (1 - SaYi.land.k). (5)

The set-aside rate, sari,i,,d,k, is exogenous. The EU restricts domestic output of sugar and milk eligible for support

through output quotas. We approximate the impact of quotas by restricting factor availability and fixing domestic production in quota sectors. This production closure forces producers to operate on a specific point of their isoquant; they cannot adjust output in response to a shock.

Transfers: Household transfers, income subsidies and direct payments to farmers, and headage premiums are modeled as fixed, decoupled lump-sum

transfers from governments to households. Hectarage premiums ~ compensat- ing EU farmers for price cuts and set-asides - increase land income.

“The output price also reflects per-unit indirect taxes and subsidies on domestic sales of

processed commodities.

*‘In our model the intervention price is supported by variable export subsidies, in the EU, by an

arbitrary combination of intervention purchases and export subsidies.

S. Weyeuhrock / European Economic Review 42 (I 998) 375-41 I 395

6.3. Farm program revenue and expenditure

Farm program revenue subsumes revenue on co-responsibility and variable import levies, and tariff revenue and quota premiums on agricultural imports captured by the government. It is a component of government revenue. Farm program expenditure includes expenditure on agricultural policies and transfers targeted to rural households such as certain income subsidies, other direct payments to farmers, and headage and hectarage premiums. We count farm program expenditure against government revenue in the government-savings equation. Changes in farm program revenue and expenditure affect the government deficit and investment. Increased farm program spending decreases government savings or increases the deficit and crowds out domestic investment.

7. The data

The database of the six-region, 13-sector CGE model includes social ac- counting matrices (SAMs) for the five explicitly modeled regions, further region-specific data, data on bilateral trade flows, and elasticities. Ken Hanson

from USDA supplied a 1987 SAM for the US and further US data. We derived the SAMs and related region-specific data for other regions from the database of the Rural Urban North South (RUNS) model. ” We aggregated the RUNS data to reflect the focus of our study on temperate-zone agricultural products. Moreover, we updated the data for all regions except the former Soviet Union from 1985 to 1987 using growth rate information (OECD, 1992). We retrieved 1987 bilateral trade flow matrices for the 13 sectors of the six-region model from data published by OECD (1988) the United Nations (1989), and Zeimetz (1991). We use the most recent policy data available. The GTAP database is the source

of our pre- and post-Uruguay Round tariff data and part of the non-tariff barrier data (Hertel et al., 1995). These data integrate Ingco’s work on dirty tariffication (Ingco, 1995; Hathaway and Ingco, 1995). Further policy data stem

from many different sources (Weyerbrock, 1994). Elasticity estimates for the six-region model were drawn from the literature.

Table 6 reports our assumptions. Assigning elasticity values represents an informal procedure because of unsatisfactory or no data. To verify the validity of our results we tested their sensitivity with respect to plausible bounds on elasticities. Our main results appear robust. ”

*‘The RUNS model’s database is documented in OECD (1991). Tsigas (The World Bank) and van der Mensbrugghe (OECD) supplied these data.

“We doubled and halved all CET elasticities and found that most aggregate results were

insensitive to changes in these elasticities. Sectoral output results changed by less than I %. Changes

in CET elasticities led to moderate effects on sectoral exports in the wheat, other grain, and meat

sectors and, in turn, on farm program expenditure.

Tab

le

6

Ela

stic

ities

in

th

e si

x-re

gion

m

odel

All

regi

ons

us

EU

E

FTA

C

EE

FS

U

Exp

ort

dem

and

CE

T

or

impo

rt

supp

ly

prod

uctio

n su

bstit

utio

n in

com

e

CE

S A

IDS

AID

S us

E

U

FSU

Whe

at

0.60

Oth

er

grai

ns

0.60

Suga

r 0.

60

Mea

t 0.

60

Oils

0.

60

Dai

ry

0.60

Oth

er

food

0.

60

Non

-foo

d 0.

60

Man

ufac

turi

ng

0.85

Ene

rgy

0.80

Serv

ices

0.

95

Equ

ipm

ent

0.80

Fe

rtili

zer

0.80

2.00

2.00

2.00

1.30

2.00

1.30

1.30

1.

30

1.30

1.30

0.

70

1.30

1.

30

1 .oo

4.

00

4.00

4.

00

1.00

4.

00

4.00

0.

75

1.00

0.

95

4.00

0.

85

1 .oo

1.

50

1.50

1.

50

1.00

4.

00

0.95

0.

95

1.00

0.

95

3.00

0.

90

1 .oo

0.

90

0.90

0.

90

I .oo

3.

00

0.95

0.

95

1 .oo

2.

00

3.00

2.

00

1 .oo

2.

50

2.50

2.

50

1.00

2.

00

2.00

2.

00

1 .oo

3.

00

3.00

2.

00

1 .oo

2.

90

2.90

0.

90

0.75

0.

75

3.00

20

.00

(8.0

0)

0.75

0.

75

_

0.95

0.

95

(12.

00)

9.00

(5

.00)

2.

00

I .50

_

0.95

0.

95

-

0.95

0.

90

6.00

1.

90

0.90

_

0.95

3.

00

2.00

2.

00

_

2.50

2.

90

_

1.75

2.

00

2.00

2.

00

_

0.90

0.

90

Not

es:

CE

S in

dica

tes

a co

nsta

nt-e

last

icity

-of-

subs

titut

ion

prod

uctio

n fu

nctio

n,

AID

S an

al

mos

t id

eal

dem

and

syst

em,

and

CE

T

refe

rs

to

a C

ET

expo

rt-t

rans

form

atio

n fu

nctio

n.

AID

S su

bstit

utio

n el

astic

ities

fo

r im

port

s in

volv

ing

the

rest

of

the

w

orld

ar

e se

t to

0.5

. T

he

US,

the

E

U,

and

the

form

er

Sovi

et

Uni

on

are

larg

e ex

port

ers

or

impo

rter

s (i

n pa

rant

hese

s)

in i

ndic

ated

m

arke

ts.

We

revi

ewed

el

astic

ities

us

ed

by

Wha

lley

(198

5),

de M

elo

and

Tar

r

(199

2),

Kilk

enny

an

d R

obin

son

(199

0),

Kilk

cnny

(1

991)

, H

arri

son,

et

al

. (1

991)

an

d ad

opte

d es

timat

es

that

fa

ll in

th

e ra

nge

of e

last

iciti

es

used

in

th

e

mod

els.

O

ur

expo

rt

dem

and

and

impo

rt

supp

ly

elas

ticiti

es

(in

pare

nthe

ses)

fo

r th

e re

st

of t

he

wor

d st

em

from

T

yers

an

d A

nder

son

(198

9).

S. Weyerbrock I European Economic Review 42 (I PA!?) 375-41 I 397

8. The experiments

Table 7 details our experiments. The first two experiments (‘policy sensitivity experiments’) explore the sensitivity of EU agricultural sectors to changes in the CAP’s major policy instruments: land set-aside rates and intervention prices. In experiment 1, EU farmers set-aside 3%, 6%, 9%, 12%, and 15% of their land. In experiment 2, we reduce the EU’s intervention price for wheat, other grains, sugar, dairy, and meat by 3%, 6%, 9%, 12%, and 15%. Figs. l-5 display the

long-run results for the policy sensitivity experiments. The remaining experiments (‘reform package experiments’) study agricultural

reform packages that require simultaneous changes in many policy instruments.

In experiment 3, the CAP reform experiment, we carry out the 1992 CAP reform. CAP reform violates the GATT agreement in that it maintains non-tariff barriers on agricultural imports. In experiment 4, we convert the EU’s and other countries’ non-tariff import barriers into tariffs and implement the lower of the post-Uruguay Round tariffs reported to the WTO or the pre-Uruguay Round tariffs. 23 By using tariffs reported by various countries rather than tariffs

reduced by formula we account for dirty tariffication. We perform experiment 4 to study if CAP reform meets the GATT agreement’s export competition targets. Because we find that CAP reform does not lead to a 21% reduction in subsidized exports and to a 36% reduction in export subsidy expenditure in all sectors we explore policy changes needed to meet these targets. The Union can reduce intervention prices or increase set-aside rates and introduce output quotas. In experiment 5 we quantify by how much the EU has to reduce its intervention prices for dairy and sugar. In experiment 6 we explore by how much the EU has to change its set-asides and output quotas. In experiments 3-5 we assume that third countries meet the GATT’s import competition targets but carry out no further reforms. 24

We perform experiments 3-6 using long-, medium-, and short-run variants of our model. These variants reflect different assumptions regarding wage flexibility, labor market integration, factor mobility, and the possibility of agricultural export taxes. In our long-run model, wages are flexible, the rural and the urban labor markets integrated, and factors mobile. The EU may eliminate

23 Many countries agreed to bind tariffs at very high levels but continue to use the lower tariffs in

effect during the negotiations. However, countries can raise their applied rate up to the bound rate at

any time without violating WTO commitments. In cases where this shift involves a large rate

increase, the minimum or current access commitments may become important. *4Becau~e this paper focuses on Europe, large agricultural exporters such as Australia and

Canada are part of the rest of the world rather than explicitly modeled. We do not expect this

aggregation to affect our results drastically. Except Canada’s dairy sector, agricultural sectors in the countries have been relatively open. The Agreement on Agriculture requires only minor policy

adjustments that will not affect world market prices (and thereby the EU) significantly (Goldin and

van der Mensbrugghe, 1995).

398 S. Weyerhrock / European Economic Review 42 (IYY8) 3 75 -41 I

Table 7

Experiment design

No. Experiment Experiment design

Policy sensitioity experiments

1 Set-aside experiment Set-aside 3%, 6%, 9%, 12%, and 15’% of land in the EU

2 Intervention-price experiment Reduce intervention prices by 3%, 6%, 9%, 12%, and

15%

Reform package experiments

3 CAP reform

Wheat, other grains Reduce threshold price by 33 (24.75)%

Reduce intervention price by 30 (22.5)%

Remove co-responsibility levy

10% land set-aside

207 (155.25) ECU/ha payment for set-asides and price

reductions

Oilseeds Various price subsidies dropped

Direct payment of 359 ECU/ha planted

10% land set-aside

207 ECU/ha payment for set-aside

Dairy Remove co-responsibility

Reduce intervention price by I .5%

Meat Reduce intervention price by 15 (11.25)%

Remove production levies

Introduce headage premiums

Structural measures Increase expenditure

4 CAP reform and market access (does the EU meet the GATT targets after tariffication?)

CAP reform Experiment 3

Market access Tariffication of import quotas and variable import levies

Implement new tariffs (dirty tariffication considered)

516 GATT agreement by means of price reductions or quantity controls (what additional policy

changes are needed to fulfill the GATT’s export competition targets’?)

CAP reform and market access Experiment 4

Export competition Reduce export subsidy expenditure by 36 (9)% Reduce export volume by 21 (5.25)%

Eliminate/reduce intervention buying/prices (experiment 5) Implement set-asides or output quotas (experiment 6)

Notes: Both CAP reform and the Uruguay Round agreement provide for long transition periods. In

our short-run experiments, the EU implements 7.5% of the final price changes and compensation

payments envisioned by the EU reformers. In addition, we assume that the EU will need to complete

25% of the changes needed to fulfill the GATT targets. Figures in parentheses indicate short-run

settings.

S. Weyerbrock /European Economic Review 42 (1998) 375-41 I

In numbers

399

J 1,500,000

S .9

1 ,ooo,ooo

= 500,000

0

3% 6% 9% 12% 15% Policy change

q Intervention price reduction

q Set-aside rate increase

Fig. 1. Rural-urban migration (in numbers)

In percent change

0

2 -2 a 2 -4

5 -6 L -0

-10 : _’ .’

/

I I I I


H Intervention price reduction

q Set-aside rate increase

Fig. 2. Farm output (in percent change).

agricultural export subsidies but will not tax producers. The medium-run variant differs from the long-run variant in that labor markets are segmented and urban capital immobile. In addition, in the short-run variant, wages are fixed and the EU may tax agricultural exports. Because CAP reform and the Uruguay Round Agreement on Agriculture allow for long transition periods, our short-run experiments reflect partial reform (see Table 7).

9. The results

9.1. Policy-sensitivity experiments

If the European Union sets aside 3S15% of its agricultural land, 10,000~56,000 rural workers leave the rural sector in the long run. Owing to the

400 S. Weyerhvock / Eumpear~ Economic Review 4-7 (1998) 375~411

0

2 -5

g-10 2 5 -15 2 -20

-25

In percent change

,:’ ._ ,: ,_’

_. :’ I I I I I



Set-aside rate increase

Fig. 3. Farm exports (in percent change)

In percent change

-60 v, :’

I I I I 3% 6% 9% 12% 15%

Policy change


Set-aside rate decrease

Fig. 4. Farm program expenditure (in percent change).

reduction in land, farm output declines by 0.3 to 1.8%. The output decline translates into a slightly larger decline of total agricultural exports. Savings on, among other things, export subsidies and intervention purchases lead to a de-

crease in gross farm program expenditure of 0.4-1.9%. The EU’s real GDP declines by up to 0.1% because land falls fallow.

A reduction in the EU’s intervention price decreases the domestic price for many agricultural products. Agricultural factor input decreases: between 0.7 and 1.9 million workers leave the rural sector. Farm output decreases between 1.4% and 8.8% and agricultural exports between 3.1% and 20.8%. Savings on export subsidy expenditure caused by reductions in exports and the export subsidy rate translate into dramatic savings on farm program expenditure. The EU’s real GDP increases by up to 0.4%.

S. Weyerbrock / European Economic Review 42 (I 998) 3 75-41 I 401

In percent change

Fig. 5

/ I I I I

10% 15% 20% 25% Policy change

Intervention price reduction

Set-aside rate increase

Real GDP (in percent change).

Figs. l-5 compare the implications of price reductions and set-asides on selected macroeconomic and farm program indicators. Note that intervention price reductions have a much stronger impact than set-asides. This is because price reductions allow an expansion of the industrial sector at the expense of the agricultural sector. Quantity controls do not allow significant structural change but lead to considerable factor substitution within the rural part of the economy.

9.2. Reform package experiments

In this section, we first examine the GATT-compatibility of CAP reform. Then, we specify additional policy changes needed to fulfill the GATT’s export competition targets. Finally, we study the impact of CAP reform and two

alternative policy packages on the EU’s macroeconomic indicators, output and export structure, and farm program revenue and expenditure. We summarize our results in Tables 8-l 1. Our discussion focuses on the long-run results.

9.2.1. GATT-compatibility results

The EU subsidizes exports of wheat, other grains, sugar, meat, and dairy. The GATT agreement requires the EU to reduce its volume of subsidized agricultural exports by 21% and its export subsidy expenditure by 36%. Do ongoing CAP reforms fulfill these targets? 25 Table 8 shows that these reforms lead to sufficient export volume and subsidy expenditure reductions for wheat, other

25 We assume that the EU meets the targets in the medium and long run if (1) its subsidy

expenditure and export volume fall by 36% and 21% or more, or if (2) export subsidy expenditure

disappear or decline by about 90%.

Tab

le

8 E

xpor

t in

dica

tors

an

d po

licy

setti

ngs C

AP

refo

rm

(3)

CA

P re

form

an

d G

AT

T

via

pric

e G

AT

T

via

quan

tity

mar

ket

acce

ss

redu

ctio

ns

cont

rols

(4)

(5)

(6)

LR

M

R

SR

LR

M

R

SR

LR

M

R

SR

LR

M

R

SR

Sect

ors

Mee

ting

the

GA

TT

ta

rget

s in

th

e lo

ng

run

Whe

at

Subs

idy

expe

nditu

re

- 10

0 -

100

- 12

8 E

xpor

t vo

lum

e ch

ange

-

34

- 27

~

58

Inte

rven

tion

pric

e re

duct

ion

~ 30

-

30

- 22

.5

Oth

er

grai

ns

Subs

idy

expe

nditu

re

- 10

0 ~

100

- 98

E

xpor

t vo

lum

e re

duct

ion

~ 60

-

56

~ 59

In

terv

entio

n pr

ice

redu

ctio

n -

30

- 30

-

22.5

Mea

t Su

bsid

y ex

pend

iture

-

100

~ 88

~

101

Exp

ort

volu

me

redu

ctio

n ~

30

- 16

-

28

Inte

rven

tion

pric

e re

duct

ion

~ 15

-

15

- 11

.3

Sect

ors

not

mee

ting

the

GA

TT

ta

rget

s in

the

lo

ng

run

Suga

r Su

bsid

y ex

pend

iture

-2

-2

-2

E

xpor

t vo

lum

e ch

ange

1

1 1

Inte

rven

tion

pric

e re

duct

ion

0 0

0 Q

uota

re

duct

ion

0 0

0

Dai

ry

Subs

idy

expe

nditu

re

-6

-7

-6

Exp

ort

volu

me

chan

ge

1 1

1

~ 1

00

- 10

0 -

128

~ 10

0 ~

100

~

130

~ 1

00

- 10

0 -

128

~ 34

-

26

- 58

-

43

- 25

-

63

- 32

-

16

- 56

-

30

30

~ 22

.5

- 30

-

30

- 30

-

30

~ 30

~

30

- 10

0 -

100

~ 99

-

100

- 10

0 -

102

- 10

0 -

100

~ 97

-

60

- 55

-

59

- 65

-

55

~ 64

~

59

- 49

-

57

~ 30

30

-

22.5

-

30

~ 30

~

30

~ 30

-

30

- 30

- 10

0 -

97

~ 10

4 -

100

- 97

-

113

- 10

0 -

89

- 10

4 -

29

- 19

~

30

~ 31

-

18

- 36

-

28

- 12

~

29

~ 15

~

15

- 11

.3

- 15

-

16

~ 11

.3

~ 15

-

15

- 11

.3

-6 0 0

-6

-3

-91

~ 90

~

25

~ 48

~

47

~ 17

1

1 -6

-6

0

- 20

-

20

-6

0 0

~ 20

-

20

-5

0 0

0 0

0 0

0 0

- 16

-

17

-5

I -8

1 -6

-

91

1 -5

-

89

-4

26 0

~ 49

-2

1 -

50

~ 21

-

19

-5

Inte

rven

tion

pric

e re

duct

ion

~ 1.

5 -

1.5

- 1.

5 -

1.5

- 1.

5 -

1.5

- 26

-2

5 -6

-

1.5

~ 1.

5 ~

1.5

Quo

ta

redu

ctio

n 0

0 0

0 0

0 0

0 0

- 20

-2

0 -6

Not

es:

Info

rmat

ion

in p

erce

nt

chan

ge

from

ba

se.

LR

, M

R,

and

SR d

enot

e lo

ng-,

med

ium

-, an

d sh

ort-

run

resu

lts,

resp

ectiv

ely.

Sh

ort-

run

resu

lts

are

base

d on

pa

rtia

l po

licy

refo

rm.

S. Weyerbrock / European Economic Review 42 (I 998) 375-411 403

grains, and meat but not for sugar and dairy. They only provide for a negligible decrease in the intervention prices for various dairy products and no changes in sugar policies. 26

What additional changes (beyond CAP reform) are needed to fulfill the GATT agreement’s targets’? To meet the GATT targets the EU can either reduce its support prices or extend set-asides and output quotas. We find that, if the EU abolishes intervention buying for sugar and dairy products, it needs to reduce the intervention price for sugar and dairy products by 20% and 26%, respective-

ly. Alternatively, the EU could reduce its sugar quota by 16% and its milk quota by 20%.

Our estimates for policy changes overstate the necessary adjustments. The export volume target applies to commercial raw commodity exports. Our model does not differentiate between commercial exports and food aid and processed and raw commodities. In addition, our base year is 1987 and not 1986-1990. EU exports increased during this period. Smaller policy changes will suffice to reach the GATT targets.

9.2.2. Aggregate results

Agricultural policy reform has moderate to significant effects on macroeco-

nomic indicators and factor markets (Table 9). All experiments lead to a small increase in the EU’s real GDP. This increase amounts to 0.2% under CAP reform. If the EU decreases the intervention prices and eliminates intervention

buying for sugar and dairy, real GDP increases by 0.4%. Meeting the GATT targets through quantity controls, however, leads to a smaller increase of 0.1%. 27 The EU’s currency depreciates moderately in all experiments. The

depreciation reaches a maximum of 1.9% if the EU cuts its sugar and dairy quotas. Agricultural policy reform in the EU leads to significant labor move- ments. CAP reform causes 1.1 million rural workers to migrate to urban sectors. Additional policy changes prompt about 1.9-2.1 million rural workers to leave the rural sector. This flow is largest if the GATT agreement is achieved by price reductions. 28 Because of the severe contraction of agricultural sectors, the EU’s

“In addition. in the medium run, the EU does not meet the targets in the meat sector. Our

alternative policy packages therefore include a further intervention price reduction or a quota for

meat. In the short run, partial CAP reform leads to wheat and meat export taxes but fails to achieve

25% of the long-run export competition targets for dairy and sugar.

” In the medium run, and particularly in the short run, agricultural policy reform leads to a loss in

real GDP. The GDP decline is largest in the short run because reform leads to unemployment.

Aggregate employment decreases by 0.8%. l8 Rural&urban labor migration in Western Europe frequently implies part-time employment of

‘family farmers’ in non-agricultural sectors. A farm is often given up only at the time of transfer. In

1991,30.5% of rural labor was older than 55 years. In comparison to farmers, paid labor can leave

the rural sector more easily. The share of paid labor in agriculture amounted to 28.8% in 1991

(Commission of the European Communities, 1993).

Tab

le

9

EU

ag

greg

ate

resu

lts

for

refo

rm

pack

ages

CA

P re

form

(3)

GA

TT

vi

a pr

ice

redu

ctio

ns

(5)

GA

TT

vi

a qu

antit

y co

ntro

ls

(6)

Lon

g

run

Med

ium

run

Shor

t

run

Lon

g

run

Med

ium

run

Rea

l G

DP

Rea

l ex

chan

ge

rate

Tot

al

agri

cultu

ral

expo

rts

Tot

al

indu

stri

al

expo

rts

Tot

al

agri

cultu

ral

impo

rts

Tot

al

indu

stri

al

impo

rts

Tot

al

empl

oym

ent

Rur

al-u

rban

la

bor

mig

ratio

n

0.2

0.8

- 12

.0

1.8

- 0.

4

0.2

0.0

1,09

4

~ 0

.1

1.0

- 7.

1

0.7

~ 0.

5

- 0.

7

0.0

0

- 0.

3

0.8

- 13

.0

1.1

- 1.

1

- 0.

5

- 0.

8

0

0.4

~ 0

.1

1.6

2.3

- 20

.8

- 11

.5

3.8

1.8

- 0.

3 0.

7

0.8

- 0.

3

0.0

0.0

2,09

2 0

Shor

t L

ong

run

run

- 0.

3

1.1

~ 16

.3

1.7

~ 1.

2

- 0.

4

- 0.

8

0

0.1

- 0.

4

1.9

2.3

- 25

.3

- 17

.5

4.1

2.3

- 0.

7 -

0.4

0.7

- 0.

4

0.0

0.0

1,87

5 0

Med

ium

run

Shor

t

run -

0.3

I.1

~ 17

.2

1.7

~ 1.

2

- 0.

4

- 0.

8

0

Not

es:

Rur

al-u

rban

la

bor

mig

ratio

n in

tho

usan

ds

of w

orke

rs;

all

othe

r in

form

atio

n in

per

cent

ch

ange

fr

om

base

. Sh

ort-

run

resu

lts

are

base

d on

pa

rtia

l

polic

y re

form

.

S. Weyerbrock! European Economic Reciew 42 (1998) 375-411 405

agricultural exports collapse. The reduction reaches 21-2.5% if the EU adopts policy changes to meet all GATT targets. Industrial exports, on the other hand, increase between 3.8% and 4.1%. Agricultural imports decrease and industrial imports increase insignificantly.

9.2.3. Output and export results All experiments yield strong changes in the EU’s agricultural output and

export structure (Table 10). Output in most agricultural sectors decreases. Output declines for wheat, other grains, meat, and oils are sizable in all experiments because CAP reform anchors on these sectors. They exceed 20% for wheat and 30% for other grains and are especially large if the GATT targets are reached by price reductions. Output in the dairy and sugar sectors declines only if we allow for a cut in output quotas. Increases in industrial output - especially manufacturing output ~ are noticeable in the long run because rural-urban labor flows increase the input base for such sectors. Fertilizer output declines because rural sectors contract.

Reductions in agricultural exports exceed output reductions in most sectors. Only the oilseed sector poses an exception. Industrial exports increase significantly. The increase in manufacturing exports exceeds 5% if the EU implements additional reforms to reach the GATT targets. 29

9.2.4. Farm program revenue and expenditure results

Table 11 summarizes our farm program revenue and expenditure results. Agricultural policy reform leads to a decrease in farm program revenue. The EU loses income from non-tariff import barriers such as variable import levies and tariffs because its agricultural imports decline. In addition, it loses co-responsib-

ility levy revenue. The revenue loss is small under CAP reform but reaches 2.5% and 5.0% if the Union further reforms its CAP.

CAP reform increases farm program expenditure by 32.4%. Expenditure on headage and hectarage transfers and structural programs exceed the savings on export subsidy payments and oilseed subsidies. 3o Farm program expenditure decreases by 11% if the EU eliminates intervention buying and cuts its intervention prices for milk and sugar because variable export subsidies almost disappear. Enormous savings on export subsidies compensate for headage, hectarage, and structural payments the EU implemented under the CAP reform. Note,

2y In the medium run, output and exports contract in sectors targeted by reforms, increase in the

other food and non-food sectors, and stagnate in industrial sectors. In the short run, partial policy

reform leads to a collapse of the wheat sector because of high export taxes, a decline in most agricultural sectors, and small changes in industrial sectors.

‘a Note that our farm program expenditure results depend on our assumptions about transfers.

We rely on projections from the EU Commission (Commission of the European Communities,

1992).

Tab

le

10

The

E

U’s

se

ctor

al

outp

ut

and

expo

rt

volu

me

resu

lts

Whe

at

Oth

er

grai

ns

Suga

r M

eat

Oils

D

airy

O

ther

N

on-

Man

ufac

- E

nerg

y Se

rvic

es

Equ

ip-

Fert

ilize

r

food

fo

od

turi

ng

men

1

CA

P re

form

(3

)

outp

ut

- 20

.5

~ 32

.3

0.0

- 31

.4

- 27

.7

0.0

~ 32

.2

~ 31

.4

0.0

Exp

orts

-

34.5

-

60.5

0.

7

- 26

.9

~ 55

.9

0.9

~ 57

.5

~ 59

.1

0.9

GA

TT

ag

reem

ent

via

pric

e re

duct

ions

(5

)

outp

ut

~ 28

.1

- 37

.6

0.0

~ 13

.9

- 27

.5

0.0

- 35

.6

~ 34

.8

0.0

~ 17

.0

~ 20

.2

0.0

- 7.

1

- 2.

4 -

4.4

0.0

5.8

- 12

.8

- 13

.6

0.0

- t.8

Exp

orts

~

42.3

-

65.2

-

7.4

- 37

.2

~ 1

8.0

- 4.

9 -

4.3

- 25

.3

~ 54

.9

- 6.

4 -

17.6

1.

5 -

4.3

7.4

~ 63

.1

- 64

.4

- 0.

3 ~

35.8

~

10.8

0.

2 -

0.2

GA

TT

ag

reem

ent

via

quan

tity

cont

rols

(6

)

outp

ut

- 21

.1

- 34

.9

- 16

.0

- 8.

7 ~

26.3

-

16.0

- 32

.3

- 31

.5

- 5.

0

~ 9.

7

0.0

- 9.

9

_ 12

.0

- 20

.0

0.1

1.5

- 20

.0

10.9

~ 11

.7

- 6.

0 -

0.2

Exp

orts

~

32.1

-

58.9

-

20.4

- 16

.3

- 48

.9

- 19

.7

- 56

.5

~ 57

. I

- 5.

6

- 28

.1

- 12

.4

_ 29

.4

~ 7.

3 ~

20.7

2.

2

9.7

~ 20

.5

12.1

- 8.

4 ~

5.4

1.2

- 10

.3

- 2.

5

- 9.

7

~ 29

.6

- 16

.4

- 28

.4

~ 11

.7

0.0

0.2

0.5

1.0

0.7

0.4

- 4.

5 0.

0 5.

9 9.

0 0.

2 0.

1 -

0.1

- 11

.6

0.0

- 0.

2 0.

3 0.

2 0.

1 -

0.2

- 9.

1 0.

8 1.

1 1.

2 2.

2 1.

8 1.

8

~ 0.

4 0.

8 6.

2 6.

6 1.

5 1.

3 1.

3

~ 8.

4 0.

9 0.

Y

0.9

1.6

1.3

1.4

- 9.

3 2.

1

9.4

0.6

- 1.

8 0.

5

- 4.

1 5.

4

8.3

4.4

- 0.

1 2.

5

1.2

0.7

0.0

- 0.

3 0.

2 -

0.1

3.3

3.1

2.8

2.7

I.8

1.9

1.3

2.2

1.0

0.4

17.2

0.

8 0.

0 -

0.4

0.5

0.6

0.2

- 0.

1

2.8

6.0

3.7

3.5

13.3

4.

8 3.

0 3.

0

1.4

2.6

I .9

2.0

9

0.6

~ 3.

8 9

0.3

0.1

2

0.4

- 3.

2 &

2

2.3

0.0

5

1.6

2.0

B

I .9

1.9

a k 4

0.9

~ 8.

6

0.4

0.4

0.6

- 3.

9

4.8

~ 0.

7

4.0

4.7

2.7

2.8

\ G

3 1.

1 -

4.8

0.5

s 2.

0

5.4

2.6

4.4

5.5

2.1

3.0

Nor

es:

Info

rmat

ion

in

perc

ent

chan

ge

from

ba

se.

Figu

res

in

uppe

r, m

iddl

e.

and

low

er

line

of a

ro

w

repr

esen

t lo

ng-,

med

ium

-, an

d sh

ort-

run

resu

lts,

resp

ectiv

ely.

Sh

ort-

run

resu

lts

are

base

d on

pa

rtia

l po

licy

refo

rm.

Tab

le

11

EU

fa

rm

prog

ram

re

venu

e an

d ex

pend

iture

CA

P re

form

G

AT

T

via

pric

e re

duct

ions

(3)

(5)

GA

TT

vi

a qu

antit

y co

ntro

ls

(6)

Lon

g

run

Med

ium

run

Shor

t

run

Lon

g

run

Med

ium

run

Shor

t

run

Lon

g

run

Med

ium

run

Shor

t

run

Co-

resp

onsi

bilit

y le

vy

Impo

rt

tari

ff

reve

nue

Var

iabl

e im

port

le

vy

Impo

rt

prem

ium

Farm

pr

ogra

m

reve

nue

Var

iabl

e ex

port

su

bsid

y

Out

put

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408 S. Weyerbrock J European Economic Review 42 (1998) 375-41 I

however, that we do not compensate dairy and sugar producers for intervention price reductions. If the EU employs quantity controls to reach the GATT targets, farm program expenditure, on the other hand, increases by 11.5%. Savings on export subsidies are not as dramatic. Again, we do not compensate farmers for changes in dairy and sugar policies. But additional price reductions and quantity rationing without compensation payments seem politically in- feasible. The EU’s farm program expenditure would escalate if we included such

payments. 31

10. Conclusion

This paper studied three questions: (1) Does ongoing CAP reform meet the targets specified in the latest GATT agreement? (2) What additional reforms are needed to make CAP compatible with the GATT agreement? And (3) does CAP reform eliminate the EU’s budgetary problem?

We find that ongoing CAP reform does not meet many targets set out in the Uruguay Round Agreement. Although this reform meets the internal support

target, it violates the new import competition rules and does not meet the export competition targets in the sugar and dairy sectors. Policies in these sectors are not sufficiently altered.

To make CAP more compatible with the GATT’s import competition requirements, EU policy-makers will need to convert the EU’s import quotas and voluntary export restraint agreements into tariffs and reduce these tariffs. In addition, the EU will need to adjust its system of variable import levies so that these levies do not exceed the limits bound in GATT. To reach the GATT’s export competition targets, the EU can take two approaches: it can either restrict supply through set-asides and quotas, or reduce intervention buying and prices. If the EU chooses to impose additional quantitative controls, it has to cut its sugar and milk output quotas by 16% and 20% below their 1987 level. On the other hand, if the Union chooses to alter its price support system, it needs to reduce its intervention prices for sugar and dairy by about 20% and 26%. Our estimates represent upper limits.

In addition to not meeting the GATT targets, CAP reform also does not ease

the EU’s difficult budgetary situation. On the contrary, it increases farm program expenditure by 32%. Generous compensation payments for price cuts and land set-asides and increased funding for structural measures exceed savings owing to reductions in support prices. Such budgetary pressures will soon

‘l In the medium run, the expenditure increase is larger owing to a smaller decrease in agricultural

export subsidies. Because our short-run results are based on partial rather than full policy reform, they differ substantially from our long- and medium-run results.

S. Weyerbrock / European Economic Review 42 (I YVX) 375 -41 I 409

necessitate further CAP reform. Our experiments show that reforms based on support price reductions are preferable to those based on quantity controls, if the EU wishes to maximize GDP or minimize farm program expenditure.

Acknowledgements

I am grateful for many helpful comments and suggestions from Irma Adel- man, Sherman Robinson, Jeffrey Perloff, Barry Eichengreen, Elhanan Helpman (the editor), two anonymous referees, and seminar participants at the 1996 EEA Congress and Rutgers University. I thank Ken Hanson, Dominique van der Mensgrugghe, and Marinos Tsigas for providing a sizable part of the data. All errors are mine. This research was supported by a research agreement with the International Food Policy Research Institute (IFPRI). Any view expressed in this article are those of the author and do not necessarily reflect the view of IFPRI.

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