The disappearing budget constraint on EU agricultural policy

Pergamon

S0306-9192(96)00006-1

Food Policy, Vol. 21, No. 6, pp. 497-508, 1996 Copyright © 1996 Elsevier Science Ltd

Printed in Great Britain. All rights reserved 0306-9192/96 $15.00 + 0.00

The disappearing budget constraint on EU agricultural policy

Alan M a t t h e w s Department of Economics, Trinity College, University of Dublin, Dublin 2, Ireland

Concern over budgetary costs has been the traditional driving force behind changes to the EU's Common Agricultural Policy. While the recent MacSharry reform of this policy was more related to external pressures arising from the need to reach an agreement on agriculture in the GATT Uruguay Round, many expect the budgetary constraint to re-emerge towards the end of this decade, particularly in the light of the impending accession of a number of Central and Eastern European countries (CEECs). This paper argues that it is unlikely that there will be any budgetary need to further reform Europe's agricultural policy to accommodate the CEECs. Applying the agricultural guideline to estimate resources and using a simple forecasting model of FEOGA Guarantee budget expenditure, the paper demonstrates that, under a range of plausible assumptions for the key variables affecting resources and expenditure, a significant positive margin should emerge between available resources and the cost of EU agricultural policy by the beginning of the next decade. This margin should be sufficient to pay the estimated costs of extending the present CAP to the CEEC countries without further significant reform. However, even though the budget constraint on EU farm policy may disappear, other factors, such as GATT disciplines and concern about agriculture's impact on the environment, will remain as pressures for further CAP reform. Copyright © 1996 Elsevier Science Ltd

Keywords: EU enlargement, FEOGA Guarantee Section, EU budget, agricultural policy

Introduction

Following the implementation of the MacSharry reform of the EU's Common Agricultural Policy (CAP) over the period 1993-1995, there has been considerable analysis of its implications for the EU's supply/demand balance in agricultural commodities and for the EU's capacity to meet the disciplines, particularly on the volume of subsidized exports, agreed in the G A T T Uruguay Round and due to take effect over the period 1995-1996 through to 2000--2001 (Guyomard and Mah6, 1993; Expert Group, 1994; Helmar et al., 1994; Mah6 et al., 1994). Less recognition has been given to the consequences of the reform for the EU's ability to control the

497

498 The disappearing EU agricultural budget constraint: A. Matthews

Table 1 Agricultural expenditure in comparison to the agricultural guideline, (mECU, current prices)

1988 1989 1990 1991 1992 1993 1994 1995 1996 (Draft) (Prel)

Agricultural guideline 27 500 28 624 30 630 32 511 35 039 36 657 36 465 37 994 40 797 Budget appropriations 27 500 26 761 26 522 31 516 32 095 35 343 36 465 37 926 40 797 Outturn 26 400 24 406 25 064 30 961 31 119 34 590 33 016 36 897 41 687 Margin +1 100 +4217 +5561 +1 550 +3920 +2067 +3449 +1047 -890

Note: The 1995 and 1996 figures include the three new member states. The appropriation figures also include the additional cost due to the monetary disturbances in 1992-1993. The 1996 outturn figure represents the estimated appropriations required in the draft budget. Only an amount up to the Agricultural Guideline can be entered in the budget, but expenditure caused by monetary disturbances can be met, if necessary, from the monetary reserve (see text).

Source: Principal Hypotheses 1996 in Estimating Expenditure Needs for the FEOGA Guarantee Section, CEC DG VI-G-1, VI/427 A/95.

future level of its agricultural spending. ~ Historically, the budget constraint has been the main driving force of EU agricultural policy reform. While the new external constraints imposed by the Uruguay Round Agreement on the EU's ability to pursue agricultural policy now appear to be more binding, a number of commentators have argued that the budget could re-emerge as a significant policy constraint later in this decade and, more especially, in the context of the EU's future eastward enlargement. 2

There have been a number of estimates of the possible cost of extending the EU's CAP to the applicant countries of Central and Eastern Europe (CEECs) (Buckwell et al. (1994) contains a summary of recent estimates; see also Mah6 et al. (1994)). These estimates vary considerably in terms of the assumptions they make regarding the mode of integration (simultaneous entry with immediate effect, staggered entry with a lengthy transition period), the number of countries covered, the extent of agricultural recovery in the applicant countries and their potential for further growth, and in the nature of the CAP at the time of entry. A common procedure has been to calculate the cost of extending the post-MacSharry regulations and levels of support to the applicant countries. The estimates vary from as low as ECU 3 billion to as high as ECU 42 billion, although the consensus probably falls in the range of ECU 8-22 billion. A price tag for the agricultural cost of CEEC enlargement of this order (excluding structural funds) indeed seems large in comparison to a total 1996 FEOGA Guarantee budget of ECU 41 billion. The higher estimates, in particular, have led to a widespread view that the EU cannot afford to maintain the present CAP after enlargement and that further significant reform will be necessary on budgetary grounds.

Credence is given to this view of a tighter EU budget constraint by the recent trends in the balance between EU agricultural resources and spending. The extra payments needed for CAP reform have strained the limit on available resources for the agricultural budget. Table 1 shows that, in the period from 1988 to 1993, the

~An exception is the study using the ECAM model reported in Expert Group (1994). It concluded that FEOGA Guarantee spending following the MacSharry reform, assuming 2.5% GNP growth in the EU over its projection period to 2001, will remain within the agricultural guideline. This is also the view defended in this paper. 2A not untypical view is that expressed in Tangermann and Josling (1994): "Even without the influence of new members on the budget, . . it is likely that current policies will exhaust the budget allocation in the very near future" (p. 47).

The disappearing EU agricultural budget constraint: A. Matthews 499

level of budgetary appropriations for the FEOGA Guarantee Section was, on average, 6.5% less than the agricultural guideline, which sets the ceiling on available resources, and the level of expenditure was 9.3% less than the guideline. However, in the 1994-1996 period, the margin for manoeuvre was much reduced as the CAP reform payments were added in and all the available resources within the ceiling were entered in the initial budgets for these years.

In our view, the argument that the budget will re-emerge as a significant policy constraint is overstated, and there does not appear to be any budgetary need to further reform the CAP in order to accommodate the CEECs. 3 The justification for this conclusion, which is reached on the basis of an explicit measure of the EU's willingness to allocate resources to agricultural policy and on the likely cost of agricultural policy (for the EU-15) at the time of enlargement, is outlined in the remainder of this paper. Crucial to the conclusion is the fact that the CAP reform payments for cereals and beef, which now account for 46% of FEOGA Guarantee expenditure, are linked to fixed base year quantities and, unlike export subsidies, are also independent of world price fluctuations. Over time, it is also likely that their value will be eroded by inflation.

Forecasting the FEOGA Guarantee budget The estimates of the potential margin of resources or "headroom" which might be available to pay the cost of extending the CAP to the CEECs are based on a simple forecasting model of the FEOGA Guarantee Section budget. The margin is defined as the difference between the resources likely to be available for EU agricultural policy (specifically, those aspects of agricultural policy financed by the Guarantee Section) and the cost of running the CAP for the EU-15 at the time of CEEC membership.

The budget model is a mechanical projection model with no behavioural content. It takes the 1996 draft budget as its starting point and forecasts both potential agricultural resources and expenditure based on assumed changes in key parameters which are discussed in the next section. 4 It assumes that resources will continue to be allocated to the FEOGA Guarantee budget on the basis of the agricultural guideline rule, introduced in 1988 as part of the inter-institutional agreement between the Council of Ministers and the European Parliament on a medium-term Financial Perspective and extended in 1992 at the Edinburgh European Council until 1999. The agricultural guideline was fixed at ECU 27 500 million for 1988, with an annual growth rate not exceeding 74% of the annual growth rate of nominal Community GNP. 5 For the purposes of longer-run

3By further reform of the C A P is meant further cuts in nominal support prices, quotas or base period numbers of crop hectares or livestock eligible for direct payments . Reduct ions in the real value of support consistent with these constraints, as will occur if nominal support prices or payments are not increased in line with inflation, are not ruled out, and indeed play an important part in the scenarios modelled later. 4The model is constructed as a series of linked Excel worksheets. Working with the model is, as far as possible, based on a point-and-click interface. Context-sensit ive help is provided through a Windows Help file. The model runs on a PC with a min imum of 8 MB memory and requires 1.4 MB hard disk space. A diskette with the model is available from the author on request. 5More precisely, it is "corrected expendi ture" , defined as the expenditure base of E C U 27.5 billion less expenditure on sugar and isoglucose levies, food aid refunds and ACP sugar refunds, which is permitted to grow by a max imum rate of 0.74% of E U nominal GNP. The est imated expenditure on these three i tems is then added back to the updated corrected expenditure to obtain the agricultural guideline for any given year. In addition, a monetary reserve was instituted to cover the impact on agricultural budget


projections, it is assumed that the guideline will continue in its present form in the later years after 1999. As the guideline lays down that the maximum resources available to the agricultural budget bear a specific relationship to the growth of EU nominal GNP, the main determinants of agricultural revenue are assumptions about the growth of EU real GNP and the average rate of EU inflation over this period.

Agricultural expenditure in the budget model is a function of the financial requirements to fund export refunds, intervention storage, other intervention costs, direct payments and agri-monetary costs. Around 72% of budgeted Guaran- tee Section spending in 1996 is explicitly modelled. Thus, an important parameter in projecting the expenditure side of the budget is the assumed trend in non- modelled expenditure.

Export subsidy expenditure is explicitly calculated for cereals, sugar, beef and milk products. Expenditure on export subsidies is a function of the quantities exported with the aid of subsidies and the per unit export subsidy. The size of the per unit export refund is a function of the difference between the EU market price and the relevant world price (expressed in ECUs). Intervention costs are explicitly modelled for cereals, beef and dairy products and are defined as the physical costs of storage and financing plus depreciation. Other intervention costs (for example, expenditure to subsidize milk product consumption) are included in non-modelled expenditure.

Direct payments, which are an increasingly important part of CAP support following the MacSharry reform, are of two kinds. First, there are payments to farmers under the various commodity regimes, such as arable aid payments, ewe premia, suckler cow and male beef cow premia, etc. These are now linked to historic base area levels and numbers. Second, there is the cost of the accompany- ing measures of the MacSharry CAP reform (the early retirement, agri- environment and afforestation schemes) which is charged to the FEOGA Guaran- tee budget.

Agri-monetary costs arise from payments to farmers in countries whose currencies revalue against the ECU to compensate them for the losses in the value of price support and direct payments which would result. The agreement on how to deal with agri-monetary disturbances when the switchover arrangement was abolished in 1993 was potentially a very expensive one, as it would have required the ECU value of CAP reform payments to be increased in line with the greatest revaluation of any member state currency. 6 While this would have prevented any reduction in the national currency value of these payments in the revaluing country, it would have increased their value in all other member states. However, the EU's liability is considerably reduced in the subsequent agreement reached by the Council of Ministers in June 1995. 7

Under the 1995 agreement, two types of additional budget costs can arise from agri-monetary disturbances: the cost of income compensation for market price reductions in strong currency countries caused by a revaluation of their green

expenditure of significant and unforeseen movements in the dollar/ECU parity in relation to the parity used in the budget. The reserve's initial resources totalled ECU 1000 million, and its operating threshold was set at ECU 400 million. From 1995, the value of the reserve and of its threshold expenditure were reduced to 500 million and 200 million ECU respectively, on the grounds that the reformed CAP is less susceptible to exchange rate fluctuations. 6Reg. (EC) No. 3813/92 (OJ No. L 387 31.12.92). 7Reg. (EC) No. 1527/95 (OJ No. L 148 30.06.95).

The disappearing EU agricultural budget constraint: A, Matthews 501

exchange rates, and the cost of maintaining CAP reform and structural and environmental payments in strong currency countries constant in national currency terms. However, these costs are expected to be only transitional given the altered monetary situation in the EU after 1 January 1999 which is the latest date set for the third stage of moving towards Economic and Monetary Union (EMU).

If all EU member states sign up for EMU by that date, then agri-monetary problems will disappear together with their impact on the budget. Even if only some member states agree to move forward to EMU, one must assume that the single currency introduced at that time to replace the member states' currencies will become the unit in which farm support prices and budetary transactions are denominated in the future. Over time, it might be expected that the single currency would appreciate relative to the ECU as currently constructed, i.e. a basket of currencies of all member states including those too weak to join the EMU. However, because farm support prices will be denominated in the single currency rather than ECUs, no problem of revaluation arises. For this reason, no additional budget cost associated with the agri-monetary arrangements has been entered in the simulations after 1999, except that it is assumed that some mechanism will be found to ensure that the value of CAP reform payments is not reduced in strong currency countries at this date. This cost (i.e. of any revaluation in the period 1996-1998) is maintained in the budget for the years after 1999.

Alternative budget scenarios

For the purpose of examining the sensitivity of the EU's agricultural budget to the key parameters which influence agricultural revenues and expenditure, three scenarios are defined: (a) a baseline scenario which is intended to represent a "best guess" with respect to the evolution of the model parameters; (b) an optimistic scenario; and (c) a pessimistic scenario. The use of the terms "optimistic" and "pessimistic" refers to the expected budgetary outcome and not to farm incomes which may move in the opposite direction. For example, a tighter policy with respect to EU support prices will benefit the EU agricultural budget at the expense of farm incomes. All scenarios are run to the year 2005 and the results are reported for the years 2000 and 2005. It is felt that this period brackets the likely date of accession of the new member countries.

The assumptions used are outlined in Table 2. The baseline scenario assumption of 3% annual growth in real EU GNP is in line with the EU's long-term growth trend (3.1% over the period 1960-1992 and 2.9% in 1970-1980) though a little higher than the 2.5% annual growth achieved in the 1980-1991 period (UNCTAD, 1994). With respect to the price assumptions, during the 1980s world market prices decreased by more than 6% a year and EU prices by nearly 4% a year in real terms (Expert Group, 1994). There are good reasons to doubt that this downward trend will continue for the next decade (FAO, 1995). Thus, the baseline assumption is that nominal world prices (in dollar terms) will grow by 2% p.a. over the forecast period from the levels assumed to prevail in 1996. In the optimistic scenario this is further increased to 3% p.a., while in the pessimistic scenario, the assumption is made that world prices remain constant at their 1996 levels in nominal terms. Real world prices (in US dollars) would continue to fall in the baseline and pessimistic scenarios assuming world inflation similar to the projected EU rates.

From the point of view of EU expenditure on export refunds, it is world prices in ECUs which are important. In the baseline and optimistic scenarios, it is assumed that the ECU/US$ exchange rate remains unchanged at the level assumed in the


Table 2 Assumptions chosen for three scenarios (growth rates refer to period 1996--2005)

Baseline Optimistic Pessimistic Parameter assumptions scenario (%) scenario (%) scenario (%)

Growth in real EU GNP 3.1) 3.5 2.5 Growth in EU inflation 3.0 2.5 3.5 Growth in nominal EU support prices 1.0 0.0 3.5 Growth in nominal world prices ($) 2.0 3.0 0.0 Growth in nominal value of compensatory direct payments 1.1) 0.0 3.5 Rate of appreciation (+)/depreciation(-) of US $ against the ECU 1).0 0.0 -2.0 Rate of appreciation of strong EU currencies against the ECU 2.0 2.0 2.0 Cereals set-aside regime 8.0 5.0 15.0 Oilseeds set-aside regime 8.0 5.0 15.0 Export quantities GATT GATI" GATT Intervention quantities End-1996 End-1996 End-1996 Growth in nominal non-modelled expenditure 3.1) 2.5 3.5

Outcomes (mECU 1996 prices) Projected resources 2000 Projected expenditure 2000 "Headroom" 2000 Projected resources 2005 Projected expenditure 2005 "'Headroom" 2005

44 136 44 787 43 492 38 583 37 599 42 114 5 583 7 188 1 378

48 807 50 438 47 223 34 529 32 556 41 466 14 278 17 882 5 578

Notes: 1. The terms "optimistic" and "pessimistic" scenarios are used with respect to the outcomes for the FEOGA Guarantee budget. Often the budget position can be improved but at the expense of farm incomes, e.g. a lower rate of growth in nominal support prices improves the budget position but disadvantages farmers. 2. All growth rates are with respect to the prices and exchange rates in the draft 1996 budget. 3. Projections for future years are calculated in nominal terms and the outcome figures are converted back to 1996 prices using the inflation rate assumed for each scenario. Source: FEOGA Guarantee budget forecast model constructed by the author.

draf t 1996 agr icul tura l budge t (0.79 E C U = 1 US$) . In the pess imis t ic scenar io , it is a s sumed tha t the US$ dep rec i a t e s aga ins t the E C U by 2% annual ly .

In the base l ine scenar io E U suppor t pr ices and d i rec t p a y m e n t s a re a s sume d to g row sl ightly by 1% p e r a n n u m in nomina l t e rms . G i v e n the inf la t ion a s sumpt ion , this impl ies a fall in real suppo r t pr ices of 2% p e r a n n u m or m o r e s lowly than in the pas t . In the opt imis t ic scenar io ( f rom a budge t pe r spec t ive ) , suppor t pr ices and d i rec t p a y m e n t s a re he ld cons tan t in nomina l t e rms ; given the inf la t ion a s sumpt ion , this impl ies a fall of 2 .5% pe r a n n u m in nomina l t e rms which is still l ower than recen t h is tor ica l exper i ence . In the pess imis t ic scenar io ( f rom a budge t pe r spec - t ive) , it is a s sumed tha t the E U tr ies to p ro t ec t bo th the va lue of suppo r t pr ices and di rec t p a y m e n t s aga ins t inf la t ion. Thus it is a s sume d tha t nomina l pr ices and p a y m e n t s will be inc reased by 3 .5% pe r a n n u m to ach ieve this ob jec t ive . In all t h r ee scenar ios , n o n - m o d e l l e d e x p e n d i t u r e is a s sumed to r e m a i n cons tan t in rea l t e rms .

Wi th respec t to quant i t i es , over the p e r i o d 1995-2000, the quant i t i es e l ig ib le for expo r t subs id ies a re l imi ted to the amoun t s spec i f ied in the U r u g u a y R o u n d G A T T ag reemen t . The s imula t ions assume tha t the E U will m a k e use of the m a x i m u m


amounts permissible under this agreement in each year up to the year 2000. 8 For the purposes of projections beyond 2000, the assumption is made that the allowed volume of subsidized exports will continue to be reduced at the same annual rate as implied by the Uruguay Round Agreement. Intervention stocks are assumed to remain constant at the (low) levels assumed for closing stocks in the draft 1996 budget. The quantities eligible for direct payments (CAP reform payments in the case of arable crops and beef, deficiency payments in the case of olive oil and sheepmeat) are assumed to remain constant at the numbers underlying the 1996 budget. 9

For the purpose of modelling agri-monetary costs, the assumption is that the strong currency countries will continue to revalue against the ECU by the same rate as they have done over the past decade (approximately 2% p.a.). For the years after 1999, it is assumed that at least a first tier of countries, including the strong currency countries, proceeds to Economic and Monetary Union in 1999 and that further revaluations against the single currency are ruled out from that date. However, the costs incurred by the protection of the value of CAP reform payments in revaluing currencies to 1999 are assumed to remain a burden on the budget in subsequent years.

The outcomes for the three scenarios are also summarized in Table 2. In the baseline scenario, agricultural resources grow substantially due to the assumed growth of 3.0% p.a. in real EU GNP. However, agricultural spending falls significantly, due mainly to the low increase assumed in EU support prices and direct payments in nominal terms over the nine-year forecast period, though the fall in subsidized export quantities and in the unit value of export subsidies also contribute. By the year 2000, a margin of around ECU 5760 million arises, and by the year 2005, this has increased to a positive margin of around ECU 14 460 million. If this outcome materialized, substantial resources would be available in the agricultural budget to meet the anticipated agricultural costs of the eastward enlargement. The power of compound interest should also be noted; there is a rapid growth in the size of the margin between 1996 (when the budget is assumed to have a small deficit; see Table 1) and 2000, and then forward to 2005.

The main difference between the optimistic scenario and the baseline one is that faster EU growth implies that additional resources are available under the agricultural guideline, while agricultural expenditure is slightly lower because EU support prices and direct payments are held constant in nominal terms. Thus, the margin of potential resources over expenditure is even greater than in the baseline scenario. The model forecasts a margin of ECU 7401 million in 2000 and a margin of ECU 18 070 million in 2005.

The pessimistic scenario is useful in showing the sensitivity of the budget balance to a considerable worsening of the parameters (from the point of view of the budget balance). In the first place, slower EU GNP growth implies that substantially smaller potential resources become available under the agricultural guideline. In the second place, the EU is assumed to hold the real value of agricultural support prices and direct payments constant, even in the face of a considerable fall in the world prices in ECU terms (due to a continuing devaluation of the US dollar vis-fl-vis the ECU). A positive budget balance remains, but of a much smaller size.

8The export constraints for the EU-12 have been used as the disciplines which will apply as those applicable to the EU-15 have not yet been agreed. 9For oilseeds, the area used is the max imum guaranteed area of 5.128 million ha.


The budget model forecasts a margin of ECU 1580 million in 2000 and ECU 5928 million in 2005.

Discussion

These results raise three questions for further discussion which are pursued in this section. First, how reasonable is the choice of the agricultural guideline rule to represent the EU's willingness to pay for its agricultural policy in the years ahead? Second, how plausible are the assumptions behind the baseline scenario which is put forward as a reasonable projection of likely trends? Third, what do the baseline scenario assumptions imply for the gap between the EU and world market prices over the projection period?

A critical assumption behind the results in the previous section is that the resources made available for agricultural policy in an enlarged Union would continue to grow at a rate equivalent to 74% of the growth in the EU's nominal GNP over the period to the year of enlargement. More precisely, given that it is unlikely that additional resources of this magnitude will be required in the years prior to enlargement, the assumption is that the EU will be willing to provide resources for agricultural policy in an enlarged Union at a level equivalent to that which would be indicated by the continued application of the current agricultural guideline in the years after enlargement.

It is important to note that this guideline implies a continued slow diminution of the share of agriculture in the total EU budget, even if the overall budgetary resources are not increased beyond the limit of 1.27% of EU GNP after 1999. This is because of the application of the coefficient of 0.74 to the growth rate of nominal EU GNP in determining the guideline ceiling. For example, assuming a growth rate in real EU GNP of 3.0% over the next decade, the agricultural guideline share of the EU budget will fall from 51% in 1995 to 48% in 2005 (the projections indicate that the agricultural expenditure actually required will fall much more rapidly, at least in the years up to the year of enlargement). If it is agreed to further increase the overall resources which the EU budget can claim in the next inter-institutional agreement to accommodate the other costs of enlargement (for example, increased structural funds), then the share of agriculture in the EU budget would fall even further. Further, the calculated agricultural costs of enlargement are gross costs. Enlargement will also increase the absolute value of the revenue made available under the agricultural guideline for any given share in EU GNP, though the size of this effect will not be great given that accession of the six CEECs will increase EU GNP by only between 3 and 5%.

Whether these potential resources will materialize will depend on decisions made in the revision of the Financial Perspective promised during the 1996 Inter- Governmental Conference negotiations and its extension in the years beyond 1999. Member states' interests and the views of the European Parliament will be the decisive factors in these decisions. The time paths of budgetary resources and expenditure indicate that a considerable "surplus" could build up well before the possible date of accession of the new member states. Given the overall limit on EU budgetary spending, such a "surplus" in the agricultural budget would be at the expense of other EU spending programmes, and there may be pressure to divert these resources elsewhere. However, the view that the EU will be willing to commit resources to agricultural policy in the future up to an amount implied by the continued application of the current agricultural guideline seems a defensible one.

Turning to the plausibility of the baseline scenario, there is clearly an infinite

The disappearing EU agricultural budget constraint: A. Matthews

Table 3 FEOGA Guarantee budget impact multipliers calculated for 1997 and 2001"

505

Parameter Absolute change in Absolute change in change of 1% in: budget revenue or budget revenue or

expenditure in 1997 expenditure in 2005 million ECU million ECU

Resources Growth in EU GNP +287 Growth in EU inflation +370

Expenditure Growth in nominal EU support prices +72 Growth in nominal value of compensatory direct payments +214 Growth in world prices ($) -86 Rate of appreciation (+)/depreciation(-) of US $ against the ECU -58 Rate of appreciation of strong currencies against the ECU* +148 Cereals/oilseeds set-aside regime +35 Growth in non-modelled expenditure + 103

+2 662 +3 635

+503 +2 432

-917

-353

+ 165 +35

+962

* All values are in 1996 prices, except for the inflation effect. This figure is not comparable to the others in the table for the reasons given in the text.

Source: Author's calculations based on the FEOGA Guarantee forecasting model.

number of potential scenarios with different combinations of the key parameters. Impact multipliers can be calculated to show the relative importance of individual variables in affecting the trend in the FEOGA Guarantee budget balance. The multipliers show the change in projected agricultural revenue or expenditure which would arise from a one percentage point change in each variable. They are calculated assuming no change in the value of the other parameters from the values assumed in the 1996 draft budget (apart from the assumption of declining subsidized export quantities over the projection period). Multiplier values for the years 1997 (a one-year effect) and for 2005 (the cumulative effect of a one percentage point difference in the variable in each year over the projection period) are shown in Table 3. The results should be interpreted bearing in mind the restricted coverage of Guarantee expenditure in the forecasting model (approximately 85% of actual export subsidies, 90% of intervention storage costs and 96% of direct payments in the 1996 draft budget are covered, while the remaining expenditure is included in the category of non-modelled expenditure).

On the revenue side, a 1% increase in the rate of inflation is worth more in terms of nominal budget resources than a 1% increase in real GNP as the latter is diminished by the coefficient of 0.74. Of course, if expenditure is maintained in real terms, the overall budgetary impact is broadly neutral (the sum of a 1% increase in support prices, direct aids and non-modelled expenditure has approximately the same effect on agricultural expenditure as a 1% increase in the rate of inflation on revenue). The biggest cause of expenditure changes is a decision to increase the value of direct payments (including olive oil and sheepmeat payments) which is immediately three times more expensive than a similar increase in support prices, and by 2005, would be almost five times more expensive (this difference arises because the impact of a support price increase is transmitted through the higher cost of export subsidies and the quantity of subsidized exports is assumed to fall


Table 4 Price assumptions used in forecasting FEOGA Guarantee expenditure (nominal values)

Commodity 1996 draft budget 2005 baseline scenario

EU support or EU f.o.b. Price EU support or EU Lo.b. Price market price export price gap market price export price gap ECU/t ECU/t % ECU/t ECU/t %

Wheat 119.2 110.6 8 130.4 132.2 - - Barley 119.2 71.1 68 130.4 85.0 53 Maize 119.2 79.0 51 130.4 94.4 38 Sugar 631.9 241.0 162 691.1 288.0 140 Beef 2 475.0* 664.0 272 2 707.0 794.0 241 Butter 2 699.9* 947.9 184 2 953.0 1 133.0 160 SMP 1 515.4" 790.9 92 1 657.4 944.0 75

* The 1996 market prices for beef, butter and SMP are imputed by adding the value of export refunds paid to the expected EU export price. Source: Principal Hypotheses and Working Document 1996 in Estimating Expenditure Needs for the FEOGA Guarantee Section, CED DG VI-G-1, VI/247 A/95 and B/95, respectively.

over the period), m A change in the assumed rate of growth of non-modelled expenditure would also have a very significant impact.

A revaluation of the strong currency countries against the ECU would have a significant immediate effect, but would be of less significance in the longer run, following the establishment of EMU in 1999. After this date, it is assumed that support for income losses is phased out completely, while the continuing cost represents the cost of maintaining the value of direct payments in revaluing countries at their 1999 level. A decision to increase set-aside also adds to budgetary costs (though this is an incomplete accounting as the change in set-aside is assumed independent of any change in production quantities in the model and the cost would also be affected by any decision to change support prices over the projection period). On the other hand, increases in world prices or in the value of the US dollar vis-a-vis the ECU reduce budgetary expenditure. These effects are not symmetrical because, in the model, EU market prices for olive oil and sheepmeat (which are supported through deficiency payments) are assumed to follow trends in world prices unadjusted for exchange rate changes.

Given that the growth rates are applied to the values of these variables used in the 1996 agricultural budget, it is important to gauge whether the 1996 values used as the base for the projections are reasonable and in line with longer-term trends. The variables of concern are the world prices for commodities which are used in the projections and the US$/ECU exchange rate reported in Table 4. Substantial price gaps are evident, and the world prices assumed in the 1996 draft budget do not appear to be unreasonably high. This table also shows the implied differences between nominal EU and world market prices in 2005 under the baseline scenario assumptions. Except for wheat, substantial price gaps would remain though if a further reduction in import tariffs is agreed in a future GATT Round, this may require reductions in EU support prices compared to those reported here.

Conclusion

Regular haggling over the budgetary costs of agricultural policy has been the

1°Direct payments include deficiency payments to sheep and olive oil producers, but the CAP reform payments to arable and beef farmers are by far the biggest element.


driving force behind changes in EU agricultural policy over the past three decades. Although the recent MacSharry reforms were more directly brought about by external pressures, many commentators believe that the budget will re-emerge as a binding constraint, particularly given the further enlargement of the EU to include the ten CEECs. Estimates of the additional agricultural costs vary widely depend- ing on the assumptions made regarding the modalities of integration, agricultural productivity in the applicant countries, and the nature of the CAP at the time of accession. The size of probable costs in published studies ranges between ECU 8 and 22 billion. There is a widespread view that the EU cannot afford to pay costs of this magnitude and that, as a consequence, further changes to the EU's CAP beyond the MacSharry reforms will be necessary.

This paper has presented three possible scenarios for the growth in EU-15 agricultural revenues and expenditures to the year 2005. A number of conclusions can be drawn. The very tight budget constraints under which EC agricultural policy operated in the 1970s, 1980s and through the mid-1990s will no longer apply to the end of this decade. Even under a pessimistic set of parameter assumptions, a comfortable margin will exist under the agricultural guideline. This turnaround is due to three principal factors: (1) the fact that the growth of the most significant component of expenditure, namely direct payments, is now curtailed by being linked to historic base year numbers and yields; (2) the more buoyant outlook for world markets which will reduce the gap between EU and world prices and hence the required size of export refunds; and (3) the necessity to reduce the quantities of subsidized exports, and hence expenditure on export refunds, to comply with GATI" disciplines.

Under plausible assumptions regarding the internal and external environment for agricultural policy over the next decade, a substantial margin of potential resources should be available in the agricultural budget by the year 2005 to fund the agricultural cost of the eastward enlargement. The baseline scenario allowed for 3% growth in EU real GNP, some increase in nominal support prices and in the value of direct payments and maintained the value of non-modelled expenditure (around 30% of the total) in real terms. These assumptions would produce a surplus in the agricultural budget of more than ECU 14 billion by 2005, increasing at a rate of about ECU 1.7 billion p.a. While more pessimistic budgetary assumptions would reduce this figure, it would take a very improbable combination of unfavourable circumstances to render it insignificant in relation to the estimated costs of accession. It should also be noted that the same factors which increase the ability of the EU to pay for accession decrease the estimated costs. Given the uncertainty surrounding the costs of further enlargement and the way these will be affected by the date agreed for accession, the exact nature of the package offered to the applicant countries and the phasing of transition arrangements, our conclusion is that budgetary factors should not prove a constraint to including the applicant countries in an agricultural policy substantially unchanged from that which currently exists after the MacSharry reforms.

To avoid misunderstanding, the argument in this paper that the budget will not be a binding constraint on future EU agricultural policy does not imply that other pressures for further CAP reform will not materialize. It is possible that the Uruguay Round disciplines will require further changes in CAP in the next decade, even if they are compatible with CAP reform over the transition period to 2000 (Buckwell et al . , 1994) and there is provision to begin negotiations on a further round of agricultural trade liberalization in 1999. Enlargement to accommodate the CEECs may prompt a more fundamental re-appraisal of the effectiveness of the


CAP in meeting its objectives in any case. Additional pressures for change could also arise from environmental considerations or from a more aggressive consumer lobby.

References

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Guyomard, H. and Mah6, L. (1993), R6forme de la PAC et n6gociations du GATI': quelle compatibilit6? Economie Internationale 55, 63-90.

Helmer, M., Meyers, W. and Hayes, D. (1994) GATT and CAP reform: different, similar or redundant, in G. Anania, C. Carter and A. McCalla, eds, Agriculture Trade Conflicts and GA TT: New Dimensions in US-European Agricultural Trade Relations, Westview Press, Boulder, CO.

Mah6, L., Codier, J., Guyomard, H. and Roe, T. (1994), L'Agriculture et 1'61argissement de l'Union Europ6enne aux Pays d'Europe Centrale et Orientale: Transition en vue de l'Int6gration ou Int6gration pour la Transition? Study commissioned by Directorate-General I of the European Commission, Brussels, mimeo.

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UNCTAD (1994), Handbook of International Trade and Development Statistics. United Nations, New York.

The disappearing budget constraint on EU agricultural policy

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