Future Role of REPS under a Changing CAP

Introduction

The Commission's Mid-Term Review (MTR) proposals in July 2002 (Commission, 2002) have received a mixed, indeed hostile, reception in Ireland. The Commission argues that the changes are necessary to respond to the concerns that EU citizens express about the effectiveness of the CAP. Critics have argued that they will lead to reduced production, a fall in net receipts from the Common Agricultural Policy, and undermine long-term public support for transfers to the farming sector. The purpose of this paper is not to evaluate the overall impact of the MTR package on Irish agriculture, but to focus on those aspects which have implications for agri-environmental policy and specifically REPS. There is broad agreement about the need for tighter integration of environmental objectives into agricultural policy, and it is likely that some movement will be made in this direction regardless of what happens to the overall package.

The paper first outlines some of the significant agri-environmental changes introduced by the Agenda 2000 and which form the starting point for the MTR. Three aspects of the MTR are then discussed for their environmental impact: decoupling of direct payments, eco-conditionality and modulation. In the light of this discussion, the paper concludes by speculating on the implications for REPS and those farmers who participate in REPS, and on the future for agri-environment schemes, were the Commission's proposals to go through.

Agenda 2000: The starting point

The Commission's proposals begin with a restatement of the objectives that agricultural and rural development policy should promote, based on the principles established in Berlin and enhanced at the European Summit of Gothenburg:

• a competitive agricultural sector;
• production methods that support environmentally friendly, quality products that the public wants;
• a fair standard of living and income stability for the agricultural community;
• diversity in forms of agriculture, maintaining visual amenities and supporting rural communities;
• simplicity in agricultural policy and the sharing of responsibilities among Commission and member-states
• justification of support through the provision of services that the public expects farmers to provide

The justification for its strategy is a concern for the maintenance and promotion of the European model of agriculture. This European model is seen as multifunctional in nature. Agriculture produces not only commodity outputs which are sold in normal commercial markets, but also non-commodity outputs such as landscape, biodiversity, safeguarding of the rural environment, food security, rural viability and even cultural heritage. A characteristic of these non-commodity outputs is that they are not priced or bought and sold in open markets. They have the characteristics of what economists call `public goods'. If society wants these goods produced, then it may have to make a direct transfer to remunerate farmers to ensure their production. There is a subtle shift in emphasis in the rationale for support to the agricultural sector in this argument. The MTR recognises explicitly that market revenues alone are not enough to ensure an acceptable standard of living for many farm households, and that direct payments continue to play a central role in ensuring a fair standard of living and stability of income for the agricultural community. However, increasing emphasis is being put on the role of market failures, the inability of the market to ensure the supply of public goods which society demands, as the justification for farm transfers in the future.

To support this changing emphasis, Agenda 2000 created the "second pillar" of the CAP, the "first pillar" being market support. The second pillar is based around the rural development regulation (1257/99), a set of 22 measures available for use for rural development. These embrace

• the accompanying measures of the 1992 reform (agri-environment scheme, afforestation, early retirement) plus the Less Favoured Areas scheme;
• all types of measures supporting structural adjustment (former objective 5a measures) and rural development (former objective 5b measures) plus measures to diversify agriculture and to support income earning activities going beyond agricultural production.

Agenda 2000 also made a significant step towards the integration of environmental goals into agricultural policy.1 To ensure that direct payments made under the first pillar do not undermine the environmental objectives promoted in the second pillar, there is a general principle that environmental conditions should be attached where feasible to all direct supports in the first pillar. As far as direct payments are concerned, this was introduced in Article 3 of the common rules for direct support schemes (1259/99) which requires Member States to "take the environmental measures they consider to be appropriate". These measures may include support in return for agri-environment commitments; requiring the observance of general mandatory environmental requirements as a condition for receiving direct aid; or introducing specific environmental requirements as a condition for receiving direct payments. The latter two options can be enforced by reducing direct payments granted under the first pillar of the CAP in the event of non-compliance.

Following the implementation of Agenda 2000, the integration of environmental objectives into agricultural policy can be represented as a pyramid with several steps (see Figure 1). At the bottom tier, Tier 0, all those farmers in receipt of direct payments must observe farming standards set out in the Code of Good Farming Practice (GFP). GFP currently defines the threshold between what can reasonably be expected from a farmer without extra payment and activities for which he should be compensated.

At Tier 1, those farmers who enrol their land in REPS receive additional payments in return for following environmentally-friendly farming practices which go beyond the GFP standards. Payments to farmers in less-favoured areas are also included at this level. Farmers in receipt of the compensatory allowances in LFAs are required only to "apply usual good farming practice compatible with the need to safeguard the environment and maintain the countryside, in particular by sustainable farming". In this sense, the environmental demands are no higher than for Tier 0 payments. However, the justification for LFA payments is to maintain the rural population and to prevent the abandonment of land in marginal farming areas, and because the additional payments are made to secure these objectives, they are included as Tier 1 payments in Figure 1.

A smaller number of farmers will enrol to achieve specific and additional environmental objectives under the REPS Supplementary Measures (except

Measure A), which we refer to as Tier 2. Finally, there are farmers whose land is designated as areas of particular nature quality under the EU Habitats or Birds Directives or under national legislation. These farmers are paid a higher REPS premium under Measure A or can apply for individual compensation based on a farm plan, in recognition of the fact that their compliance with higher environmental standards is compulsory rather than voluntary as is the case with the rest of the REPS participants.

Decoupling: environmental implications

The Mid-Term Review of the Agenda 2000 strategy has three main axes: market measures (mainly confined to the cereals sector), decoupling of direct payments, and strengthening of the second pillar. There will be some environmental impacts arising from the market measures (in particular, arising from the proposed rule changes introducing compulsory long-term set-aside on arable land instead of the present rotational set-aside) but these are not discussed further here. In this section, we look at the environmental impact of decoupling direct payments.

The Commission's proposal is the introduction of a single decoupled payment per farm, based on historical payments adjusted to take into account the full implementation of Agenda 2000. Six reasons are given for this proposal.

• It would simplify the process by which a farmers gets support in a manner which is neutral with respect to payments to producers.
• It would allow farmers to better respond to what the market demands by delinking the level of support and production decisions. Direct payments would no longer steer the production decisions of farmers.
• In many cases it would improve the efficiency of transfers to farmers, and should help to improve their income situation.
• Decoupling will contribute to environmental integration by removing production specific incentives, which potentially damage the environment
• Decoupling will facilitate the integration of the new Member States into the Common Agricultural Policy.
• Because decoupled payments fall into the WTO Green Box, they could not be challenged by other WTO Members in international trade negotiations.

The environmental benefit arises because decoupling should lead farmers to more extensive production, thus reducing pressure on rural resources. The Commission proposal does recognise some risks. Reduced production could have a knock-on effect on the processing sector and it could lead to the abandonment of land in some marginal farming areas. From the Commission's perspective, reduced production (particularly in beef) is a desirable outcome anyway, while it believes the threat of land abandonment could be met by more targeted policy instruments, such as less favoured area or agri-environment payments.

There are three issues to be addressed in this debate. First, is the Commission right to expect that decoupling direct payments will lead to more extensive production? Economic logic supports this outcome, as farmers will now use inputs only up to the point where their use is justified by the market price return, and not by the combined market price and direct payment. Empirical studies are less clearcut. A recent review of the impact of the MacSharry and Agenda 2000 reforms on extensification commissioned by the UK Ministry for the Environment, Food and Rural Affairs came to a somewhat ambiguous conclusion (DEFRA, 2002). Second, some observers fear that decoupling will lead farmers not just to more extensive production but to abandon farming, while still retaining their payments. The Commission responds that payments will be conditional on cross-compliance which will require continued farming. Third, farmers worry whether there will be long-term public support for decoupled direct payments which have, at best, only limited and indirect environmental benefits. This may, paradoxically, increase the political attraction of more targeted agri-environmental schemes where the environmental benefits can be more clearly demonstrated.

Eco-conditionality

Eco-conditionality for direct payments and the associated system of penalties was introduced in Agenda 2000, but suspicions remain about the commitment of Member States to enforcing this conditionality. The Commission has sought to tighten up its monitoring of Member States' activity in this area under Regulation 963/2001 requiring, inter alia, an annual progress report on the implementation of the measures and penalties, including an assessment of their environmental effects. The issues for discussion under this heading include:

The scope of the standards: The MTR proposes that eco-conditionality would include environmental, food safety and animal health and welfare standards, as well as occupational safety requirements for farmers. The Irish GFP covers most of these areas apart from food safety although, for cattle farmers at least, this aspect is now covered by the National Beef Assurance Scheme.

The level of the standards: The Commission, while recognising that standards of good farming practice may vary across regions, is also concerned that differences in standards, and differences in the enforcement of such standards, could lead to distortions of competition within the single market. It proposes that Member States should define and enforce standards, "following a common framework providing basic implementation criteria". It is not clear whether this implies that the Commission will pursue the harmonisation of standards or seek agreement on some minimum set of standards. There is also some confusion in the level of standards to be aimed at, with the Commission arguing at one stage that good farming practice is defined as meeting mandatory standards, and elsewhere as the standard of farming that a reasonable farmer would follow in the region concerned. The level of GFP standards has a knock-on effect on the REPS, because the philosophy of REPS is only to reward farmers for practices which go beyond GFP. Nevertheless, it does not appear that anything in the MTR will require a major revision or upgrading of the GFP standards agreed by the Department of Agriculture and Food with the farming organisations and now in use.

The monitoring of standards: Partly to address the issue of lax enforcement of standards, the Commission proposes a Community-wide system of farm auditing for compliance with GFP for commercial farms, to be defined by Member States on the basis of economic size. It proposes that, initially, farm audits will be mandatory for all producers receiving more than €5,000 in direct payments, while allowing other producers to participate on a voluntary basis. It proposes to make available financial support for farm audits under the rural development regulation. As farmers are already open to Department inspections for conformity with GFP, the additional requirement of farm audits should not be too onerous an imposition.

Modulation: Budget rebalancing

Modulation is designed to address a major criticism of the two-pillar structure set up under Agenda 2000, namely, the relative lack of funds available for the second pillar. The MTR document points out that only 16% of total FEOGA expenditure, and only 10% of FEOGA Guarantee expenditure, is currently used for rural development. As there is no prospect of additional funds by raising the agricultural budget ceiling agreed for Agenda 2000, the transfer of funds from Pillar 1 to Pillar 2 through the modulation mechanism is put forward as the alternative. In order to increase resources for the second pillar, the Commission proposes introducing a system of dynamic modulation on a compulsory basis for all Member States replacing the current optional arrangements from 2004 onwards. Under this system, all direct payments should be reduced progressively in arithmetic steps of 3% per year to reach 20%, the maximum agreed in Agenda 2000. Acknowledging the higher labour intensity of small farms, a franchise dependent on the employment situation on each farm would be introduced. For up to 2 full time annual work units (AWU) the franchise will be €5,000 per AWU and for each additional AWU an additional €3,000 may be granted on an optional basis by Member States. After the application of modulation, the total amount paid per farm should not exceed €300,000 plus the franchise.

Agenda 2000 already included modulation as a voluntary option at the Member State level, but few Member States have applied it or appear to have any intention of doing so. Whether the Commission will succeed in making it mandatory remains to be seen. Problems in persuading Member States to shift funds to the second pillar include:

• Distributional issues within farming. The larger farmers who face reductions in their direct payments resulting from modulation are not necessarily those who will benefit from increased second pillar spending. These difficulties within farming might be faced down if there was a recognition that there were national gains from pursuing this route, but not all Member States feel they will benefit for the following reasons.
• Distributional issues among Member States. A major obstacle to converting agricultural policy into a more integrated rural policy are the distributional effects among Member States provoked by reducing the first pillar and increasing the second one. The Commission proposals attempt to limit this redistribution while improving the contribution to economic and social cohesion by setting criteria (area, employment, prosperity) for the way modulated funds will be redistributed to Member States.
• Countries in a weaker economic position find it difficult to find the counterpart funds required for second pillar schemes, unless the level of Community co-financing in the second pillar is very high.
• Second pillar schemes have higher transaction costs. Plans must be drawn up, compliance with measures needs to be monitored, evaluations must be undertaken, etc. Studies show that between 5 and 30% of programme costs can be lost in this way, reducing their attractiveness to Agricultural Ministries.
• Agricultural Ministries are not necessarily familiar or comfortable with running environmental or rural development schemes, and may not have responsibility for these areas. Thus there is little incentive for Agricultural Ministers to agree to a transfer of first pillar funds.
• There have been problems in the rural development area in finding worthwhile projects to support, thus leading to fears whether second pillar funding could be absorbed by a country even if it qualified for additional funding under the redistribution criteria.

If dynamic modulation is agreed, then additional funding would become available for Pillar 2 measures in Ireland. This additional funding could be used to reinforce rural development programmes on the basis of needs identified within the framework of the mid-term evaluation of these programmes. The Commission is also proposing new rural development measures to address food quality, to help farmers to meet higher environmental food safety and animal welfare standards as well as support for farm audits.

With respect to agri-environment schemes such as REPS, the MTR proposes the possibility to offer animal welfare payments for efforts that go beyond a mandatory reference level. It also proposes to increase the fixed co-financing rate for agri-environment schemes by a further 10 percentage points, to 85% in Objective 1 areas and 60% in other areas.

Conclusions: Implications for REPS

Having examined the possible environmental implications of the MTR proposals, we turn in this final section to speculating on their likely implications for the future of REPS.

A key point to note is that all of the changes examined - decoupling, eco-conditionality and dynamic modulation - only affect farms producing commodities where some support is provided through direct payments. Commodities whose support is provided entirely through market price support, such as milk and sugar, remain unaffected by these changes,2 although dairy producers will find themselves included as direct payments are phased in beginning in the 2005/6 marketing year. From this perspective, the proposals do not appear to make it any more or less likely that producers of these commodities, who are currently underrepresented in REPS, will participate in REPS in the future.

If decoupling of direct payments does reduce the intensity of agricultural production on cattle, sheep and arable farms, it may make it marginally more attractive for these farmers to consider entering REPS by reducing the opportunity cost of complying with REPS conditions.

Proposals to set EU-wide minimum standards for good farming practice could potentially have an adverse effect on REPS participation if they raised the bar above which Tier 1 payments took effect. However, my view would be that the Irish GFP guidelines would not require to be changed even if new EU-wide standards came into force.

Dynamic modulation potentially can make additional resources available for rural development schemes in Ireland, among them REPS. Raising the rate of EU co-financing would make it easier for the Irish Exchequer to consider more generous funding levels where these were justified by the rules of the scheme.

In the longer-term, if the rationale for paying decoupled payments to farmers were questioned by the wider public, more targeted agri-environmental schemes (including the less favoured areas scheme under this heading) would seem easier to defend and could become politically more attractive agricultural policy instruments.

Of course, the greater the funding put into the REPS scheme, the more it will be asked to justify the environmental benefits it provides to a wider public. This is partly a matter of demonstrating that there are clear environmental benefits, and that the scheme is not just paying farmers for practices they might have engaged in anyway. But it is also that, in the broader debate on multi-functional agriculture, there is still great uncertainty about the value which the public puts on these environmental benefits and how much it is willing to pay to obtain them. Opinion poll data shows broad support for transferring agricultural support from products to producers and public goods, but does not answer the question of how valuable in absolute terms these benefits are to the public. Some studies show relatively minimal willingness to pay for the multifunctional benefits of agriculture. However, REPS payments at current levels appear to have wide political acceptance and higher levels of payment would also appear sustainable, particularly if this was financed by enhanced Community co-financing.

In summary, the environmental implications of the MTR package appear to pose few threats to Irish farmers and the prospect of greater funding for REPS will be seen as a positive element. Of course, whether the MTR package is considered positively or negatively will depend on much more than its environmental implications. To hazard a guess at the likely outcome of the negotiations, it may be that decoupling will not be accepted on this occasion, but strengthened eco-conditionality and some form of modulation are likely to be elements of the final package agreed.

References

Commission of the European Communities, 2002. Mid-Term Review of the Common Agricultural Policy, COM(2002)394, Brussels.

DEFRA, 2002, Study to Provide an Initial Mapping of the Potential Environmental Effects of CAP Reform, Available at http://www.defra.gov.uk/esg/economics/CAPReform.htm

Department of Agriculture, Food and Rural Development, 2002, Report on Eco-Friendly Farming, Dublin.