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Reaping What the EU Sows

How justified are the farmers of Eastern Europe in arguing that EU proposals on agricultural subsidies are discriminatory? by Tomas Doucha 17 May 2002 PRAGUE, Czech Republic--Since the beginning of this year, agriculture has become one of the most visible aspects of the European Union's membership negotiations with the candidate countries from Central and Eastern Europe.

In January, the European Commission released a series of recommendations on how the EU's agricultural policies should be applied to the new members. The report recommended that farmers in the new member states receive fewer direct payments from the EU budget than the current 15 member states do.

Under the proposal, the new members would receive only 25 percent of the direct payments in their first year of membership, 30 percent in their second year, and 35 percent in their third year, finally reaching the level granted to the current members by the year 2012. The EC's arguments in favor of limiting the direct payments to the new members can be summarized in two key points:

a) The EC argues that the incomes of farmers in the candidate countries will be higher after entering the EU even if they do not receive any direct payments at all. Their incomes will go up because the prices of agricultural products in the EU will be substantially higher at the time of enlargement than prices in the candidate countries.

b) It also argues that if the EU started giving the candidate countries the full direct payments immediately after they joined the EU, labor costs could end up being two or three times as high as they are now expected to be when the Eastern European countries join the union. This could have drastic social consequences. It would also stall the further restructuring of the agricultural sectors in the candidate countries.

The EC's proposals and arguments have been met with a significantly negative reaction in the agricultural circles of every candidate country, including the Czech Republic. Some farmers even suspect the EC of wanting to wipe out the agricultural sectors of the candidate countries.

Nevertheless, it would be beneficial to analyze the EC's arguments in a more objective light. Any analysis must take into account the conditions under which the agricultural sector in the EU operates, and on the basis of that, each candidate country should decide the extent to which its farmers are prepared for accession.

The EU's Common Agricultural Policy (CAP) has a strong influence on the agricultural sector of each EU member state. The influence of the CAP is evident in one simple statistic: Approximately 35 out of every 100 euros that a farmer in an EU country makes comes in the form of aid, which is financed by taxpayers and consumers.

For some time now, the EU has been trying to reform the CAP, which is aimed at supporting the social status of farmers and helping to preserve rural life. But it also leads to excessive agricultural production. The CAP has gradually developed into an administratively complex social safety net for farmers based on the distribution of aid and the imposition of limits on production. Operating above the safety net is an essentially free market based on unrestricted competition.

Thanks primarily to the initiative of EU Agriculture Commissioner Franz Fischler as well as under the influence of the spread of "mad cow" disease and the EU's preparations for negotiations with the World Trade Organization, ideas for reforming the CAP and creating a "European model" for agriculture are gradually taking shape within the EU. For the moment, individual member states (as well as candidate countries) and various interest groups in the EU have differing interpretations of what such a model should look like.

In general, however, the dominant idea is to put greater emphasis on the consumer, on the multi-functional nature of agriculture--which can produce both private goods, such as food products, and public goods, such as environmental benefits--and on tighter links between agriculture and the development of rural areas.

The accession of new member-states to the EU could serve as a trigger for changing the CAP. The EC's arguments in favor of offering the candidate countries less support than current member states should be viewed within this context. At the moment, about 90 percent of the CAP money is spent on direct payments to support markets and commodities, while only 10 percent goes to support structural development in the agricultural sector. In comparison, the Czech Republic spends less than 70 percent of its agricultural aid funds on market and commodity support, while more than 30 percent is invested in development.

If the CAP is left unchanged when the country enters the EU, Czech farmers will find themselves in an environment that might, to a certain extent, work against current Czech agricultural policies, which are aimed at restructuring the sector. In fact, the CAP, with its emphasis on direct payments, would doubtlessly encourage those who would like to maintain the needlessly expansive character of the Czech agricultural sector. But, as far
as key commodities are concerned, those expansionary tendencies do not reflect the climactic and natural conditions of the Czech Republic. Such policies could lead to less than effective use of the country's agricultural capacity.

IS THE CZECH AGRICULTURAL SECTOR READY FOR THE EU?

So are the EC proposals fair? The answer depends on the degree to which the candidate countries are ready for EU accession in the area of agriculture. How far and how deeply has the process of restructuring the Czech agricultural sector gone since the collapse of the communist regime in 1989?

We often hear from certain politicians (and some European economists) that the transformation of the Czech agricultural sector is finished, that the sector is now largely based on viable commercial farms of all legal forms, and that we are now in the phase of simply letting market forces add the finishing touches.

But Fischler argues that the main reforms have not been completed and that the process of restructuring must continue. In various speeches, he has indicated that the candidate countries need to further simplify their agricultural sectors: sub-divide, wherever necessary, any excessively large companies into smaller and more manageable units; substantially improve the organizational structure of the farmers' market; and extend the restructuring process to the entire food-production chain, including food-processing companies.

Fischler is right; there is no way one can say that the transformation of the ownership structure in the Czech agricultural sector has been completed. There are several reasons for that.

First, the phase involving the initial allocation of capital in the sector is not over. There are still some outstanding restitution claims on agricultural property and, above all, at least 500,000 hectares of state-owned agricultural land remain to be privatized.

Second, the agricultural sector is still burdened by a heavy debt load that goes back three generations and includes a substantial amount of debts related to the post-communist transition. It is widely expected that, before the country joins the EU, the state will attempt to ease the debt burden of companies in the sector or wipe them out all together, as it has with other debts in the past.

Third, foreign investment has started to flow into the Czech agricultural sector, but that is not necessarily just a positive development. On the one hand, foreign investment helps the development of the land market because it increases demand both for renting and buying land. On the other hand, Czech farmers cannot hope to compete against foreign investors, who have more capital behind them than any local company could have under current conditions.

Fourth, the average Czech agricultural company has to rent up to 92 percent of the land on which it operates, but there is no special law governing the relationship between land owners and users. Most rental agreements allow the land owner to cancel the deal with one year's notice. That makes it difficult for farmers to make long-term investment plans; it also makes it hard to use the land as collateral for getting loans or to make any necessary alterations in the use of the land.

ADAPTING TO NEW CONDITIONS

Likewise, it cannot be said that Czech companies have finished the process of adapting to the new economic conditions or that they have managed to raise their productivity to the optimal level. It is true that many Czech companies--including some large individual farms, some well-managed co-operatives, and some commercial firms--have managed to raise their productivity to the level of Europe's top agricultural firms. But a substantial number of below-average companies, which would have been forced out of the market under tougher economic and legal conditions, continue to survive.

It is safe to say that the productivity of the average Czech agricultural company does not match that of its counterpart in the EU. The average Czech company invests more land, animals, feed, fuel, and especially labor into each unit it produces. Although the two key factors--labor and land--are very cheap in the Czech Republic, that may not be true by the time the country becomes an EU member.

The reasons for the lower productivity of the Czech agricultural sector are partially based on the relative lack of financing for modernization and the spotty legal environment, including the poor enforcement of contracts and the inordinate amount of time it takes to change the ownership or zoning structure of a piece of land.

The problems can also be attributed to the management standards at agricultural companies in the Czech Republic. Managers at the large companies are generally burdened by an unsually extensive network of interest groups, which includes the owners of capital, labor, and land. Many joint stock companies in the country do not have a majority or strategic owner but rather a fragmented ownership structure, divided up among hundreds of shareholders. They also tend to lease land from dozens of different land owners. The management at many companies also find it difficult to cut labor costs by laying off employees who are also partial owners of the company.

But things are gradually changing. The proportion of such owner-employees in Czech agricultural companies has been declining steadily, gradually freeing up some decision-making room for the management. This, along with the relative flexibility of shareholders' capital, is creating the conditions for management takeovers at an increasing number of agricultural companies.

While many agricultural firms in the Czech Republic are at this stage of development, it is still not clear who will, in the end, receive aid from the EU. Judging from the practice within the EU, it seems clear that land owners, investors, and suppliers will profit more from such aid than the farmers themselves. In the context of the Czech agricultural sector, it is probable that EU support would be unequally divided up within the agricultural companies themselves. But the EU's aim in distributing such support is to ensure a reasonable standard of living for the entire rural population of its member states.

In efforts aimed at creating a European model of agriculture, companies will have to be able to efficiently produce both private goods, such as basic foods, as well as public goods. The latter refers to the beneficial impact of farming on the environment and the quality of life in the countryside. The future structure of the Czech agricultural sector within the EU will depend to a certain extent the ability of domestic companies to efficiently produce both types of goods.

And what about Fischler's reference to the organizational structure of the sector? Czech farmers often complain about the increasing disparity between the prices at which they sell their produce and the prices that consumers pay for food products. But that seems to be an inevitable trend. In the Czech Republic, the prices of agricultural produce make up only 40 to 50 percent of the price that consumers pay in the grocery store; in Western countries the proportion is about half that size.

If farmers want to ensure a more just division of the added value in the chain of food production, they cannot just rely on state regulation but must start to organize themselves and place more emphasis on marketing. And this is another weakness of the Czech agricultural industry: not only are farmers in the Czech Republic economically and politically fragmented, but they do not even cooperate effectively on a commercial level.

While some sales organizations for farmers have been established in the country, they tend to be unstable due to a lack discipline among the farmers. In that sense, the farmers make easy prey for the more concentrated and focused suppliers, food-processors, and retailers. On the whole, then, Fischler is right when he says that the Czech agricultural sector really needs further restructuring in order to be competitive within the EU. Czech farmers have the right pre-requisites to be competitive, but they have to learn to use them.

ARE THE EC PROPOSALS DISCRIMINATORY?

The EC's proposals also deal with the agricultural production limits and quotas allotted to new members, which are used to determine the size of the direct payments. In fact, the production limits are likely, for many reasons, to be a substantially more significant factor than the level of the direct payments for the future of the agricultural sectors in the region.

The EC has based its quota proposals on developments in the Czech agricultural sector in the recent years. In that sense, they would have the effect of freezing into place the current production structure of the sector, which is not based on its real potential.

The EC's proposals for the Czech Republic favor production on arable land, which is of relatively low quality in 60 percent of the country. At the same time, the proposals are somewhat restrictive toward animal farming, which is supposed to serve as the basis for creating a multi-functional agricultural sector in the Czech Republic. The Czech Republic would be justified in trying to negotiate higher limits and quotas with the EC, especially in the case of cattle and sheep.

As for the proposed limits on direct payments, the EC has tried to argue that farmers in the candidate countries can supplement the direct payments with other forms of support that they will receive. Such support will be allotted for modernization, for adapting to the strict standards of the acquis communautaire in the areas of the environment, food quality, and animal welfare, and for diversifying the sector.

But there is a widespread fear among the candidate countries that such support will not be enough to replace the overall direct payments and that only well-prepared companies capable of ensuring co-financing will be in a position to receive the reduced payments. That, however, is precisely the point of the direct payments.

Moreover, studies conducted by the Research Institute of Agricultural Economics (VUZE) indicate that even lower levels of support from the EU would improve the finances of the average Czech agricultural company, especially those that produce commodities such as grains, oilseeds, and sugar beets, as well as dairy farms and cattle farms that use special grazing techniques. The EC proposals would likely be damaging for the country's non-specialized pig and poultry farms.

As far as prices are concerned, the only Czech agricultural prices that are likely to get substantially higher after the country joins the EU are those for milk products and cattle. Pork and poultry prices will probably go down. Moreover, Czech agricultural producers have a lot of room for cutting production costs.

Naturally, the perspective of the Czech agricultural sector is only one angle from which the issue can be viewed. There are still politically sensitive questions surrounding what kind of impact the EC's proposed treatment of new member states would have on the ability of Central and Eastern European farmers to compete with their counterparts in the West. Those questions will have to be resolved in the coming weeks and months.

But as far as the Czech agricultural sector is concerned, the EC's proposals are not really discriminatory. The proposals could improve the financial situation of the sector while at the same time creating enough pressure and stimulus for Czech companies to mobilize their internal reserves and to engage in further restructuring.
Tomas Doucha is chairman of the Czech Republic's Research Institute of Agricultural Economics (VUZE).

Related stories:

Our Take: Biting the Bullet
The EU candidate countries will try to haggle, but in the end they will probably have to accept lower subsidies for their farmers.
4 February 2002

Week in Review: That's Not Enough
The EU candidate countries from Central and Eastern Europe cry foul over the EU's latest proposal on agricultural subsidies for new members.
by Giedrius Blagnys, Barbora Tancerova, and Ales Gaube
29 January - 4 February 2002
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