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Asked by MiMoZa | May 25, 2007 | A Level > Economics > Coursework
MiMoZa asks:

a)Examine the impact of the European Union's Common Agricultural Policy on the world trade in agricultural goods(40 marks)
b)Evaluate the implications of a significant reduction in barriers to the trade in goods and services for the global economy.(60 marks)

etutor answers:

I have set out some detailed notes on both issues below, which contain plenty of evaluattion.

a) The objectives of the CAP were set out in Article 39 of the Treaty of Rome: to make the area self-sufficient in agricultural produce; to increase agricultural productivity to guarantee food supplies; to stabilise agricultural markets; to ensure a fair standard of living for farmers; and to ensure affordable prices for consumers. The first three of these objectives have been broadly achieved. Climactic variations in farm output from year to year have been significantly reduced by developments in agricultural technology and biotechnology, so much so that the EU nowadays has a surplus of food. Competitive agricultural markets and technological innovation have guaranteed increased farm production and higher yields (indeed, the CAP is no longer needed to achieve this aim, since in a market-based system, farmers would be forced to produce efficiently to remain profitable). Agricultural markets have been stabilised, though only at great economic and environmental cost. The fourth and fifth objectives have, however, been the subject of constant controversy. The CAP does not deliver an equitable outcome - there is a division between large-scale and small-scale farmers within the EU, while the accession of new countries after 2004 has exposed the extent to which farm support affects farmers of different size. CAP has increased European food prices, leading to a loss of consumer welfare.

The CAP is a collection of packages of policy instruments applied to different commodities and sectors. Traditionally, price support and intervention schemes have been at the heart of policies protecting EU farming. Originally the most visible characteristic of the CAP was the practice of setting prices above the market equilibrium, with the resulting surpluses bought up by the European Commission. Some of this surplus is stored, some of it is destroyed and some of it is exported outside the EU at low, subsidised prices. A common external tariff is imposed on all imports of agricultural produce from outside the EU and is set such that the price of imports is at least as high as that of the least efficient EU producers. In more recent years, set aside payments (payments for leaving a percentage of arable land fallow) were introduced, as well as additional subsidies for switching to organic farming. Reforms introduced in 2003 have altered this system of farm support (see later).

Guaranteed Minimum Prices: The intervention price is set above normal world price levels. This encourages an expansion of supply, but a contraction of demand. The excess supply is bought up by the European Commission and put into storage. Reforms of the CAP have gradually reduce the scale of intervention purchases, though the cost of storage remains an issue.
Export Refunds: Export refunds are paid to an exporter of produce to countries outside the EU in order to compensate for the difference between EU and world prices. Hence producers have an incentive to offload their surplus production onto world markets. The strategy is highly controversial since, at times of falling world food prices, generous export subsidies can reduce EU export prices well below the production costs of farmers in less developed countries.
Import Tariffs: The EU sets Minimum Import Prices, achieved through a variable import levy on food coming into the EU. The tariff leads to an expansion of EU farm output, but the higher prices cause a contraction of demand. Hence the volume of imports into the EU declines. If world food prices fall, the EU import levy will increase to maintain the minimum import price, which then insulates the EU from falls in real world price levels. Tariffs provide protection for EU farmers and thereby boost output and protect farm employment and incomes, but reduce consumer welfare. And while price supports keep smaller farmers in business in the short run, the greatest benefits are obtained by larger farmers.

The CAP has been criticised on a number of fronts. Even with the accession of ten new members in 2004, the proportion of the EU workforce employed in agriculture is below 5% and farming accounts for only 1.6% of EU GDP, yet the CAP accounts for the largest proportion (around 42%) of the EU’s annual £70B budget. Its share has in fact declined since the mid -1980s, when nearly 75% of the budget was devoted to it. The CAP reduces competitive pressure in the farming industry and raises prices for consumers, who also fund the policy through the taxes that they pay into the annual EU budget. It enables small and inefficient farmers to survive, inhibits restructuring, discourages diversification and harms the environment. It has frequently resulted in over-production, leading to the familiar butter and beef ‘mountains’ and wine ‘lakes’. It makes it difficult for developing countries to sell their produce in the EU, while at the same time floods their markets with subsidised surplus EU produce, thus making it impossible for much of the local industry to compete and to remain in production. CAP is a classic example of government failure because the pursuit of self-interest in protecting agriculture has over-ridden economic concerns, in large part because of the political influence that the farming lobby has brought to bear. Often, national governments have been 'captured' by the farming industry in blocking or diluting proposed CAP reforms. Governments have also failed to appreciate the longer term economic and environmental consequences of farm support policies, including the effects of dependency on farm subsidies and the high costs arising from surpluses and waste in many agricultural markets.

CAP is also increasingly out of step with the need for the EU to respond to the challenges of globalisation. Internationally, it continues to attract criticism, creates tensions in the EU's relations with trading partners, and imposes significant costs on developing countries.

Hence the main arguments against the CAP are:

  1.  Production inefficiency - CAP intervention prices have encouraged excess output and have allowed production inefficiencies and dependence upon farm subsidies - all of which represents a misallocation of resources. 
  2.  Loss of allocative efficiency - the CAP fails to meet society's requirements from agriculture in terms of food safety, animal health and the rural environment; until recently, Cap was inconsistent with policies on sustainable development, and did not meet demands for high quality local and regional foods.
  3. Fiscal costs: The budgetary cost of EU farm support has been huge and represents a large opportunity cost - the money might have been directed to more beneficial uses.
  4. Fraud: There is endemic fraud within the system, as well as rising costs of administration and compliance.
  5. Damage to consumer welfare: Farm support imposes higher food prices for EU consumers, which particularly penalises low income families. Consumers pay twice - first, because of import tariffs and second, through higher taxes to finance the CAP. In the UK, the Consumers' Association estimates that this costs each family £16 a week. 
  6.  Environmental concerns: The CAP has encouraged intensive farming, prompting concern about its environmentakl impact.
  7. Global market distortions: The CAP distorts domestic, EU and international markets, threatening the development potential of many low-income nations - a cause of tension in EU-rest of the world global trade negotiations. An OXFAM study in 2002 found that the EU's wheat export prices were 34% below the typical costs of production in developing countries.

There have been periodic reforms of the CAP, albeit only at the margin; the fundamental principles have remained intact. The MacSharry reforms (1992) reduced the level of quotas and support prices on a number of products, reduced intervention purchases for beef and introduced direct income support for larger farmers willing to set aside at least 15% of arable land. There were also moves towards encoraging less intensive farming techniques, forestation subsidies to encourage the planting of more trees and financial support to encourage the early retirement of farmers. The Fischler reforms (1999) began the process of fundamentally questioning the efficiency and equity of CAP support, introducing more cuts in guaranteed prices and shifting aid further from price support to direct income payments.

The Agenda 2000 reforms included further cuts in intervention prices for cereals and beef and lower quotas for milk. Most recently, in 2003 (the Fischler Review), the blanket farm support arrangement was replaced by a single payment scheme (called 'decoupling') that subsidises farmers’ incomes directly (and in principle independent of production levels) rather than guaranteeing higher prices for their crops and livestock. Income payments are conditional on farmers meeting agreed standards of environmental care, food safety and animal welfare. A limit was also placed on CAP spending, while more spending was channelled into programmes that do not distort trade, such as rural development, and with a focus upon marketing and processing local foods (from 2007, there is a reduction in payments to larger farms in order to fund this objective). Yet production-linked subsidies were retained in most farm sectors, largely on account of powerful lobbying by France. Hence farmers are now on average paid only a third above the world market price for their produce, compared with 80% in the mid-1980s. Overall, subsidies have declined from over 40% of total farm receipts in the 1980s to below a third in 2006. When fully implemented, the 2003 changes mean that some 90% of EU farm support will be classified as ‘non trade-distorting’. But the changes amount only to partial reform, since they did not affect external tariff levels, the principal focus of dispute between the EU and the rest of the world.

The huge spending on the CAP is simply not consistent with the declaration of EU leaders in 2000 that they were seeking to create the most competitive, knowledge-based economy in the world. It is the classic example of protectionism, and the world’s largest agricultural exporters constantly demand freer access to the EU market, and thus sharply lower tariffs on their exports.
The lack of progress at the Doha Round of world trade talks can be linked directly to the EU’s intransigent refusal to open its markets more widely to overseas farm producers. EU members settled on 2013 as the date for the elimination of export subsidies on agricultural produce. A spokesman for the EU described the pledge as ‘substantial’, but added that there would be no further concessions until emerging nations had opened their markets to industrial goods and services. Yet, according to the World Bank, the agreement on export subsidies is equivalent to a mere 2% of the theoretical gains from free trade; moreover, most of them will have disappeared anyway by 2013 as a result of earlier CAP reform.

b) A significant reduction in global barriers to trade represents part of the process of globalisation - i.e. international economic integration, involving

  • A huge increase in world trade in goods and services, as trade barriers are reduced; global trade rose to a record 39% of world GDP in 2006, compared with 18% in 1990. The growth in world trade (between 5 and 6% a year) from 2004-06 saw the highest annual increases for thirty years.
  • Internationalisation of products and services by large, multinational firms; globalised supply chains
  • Huge increases in transfers of financial capital across national boundaries, reflected in the escalation of FDI
  • Expansion of the transnational activities of MNCs, increasingly through mergers and acquisitions, and particularly in cars, oil, pharmaceuticals, airlines and financial services
  • Regular shifts in production (and consumption) from country to country
  • The integration and fusion of national markets, in part through free trade zones such as NAFTA
  • New information technologies and methods of buying and selling – cross-border ‘connectivity’

Hence, some of the key results include:

  • Greater integration of national economies – the development of trading blocs and economic unions
  • Improved mobility of physical capital, reflecting transportation improvements
  • Improved mobility of financial capital (up x 5 since 1992), reflecting deregulation of financial markets, the abolition of capital controls, the opening up of capital markets in developing countries and in the former Soviet bloc, easier achievement of acquisitions and mergers
  • Reduction in the cost of transmitting information – internet communications with branches, suppliers, plants, distributors, customers; production and trading do not always require a physical presence in another country, as they can be achieved through franchising and licensing
  • In the context of rapid world trade expansion, diversification of MNC production and search for greater profits and market access through location of plants in low (labour) cost countries; includes forward vertical integration (intermediate products are converted into finished products in low-cost countries)
  • A means of circumventing protective barriers by locating plants in the countries or within the trading blocs that erect them

Economic theory suggests that continuing globalisation will increase world output and living standards through the exploitation of comparative advantage and the benefit of economies of scale (static and dynamic efficiency gains)and greater competition. It also reduces prices, offers consumers more choice, and raises world incomes through the impact of the international trade multiplier. The greatest 'winners' are those whose fortunes are tied to capital, such as the financial sector.

The World Bank argues that there is a strong link between freeing up markets and the eventual eradication of poverty, but the UN maintains that increasing global competition does not automatically lead to faster growth and development. The provess has regularly spawned protests in recent years – in Seattle, Milan, Barcelona, Cancun, etc.

In almost all developing countries that have undertaken trade liberalisation unemployment has increased and wages for the unskilled have fallen. The report of the World Commission on the Social Dimension of Globalisation (2004) showed that in 16 developing countries with 45% of the world’s population (and including China and India) GDP per capita rose by more than 3% a year between 1985 and 2001. In 23 countries (5% of the world’s population) GDP per capita declined; in another 14 countries (8% of the world’s population) GDP per capita rose by less than 1% a year. It is estimated that the numbers in poverty in Africa have doubled in 20 years - countries had neither the resources nor the education to take advantage of new production methods
Human Rights issues - objections to MNCs’ use of 'sweated' and child labour in many less developed countries
Globalisation enables MNCs to produce in low-wage countries where environmental legislation is weak
Goods produced in developing countries are sold largely in high income countries, while company accounts are often located in low tax countries – so maximum profitability for MNCs with minimum social responsibility or accountability
Financial liberalisation has damaged many developing countries as a result of the instability of financial flows
Globalisation increases global income inequalities; higher import penetration and higher structural unemployment; ‘digital divide’ of the ‘information age’
A threat to existing protected markets, and to sectors dependent on subsidies – the US and EU are accused of hypocrisy in demanding that developing countries open up their markets while maintaining their own protective barriers
Low skilled, low paid labour in developed countries may be made unemployed as production shifts to Third World countries where pay is still lower; increase in job insecurity
Globalisation causes not only blue collar job losses in developed countries, but also white-collar services jobs at risk; offshoring (moving service jobs abroad) increases companies' productivity and profits, raising domestic employment and wages (for work that cannot be outsourced abroad), but this is nothing like enough to offset the downward pressure on wages resulting from cheaper labour-intensive imports from low-wage countries
In the USA, EU and Japan there has been an increase in the share of profits in national income at the expense of wages (now recording their lowest share for decades); downward pressures on wages (and rising unemployment among the less skilled) have weakened the bargaining power of unions - many (as in Germany) have found themselves negotiating pay cuts to avoid shifting production to Eastern Europe and Asia (and increased migration has depressed wages in several low-paid sectors); globalisation is also used as a pretext for removing social protection (the experience of low paid young workers in France in 2006 is an example)
Huge benefits to China and India (combined populations of 2.4B) - unprecedented growth due to globalisation of knowledge and of markets - but huge increase in world supply of workers reduces the price of labour relative to capital, and increases global inequality; in the USA, for example, the lowest wages are falling, and are (in real terms) 30% below those of 1975

Countries in the developed world have increasingly grouped themselves into regional trading blocs to the disadvantage of developing countries, which suffer from dumping of excess output (particularly farm produce) and trade barriers. The earlier Uruguay Round agreement at Marrakesh had the effect of making countries in sub-Saharan Africa poorer - the developed world insisted the deceloping world remove trade barriers and eliminate subsidies, but there was little by way of reciprocation (70% of people in LDCs depend directly or indirectly on agriculture). The collapse of the more recent Doha world trade talks highlights the problem of negotiation between blocs and countries with very different interests. Protectionism (especially in agriculture and textiles) is seen as the major obstacle to reducing poverty; OXFAM claims that protection costs poor nations over $100 billion a year – twice what they receive in official aid. The World Bank estimates that the breakdown of WTO negotiations will lead to144 million people not being lifted out of poverty.

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