Home Economics Business Studies Search the Guru Links Message Boards Contacts

The Common Agricultural Policy

You need to know how CAP affect the world markets.  Think about the implications of CAP rather than the mechanics of it.

Why Intervene in the Agriculture Markets?

In the past most of the population were employed by agriculture.  Labour has been very slow to leave agriculture which has resulted for most of the sector incomes which are below those of other occupations.  This was deemed to be inequitable, so the government used social policies to try and raise them.


An economic reason for intervention is that prices are inherently unstable in a free market.  Price elasticities of demand for food products are low because they are a need.  This means that a very small change in quantity will lead to a large change in price.  Supply is perfectly inelastic in the shortrun as farmers are unable to increase supply of foodstuffs until the following year.   Unstable prices fail to signal to producers what consumers really want, therefore stabilising prices will lead it improve economic efficiency.  This can also have a detrimental effect on the disposable incomes of farmers and consumers.


There is also a strategic argument for intervention, as a secure food supply is essential to any nation.


The objectives of CAP

The following aims were highlighted in the Treaty of Rome:



Increase productivity.


Raise farm incomes.


Stabilise markets.


Assure the availability of supplies.


Ensure reasonable prices for the consumer.


The formal title for the executive body of CAP is the European Agriculture Guarantee and Guidance Fund (EAGGF).


Guarantee System

Whilst different agricultural goods are treated in different ways, the basis of the system is in the setting of a target price for each product.  Different target prices are set for each area of the EU.  This is not set with reference to world prices, but is based upon the price which is needed to cover costs, including a profit.  The EU then sets an intervention or guaranteed price for the product in that area - this is usually about 7-10% below the target price.


If the price is in danger of falling below the guaranteed price then the commission will intervene to keep the price above that level.  This is done for all areas in the union.  The guaranteed price acts as a floor below which the price cannot fall.


If this system of guaranteed prices is to work then EU farmers must be protected from low priced imports from overseas.  This is done by the use of tariffs.  This will not need to cover exactly the difference between the world price and the target price as the importer incurs transport costs.  The tariff must therefore be large enough to raise the import price at the border to the target price minus transport costs - this is known as the threshold price.  This calculation takes place in the highest cost area of the EU, this means that the import tariff will more than protect the producers in areas with lower target prices.


Finally should the EC producer wish to export an agricultural product, then an export subsidy will be paid to bring the receipts up to the intervention price.


The effects of the CAP

The downgrading of the guidance section has meant the continuance of many small high cost farmers with correspondingly high target prices.  High target prices have in turn encouraged excess supply in a number of products.  This has required substantial purchases by EAGGF to keep the prices at the target level.  These purchases create a number of problems of storage, which can only be reduced by selling at prices well below the intervention price.  This puts a further strain on the budget.  Many agricultural countries therefore suffer the effects of the world price for their good being depressed in addition to the lack of access to the European market.  A study by the Australian Bureau of Agricultural Economics in 1985 suggested that CAP surpluses reduce the price of wheat, meat and sugar by between 9% and 17%.


Nearly 30 years of the policy has seen the EU transformed in markets such as wheat, where it used to be a net importer to a situation now where it is the second largest exporter after the USA.  This situation came about from the mid 1970s and has led to an increasingly costly policy as the USA has tried to recover sales lost to EU farmers.  Their export enhancement programme has had the aim of winning back sales to selected markets by offering extra subsidies.  The effect of this subsidy war has been to lower the world price in many different agricultural goods.  This problem has been amplified by the fact that production has been rising at a faster rate than consumption.  Many farmers are also paid large sums of money to not grow anything, obviously this demonstrates there is a large amount of excess capacity (see following page).


Problems of Reform

Although we have seen a series of measures taken to try and reform the CAP, involving both price and output measures they have had relatively little impact.  This has meant that within the union there have been many budget crisis's.


As we have seen it is not only the EU which has a costly system of protecting domestic agriculture.  An OECD report estimated that the cost of this protectionism ran at $53 billion for the EU, $33 billion for Japan and $32 billion for the USA.


During the Uruguay round of GATT talks there was a willingness to discuss a withdrawal of agricultural subsidies and to negotiate reductions of tariffs on foodstuffs.


GATT hoped the following points would be implemented, however to date, they have yet to be achieved:



To allow market signals to influence agricultural production through a progressive and concerted reduction of agricultural support.


The immediate need to prevent yet greater market imbalances by reducing the guaranteed prices and other production incentives.


Any production restrictions or other interventions in markets should be implemented in ways that allow markets to work better.


Low income farmers would  be best helped through direct income support rather than by price guarantees or output related assistance.


Eventually under pressure after the Uruguay round of the GATT talks the MacSharry reforms were agreed to lower the level of support provided by the EU.




E-mail Steve Margetts