Analysis: agriculture subsidy prospects in and out of the EU

Whether the UK votes to stay in or leave the EU, support for farming is likely to fall overall as the union and national governments wrestle with the challenges presented by today’s wider economic and political landscape.

The Common Agricultural Policy (CAP) was set up with the main objectives of ensuring a fair standard of living for the agricultural community and securing the availability of food supplies at reasonable prices.

EU support accounted for about three-quarters of UK farm profit in 2015, up from 55% in 2014, with the dramatic leap accounted for by farmgate price crashes in almost all sectors through 2015.

See also: Analysis: Agricultural trade in a post-Brexit world

While this demonstrates the significance of support, many argue that subsidy inhibits innovation and structural development in businesses.

How does it work now?

EU budget and spending:

• Spending is organised in seven-year periods, known as multiannual financial frameworks (MFFs).
• MFFs set out what the budget will be spent on and spending limits for the period.
• The current MFF covers 2014-2020 and is €960bn, a real-terms reduction on the previous MFF.
• Annual budgets are negotiated by the EU Commission, the European Council and the European Parliament.
• Spending is 99% funded by member states, based on Gross National Income (GNI), customs duties, sugar levies and VAT.
• The CAP accounted for 39% of the EU budget in 2015, a share that has fallen from about 78% in 1985.
• The UK contributes to the EU budget and receives a rebate, introduced in the mid-1980s, to address the issue of the UK making relatively large net contributions.
• In 2015, the UK’s contribution after rebate was about £12.9bn. The UK received £4.4bn from the EU budget, making an estimated net contribution of £8.5bn.

What support does UK agriculture get from the EU?

CAP support to the UK is worth about £3bn a year. About £2.5bn of this is paid in direct support under what is known as Pillar 1, the Basic Payment Scheme (see graph below).

In England, Pillar 2 is largely funded by 12% of Pillar 1 funding being transferred (modulated) to provide cash for agri-environment schemes (85%) and for the Rural Development Programme (RDP), including grants to improve farm productivity and to develop businesses in rural areas.

The RDP schemes in the UK also support the wider rural economy, with priorities relating to tourism, rural broadband and small and medium-sized enterprises in general.

There is a small element of match funding in Pillar 2 (about 15%) whereby the UK government matches the amount paid for certain measures through the CAP.

Scotland takes 9.5% from Pillar 1 for rural development; Wales siphons the full 15% allowed and Northern Ireland takes nothing.

What will happen to the subsidy if we stay in the EU?

The next round of CAP reform negotiations for 2021-2027 is expected to begin in earnest in 2018/19. Support is likely to continue falling because of budget constraints and EU enlargement.

EU agriculture commissioner Phil Hogan has made CAP simplification a priority. This theme is expected to continue through next year and into the reform process.

Each round of CAP reform is also being driven in part by the requirement for more convergence of subsidy rates – the need for the rates paid to recent joiners and long-standing members to become closer.

The UK is a beneficiary of this, points out the NFU’s chief economics and international affairs adviser, Gail Soutar. Payments here are lower than 90% of the average payment, so the amount of cash heading to the UK each year through to 2020 is increasing.

The post-2020 CAP is also likely to feature more flexibility in how member states implement the policy.

An example of this in the last round saw member states able to decide how much they would pull from Pillar 1 to Pillar 2 (up to a maximum of 15%).

A further example saw Scotland choosing to retain an element of so-called “coupled” support, whereby CAP funding is linked to production levels – in this case, supporting sheep and beef production to a greater extent than in England, for example.

Devolved regions can also take a different approach to greening and elements such as the young farmer scheme may become voluntary.

“Although no radical changes are expected as part of the mid-term review of the current EU Multiannual Financial Framework (MFF) due later this year, all bets are off when it comes to the Commission’s proposal for the next MFF for the period after 2020,” says Alan Matthews, emeritus professor of European agricultural policy at Trinity College, Dublin.

What would agricultural support look like outside the EU?

Support is likely to continue, but there are no certainties about its level or direction.

After a vote to leave, agriculture will enter a new arena where it must compete with other significant calls on public spending. Some of these – health, education, defence and overseas aid – are ring-fenced against cuts, whereas Defra’s budget has fallen by a third since 2010.

Departure from the CAP will not necessarily cause output and incomes to plummet, just as accession to the European Economic Community in 1973 was not followed by a farm income boom (although land prices certainly rose), says Prof Allan Buckwell in his Brexit report for the Worshipful Company of Farmers.

Injecting subsidy into a competitive sector such as agriculture does not raise the incomes earned in that sector, he argues. Rather, the subsidies are shared among all the trading partners in the food supply chain, and become capitalised into land values.

“This suggests that withdrawing subsidy may have the reverse effect – initial shock to incomes, subsequently dispersed up and down the food chain and reflected in land values and rents.”

However, Prof Buckwell also suggests that the effects of WTO limits on national subsidy levels are not likely to be constraining.

The level and type of post-exit farm support will depend on:

• UK economic health
• The shade of government
• Influence of others – including corporate, environmental, welfare and consumer interests
• Terms of UK trade agreements with the EU and other countries

Many claims have been made about the ability of the UK to match – or even pay more than – other European countries that have trade agreements with the EU.

Norway is often cited as an example of a country with higher-than-EU levels of support.

However, there are some fundamental economic and farm structure differences between Norway and the UK, and in the likely conditions under which the UK may seek to trade with the rest of the EU in the event of a leave vote.

Norway is a very wealthy country, with a sovereign wealth fund of £590bn and national debt at 29.5% of GDP, compared with UK debt at 81%. Its farm numbers have fallen 34% in the past 10 years and average farm size is 21.4ha (according to 2010 figures).

At the other extreme, some proponents of leaving the EU point to New Zealand, which removed almost all farm subsidy over three years, starting in 1984.

However, it is widely assumed that such a drastic option will not be chosen.

Regional autonomy

Further devolution of the UK is likely whether or not we stay in the EU and as agriculture is a devolved matter, the regions have great autonomy in this respect. “It will be for each devolved region of the UK to decide how to spend their block grant from Westminster,” says the NFU’s Mrs Soutar.

So, differing approaches will place some farmers at a disadvantage compared with others.

A further possible development in farm support suggests that entitlement to support payments might be issued as a bond that could be capitalised (for example, putting a value on the right to receive subsidy over the next, say, 10 years). These bonds could then be cashed in by those wanting to exit or restructure their farming businesses.

The value of post-exit farm subsidy would have to be assessed in the context of a different economic background. If we leave, many expect the pound to lose significant value. While this could give a big export boost in the short-term, ultimately it would be likely to be inflationary, bringing with it more challenges.

Farm business consultancy Andersons suggest that it would be wise for farmers to expect a phased withdrawal of support, down to 30-40% of current levels over the five years following an EU exit, with more support targeted at rural development.

What has the government said?

There have been many insights into government thinking on farm subsidy, including through the most recent CAP reform negotiations for the 2014-2020 period.

The UK has argued for cuts in CAP support and a more market-orientated policy without income support.

When he was agriculture minister in 2012, Jim Paice said: “The UK government wants to see ambitious reform of the CAP. We will continue to argue for a very substantial cut to the CAP budget, focused on Pillar 1.

“The CAP that remains should provide better value and prepare for a future without income support. It should be used to encourage improved productivity and innovation to increase the competitiveness of the agriculture sector.”

A 2005 Treasury policy vision wanted UK agriculture to be “internationally competitive without reliance on subsidy or protection”.

Leaving the [EU] regime would probably reduce farm incomes, according to a parliamentary briefing for MPs, as past government positions on CAP reform have indicated UK government and devolved administrations may be unlikely to match the current levels of subsidy and/or would require more “public goods” in return for support.

Prime minister David Cameron has simply pledged that an agricultural support system would be “properly maintained” under his leadership.

What have other people said?

Many assertions have been made about how the UK might support its agriculture if it left the EU, but the detail is lacking.

Ukip MEP and agriculture spokesman Stuart Agnew argues farm support is more likely to fall if the UK remains an EU member, because new countries joining the EU are all likely to be net recipients of the CAP.

The Norfolk poultry producer dismisses suggestions that government would slash farm support outside the EU. “If you just pull the rug from under agriculture, most farmers would make a loss,” he says. “If you make a loss, you don’t pay tax, but you can claim a tax rebate on previous years.

“This means the government might make a bit of a saving by stopping farm support, but they are still going to be paying a lot out.”

Stopping farm support would also cause farmers to lay off staff, says Mr Agnew. “You would get into a rural meltdown and nobody wants that.”

Prior to this year’s Oxford Farming Conference, former agriculture minister Owen Paterson said he believed a UK government could better support agriculture outside the EU and even allocate more generous farm payments – in a “much more effective and targeted manner”.

A significant level of support from the UK exchequer would be essential, he said at the conference – but offered no definition of “significant”.

In February, Defra minister of state George Eustice floated the possibility of accreditation schemes, with farmers enrolling automatically rather than having to meet an annual subsidy application deadline.

The UK would continue to give farmers and the environment as much support as they get now – or perhaps even more, said Mr Eustice, who also suggested that the Pillar 2 structure would probably be dismantled and that the government would look at risk management tools for farmers, such as insurance.

Mr Paice attacked these claims, saying they were “fanciful” and “not credible”, especially given all the other demands for government funding.

Conclusion

Agriculture and its supply and service sectors are in a delicate state and face a tough few years, whatever the outcome of the referendum.

The financial value of direct support is set to fall, either way. Leaving the EU would probably accelerate the pace of the fall, which may be accompanied by more dramatic change in the countryside than would otherwise be the case.

The future of subsidy on exit will be strongly influenced by the terms of trade agreements, while the broader terms of exit will also bear on the wider economy, potentially affecting demand for food, drink and some of the diversified activities run by farm businesses.

However the economic, social and political challenges faced by the EU and its member states to varying degrees mean that this course could also be a choppy one.

The diverging policies of the devolved regions are also likely to have an increasing impact on the competitiveness of their farmers – in or out of the EU.

Currency is a big determinant of the level of farm income and many expect sterling to fall in the year or two immediately after an exit vote, boosting exports but ultimately leading to higher inflation and costs.

Any agricultural support policy, whether the UK is a member of the EU or not, needs to address the fundamental question of what the nation wants from farming and its countryside. Food security, and not simply a drive to conquer export markets, must be a top priority.