Lecture 11. Analysis of decoupling Economics of Food Markets Alan Matthews

Questions and lecture outline Can a payment to farmers ever be fully decoupled? –Identification of mechanisms whereby payments may influence production –Empirical evidence? What would design of decoupled payment look like? –US Production Flexibility Contract payments introduced in 1996 FAIR Act –EU Single Farm Payment scheme –Bond scheme proposal (Swinbank and Tangermann)

OECD definitions Full decoupling –Where payment does not influence production decisions of farmers –Both shape and position of supply and demand curves should not be affected Effective full decoupling –Where policy results in a level of production and trade equal to that which would have occurred under free market conditions –Example: price support combined with quota –May result in same equilibrium level of output but not necessarily same response to shocks –Shape of supply (or demand) curve affected

Degree of decoupling A measure of the production and trade effects of a policy package relative to those of an effectively fully decoupled policy Compare policy packages having the same ex ante impact on total PSE

Decoupled payments? Static effects –Arise from changes in the incentive prices of outputs and inputs Insurance and wealth effects –Payment increases farmer’s wealth and this can affect farmers’ attitude to risk (wealth) –Payment may affect the degree of risk faced by the farmer (insurance) Liquidity affects –Payment may ease credit constraint and boost investment Expectations about future policies Influence entrance/exit from farming

Decoupling – static effect - no (less?) incentive to produce - more extensive production P Q S PmPm PiPi Q1Q1 Q2Q2

Source: OECD 2005

Decoupled payments in EU – production effects Size of effect can depend on modelling issues For EU/Ireland effects, see –FAPRI Ireland –Dixon and Matthews

Future of decoupled payments Link to land creates land market distortions Compatibility with WTO Green Box rules CAP Health Check proposals –upper and lower limits –move to more uniform area payment