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Economic Policy in the EU - lecture 4 (2020)
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lecture 4, economic policy in the EU
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Agriculture and regional policyFor a long time, agriculture was the largest budget expenditure. The regional was created by
the treaty of Rome, but really became important with the joining of the Mediterranean
countries.
Agriculture typically is not about creating an internal market, it is an industrial policy.
Agriculture does not fit in that well. In the 1950’s agriculture was still a relatively important
sector in the EU. Some numbers that show the difference between 1950 and 2000:
Agriculture in the 1950’s was very unproductive (see the employment rate vs GDP share of
France and Italy). The common agricultural policy was laid down in art. 39 of the treaty of
Rome. It intended to increase productivity in agriculture. It also wanted to stabilise market –
agricultural markets are very volatile. Another important goal was food security. After the
war, and famines that caused it, the EU wanted to create a stabilised food supply for
reasonable prices both for the farmers and the consumers. How were they going to reach all
of these goals? In the 1950’s and 60’s the Common Agricultural Policy (CAP) method was
introduced. It guaranteed minimum prices for farmers. This would make for stabilised prices.
Farmers will get that minimum intervention price for any amount they produce. Another
measure was the introduction of import tariffs. The border price was artificially increased to
the domestic price, which meant variable tariffs.
This graph shows the purpose of the agricultural policy with a set of supply (blue) and
demand (green) curves. Demand and supply are fairly inelastic. The steepness of these
curves is because everyone needs a
certain amount of food, regardless of
price. The supply is inelastic because
the harvest is either good or bad,
those are the only options.
We start at the most left equilibrium.
Over time, the demand moves to the
right, supply moves a little bit more
to the right. The demand increases
because of an increase of income. We
eat a bit more meat, for example.
That is why demand increases a little.
We only need about 2000 calories a
day and that will not double with
double the income. The production
increase is bigger. This is partly due to
the success of the CAP policy. All
output will be bought, which creates
, an incentive to produce more output. The consequence is that the middle equilibrium is now
reached. There is an increase in output, but the price is lower. There is a tendency for
agricultural prices overall to go down. With that, farm income will decrease.
In this graph the world price is indicated by the lower red line. The world price is also the
border price. The higher red line is the domestic price, or the price with the tariff. The tariff
will vary so that it will always add up to the domestic price. Without the tariff there is a lot of
import taking place. The lower green horizontal line indicates the import in the situation
without a tariff. If you introduce a tariff, imports will go down to the second longest green
horizontal line. This will cause less consumption (import) and more domestic production.
Given that you will always get the domestic price for your goods, there is an incentive to
create more. This will make for more domestic output which will give us the middle blue
supply line. This will make for import the size of the second smallest green horizontal line.
The incentive to produce more remains. This leads to the supply being as big as in the most
righthand supply curve. This leads to a price lower than the intervention price. The European
exporters then become exporters. The guaranteed price and guaranteed sale create a very
high incentive to produce more efficiently and to increase supply.
The agricultural policy is extremely successful. It turned the EU from importer to exporter.
However, it is also an extremely expensive policy. It is open end, everything is bought. If a
surplus is created, it has to be destroyed, which also costs money. How to continue?
The prices were in mark or frank or guilder. This is no problem if they are the same value.
However, if currencies change, it could be profitable to exchange between countries. If one
guilder is worth two German marks. It becomes beneficial for German farmers to offer their
production in the Netherlands and then exchange the guilders they received into double the
amount of German marks. This was possible because of the completed customs union. There
was a free flow of goods. This causes trade flows to the places where the revenue of the CAP
is the highest. The EU then has problems with the price mechanism. The fixed price method
becomes problematic in the 1970’s when exchange rates start to fluctuate. This leads to
what is called a system of green exchange rates, an exchange rates system just for
agricultural input. And the intervention price becomes a price in the European Currency
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