1. agriregionieuropa The impact of pillar I support on farm choices: conceptual and methodological challenges Daniele Moro and Paolo Sckokai Università Cattolica, Piacenza, Italy 122 nd European Association of Agricultural Economists Seminar Evidence-Based Agricultural and Rural Policy Making Methodological and Empirical Challenges of Policy Evaluation February 17 th – 18 th, 2011, Ancona (Italy) associazioneAlessandroBartola studi e ricerche di economia e di politica agraria Centro Studi Sulle Politiche Economiche, Rurali e Ambientali Università Politecnica delle Marche

2. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  First Pillar – Budget First pillar is still 75% of the EU agricultural budget (43.4 bln € in 2010) Decoupled payments (SFP) cover 57% of the EU agricultural budget (33.3 bln €) – Future CAP Post-2013 CAP likely to be structured again in two pillars SFP likely to be again the most important policy tool (although eventually revised) Background and motivation

3. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Evolution of the EU PSE (OECD) Background and motivation (2)

4. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Future trends (EU Commission proposals) – Post-2013 CAP still structured in two pillars – Central role of the SFP also after 2013, eventually redesigned: Redistribution of payments across farmers (with un upper ceiling?) Stronger linkage of payments to environmental objectives (mandatory for a component of direct payments?) – Coupled payments limited to very specific cases – Stronger focus on the food supply chain Imbalance of market power and contractual relations Competition at each stage of the chain Transparency of food pricing Background and motivation (3)

5. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Key issue, given policy developments and WTO agenda: – Impact of decoupled payments (SFP) on farm choices (not just on farm output)  First analyses of decoupling (Fischler reform scenario vs. continuation of old policies) – PE and GE models adopted arbitrary (implicit or explicit) “coupling” factors attached to the SFP (Gohin, 2006; Balkhausen et al, 2008) – This is a clear signal of the difficulties in modelling the complex impact of decoupled payments on farm choices Research questions (1)

6. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  (Some) mechanisms through which decoupled payments may affect farm choices: – Farmers’ risk aversion (wealth and insurance effects) – Dynamic impact on investment decisions – Expectations on future policy developments – Relaxing credit constraints – Capitalisation in land values – Entry/exit decisions – Labour/leisure choices and on farm/off farm labour allocation  This list is not new (see OECD, 2001) Research questions (2)

7. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Now a relevant number of studies available – Most of them based on case studies analysed using farm level data (i.e. individual response matters)  CAP-related EU research agenda changed: – FP6 calls on first pillar: GE/PE modelling of EU agriculture, possibly at MS level (AGMEMOD, EDIM, WEMAC) Few comprehensive study on decoupling (IDEMA) – FP7 calls on first pillar: Emphasis on land, capital and labour impacts (FACTOR MARKETS) and on FADN (FACEPA, FADNTOOL) Emphasis on food supply chain (TRANSFOP) Research questions (3)

8. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Review the available studies on the impact of decoupled payments on farm choices – Focus on econometric analyses of farm-level data (i.e. individual response matters)  Develop a stylised model of profit/utility maximisation, through which the above mechanisms are analysed  Discuss the main results (what do we know with a reasonable level of ‘uncertainty’?...)  Propose an agenda for further research by agricultural economists Objectives of the paper

9. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Risk in agriculture – two dimensions: market (price) risk and technological (output) risk  Risk neutrality – decoupled payments do not affect marginal production decisions – risk neutral (primal or dual) models widely used to analyse coupled or partially coupled tools (area payments, quotas) – in these studies, some relevant issues not always fully addressed (i.e. estimation of ex-ante cost- functions) Decoupling and risk (1)

10. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Risk aversion: theory – Under DARA, decoupled payments may display a positive wealth effect a positive insurance effect, when payments reduce farm income variability (Hennessy, 1998)  Risk aversion: modelling (static) Primal models (Serra et al, 2006; Koundouri et al, 2009) Dual models (Sckokai and Moro, 2006) –Both type of models rely on max E(U(W)) (typically depending on two moments of the W distribution) –Expected prices modelled as adaptive expectations –Price and quantity indexes should be computed accounting for risk (Coyle, 2007) Decoupling and risk (2)

11. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Risk aversion: results – Available models have confirmed risk aversion Spain (Serra et al, 2008), Finland (Koundouri et al, 2009), Italy (Sckokai and Moro, 2006) – The degree of risk aversion seems to decrease with farm size and with the shift from price support to direct payments Sckokai and Moro (2006) and Koundouri et al (2009) – The wealth effect is small US (Serra et al, 2006); EU (Sckokai and Moro, 2006) – The insurance effect may be quite large when payments replace price support (Sckokai and Moro, 2006) Decoupling and risk (3)

12. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Risk aversion: problems – Just (2008) raised serious doubts on this approach: Models unable to identify risk preferences (attitude toward risks) and risk perceptions (agents’ subjective probability) Models would lose their normative value (type of preferences) maintaining only a positive value (size of distortions) – Models need to be refined, eventually integrating them with other approaches Calibration, technological information, experimental methods... Just (2009), Just and Peterson (2010), Zhengfei et al (2006), McIntosh et al (2007) Decoupling and risk (4)

13. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Theory – Decoupled payments may relax different types of credit constraints interest rates on long and short term loans quantity constraints on amount of credits bankruptcy risks  Modelling – Theoretical models (both static and dynamic) Ciaian and Swinnen (2006), Vercammen (2007) – Empirical models (both structural and ad-hoc) Kumbhakar and Bokusheva (2009), Blancard et al (2006); Goodwin and Mishra (2005) Decoupling and credit constraints (1)

14. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Theory – Theoretical models predict a relevant impact of payments in presence of credit constraints credit constraints may increase land rents more than the amount of the payments (Ciaian and Swinnen, 2006) reduction in bankruptcy risk may increase investment demand, especially by middle-sized farms (Vercammen, 2007) – Both structural models and ad-hoc models find a significant impact of credit constraints Blancard et al (2006); Goodwin and Mishra (2005) – Results are rather scarce and not conclusive Goodwin and Mishra (2006) do not obtain the same results on different years of the same data Decoupling and credit constraints (2)

15. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Theory (static model, risk neutrality) – Decoupled payments (linked to the continuation of farm activity) may relax the standard exit condition p<AC(q*), that would become p<[AC(q*)-G/q*] – The persistence of infra-marginal farms implies inefficiencies and slower restructuring  Results – US evidences seem to confirm persistence of inefficient farms and slower structural change Chau and De Gorter (2005); de Gorter et al. (2008), Key and Roberts (2006) – No EU studies available Decoupling and exit decisions

16. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Theory (static model, risk neutrality) – Both US and EU decoupled payments are linked to land. They should be fully capitalised in land rents/values (accruing to landowners!) – The extent of this capitalisation depends on the price elasticity of land demand and on the substitutability between land/non-land inputs  Modelling – Structural max profit models deriving determinants of land rents – Extensions of the traditional PVM – Ad-hoc regressions (identification problems) – Cointegration techniques Decoupling and land values (1)

17. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Results – Studies reviewed in Latruffe & Le Mouel (2009) – Degree of capitalisation of decoupled payments around 80-90% (35-45% for coupled subsidies) Likely linked to the requirements for obtaining payments (i.e. cross-compliance, set-aside,…) – These evidences are mainly related to the US Roberts et al (2003), Lence and Mishra (2003), Goodwin et al. (2003), Devadoss et al (2007) Mishra et al (2008) – Very few EU studies available Patton et al (2008); Latruffe et al. (2008) – New studies needed, given relevance of national legislation and local market conditions Decoupling and land values (2)

18. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Theory (static model) – Decoupled payments should reduce on-farm labour intensity and also off-farm labour allocation (less risk) – Assuming additional non pecuniary benefits from on-farm labour, decoupled payments may generate substitution of on-farm for off-farm labour and lower wages (Roberts and Key, 2009)  Results – Negative impact on off-farm labour confirmed (US studies) Serra et al (2005), Ahern et al (2006), El Osta et al. (2008) Decoupling and labour supply

19. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Theory (Dynamic model, risk aversion) – In presence of imperfect capital markets, decoupled payments may stimulate farm investment, with a long term impact on output – Accounting for risk aversion, the impact may be stronger (payments may affect income volatility)  Modelling – Structural dual model of decision making under uncertainty (Sckokai and Moro, 2009) – Reduced form of the same model, with three investment regimes and different adjustment costs (Serra et al, 2009) Decoupling and investment (1)

20. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Modelling (cont.d) – Extensions of the q-model and simpler 2-period models extendable to the issue of decoupled payments Feinermann and Peerlings (2005); Huettel et al (2010)  Results – Clearly not conclusive Sckokai and Moro (2009) found a rather small investment and output effect of the SFP in a simulation on Italy Serra et al (2009) found rather large investment elasticity on Kansas farms, especially in the disinvestment regime – More research needed in this area Decoupling and investment (2)

21. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Theory – If payments based on parameters that can be updated (i.e. base acreage and yields of US payments), expectations may affect current choices  Modelling and results – Dynamic simulation models based on expected utility function (with or without risk aversion), calibrated on actual farm/survey data Bhaskar and Beghin (2010) and Lagerkvist (2005) – Main results: tendency to overinvest in land and to allocate more land (6.5%) to program crops Decoupling and expectations on policy

22. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Possible improvements of FADN 1.Quantities of variable inputs Relevant for analysis of cross-compliance/envirnoment 2.Household characteristics Socio-demographic information and off-farm sources of income/wealth 3.More details on investment/capital goods 4.Longer permanence of farms in the sample Both relevant for dynamic models 5.More details on the downstream supply chain – Is there any communication channel with FADN officials? Empirical issues: data

23. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  General issues – Individual farm data take the form of unbalanced rotating panels – Estimation often involves complex systems of equations with censoring  Approaches in the literature – Most studies adopt classical econometrics – Alternative approaches (Bayesian and Maximum Entropy) less popular, despite their claimed advantages (i.e. prior info, individual params) – Panel data and censoring typically addressed with simplified approaches Empirical issues: econometrics (1)

24. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Recent developments – Advancements in estimation of systems of equations on unbalanced panel data Platoni et al (2010) developed two-way SUR – Advancement in estimation of censored systems of equations (demand analysis) Shonkwiler and Yen (1999); Yen et al (2003); Yen (2005); Yen and Lin (2006 and 2008) – Combination of the two issues not fully explored – Results of adopting different techniques may be rather different Empirical issues: econometrics (2)

25. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Two-way SUR estimation Empirical issues: econometrics (3) FE One-way RE one-way (GLS) RE one-way (ML) FE two-way RE two-way (GLS) RE two-way (ML) SUR WB one-way (GLS) SUR WB two-way (GLS) SUR QUE two-way (GLS) q1 p10.1548*0.05850.0867-0.0894-0.0776-0.08990.04360.04430.0444 a10.2368***0.6422***0.5802***0.2507***0.5907***0.5810***0.4743***0.4807***0.4775*** q2 p2-0.04430.03700.02020.01040.06740.0594-0.0955**-0.0930**-0.0942** a20.02120.01650.0200-0.0361-0.0250-0.02110.02520.03610.0302 q3 p3-0.3370**-0.1100-0.1331-0.4149**-0.3682**-0.3095*0.18550.16980.1785 a30.2718***0.6620***0.6145***0.2405***0.5608***0.5897***0.2829***0.2645***0.2731*** q4 p41.5653***2.5607***2.4056***3.2017***4.2357***4.1193***2.7524***2.7954***2.7737*** a40.1140*0.3582***0.3206***0.2112***0.3993***0.3704***0.4406***0.4382***0.4414*** *** 1% significance, ** 5% significance, * 10% significance

26. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  The available literature – Most literature based on case studies analysed on individual farm data – EU studies mainly based on pre-SFP data – Less studies on the EU with respect to the US and results not conclusive in many areas: Risk studies to be refined Studies on credit constraints, entry/exit, off-farm/on farm labour and capitalisation in land values refer to the US (with a few exceptions) Studies on dynamic impact on investment reached diverging results Studies on policy expectations based only on stylised simulations A research agenda (1)

27. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Areas virtually unexplored (under the econometric/farm data approach) – Linkage between payments and non-land input use (cross-compliance/environment) – Linkage between payment, redistribution hypotheses (post-2013) and other impact channels (risk, entry/exit, labour, investment, land values) – Impact of payments in the context of the food supply chain (i.e. value added accruing to agriculture, imperfect competition,....) First results show the bias of assuming perfect competition may be relevant (Soregaroli et al, 2010) A research agenda (2)

28. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy)  Key methodological problems – Adoption of appropriate econometric techniques (i.e. unbalanced panel data, censoring,...) – Generalisation of results of case studies to the aggregate sector level Objective: bridge the gap between individual farm level results and large aggregate models used for policy simulations Plausible parameters should replace arbitrary “coupling factors” FADN weighting mechanism good starting point for rigorous generalisations A research agenda (3)

29. agriregionieuropa 122 nd EAAE Seminar, February 17 th – 18 th, 2011, Ancona (Italy) Thanks for your attention!