INTRODUCTION

  1.  The 2004 EU enlargement added substantial resources in terms of utilised agricultural area and labour to the agricultural sector in the EU and necessitated financing at the EU level for the implementation of the CAP to the New Member States (NMS).

2.  Bulgaria and Romania are on their way to becoming members of the EU. This forthcoming enlargement will involve the two poorest countries in the EU-27 (recent data indicate that GDP per capita in purchasing power standard was Euro 5,940 in Bulgaria and 6,080 in Romania) both with large and underdeveloped rural areas. The EU has explicit political commitments to these two countries for their full membership

3.  The initial adjustments of the 10 2004 NMS to the single market, the phasing-in of the farm income support and the accession of Bulgaria and Romania will take place during the next financial perspective 2007-13. All the above will require substantial financing from the EU budget.

4.  The Committee has formulated a number of questions related to the future financing of the CAP and particularly the potential implications of capping the EU's own resources at 1 per cent of GNI during 2007-13. According to my area of expertise, I will focus mainly on the implications of the capping for the rural areas in the NMS and will share a few ideas about the need for future CAP reform.

5.  In this evidence, my sources of information are some results from research projects I have been involved with colleagues from Imperial College, London and my participation in the Network of Independent Agricultural Experts on Central and Eastern European Candidate Countries funded by the European Commission.

RURAL AREAS IN THE NMS: DEPENDENCE ON AGRICULTURE AND RURAL LIVING STANDARDS6.  Rural areas in the NMS are strongly dependent on agriculture as the main employer. This automatically, under the current CAP, leads to substantial costs. The dependence on agriculture will increase with the accession in Bulgaria and Romania. The table below indicates that in some NUTS2 regions in Romania employment in agriculture is over two thirds of the total employment.

  Region Share

  North-East 55.9

  South-East 68.7

  South 56.8

  South-West 57.2

  West 65.7

  North-West 72.7

  Centre 70.7

  Bucharest 44.5

  Average 61.7

  7.  Most of farmers in the NMS operate very small holdings (large farms are mainly incorporated and are successors of the state and collective farms from the previous system) with low productivity and low farm incomes. In the NMS, individual farms typically have less physical, financial and landed capital than in the EU-15 and often the only item they own is a parcel of land. The average farm size in the eight NMS from Central and Eastern Europe plus Bulgaria and Romania is 5 ha and 27 per cent of the land is cultivated by farms smaller than 5 ha. The net farm income per annum per farm in countries where individual farmers prevail varied just before the accession from 2,150 Euro in Latvia to 5,600 in Slovenia. Due to price effects, principally from increases in land and labour prices, the accession will undermine the competitiveness of the NMS on the world market. These countries will need dynamic enhanced productivity growth to at least recapture their pre-accession positions. All these points, suggest the need for substantial investment in modernisation of agricultural holdings.

  8.  A large number of farms in the NMS are producing for self-sufficiency and only sell the surplus output. They do not contribute to market balances but have important social role. The cash income generated by these farms is very low. In order to avoid the persistence of poverty in the rural areas of the NMS, the provision of funding for support to the commercialisation of such semi-subsistence farms (which is a specific rural development measure for the NMS) is of substantial importance and has to be maintained for a longer period.

  9.  As a result of the high dependence on agriculture and low net farm incomes, the share of rural population living in poverty (the poverty line is defined differently in different NMS) is much greater than the national average: 171 per cent in Latvia, 120 per cent in Romania and 114 per cent in Bulgaria. The unemployment rates in rural areas are higher than the national average, reaching 20-25 per cent in rural Bulgaria and Slovakia. Closing the welfare gap between rural and urban population in the NMS also requires significant financial commitments.

  10.  All these handicaps of farming and rural environment in the NMS highlight the crucial importance of rural development and farm modernisation. The majority of individual farms persist through a lack of other employment options. To deal with this problem, the stimulation of the non-farm rural economy is paramount. At present the latter is underdeveloped and this hinders structural adjustment.

  11.  Diversification into non-farm activities could help increase household incomes. A study of farm households in Poland, Hungary and the Czech Republic indicates that the lowest income group always has the greatest proportion of households relying on farm income only. However, the empirical evidence from these three countries suggests that the investments in non-agricultural businesses have been rather small, farm tourism included. This emphasises the need for the implementation of farm diversification support.

  12.  All of the above emphasises the need for significant expenditure for Pillar 2 in the NMS. There are, of course, fears that (i) the absorption capacity will be limited at the beginning and (ii) not all the spending will be well-targeted to providing the maximum effect for those most in need. Improvements in the implementation of the rural development programmes are necessary to increase the effectiveness of expenditure on Pillar II.

WHY IS THE TIME NOT RIGHT FOR IMPOSING A 1 PER CENT OF GNI CEILING?

  13.  In principle, a decreased spending on CAP is a positive step. However, capping the expenditure at 1 per cent for the financial perspective 2007-13 could hinder the development of the rural areas in the NMS. To proceed with such cuts during the next financial perspective may be premature as the period is unusual due to the large scale of 2004 enlargement with relatively poor countries and the forthcoming 2007 enlargement with Romania and Bulgaria.

  14.  Capping the expenditure at 1 per cent of GNI will not directly affect the single farm payment. Although acclaimed as one of the most important changes to the CAP in its history, fundamentally it is consolidating payments that stem from past price support.

  15.  Capping the expenditure, will most probably affect rural development. Pillar 2 of the CAP seems to be gaining speed, although slowly. If the simplification of the programming process were to be successful, then contributions to the European Agricultural Fund for Rural Development (EAFRD) would be a good investment, which it would be a pity to spoil at a period when the problems of rural areas are widening and deepening due to the EU enlargement.

HOW CAN CAP ADJUST IN FUTURE?

  16.  Looking beyond the 2004 enlargement, the accession of Bulgaria, Romania and, in a longer-term most probably Croatia, FYR of Macedonia and Turkey, would also further substantially enlarge the agricultural area of the EU. This implies that the 2003 CAP reforms cannot be the last and that further reductions in the farm payment might be a reasonable step ahead (this will also save some of the phasing-in money, as the NMS would have to align to a lower EU-15 level of payments).

  17.  By 2008 there will be a review of the reformed CAP. This could be an adequate opportunity to proceed with further reforms.

  18.  In order to decrease the burden of financing the CAP, one of the main directions of a further reform may be the capping of the single farm payment and modulation. Neither instrument is new in the policy reform debate, but neither has ever been properly agreed upon. The compulsory Community Modulation Scheme, as agreed to date, will exert little pressure on farms to cut costs and modernise, and will provide a very small injection to rural development in countries which do not follow the experience in England of an additional national rate of modulation. However, although the Community rate of modulation is modest and not progressive in this phase of CAP reform, the introduction of such a compulsory scheme paves the way for its more effectual future use. A higher and progressive rate of modulation may be considered as an important tool to secure funding for rural development whilst at the same time decreasing the CAP financing.

  19.  However, even without a further reform, the financial discipline might be enforced resulting in decreasing amounts disbursed as income support to the farmers in the EU-15. To what extent the financial discipline will become an effective instrument to decrease the Pillar 1 money depends on the decision about Bulgaria and Romania, namely whether they will be included in the Brussels ceiling. If they are included, this in fact will mean a further reform with more substantial cuts in the single farm payment. Although positive from economic point of view, this is a sensitive issue as it will redistribute support from the EU-15 farmers to farmers in Romania and Bulgaria.

February 2005