FARM EUROPE’S RESPONSE TO THE INQUIRY OF THE HOUSE OF LORDS ON RESPONDING TO PRICE VOLATILITY: CREATING A MORE RESILIENT AGRICULTURAL SECTOR
The UK House of Lords launched an inquiry into price volatility and agricultural resilience before Christmas and started a debate on the topic yesterday.
Farm Europe has been invited to contribute to the debate.
Below our responses:
- What is the role of public policy in mitigating the impact of potential price volatility? To what extent should the response be a shared endeavor between the EU institutions and Member State governments? What are the differing roles of industry on the one hand and individual farmers on the other?
Farm Europe agrees that price volatility drivers are indeed variable and complex. More frequent extreme weather-related events as a result of global warming, increased food demand as a result of population and income growth, and the interlinkages between commodity and financial markets do appear however to play a significant role.
None of the above drivers of price volatility are amenable to appropriate mitigation by individual farmers or other agro-food actors. Therefore public policy should play a role to respond to its negative impacts.
The resilience of the agricultural sector underpins the secure, sustainable and affordable supply of food to the citizens of the EU, as well as providing financial security for EU farmers. A resilient agricultural sector is one which can respond to risk effectively and take steps to mitigate the wider effects of global price volatility.
The agriculture policy being a long-standing European Union common policy, the Common Agriculture Policy (CAP) should thus be the right framework for adequate policies to mitigate the effects of price volatility.
The CAP cannot achieve that goal without engaging with, and delegating to, Member States authorities and private sector actors. Diverse and detailed instruments would be called upon to implement its policies, and that is best done at national or sub-national level, and with public and private actors. Public private partnerships could be a model in this area.
Farmers are by far and large the most affected and interested group, and they should benefit from the mitigating measures to be applied. Farmers should also be called upon to participate in those measures to a reasoned and balanced extent.
The role of industry should be to provide as far as possible stability to the farming sector, and a more balanced distribution of benefits across the value-added chain.
- Should public policy responses make a distinction between support for the resilience of the industry as a whole, support for the resilience of specific sectors and support for the resilience of individual units of activity?
It is difficult to support the resilience of the whole industry, without supporting first and foremost the individual units of activity – the farmers.
In addition to that support targeted to specific sectors which face specific difficulties could be a means of increasing the effectiveness of the measures. There is no such thing as a one-size-fits-all measure, and well targeted support is more effective than blanket policies.
- Currently, what are the key elements involved in the industry’s management of price risk? What further tools are needed?
Effective risk management can mitigate the adverse effects of price volatility. In the words of the OECD, “Risk management in agriculture is now an essential tool for farmers to anticipate, avoid and react to shocks. An efficient risk management system for agriculture will preserve the standard of living of those who depend on farming, strengthen the viability of farm businesses, and provide an environment which supports investment in the farming sector.”
In responding to this question Farm Europe believes it is useful to distinguish between farm level and agro-industry. There are currently big differences between sectors. Those sectors who have strong cooperatives are in a very different position than those which have only private actors. The farmer owned cooperatives have to a certain extent more possibilities and means to soften the impact of price volatility. At farm level the instruments available are contained in the CAP. They concern public intervention prices for some commodities (grains, beef, dairy), which are set at a low level to make sure they are only triggered in extreme situations; support to private storage when prices fall below established levels (pork, dairy); and indirect support to producer organizations in the fruit and vegetable sectors to withdraw surplus production. In addition to these instruments there is the possibility for Member States to support insurance schemes through ‘second pillar’ funds.
At the agro-industry and cooperative levels there are also some financial hedging mechanisms which are available to a few selected commodities and in a few selected markets. Currently in the EU future markets concern only two commodities and are available in only two markets– wheat (in Paris) and sugar (in London). Future markets, even if extended to other commodities, cannot but partially cover the agriculture output. For instance it is conceivable to have a future market for skimmed milk powder, but not for the highly diverse cheese production. To these limitations inherent to the instrument should be added the fact that it requires highly specialised knowledge to be used.
The existing mechanisms have proven to be insufficient when crisis strike, as demonstrated by the recent crisis in the dairy sector. In particular the insurance mechanisms are too few, and too weak to provide appropriate support for sectoral price falls.
At present the CAP spends 1% of its budget on supporting insurance, in contrast with 60% which are spent in direct income aids (direct payments) irrespective of market fluctuations.
A new framework for strengthening insurance mechanisms, with adequate support from the CAP, is a fundamental tool to be developed.
- What effect has the commoditisation of agricultural goods had on the ability of farmers to respond to risk effectively? How are farmers to mitigate the on-farm effects of volatile global commodity markets and currency fluctuations?
Commoditisation of agriculture goods should be seen in conjunction with
increased interlinkages between commodity and financial markets, and within commodity markets between agriculture and other commodities (energy, metals).
The effect of these developments has been to increase price volatility and therefore to further expose farmers to price swings stronger than what should be expected from usual supply and demand forces. The instruments farmers dispose to deal with these risks are at present rather limited – a few scattered insurance schemes, even fewer hedging instruments. Availability of relevant and accurate market information is also an area where there is still room for improvement.
- What are the barriers to more effective on-farm price risk management, including longer term pricing mechanisms, diversification, co-operative working and leasing? How can those barriers be overcome and what is the role of EU and national public policy?
It is the view of Farm Europe that on-farm price risk management is impaired by the lack of well funded instruments, in particular the lack of across the board insurance schemes.
Diversification helps, but there are limits to how far a farmer can diversify operations. Land, climate, technology and capital are well known constraints.
Cooperatives can help stabilize prices, but only up to the point of their financial and contractual capabilities. Future contracts are also helpful, but they are very limited in scope.
Farm Europe argues that EU and national public policies have a role to play, by providing appropriate insurance schemes across sectors and countries.
EU and national public policies should also set the right framework for better price transmission and a more balanced distribution of the added value in the food marketing chain.
- How ‘fit for purpose’ are market-based instruments? Could the marketplace help to mitigate risks by providing ways of smoothing out the impact of volatility? Are there ways in which EU and national public policy could encourage, and reduce the risk of introducing new financial products?
Insurance against significant price drops or crop failure could be provided through the marketplace, with adequate backing from EU and national public funds to guarantee stop-loss coverage to private insurers and to make premium affordable to farmers. Due to the very large financial requirements associated with price insurance schemes Farm Europe believes that they should be designed and supported at EU level, with CAP funding. It is unrealistic in our opinion to expect price insurance to be implemented only at national or sub-national level, as it is highly unlikely that the financial needs to cope with sharp price falls would be available. Another avenue open to market actors is to expand the use of contracts between farmers, or their cooperatives, and buyers (agro-industry, wholesale and retail), that could increase price stability and forward pricing.
- How realistic are terms for access to investment finance? What role is there for the European Investment Bank to support on-farm investment at a low cost? What other instruments could improve access to finance in a volatile environment?
Investment is key to the sustainable and competitive development of farming. One of the biggest problems facing farmers that are willing to invest or have invested in the recent past is how to cope with paying back loans in a volatile price environment.
Farm Europe sees the potential for the European Investment Bank to step-in and provide financial backing to lenders in the EU. The EIB could offer credit to lenders tailored to soften the terms under which farmers access investment credit.
- What level of information is available to farmers to engage with market-based instruments and to consider alternative options for on-farm actions? How might knowledge availability be improved? How can farmers be encouraged to acquire the skills needed to operate a modern business-like operation?
National advisory bodies provide information to farmers. A case should be made for that information to include how farmers could benefit from market-based tools to mitigate volatility and increase resilience, including insurance, contracting and future markets.
Also national authorities could provide training for farmers or their representatives to understand how to engage in contracting and in future markets.
- What role should innovation play in creating a more resilient agricultural sector? Should more be invested in scientific research which could have the potential to transform agricultural practices?
Innovation is in Farm Europe’s opinion a key to the future of the agriculture sector. Innovation could help farmers cope with more extreme weather events, through for instance more resistant seeds and improved soil management.
To foster innovation, research is paramount. The increase in productivity has slowed down in the last decades, questioning the ability of the farm sector to satisfy increased demand from a larger and wealthier population, in particular in emerging economies.
Worth underlining that the last decades have also witnessed a drop in agricultural research that needs to be reversed to provide enough food for the world increased demand.
Public and private bodies, at the EU and national level, should work together to foster agriculture and food research, and to disseminate its results.
- How effectively does EU agricultural policy currently assist farmers to mitigate the impact of potential price volatility? Is there a need for management of price risk to be an explicit objective of the Common Agricultural Policy? What long term changes should be made to the Common Agricultural Policy to support the agricultural industry in responding to price risk more effectively? Should insurance schemes play a more prominent role?
The current CAP attempts to stabilize farm incomes through direct income aids irrespective of the evolution of prices. As mentioned above 60% of the budget is thus spent, as compared to only 1% in insurance. In addition to that the CAP provides a number of safety net measures to some key sectors- grains, dairy, beef, pork, fruits and vegetables. However these measures have proven insufficient to address more important price falls, resulting in severe income losses for farmers on more affected sectors, which in turn jeopardizes farmers’ ability to invest and modernize and better cope with price volatility.
Farm Europe defends that to increase the resilience of the farm sector explicit and strong measures should be implemented to respond to price risks in the CAP. In particular insurance schemes should become a central feature of the CAP with adequate funding. These insurance schemes should be provided at national or sub-national level, by private or public bodies, and be well adapted to farmers’ needs. They should be available across the EU for all farmers to subscribe. As said above, public funds should provide the right incentives for insurance companies and farmers to make these insurance schemes viable, and that can only be achieved with EU level support. The cost of insurance should be affordable to farmers, and insurance companies should have appropriate guarantees to cover catastrophic losses.
Farm Europe sustains that progress in this direction could be made in a two-step approach. In the short-term additional resources could be transferred from direct income aids towards increased support to insurance schemes. That would require a mid-term review of the current CAP that would make it possible, by increasing the share of ‘first pillar’ direct income aids that could be transferred to the ‘second pillar’.
However the CAP in the medium to long-term needs a more fundamental review. For Farm Europe there are three key objectives for a common policy – support the resilience of the sector, promote sustainable farming, and spur growth through innovation and investment in particular. It is questionable whether to commit 60% of the resources to income aids irrespective of market price fluctuations is the right way forward.
In a second step, Farm Europe has thus the vision of a CAP that would be structured around these three key objectives. In that new, reformed CAP insurance schemes would be a fundamental pillar, the one that would foster resilience.