Endogenous Supranational Policy Decisions: The Common Agricultural Policy of the European Community

Endogenous Supranational Policy Decisions: The Common Agricultural Policy of the EuropeanCommunityAuthor(s): Harald von WitzkeSource: Public Choice, Vol. 48, No. 2 (1986), pp. 157-174Published by: SpringerStable URL: http://www.jstor.org/stable/30024589 .

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Public Choice 48: 157-174 (1986). c 1986 Martinus Nijhoff Publishers, Dordrecht. Printed in the Netherlands.

Endogenous supranational policy decisions: The Common Agricultural Policy of the European Community

HARALD VON WITZKE*

Department of Agricultural & Applied Economics, University of Minnesota, 231 Classroom Office Building, 1994 Buford Avenue, St. Paul, MN 55108

1. Introduction

One of the central goals of the supranational EC Common Agricultural Policy (CAP) is to reduce the secular income problem of the Community's agricultural sectors (EEC Treaty, 1957). The pivotal instrument employed to achieve this goal is the support of domestic prices on a considerably higher level than those on the world markets. These policies have been

severely criticized because they cause (among others):

- a misallocation of resources within the EC (Koester and Tangermann, 1977);

- an additional distortion of international trade in agricultural commodities (e.g. Sampson and Snape, 1980);

- an additional distortion of agricultural incentives in many less developed countries (e.g. Koester, 1982; Bale and Lutz, 1981; Josling, 1980);

- an increased instability of world market prices (e.g. Schmitz and Koester, 1983)1;

- adverse effects with respect to regional (Tarditi and Croci Angelini, 1982), and personal income distribution (von Witzke, 1979);

- adverse transfer effects between the member states (Koester, 1977), and - huge budgetary expenditures by the EC (e.g. Petersen, 1983; Seebohm,

1981) which have created severe political disputes.

In the presence of the economic consequences of the CAP it is not sur-

prising that numerous proposals for a more or less fundamental change of EC price support policies have been put forward during the last couple of

years (e.g. Schmitt and von Witzke, 1981; von Witzke, 1980; Koester and

Tangermann, 1977). Most of these policy alternatives suggest reducing the level of price support and allowing the resulting structural change, tempered by some form of direct income aid, to solve the agricultural income

problem. The Council of Ministers, the body responsible for CAP decisions, has,



158

however, resisted to any major change towards a reduction of agricultural protectionism. In fact, market regimes have been established for additional goods (e.g. sheep meat), existing regulations have been tightened (e.g. dairy products), and the comparatively low increases in (nominal) guaranteed prices around the last turn of the decade have been followed by higher price increases (e.g. Tangermann, 1983). Moreover, in the presence of the over- stretched budget the EC is seriously contemplating additional tightening of the market regimes such as imposing production quotas, and additional taxes and/or tariffs on grain substitutes (soy meal, cassava products, etc.) and vegetable oil.

Considering both the comparatively low growth rates of support prices around the turn of the decade, and several publications by the EC Commis- sion (1981 a, b) many experts began hoping that the EC would be reoriented towards a reduction of protectionism (e.g. Council of Scientific Advisors to the German Federal Ministry of Agriculture, 1981). This trust turned out, however, to be wrong, mainly because the forces which underlie the decision making process of the EC had been neglected. They were necessarily neglected because the determinants of agricultural policy decisions in general (Rausser, 1982; Schuh 1981) and especially with respect to the supranational CAP (Hagedorn and Schmitt, 1983; Schmitt, 1984, 1982) are still largely unknown.

Endogenizing supranational policy decisions is difficult. Firstly, the popular approach which is based on the (expected) behavior of voters2 cannot be applied without major modifications when the decision makers are nationally elected by the voters of the respective countries (Hagedorn and Schmitt, 1983); secondly, supranational policy decisions are very often made without involving a supranational bureaucracy;3 thirdly, lobbying4 occurs in these cases primarily on the national level, and finally, most supranational decisions occur erratically, which renders empirical analyses difficult.

Despite the fact that the Council of Ministers is not directly elected by the voters of the EC but by the voters of the respective member countries, the supranational decision making process of the Community is characterized by many features that are typical for national policies and which might facilitate an analysis. The EC has a bureaucracy of its own5, lobbying does also take place on the Community level,6 and decisions on Common agricultural prices are made annually. Finally, it has to be mentioned that EC policies are, in essence, only agricultural policies; hence, the separability assumption - crucial in the analysis of sectoral policy decisions - is de- fensible with respect to the CAP.

Basically the factors that underlie policy decisions could be explained by three different approaches. "First, we can focus directly on policy instrument behavioral equations; second, we can focus on the structure of the



159

behavioral of all agents in political economic markets; third, we can focus on the reduced form of the structure which involves capturing the governing policy or political preference function" (Rausser, 1982).7

The focus of this paper is on the determinants of the Common Agricultural Policy of the European Community which is supranational in character. Given the state of arts with respect to supranational policy decisions8 and EC agricultural policies it appears to be adequate to restrict the discussion to the approach mentioned first, namely to model the black box of the CAP in order to gain some quantitative insights into those factors that underlie the decision making process of the European Community.9 The analysis will focus only on the determinants of price policy decisions because this is by far the most important instrument of the CAP.

It has often been emphasized that CAP decisions are heavily influenced by special national interests (e.g. Ritson and Tangermann, 1979; Heidhues et al., 1978; Koester, 1977) in conjunction with the uanimity decision rule which has been considered to allowing any single member country to act as a dictator (e.g. Schmitt, 1984; Hagedorn and Schmitt, 1983). Here, I will present a model that neglects these special national interests and that does not explicitly take the decision rule into account but that is formulated for the EC as a whole.1o

The remainder of this paper will be structured as follows. First, a theoretical framework suitable to derive hypotheses about price policy determination will be developed; second, these hypotheses will be tested empirically; and third, some conclusions will be drawn with respect to the CAP and possible interactions between agricultural policies in the Community and in other countries.

2. Theoretical considerations

As already indicated, the central agricultural income policy goal of the European Community is to achieve an adequate standard of living for the agricultural population by increasing per capita agricultural income. The member countries have established analogous goals on a national level. The definition of the EC agricultural income goal is rather vague and allows various interpretations (for details cf. von Witzke, 1980). In the 50s and ear- ly 60s, a popular interpretation was that average agricultural income and average income outside of agricultural should be equal. When the impor- tance of sectoral income differences for structural change in agriculture had become generally accepted, the most widely held interpretation was that average agricultural income should be somewhat lower than average nonagricultural income but that both should grow at about the same rate."

In the following it is assumed that there is a desired growth rate of agri-



160

cultural income, that it is constant over time (It), and that there is only one commodity:12

WYt = u (1) ya = desired agricultural per capita income ya = actual agricultural per capita income * = expected value of a variable P = EC market regime price (guaranteed minimum price) B = EC budget expenditures t = subscript for time A W in front of a symbol denotes a growth rate'13

Assume further that EC policy makers have some ideas about the future development of agricultural income growth which have been formed according to adaptive expectations (Nerlove, 1958):14

WYat* = WYat1 + -(WYat-1 - WYa*t-1) 0<-a1<-1 (2)

or

WYa*t = Et=0

a1(1-a1)t-WYa-1 (3)

W denotes the exptected real agricultural income growth without adjustments of the market regime price. The assumption of adaptive expectations appears to be plausible, because the EC Commission elaborated and applied a formal instrument, the so called 'objective method,' which contained typical elements of adaptive expectation formation. It was used in order to quantify the expected agricultural income without additional adjustments of support prices and to determine the price increases necessary to achieve whatever income growth was desired (for details cf. de Veer, 1979; Swinbank, 1979).

Subtracting eq. (3) from eq. (1) yields the gap between the desired agricultural income growth and the one expected in the absence of any adjustments of the guaranteed price:

WYat-WYa*t =u- Zt a*(1-,)t-X'WYa (4) X=O

The nominal growth rate of the support price that is necessary in order to achieve the agricultural income policy goal is assumed to have the following form:'15,16

WYat-WYa*t=WPt+ut (5)



161

From eqs. (4) and (5) it follows immediately:

WPF = u-1Zt0

WYa-, (6)

If the desired growth rate of agricultural income were the only variable that determinted CAP decisions WPt would be equal to the actual price increase. This is, however, not the case as there is a 'political' price of the CAP.

The EC used to be a net importer of many agricultural commodities. Under this condition the specific kind of agricultural price support, namely a variable levy system, causes receipts by the EC budget. Due to a considerable productivity growth in conjunction with a price support on a level

high above the world market prices the supply has been growing significantly and the EC has become a major net exporter of many agricultural key commodities such as dairy products, wheat, or sugar. The surplus production of the Community has been subsidized for export resulting in budgetary expenditures.

Beginning in the mid 70s budget spendings reached a level which attracted much public attention, and the extent of public attention and criticism and of public debates on a reorientation of the CAP appears to be correlated with the growth rates of price support related budgetary expenditures (Tangermann, 1983). The Council of Ministers does not worry very much about welfare losses within the Community, distortions of agricultural trade, or adverse distributional effects but does pay attention to growing public spendings. Therefore, EC budget expenditures related to the CAP could be considered the political price of EC price support.

As already mentioned the explanation of the behavior of the agents involved in the decision making process of the EC is beyond the scope of this

study. However, it appears plausible to assume that the growth rate of

budgetary expenditures and the price policy decisions of the EC are inverse-

ly related. If it is assumed that the expectation formation concerning the growth

rates of budget expenses is Nerlovian, we get:

WB* = Z

a2(1-02)t-X.WBx-1 (7)

Furthermore, it is assumed that the growth rate of the EC budget affects the orice decisions as follows:

WPt=WPt-y Zt0

2)(1t-"WBX- (8)



162

Eqs. (6) and (8) imply:

WPt = u-1Zt

al(1-al)tl.WYi-1 (9)

-7Y Z a2.(1-a2)t-X.WBx-1 vt

Eq. (9) expresses the price policy decisions as a function of past income growth, past change of budgetary expenditures, and a constant term which is determined by the policy parameter 7r and the agricultural income goal it; Ua1, c2, and y behavioral parameters, and vt is an error term (= - ut/r).

One could hypothesize that the domestic price level of agricultural commodities or its growth rate might also be considered as a component of the political cost of price support measures. However, it appears that this is not likely to have a significant effect on the annual price decisions for the following three reasons. First, there is theoretical and empirical evidence that consumers could not be considered a strong counterveiling power relative to whatever forces might ultimately underlie agricultural protectionism (e.g. Becker, 1983; Haase, 1983) in the EC;17 second, the portion of consumer income spent for food is comparatively low in the EC and is further decreasing (e.g. EC Commission, 1983);18 third, net producer prices of agricultural goods have on an average declined in the EC during the last 10 years, despite price support (e.g. Eurostat, 1982) resulting in the fact that agricultural protectionism is not visible in terms of increasing real prices.

Eq. (9) expresses the price policy decisions as weighted averages of past growth rates of agricultural income and budget expenses. WY,-1 and WBx-i are also functions of previous price decisions. If it is assumed that technical progress and outmigration is constant over time and that agricultural output response to price decisions occurs instantaneously then:19

WYt=o+~1WPt+ut,' (10)

There are various sources of EC budget expenses that are related to the CAP such as deficiency payments, producer subsidies, stock piling, or export refunds. These sources of budgetary expenditures, the most important being export refunds, depend to a large extent on (surplus) production and the level of price support. As a detailed model of the EC budget (Petersen, 1983) is beyond the scope of this study, and export restitutions are the most important source of budget expenses the theoretical considerations will be restricted hereupon.

Total expenditures for export refunds depend on the surplus production (SQ) and the level of price support. The refund per unit exported (XS) is the



163

difference between the domestic price (P) in ECU (European Currency Unit) and the ECU world market price. The latter depends on the world market prices in U.S.$ (PWM$) and the exchange rate of the ECU against the U.S.$ (ER).

Hence, total budgetary expenditure and its growth rate respectively are:

Bt = SQt"XSt (11)

Bt = SQtr(Pt-PWM$-ERt) (12)

WBt = WSQt+vWPt-(ot-1)f(WPWMt+WERt (13)

WOt = =PXSt

(14)

Notice that eq. (13) implies that the effect of changing surplus production on the exchange rate is negligible. Again it is assumed that output response to price changes occurs instantaneously; moreover, it is assumed that the

growth rate of surplus production as a function of price decisions has the

following form:20

WSQ,=oo+f1uWPt+u' (15)

Eqs. (13) and (15) imply:20

WBt=o+Gi+wt)WPt-(cot-1)'(WPWMt+WERt+u"' (16)

If eqs. (10) and (16) were introduced into eq. (9) we would obtain the growth rate of guaranteed prices as a function of past price decisions, the world market prices, the change of the exchange rate and some error terms. This

equation could formally be transformed into a linear regression equation without major difficulties. If the assumption of immediate supply response is dropped it could not be assumed a priori that the residuals are serially un- correlated. This type of problem is rather common with respect to time series analyses and could be solved by applying suitable econometric methods (e.g. Nerlove, Grether, and Carvalho, 1979).

The pivotal problem of this analysis is, however, more or less trivial in nature. As there will be less than ten observations and some variables re-

quire to be lagged degrees of freedom are few (cf. the following section). That is why we will be forced to apply a less ambitious approach, namely to estimate the determinants of price decisions, agricultural income, and

budget growth separately.

3. Empirical evidence

The empirical analysis of the determinants of CAP price decisions is over



164

the time period 1975/76-1981/82. This appears to be adequate because the first enlargement of the EC was completed in 1973;21 the most recent (reliable) data include 1981/82. As discussed in section 2 the formulation of the agricultural income goal of the European Community as specified in Art. 39 of the EEC Treaty (1957) is rather vague and allows various interpretations. Two of these are tested in this paper. The first one is that the agricultural income goal is determined by the difference of agricultural and nonagricultural income growth and the second one is that the desired income growth is exogenously given and has been constant during the period analyzed here. The latter hypothesis does not imply that the agricultural income goal is actually exogenous; it simply means that the goal formation over time is not explicitly considered here and influenced by additional variables that have not been included in the analysis (e.g. unemployment). An explanation of policy goal formation over time would sure- ly be an interesting and important task. However, the limited number of observations necessitates, on the one hand, to restrict the analysis. On the other hand, it appears plausible to assume that the agricultural income policy goal of the EC has not changed significantly during the period analyzed because nonagricultural income growth was more or less constantly low, and unemployment, an important determinant of structural change,22 (de Haen and von Braun, 1977), and inflation rates more or less constantly high.

From a theoretical point of view the disposable income of farm (and non- farm) households would be the most adequate income measure; political justifications of agricultural price support are very often explicitly or im- plicitly based on such a measure.23 Disposable income is, however, not available for EC agriculture. The CAP decision makers cannot base their price decisions on this variable, either. Therefore, the net value added at factor costs and the gross value added at market prices respectively are used in this analysis.

In order to account for the 'objective method' which was based on 3-years' moving averages of income,24 and to save degrees of freedom the growth rates of income have been based on 3-years' moving averages. Two different endogenous variables were used. WP2 is the weighted average of all market regime price growth rates in ECU; and WP1 is the weighted prices increase in national currencies, including changes of the Monetary Compen- satory Amounts (MCAs)25 decided on during the annual price rounds and those which occurred during the respective periods.

Table I contains the estimates with respect to the determinants of price policy decisions. Using the difference of agricultural and nonagricultural income growth rates (WSYD), as exogenous variable did not yield statistically significant results. Regression no. 6 represents a typical result obtained on the basis of the hypothesis that sectoral diverging income growth is a deter-



165

Table

1. The

determinants

of EC

agricultural

price

policy

decisions

1975/76-1981/82

Regression

coefficientsb,

c

Regression

Dependenta

Intercept

WSYDt-2

WYat-2

WB2

WBt-

WBt-2

F

R2

R2

no.

variable

-adj.

1

WPlt

6.316

- .828

- .298

38.921

.941

.912

(- 7.409)***

(- 2.907)**

2

WPlt

6.657

- .931

- .072

12.041

.858

.786

(-4.907)***

(- .521)

3d

WP1i

6.656

- .873

.057

3.250

.684

.474

(- 2.480)*

(.246)

4

WP2t

3.698

- .649

.069

8.095

.802

.703

(-3.984)**

(.492)

5

WP2t

3.655

- .648

- .161

15.126

.883

.825

(- 5.341)***

(- 1.788)

6d

WPlt

1.121

-1.414

-.144

4.811

.762

.604

(-2.161)

(-.690)

Source:

Own

computations;

based

on (i) EC

Commission,

Report

on the

Agricultural

Situation

in the

Community

(various

volumes);

(ii)

Petersen

(1983);

Agra

Europe

(various

volumes),

EUROSTAT

Review

(various

volumes).

When

differing

numbers

were

published

the

most

recent

numbers

were

used.

a WPI

= growth

rate

of nominal

agricultural

prices

in national

currencies

(in

p.c.).

WP2

= growth

rate

of nominal

market

regime

prices

in ECU

(in

p.c.).

All

variables

are

in p.c.

b Wya

= growth

rate

of 3 years'

moving

average

of real

net

value

added

at factor

costs

per

person

employed

in agricultural

(in

p.c.).

WSYD

= growth

rate

of gross

value

added

at market

prices

in agriculture

minus

growth

rate

of gross

value

added

at market

prices

in the

rest

of the

economies

(3-years'

moving

average).

WB

= growth

rate

of gross

guarantee

section

expenses

minus

growth

rate

of total

EC

budget

expenses.

c t-values

in parentheses;

significance

level:

***

> .99;

** > .95;

* > .90.

d 1976/77-1981/82.



166

minant of CAP decisions. Two interpretations of this are possible. On the one hand this might perhaps be interpreted that this reading of the agricultural income goal popular in the late 60s and 70s, had changed after the emergence of considerable unemployment. On the other hand this could be interpreted such that the Council of Ministers has been orienting its price decisions on a trend of nonagricultural income growth. The latter appears to be as well plausible because nonagricultural income is characterized by considerably less year to year fluctuations relative to agricultural income.

The regressions based on the hypothesis that the agricultural income goal has been constant over time (no. 1-5) yielded satisfactory results with respect to price changes in national currencies (no. 1-3) whereas the estimates for price decisions in terms of the ECU are rather weak (no. 4 and 5). This indicates that MCAs are an integral part of the CAP decisions (e.g. Heidhues, et al., 1978; Langworthy, Pearson, and Josling, 1981).

Further discussions will restricted to the explanation of price changes in national currencies. The growth rate of the 3-years' moving average of agricultural income yielded significant coefficients and the expected sign if it was lagged two years behind. This appears to be plausible because the price decisions for t are made at the end of t - 1.26 At this time the Council of Ministers has reliable data on the income development in t-2 and t-3, and satisfactory estimates for t - 1. The coefficients with respect to budget growth rates yielded satisfactory results only if unlagged. Due to "overlapping" periods the actual lag of the budget variable at the time when the decisions are made is about 0.5,27 i.e. price decisions are influenced by the actual budget situation. This corroborates results obtained by Ritson (1982) and Koester (1982); both authors found statistically significant interrelations between world prices which are, as already discussed, important determinants of EC budgetary expenditures, and the current price decisions.28

The estimates of the growth rates of agricultural income as a function of past price decisions yielded the following result:29

WYt = -7.372 + .627 WPlt-2 (17) (5.738)**

F = 32.929 R2 = .943

R2-adj. = .915

Table 2 shows the results of the regression analysis of the growth rates of budget expenditures. Actual or past price decisions did not yield significant results whether entering the regression alone or in combination with other variables (no. 1, 2, 3, 5, and 6). It appears to be likely that this is due to the relative short period that could be analyzed here and that one will get significant results when longer time series will be available in the future. Regres-



167

Table

2. The

determinants

of EC

budget

expenses

Regression

coefficientsa

Regression

Intercept

WPI1

WPlt-I

WPlt-2

WPWMI

WERt

F

R2

R2 -adj.

Time

no.

periodb

1

3.307

- .588

1.948

.280

.136

1

(-

1.396)

2

-4.634

.332

.345

.079

- .151

2

(.587)

3

- 9.203

.920

5.128

.631

.508

3

(2.264)

4

- .8438

- .094

- .305

12.303

.860

.790

1

(- 2.446)*

(- 3.965)**

5

2.794

- .457

-.127

-.173

10.124

.910

.828

1

(- 1.291)

(- 2.890)*

(-1.383)

6

- 2.390

.280

-.124

- .248

16.452

.980

.921

3

(1.195)

(- 2.394)

(-3.789)*

Source:

Cf.

Table

1.

a See

Table

1, footnote

a and

b; WPWM$

= growth

rate

(in p.c.)

of weighted

average

of world

market

prices

for

wheat,

sugar,

butter

and

skimmed

milk

powder

(U.S.$)

(weighting

factor

according

to EC

production);

WER

= rate

of change

(in

p.c.)

of the

exchange

rate

(ECU/U.S.$).

b 1: 1975/76-1981/82.

2: 1976/77-1981/82.

3: 1977/78-1981/82.



168

sion no. 4, containing only the growth rates of world market prices in U.S.$ and the exchange rate (ECU/$) as exogenous variables resulted in plausible signs and significant coefficients for both variables.30

Replacing the budget variable (in regression no. 1, Table 1) by the growth rate of ECU world market prices yielded the following results:3'

WPt = 6.275 - 1.078WY'a2 + .079WPWMECU (18) (-8.128)*** (2.651)*

F = 34.248 R2 = .945

R2-adj. = .917

The results are comparable to those of regression no. 1 in Table 1, although the quantitative effect of past income growth is somewhat more pronounced in eq. (18). Notice that the positive sign of WPWMECU is plausible because growing ECU world market prices affect the budget growth rate negatively.

As already mentioned eqs. (5) and (10) would be identical if the policy makers' expectations about agricultural income growth without adjustments of market regime prices (WY*) were to hold and the decision makers were to know the true relationship between price decisions and agricultural income growth. If it is assumed that this is the case, it is possible to compute and to examine the plausibility of ^. According to eq. (17) t,

(= 7^i) is .627 whereas the estimates for u/u are 6.316 (Table 1, # 1) and 6.275

(eq. (18)). Hence, ̂ is 4.0 and 3.9 respectively. Information about the real growth rate of the nonagricultural net value added at factor costs per person employed, the income measure corresponding to WYa, was not available. Using the average growth rate of the volume of GDP at market prices per caput during the corresponding period as a proxy, we get 3.5 p.c. as the nonagricultural income growth,32 which is considerably close to the estimates for A.

4. Conclusion

The analysis of the supranational EC decisions on the CAP indicates that they are endogenous and could largely be explained by past income growth and the development of budgetary expenditures prevailing at the time of the price decisions. The empirical results corroborate the hypothesis that Monetary Compensatory Amounts are integral part of Common price decisions. Agricultural income growth could be explained by past price policy decisions whereas budget expenses are determined by U.S.$ world market prices and the exchange rate of the ECU against the U.S.$



169

If the CAP were to be a national agricultural policy the results obtained would not be very surprising. The decision making process with respect to the Common Agricultural Policy, however, is supranational in character. Apparently the same forces that one might expect to determine national agricultural policies underlie CAP decisions, too.

A question that immediately rearises is this context is, what are the determinants of the behavior of the agents involved in the decision making process? As already mentioned, the approach based on the (expected) behavior of voters is not likely to contribute to an explanation of CAP decisions because on an average the portion of agricultural voters is low in the EC. Moreover, empirical analyses for the Federal Republic of Germany did not find significant interrelations between price policy decisions or agricultural incomes and the popularity of the government on the side on agricultural voters (Haase, 1983). Finally, the Council of Ministers is not elected by the voters of the European Community as a whole; the ministers are members of the respective nationally elected governments.

To what extent the behavior of bureaucrats and the behavior of pressure groups contribute to the observed CAP decisions is difficult to judge and even more difficult to analyze empirically because presumably the most important factors influencing the supply of (bureaucracy) and the demand for price support (pressure groups) are identical, namely agricultural income and budgetary expenditures (Beusmann and Hagedorn, 1984).

The model developed in this paper could contribute to avoiding misinter- pretations of EC price policy decisions as occurred around the turn of the last decade. The comparatively low growth rates of guaranteed prices during that time were not symptoms of a policy change but a consequence of relative budget scarcity and comparatively high income growth due to high price increases in the past.33 Once there had been a budget relief and relatively low agricultural income growth the growth rate of support prices increased again.

As has been shown, price policy decisions are not completely determined by past income growth and thus by past decisions on market regime prices. The growth rate of budget expenses is also an important determinant of price decisions. The growth rate of budget expenses is (among other things) also affected by changing exchange rates (ECU vs. U.S.$) and U.S.$ world market prices. This allows some interesting additional insights into some international determinants of CAP decisions. While it could be argued that the impact of the world market prices and the exchange rate (ECU vs. U.S.$) via EC budget expenses is quantitatively less important than the effects of past price decisions these international aspects must not be over- looked.

The following may help to illustrate such interrelationships. The present comparatively high value of the U.S.$ against the currencies which form the



170

ECU reduces the EC price support in terms of the ECU, i.e., it reduces the difference between domestic prices and the ECU world market prices and thus eases the budget situation which in turn contributes to relatively higher increases of the support prices. The arguments with respect to world market prices in U.S.$ are quite similar; comparatively high U.S.$ prices on the world market (caused e.g., by the 1983 drought in the USA or the U.S. PIK program)34 reduce export refunds per unit and thus the EC budget expenses.

Although the quantitative effects are, as yet, unknown, lines of argument such as the following one appear to be plausible. The comparatively high value of the U.S.$ against the ECU during the last couple of years has c.p. eased the EC budget situation and thus contributed to comparatively high increases in support prices. As the large country assumption holds for EC agriculture the increased surplus production of the EC has caused relatively lower world market prices and thus contributed to agricultural income problems in other countries and/or additional income measures there. Assuming that these other countries are not small in economic terms, and that they introduce measures which in essence reduce their supply of agricultural commodities (such as a PIK program), then it become obvious that such a policy in turn contributes to relatively high growth rates of agricultural support prices in the EC.

NOTES

* The author is indebted to K. Brooks, J.P. Houck, C.F. Runge, S.J. Thompson, and the Editor of this Journal for valuable comments and suggestions.

1. For a detailed analysis of potential instability effects of EC price support policies cf. Schmitz (1984).

2. Cf. e.g. Frey and Schneider (1979), Peltzman (1976), Posner (1974), Stigler (1970), Buchanan and Tullock (1967), Downs (1957).

3. For details about the effects of national bureaucracies on policy decisions cf. e.g. Niskanen (1971), Downs (1967). For possible effects of national bureaucracies on supranational decisions cf. e.g. Brito and Intriligator (1981).

4. For the influence of pressure groups on policy decisions cf. e.g. Becker (1983), Krueger (1974), Olson (1965).

5. The executive branch is the EC Commission. 6. Farmers' pressure group on the EC level is COPA (Comit6 des Organisations Profes-

sionelles Agricoles de la C.E.). 7. For a survey of alternative approaches to endogenize agricultural policy decisions cf.

Rausser, Lichtenberg, and Lattimore (1982). 8. Cf. e.g. Olson and Zeckhauser (1966), Frey (1985). 9. For typical analyses that focus on national agricultural policy reaction functions cf. e.g.

Gerrard and Roe (1981), Gulliver et al. (1979), Lattimore and Schuh (1979). 10. Notice in this context, that national policy decisions are as well made for regionally in-

homogenous countries and are influenced by various diverging regional interests, also. 11. Since macroeconomic growth started to stagnate it has become more and more popular to

consider the (growing) rate of unemployment in the industrial sector, too, when comparing



171

sectoral incomes or their growth rates. The true income goal formulation has, however, always remained hidden but it could be uncovered by an empirical analysis of the revealed preferences of the CAP decision makers.

12. One could well think of /1 as being the average non-agriculture income growth rate. Cf. later.

13. All growth rates are in real terms; the growth rate of the guaranteed price is in nominal terms. Cf. later.

14. Notice that WY), I(eq. 3) could be decomposed into the growth rate of agricultural income without adjustments of guaranteed prices, and the corresponding price policy income effect.

15. Alternative model specifications would be either to express all variables in nominal terms and to introduce inflation explicitly, or to formulate the model in real terms which would include that the market regime price declines according to the inflation rate. Both model alternatives would require the introducion of explicit hypotheses about the expectation formation with respect to the inflation rate. The model formulation presented here avoids this which could be considered an advantage because degrees of freedom are few in the empirical analysis. Moreover, the model formulation presented here is similar to the EC Com- mission's 'objective method'.

16. WP, is the growth rate of the market regime price necessary in order to achieve the income goal and ut is an error term. For details about the formulation of eq. (5) cf. von Witzke (1979).

17. One could also refer to the observation that there are, in essence, no very pronounced differences between the major parties in Europe in their attitude towards agricultural protectionism (e.g. Wilson, 1978).

18. Becker's argument (1983) that "... agriculture is often heavily subsidized when a small sector ...; and heavily taxed when a large sector ..." appears to be consistent with this view.

19. Notice that if the expectation WY, holds, then WY' = o, and if the policy instrument eq. (5) expresses as the true relationship between price and income change, eqs. (5) and (10) are identical.

20. The EC is not a small country with respect to agricultural exports. A changing EC surplus production via changing EC price level affects the world markets. Hence, one could think of endogenizing WPWM$, also. This would, however, require to develop a model of world market price determination which is beyond the scope of this study.

21. The original member countries were France, F.R. Germany, Italy, Netherlands, Belgium, and Luxembourg. The first enlargement included the United Kingdom, Ireland, and Denmark.

22. High rates of unemployment are often considered a determinant of income policy goal formation (e.g. Schmitt, 1982).

23. For details cf. von Witzke (1980) and the literature quoted there. 24. Cf. de Veer (1979), Swinbank (1979). 25. MCA's have been introduced in order to avoid, or at least reduce sudden (and sometimes

quite significant) changes of market regime prices in national currencies and thus agricultural incomes due to fluctuating exchange rates of the member countries' currencies. In essence, MCA's are intracommunity tariffs and result in divergent agricultural commodity prices in national currencies. They are also used in order to pursue nationally diverging income goals which could not be achieved by Common prices. For details cf. Heidhues et al. (1978), Schmitz (1979), Langworthy, Pearson, and Josling (1981).

26. The financial year differs from one commodity to the other, as do the fiscal years of agricultural income between the member countries.

27. The use of a half year's lag was due to "overlapping" periods (financial and calendar years).



172

28. Ritson (1982) denotes world market prices as lagged one year behind because he formually relates growth rates of market regime prices in one period with growth rates on the world market in the immediate past period. Comparing world price growth rates with the point in time when the price decisions are actually made would formally reduce the time lag to '0.5'.

29. Due to a lack of availability of suitable data the estimates had to be based on the relatively short period 1977/78-1980/81. Source: Cf. Table 1. Significance level: ** > .95.

In order to use consistent data in the text eq. (17) was based on nominal growth rates of prices. The estimates based on real growth rates of prices are:

WYt = 1.759 + 1.390 WPlt-2 (4.048)*

F = 16.389 R2 = .891

R2-adj. = .837

30. Notice that the coefficients contained in Table 2 are not identical to the weighting factors of eq. (13). First, budget growth rates were in the empirical analysis captured by the growth rate of total price policy expenditures minus the growth rate of total budget spendings; this was done in order to avoid to explicitly considering the 'automatically' growing so called own resources of the EC (e.g. Tangermann, 1983) over time. Second, eq. (13) was formulated only for export restitutions.

31. 1975/76-1981/82. Source: cf. Table 1. Significance level: *** _ .99, * _ .9. 32. Cf. Eurostat, various volumes. 33. For the consequences of different decision rules about market regime prices on income

growth over time cf. Heidhues (1976). 34. Basically the PIK program payments to farmers are subsidies for not producing certain

agricultural commodities. Cf. Egertson, Hasbargen, and Benson (1983).

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Endogenous Supranational Policy Decisions: The Common Agricultural Policy of the European Community