Impact of the abolition of EU Milk quotas on Agriculture in the UK

Abstract

In recent years the CAP has undergone significant reforms, but the dairy sector has largely avoided wholesale changes. The sector, however, is now faced with a significant effort by the Commission to instigate reform. In this study the FAPRI-UK modelling system is simulated to identify the impact of abolishing or phasing out EU milk quotas on the dairy sector in the UK and the results are compared against a 2007 Baseline projection (2007--2016). The results demonstrate that although the impact of the abolition of dairy quotas is fairly modest at the EU-25 level, significant impacts are apparent at the individual country level.

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Impact of the abolition of EU Milk quotas on Agriculture in the UK



Myles Patton1, Julian Binfield2, Joan Moss1, Philip Kostov3, Lichun
Zhang3, John Davis1 and Patrick Westhoff2


1) Agri-Food & Biosciences Institute Northern Ireland
2) FAPRI at the University of Missouri, USA
3) Queen’s University Belfast

Contact: Myles.Patton@afbini.gov.uk















Paper prepared for presentation at the 107th EAAE Seminar "Modelling of
Agricultural and Rural Development Policies". Sevilla, Spain, January 29th -
February 1st, 2008









Copyright 2007 by Patton, Binfield, Moss, Kostov, Zhang, Davis and Westhoff. All rights reserved.
Readers may make verbatim copies of this document for non-commercial purposes by any means,
provided that this copyright notice appears on all such copies.

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Abstract
In recent years the CAP has undergone significant reforms, but the dairy sector has largely
avoided wholesale changes. The sector, however, is now faced with a significant effort by the
Commission to instigate reform. In this study the FAPRI-UK modelling system is simulated
to identify the impact of abolishing or phasing out EU milk quotas on the dairy sector in the
UK and the results are compared against a 2007 Baseline projection (2007 – 2016). The
results demonstrate that although the impact of the abolition of dairy quotas is fairly modest at
the EU-25 level, significant impacts are apparent at the individual country level.

Key words: Milk Quotas, CAP Reform, Commodity Modelling


1. Introduction

The EU milk quota regime was introduced in 1984 to restrict milk production levels and
control EU dairy commodity surpluses. The regime will automatically expire in 2015 unless
a decision is taken to renew it. The EU’s agricultural policy will be reviewed in 2008 and the
Agriculture Commissioner has announced her intention to abolish milk quotas in due course.
It is likely that the abolition of EU milk quotas will have differing implications across
member states. Based on a partial equilibrium modelling system, this article examines the
impact of abolishing EU milk quotas on the dairy sector in the UK. The models consist of a
set of annually validated econometric equations of the beef, sheep, dairy, pig, poultry, cereal
and oilseed sectors of England, Wales, Scotland and NI. The UK models are run in
conjunction with the FAPRI European Union model (GOLD) run by the University of
Missouri which is in turn linked to the FAPRI Global modelling system. The FAPRI-UK
modelling system produces Baseline projections, over a ten year period, of key variables in
the beef, sheep, dairy and cereal sectors for each country in the UK. It is assumed that current
policies remain in place and specific macroeconomic assumptions hold.

The impact of the abolition or phasing out of EU quotas is dependent upon the underlying
WTO trade rules. The 2007 Baseline incorporates the existing trade regulations but the EU
has already declared that, irrespective of a new WTO agreement, EU export subsidies are
going to be eliminated (Agra Europe Weekly, 2007). The first policy scenario investigates
the impact of export subsidy elimination prior to changes in the EU dairy quota regime. The
second and third scenarios examine the impact of the abolition of EU milk quotas with
differing assumptions about EU import tariffs. Finally the impact of phasing out quotas
through quota expansion is investigated. An overview of the methodology underlying the
policy analysis is provided in Section 2. Section 3 describes the scenarios undertaken in this
study. The results are presented in Section 4 and conclusions are drawn in Section 5.

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2. Methodology

2.1 Baseline
The FAPRI-UK modelling system, which is integrated into the FAPRI European model
(GOLD), produces Baseline projections, over a ten year period, of key variables in the beef,
sheep, dairy and cereal sectors for each country in the UK, under the assumption that current
policies remain in place and specific macroeconomic assumptions hold. The Baseline does
not constitute a forecast, but provides a benchmark against which projections of the policy
scenarios can be compared and interpreted. The following analyses are based on a Baseline
generated in October 2007. During 2007 there has been a sharp rise in international
commodity prices and as a result the world prices obtained from the January FAPRI 2007 US
and World Agricultural Outlook (FAPRI, 2007) have been adjusted to reflect market
developments


2.2 Quota Rents
In the past the GOLD model has functioned as if production were determined by quotas, i.e.
that quota rents were positive. In order to model the elimination or phasing out of quotas, a
new equation has been added to the model. This equation determines “planned production”
which is equal to that determined by the quota, where there are positive rents, but allows for
the simulation of situations where quotas are eliminated. When quotas are abolished, the
quota rental value determines the deviation of milk production from the quota. In the case of
positive quota rents, this leads to an increase in milk production. Thereafter, milk production
responds to milk price changes that occur either as a result of shocks to the sector or from
outside forces.

Unfortunately it is not straightforward to determine quota rents. In the UK it is clear that the
rent associated with quota is minimal. For other countries where quota transfer has been
restricted it is less easy to determine rental values. Other than the UK, the rents that are used
for the model are based on those calculated by Lips and Rieder (2005). They used a general
equilibrium framework to compute macroeconomic estimates of quota rents for the EU-15
plus Switzerland. Their macro-economic quota rents are used to calibrate the country-specific
quota rent estimates, obtained using micro-economic procedures by the INRA (Institut
National de la Recherche Agronomique) -Wageningen consortium (Consortium INRA-
University of Wageningen (2002)). The rents that are used in the GOLD model are shown in
Table 1 under the column labelled Lips.

Rents for the EU-15 are calculated as a proportion of the milk price and as stated are based on
those calculated by Lips and Rieder (2005). The figures that this source used were for 1997,
so in order for these to be relevant for the purposes of this exercise they have to be projected
forward. This is achieved using milk prices that are projected as a matter of course by the
GOLD model and by taking account of a cost index. The cost indices for the countries are
based on FADN information. Feed costs are projected using GOLD projections of grain and
meal prices; energy and fertilizer prices are projected using the Global Insight’s oil price; and

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other costs are proxied by the GDP deflator and a constant. For Poland and Hungary, rents are
determined by the difference between pre-accession and current year prices and costs, with
other NMS-10 rents set at an average of these values. In accordance with the literature, the
short run elasticity of planned milk production to changes in milk prices is approximately
0.25, while the long run elasticity is close to 1.5. While rents differ between countries, the
structure and elasticities of the equations, with the exception of the UK and Ireland models,
are the same.

Table 1: Rents used in the model, 1997 (% of milk price)

Lips INRA
France
Germany
Ireland
Italy
Other EU
0.22
0.20
0.31
0.30
0.19
0.35
0.35
0.45
0.30
0.37

Unlike the other country models within the GOLD model, quota rental values are not used as
a basis for defining milk production functions within the UK dairy model. In the UK given
that production has consistently been below quota in recent years and the low price of quota,
it is apparent that the rent associated with quota is minimal. In addition, the free transfer of
quota between each country in the UK facilitates the estimation of milk production functions
rather than employing quota rental values derived from microeconomic studies. Milk
production in each country in the UK is modelled using separate latent milk output functions
for each region. These indicate how much each UK country would have wanted to produce, if
the quota was not binding. The four countries’ latent production values are added together to
obtain the latent UK milk output. If the computed UK latent production exceeds the quota, it
needs to be reduced (scaled back) to the quota level. This is achieved by appropriately
reducing (scaling back) the individual regions latent production value to obtain their final
production. On the other hand, if the computed UK latent production is below quota, no
scaling back takes place and UK milk production is equated to this value. The practical
implementation of this milk production system and its estimation are outlined in FAPRI-UK
(2007).

Using the latent production approach, it is feasible simultaneously to estimate production
functions for England, Wales, Scotland and NI. Estimation generates upward sloping
production functions with different elasticities for each country in the UK. The latent
production approach also generates quota shadow prices that are consistent with milk
production in the UK falling below quota levels in recent years.

Using the estimated latent milk production functions the model assumes production is equal
to the quota providing the incentive price (milk producer price plus production enhancing
effect of dairy compensation element of the SFP) exceeds the quota shadow price. However,
if incentive prices fall below the quota shadow price milk production is determined by the

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upward sloping supply functions in each country. In the latter case, milk production is
determined by milk prices, SFP component and a dairy input cost index of each region. The
dairy input cost index is specified as a function of the prices of the different feed grains and
oilseed meals, energy costs and a measure of general price inflation.


3. Scenario Definitions

The following policy scenarios were examined:

Scenario 1:
Phasing out of export subsidies between 2009 and 2013, with 50% reduction
by 2010. This scenario involves the phased reduction in the value and
volume of export subsidies. By 2013 all export subsidies are prohibited. In
conjunction with the phased elimination of export subsides, it is assumed that
intervention prices are lowered, where necessary, to allow the markets to
clear, thus avoiding the build up of stocks.

Scenario 2:
Elimination of EU milk quotas in 2010, in conjunction with the phasing out of
export subsidies between 2009 and 2013. This scenario maintains the same
assumptions as Scenario 1, with the exception that the EU milk quotas are
abolished in 2010. Because the FAPRI-UK model runs on a ten-year
horizon, updated each year, it would not be possible to obtain full estimates
of the impact of quota abolition if this was applied to the model in 2015.
Consequently 2010 was selected for modelling purposes as the appropriate
year to introduce this policy change. Note that it is assumed that no
restructuring aid is provided.

Scenario 3:
Elimination of EU milk quotas in 2010, in conjunction with reductions in EU
import tariffs and phasing out of export subsidies between 2009 and 2013. In
this scenario EU tariffs agreed under the Uruguay Round Agreements Act are
reduced by 65% for all products, apart from cheese, where the reduction is
60%. Tariff reductions are phased in between 2008 and 2013. This scenario
maintains the same assumptions as Scenario 2, with the exception that tariffs
are reduced.

Scenario 4:
EU quotas are expanded by 2.5% a year between 2010 and 2015 (total 15%)
and then eliminated plus import tariffs are reduced and export subsidies are
eliminated. This “phasing out” scenario is the same as Scenario 3 except that
milk quotas are gradually increased rather than abolished. This scenario
should be treated as the focal point of the FAPRI-UK modelling exercise
since it corresponds most closely to the policy preference of the EU
Commission as stated in the recent Health Check announcements – the so-
called soft landing approach.