Alexandre Gohin

Hervé Guyomard

Agenda 2000, Dairy Policy Instruments and Farm Milk Price

Introduction

In a general way the Agenda 2000 common agricultural pol icy (CA P) reform deepens and extends the 1992 reform through further shifts from price support to direct payments. ln the case of dairy products. the EC opts for a cautious approach at this stage and discards radical solutions such as drastic price cuts or rapid abolition of the quota system. The quota system would be extended up to 2006 ; intervention prices for butter and sk immed milk powder wou ld be reduced by I 5 percent in fou r steps starting on I July 2000 ; price cuts would be compensated by the introduction of a new yearly payment for dairy cows ; and quotas wou ld be increased by 2 percent in four steps, the increase to be shared between young farmers and producers in mountain or Nord ic areas [START_REF] Ec | Draft Agenda 2000 regu lations on cereals, beef, and dairy products[END_REF]. 1 Gauging the effects of Agenda 2000 proposais on producer prices is a key issue for an overall appraisal of the package. ln very general tenns the question is: will EU market prices follow the 1 As far as dairy products are concerned, the 1998 EC proposais differ from the final package adopted in March 1999 as follows. The milk quota regime is extended, officially up to the year 2006, in practice up to the year 2008, and milk quotas are increased by 2.4 percent. Intervention prices for butter and sk immed milk powder wi ll be reduced by 15 percent in three steps starting on I July 2005, and price cuts will be compensated by th e introduction of new yearly payment on a flat rate basis per tonne of quota.

DOCUMENTATION ÉCONOMIE RURALE RENNES

1111111 11111111111111111111 IIIII IIII IIII * 0 0 4 6 5 6 * fall in intervention prices? ln the case of grains, there is now ample evidence that a one unit change in the intervention price results in a smaller than unit variation in market prices. ln the case of rnilk, the problem is that the intervention mechanism does not apply at farm level. Fu1 1herrnore there are intervention purchases onl y for butter and skimmed milk powder.

The mai n objective of this paper is then to analyse the impact of changes in dairy policy instruments, i.e., butter and skimmed milk powder intervention price cuts, decreases of expo1 1 subsidies for dairy products and quota level increases, on milk farm price. The vehicle for this analysis is a computab le general equilibrium model of the French economy which highlights agricultural and food sectors and with special attention given to mode lling of the various instruments of the CAP. In section 2 we brietly present the model and we explai n how dairy policy instruments are modelled. In section 3 we present simulation results and section 4 concludes.

Mode! overview and modelling of CAP instruments

The model used in this paper is a static, single-country, multi-sector computable general equilibrium (CGE) model of the French economy benchmarked to data for 1990. The general structure of the model is underlined in Table 2.1.

Mode! disaggregation

The current version of the model includes 15 agricultura l and food processing sectors and 25 agricultural and food products. The rather detailed level of disaggregation of the model allows us to capture the main forward and backward linkages among the various agricultural sectors on the one hand, among these agricu ltural sectors and their economic environment (food processing sectors and input suppliers) on the other hand.

Milk quotas are implemented at farm level. We assume that there are two representative dairy producers. The first producer is a specialised dairy farmer. ln this case, beef is supposed to be a joint by-product of milk production and there are no substitution possibilities between beef and milk (Leontief transformation fonction). The second producer is a mixed dairy farrner. Here, beef and milk substitute fo r each other through substitutable revenue fonction. Mil k is entirely sold to the domestic dairy industry which offers two dairy products: an aggregate of butter and skirnmed milk powder (B&SMP) and an aggregate of other dairy products including fat milk powder, cheese, yoghurts, ... (ODP). This modelling framework allows us to duplicate the worki ngs of the com mon market organisation (CMO) of dairy products, in pa11icular in terms of price transmission between dairy products and farm rnilk. 4. Four primary production factors: labour, capital, land and production rights.

5. Three institutional sectors: a single representative consumer, the French "government" and the FEOGA.

6. Multi-stage, multi-product, constant-returns-to-scale production technologies with substitution between inputs, including intermediate inputs.

7. Multi-stage budgeting process for the single representative consumer and allocation of its disposai income on the basis of linear expenditure systems (LES).

8. lmperfect substitution between domestic and foreign commodities on both the import side and the expott side (except for some "regulated" products). Arm ington specification. 9. Small coun try assumption on both the import side and the expo11 side with respect to the RoW, except for some agricultural and food products (including dairy products ) on the expo1t side.

1 O. Explicit modell ing of public policy instruments with special attention given to CAP instruments: intervention price mechani sm, export subs idies, import tariffs, production quotas, directs payments, set as ide, ... 11. Imperfect mobility of primary production factors across activity sectors on the basis of nested CET ( constant elasticity of transformation) fonctions.

12. Competitive markets and neoclassical macro-economic closure.

Model disaggregation

The current version of the model includes 15 agricultura l and food processi ng sectors and 25

agricultural and food products. The rather detailed level of disaggregation of the mode! allows us to capture the main forward and backwa rd linkages among the various agricu ltural sectors on the one hand. among these agricu ltural sectors and their economic environment (food processing sectors and input suppliers) on the other hand.

Mi lk quotas are implemented at fa rm level. We assume that there are two representative dairy producers. The first producer is a specialised da iry farmer. ln this case, beef is supposed to be a joint by-product of milk production and there are no substitution possibilities between beef and milk (Leontief transformation fonction). The second producer is a mixed dairy fo rmer. Here.

beef and milk substitute for each other through substitutable revenue foncti on. Milk is entirely sold to the domestic dairy industry which offers two dairy products: an aggregate of butter and ski mmed milk powder (B&SMP) and an aggregate of other dairy products inc luding fat milk powder. cheese, yoghurts .... (ODP). This modelling framework allows us to duplicate the workings of the common market organisation (CMO) of dairy products, in pa1ticular in terms of price transmission between dairy products and fa rm milk.

Production technology specification

As regards the production technology of the dairy industry, we assume that this sector uses ail the mi lk produced by the two agricultural dairy producers in fixed propo1tions. The allocation of milk between the two dairy products is the result of revenue maximisation subject to a constant elasticity of transformat ion (CET) fonction. The curvature of the CET reflects substitut ion possibilities between B&SMP and ODP. As the e lasticity of transformation of the CET increases, substitution poss ibilities increase. We will show that the value of this parameter is a key factor which largely determines the final impact of a B&SMP intervention price eut on milk fann price. The sensitivity of simulation resu lts to the value of this parameter will be investigated in the next section.

The maximisation programme of the dairy industry may be written as:

(

1) max n =P1 •Y1 + P2-Y2 -w,.! -wx .x "1 ,Y2J,x S . t.
where y 1 is the quantity of B&SM P and Pi the corresponding producer pnce ; y 2 is the quantit) 1 of ODP and p 2 the corresponding producer price: / is the quantity of milk used by the da iry industry and w 1 the corresponding price ; and x is the quantity vector of other inputs used by the dairy industry and wx the corresponding vector price. ln order to simpl ify the presentation, we assume in this section that ail inputs, including primary production factors, are variable. As a result, the vector x represents ail production factors, but milk, used by the dairy industry.

Optimisation proceeds as a two-stage process. The first stage corresponding to revenue maxim isation subject to the CET fonction defines the supply foncti on of B&SMP, the supply fonct ion of ODP and the revenue fonction for a g iven milk demand and fo r a given factor x demand. ln the second stage milk and factor x demands are obtained from Shephard's lemma, i.e., by taking partial deri vatives of the cost function with respect to the relevant factor price.

Note that x is defined as a constant elasticity of substitution (CES) function of labour and capital wh ile intermediate inputs are used in fixed proportions.

Under the assumption of constant returns to scale, there is no profit and total revenue equals total cost. lt results that we can define an equilibrium relationship between the milk price w 1 on the one hand, the prices p 1 and p 2 of the two dairy products and the price H\ of inputs x on the other hand:

Equation (2) shows that the price of milk depends positively on the pnces of the two dairy products and negatively on input x price. Furthermore one can show that each price p, is a decreasing fonction of quota level (other things being equal).

Agricultural policy instrument modelling

It is now well recognised that the representation of agricultural support programmes in partial or general equilibrium models can have a substantial bearing upon the mode! predictions and outcomes (see, e.g. , Whal ley and [START_REF] Whalley | Terms of trade effects, agricultural trade liberalization and developing countries[END_REF]. One important feature of our mode! is that main CAP instruments are explic itly modelled.

The first principle underlying the common dairy policy is the management of the markets for dairy products in order to secure product prices that permit milk producers to obta in the target price for milk. This ma inly involves the annual fi xing ofa target price for milk, the annual fixing of an interven tion price for butter and skimmed milk powder, the imposition of tariffs on imports for dairy products, the payment of subsidies on experts for dairy products and the payment of aids for disposai of some dairy products on domestic market. Faced with the problem of achieving a better balance between supply and demand, and the derived problem of an increasing budgetary cost, the EU introduced the milk quota system in 1984. Originally with a five-year life. the system was extended until 2000 as part of the CA P reform package in I 992. lt would be extended at least until 2006 under Agenda 2000. The various dairy policy instruments mentioned above are explicitly mode lled using a mixed-complementarity approach.

Milk quotas

M ilk quotas are represented by means of an additional primary factor of production which ensures that the zero profit condition holds for both the specialised dairy farmer and the mixed dairy farme r (Herte l and Tsigas, 1991 [START_REF] Peerlings | A n applied genera l equilibriu111 mode! for Dutch agribusiness policy analysis[END_REF].

We assume that one unit of quota rights is necessary to produce one unit of milk. As a result, the maximisation programme of a dairy producer (specialised or mixed) may be wri tten as:

(3) maxrr = p.y -C(y, w) s.t. y ~y ...

where p is the producer price of milk, y is the quantity of milk, C(y, w) is the cost fonction of milk production and y is the quota level of the considered producer. ln order to simpl ify the presentation. we do not take into account beef production in this paragraph. First-order conditions associated with programme (3) are:

(4) p-ôC / ày -À.s, O, y::2: 0, y.(p -ôC! oy -À.)=0

(5) y-y s, O. À. ::2: O. À..(y-y)= 0 where À. is the multiplier associated with the quota constraint. ln our case, À is simply the price of quota rights. lt depends on the type of dairy farmer, specialised or mixed .

Equations ( 4) show that milk production is positive when marginal profits equal the price of quota rights and that milk production is nul! when marginal profits are lo\,er than the price of quota rights. Equations ( 5) show that the level of milk production is equal to (respectively lower than) the quota level when the (shadow) price of quota rights is positive (respectively null). ln the second case, the quota is not constra ining for the considered producer.

Eq uations ( 4) and ( 5) are used in our model in order to imitate the wo rkings of the quota mechani sm. They represent a set of simultaneous equations that are a mix of strict equalities and inequalities, with each inequality linked to a bounded variable in a complementar)-slackness condition [START_REF] Rutherford | Extensions of GAMS for co111ple111entarity proble111s arising in a pp lied econo111ic analysis[END_REF]. This approach has a lready been used in agricultural CGE model s (see, e.g., Lôfgren and Robinson, 1997). 1-lowever, to our knowledge, it is the first time it is used to represent the dairy quota system in the EU. The main advantage of this modelling strategy is that the status of the quota ( i.e., constraining or not constraining) is endogenously determined as part of the mode! solution.

Intervention price mechanism

The mixed-complementarity approach is also used to mode! the intervention price rnechanism prevailing for butter and skimrned milk powder. ln order to simplify the pre entation, we a:,:,ume in this paragraph that total imports of B&SMP are fixed at level m . Furthermore we assume that the domestic demand and the demand from the RoEU can be defined as a single demand.

With no public intervention, the market clears at price p: where y(p) is the domestic supp ly fonction , d(p) is the "domestic" demand fonction (i.e., including the RoEU) and e(p) is the export demand fonction from the RoW.

In practice. the EU intervenes on the considered market by engaging 111 three kinds of intervention activities. The first of these activities consists of consumption subsidies in order to favour domestic use. 2 The second of these activities is the public purchase of goods for storage and the thi rd of these activities is the provision of export subsidies to dispose of domestic excess supply on RoW markets. Note that goods that are initially purchased for storage are likely to be exported with the help of export subsidies in a second step.

ln our mode! we assume that the unit expo1 t subsidy s is the endogenous equilibrium variab le wh ich ensures that the market c lears when the market price p is equal to the intervention price p. ln that case, the unit export subsidy s is implicitly defined by: 3 Equations (8) and (9) show that the price regime is endogenously determined. When total expo1t subsid ies Sare positive, the domestic market price is equal to the intervention price. The latter is then greater than the RoW price and the unit expott subsidy covers the difference between the domestic price and the world price. When total export subsidies Sare null , the dornestic market price is greater than the intervention price. This can arise when the unit export subsicly equals zero (in such a case, EU and RoW market prices are equal) or when ex.ports to the RoW equal zero.

1 These consumption subsidies are modelled by means of fixed ad-valorem subsidies.

3 In equation ( 7), we assume that there are no domestic consumption subsidies.

Equations ( 8) and ( 9) are used to imitate the workings of the intervention mechanism app lied to butter and skimmed milk powder. For other dairy prod ucts, the domestic market price is not regulated by an intervention mechanism. Prices adjust to ensure market equilibrium and the unit export subsidy is an exogenous political variable.

. Simulation results

First set of scenarios: impact of a -15 % intervention price eut of B&SMP

The first scenario corresponds to a -15 % intervention price eut of B&SMP, other things being equal. ln particular we assume that other dairy policy instruments are maintained unchanged at base period levels. The central e lasticity scenario presents the resu lts with our •' best'' guess of the elastic ity of transformation between B&SMP and ODP ( a = O. 5 ). ln order to analyse the sensitivity of results, this scenario is rerun with a very low and a very high elasticity of transformation (0. 1 and 0.9. respective ly).

Let us first consider the central elasticity case (a= O. 5 ). ln that case, a -15 % reduction in the intervention price of B&SMP corresponds to a -15 % decrease in the market price of this aggregate and to a -5.5 % decrease in domestic supply. The first effect of a eut in the intervention price of B&SMP is to increase the price ratio between ODP and B&SMP, other things being equal. This substitution effect leads to a decrease in B&SMP domestic supply and to an increase in ODP domestic supply. ln the final situation ODP domestic supply increases by + 1.6 % and the corresponding producer price decreases by -1.8 % . This price decrease leads to an small increase in domestic demand (+ 0.7 %) and to a substantial increase in exports to the RoW (+ 19.0 %). It is important to recall that unit subsidies on ODP exports to the RoW are supposed unchanged in this scenario.

Note that ail these changes in the dairy industry output and price structure are obtained for a given derived demand of milk si nce quotas are maintained unchanged at base period levels.

According to equation (2), and g iven the fact that price variations of production factors x are negligible. one verifies that price decreases of B&SMP and ODP lead to a reduction in farrn milk prices. ln this central scenario the decrease of farrn rnilk prices is equal to -9.3 % with respect to the base. Output of both the specialised dairy farrner and the mixed dairy farrner is unchanged at quota leve l. but these producers suffer from the rnilk price decli ne. This can be observed by noting that the unit price of quota rights decreases by -35.8 % for the specialised dairy forme r and by -45.0 % for the rnixed dairy former.

We do not comment the effects of this scenario on other sectors and markets. However, ir is important to note that this scenario leads to a signifïcant welfore gain for the French economy (+ 2.6 billion French francs with respect to the base).

The central scenario corresponds to an elasticity of transformation of 0.5 between B& SM P and ODP. lt clearly shows that the farm milk price fa ll is not as deep as the drop in B&SMP in tervention prices, other things being equal. When substitution possibilities between B&SMP and ODP are lowered, the effect of a decrease in the B&SM P intervention price on farm milk prices is reduced. For example when the elasticity of transformation is 0.1 , the milk farm price decrease is 7.4 % only. With respect to the central scenario, changes in the dairy industry output and price structure are now smaller. ln particular the producer price of ODP decreases by -0.4 % onl y wh ich results in a smaller negative impact on form milk prices. A reverse result is ohtained when substituti on possibilities between B&SMP and ODP are increased, i.e .. when the elasticity of transformation is higher. However it is important to note that the effects of an increase in the intervention price of B&SM Pare not linear because the policy regime can endogenously change .

For example when the elasticity of transformation is 0.9, the intervention mechanism does not apply. As a result, the market price decline of B&SMP is now smaller than the intervention price eut (respectively -14.0 % and -15 %). This result can be explained as fo llows, using eq uations ( 8) and ( 9). When substitution possibilities between B&SMP and ODP are "suffïciently" high, a -15 % decrease in the intervention price of B&SMP leads to a strong decline in B&SMP domestic supply (-8.4 % when cr= 0.9 ). Exports of B&SMP to the RoW are now equal to zero and the domestic market price of B&SM P wh ich adjusts domestic supp ly to "domestic" demand is now greater than the intervention price. When the elasticity of transformation between B&SMP and OD P is 0.9, a -15 % eut in the intervention price of B&SMP leads to a -10.1 % reduction in farm milk price. Il 3.2. Second set of sccnarios : impact of a decrease in subsidies on ODP exports to the RoW ln addition to the -15 % eut in the intervention price of B&SMP, we now suppose that subsidies on ODP exports to the RoW are simultaneously reduced. We consider two cases. The first scenario corresponds to a reduction of the unit export subsidy by -15 % and the second scenario corresponds to a regime where ODP export subsidies are null. Results are reported in Table 3.2.

Three main points are noteworthy. Firstly when ODP expo1t subsidies are si multaneously decreased, the final impact of a -15 % eut in the intervention price of B&SMP on milk farm prices is more important. For example when the unit export subsidy is reduced by -15 %, farm milk prices decl ine by -11.5 % to compared with a decrease of -9.3 % when the unit export subsidy is maintained unchanged at base period level. This is due to the fact that the domestic market price of ODP also decreases by a larger percentage (respectively -3.3 % and -1.8 %). The higher the eut in the ODP unit export subsidy. the higher the milk farm price decrease (under the condition that the intervention price mechanism for B&SMP continues to apply). This fïrst result clearly shows that the final impact of Agenda 2000 dairy reforms on farm milk price is closely linked to the EC management of expo,1 subsidies (on dairy products).

Secondly one notes that when expo11 subsidies on ODP expo,1 are nulL then the farm milk price decrease is ••sufficiently" important (-20.3 %) so that quotas are no more constrain ing for mix.ed dairy fa rmers. The price of quota rights for these producers is now zero and their milk supply adjusts downwards. As a result, total milk suppl y decreases by -0.2 % with respect to the base.

Of course. this result holds only under the condition that there is no quota rransfer bet,veen the two types of producers.

Thirdly the wel fare effect of a decrease in ODP export subsidies is substantial, 111 particular when they are equal to zero(+ 8.8 billion French francs with respect to the base).

Third set of scenarios: impact of a quota increase

We now analyse the effects of a quota increase. Results are reported in Table 3.3. As expected, a quota increase tends to increase the negative impact of the intervention price eut on farm milk price. Columns 3 and 4 of Table 3.3. suggest that a + 2 % quota increases induces a + 3 % additional decrease in farm milk price. The last column of this table shows that a -15 % decrease in B&SMP intervention prices. a + 2 % quota increase and a -15 % reduction in unit export subsidies on ODP exports lead to a decline in farm milk price of nearly -15 %. Finally it is important to note that a quota increase leads to a domestic welfare improvement. This result may be surprising at first sight because an increased quota means higher export subsidies of ODP, other things being equal. In fact the quota increase m eans also higher value added in the economy.

This second effect dominates the first effect in terms of welfare.

Conclucling remarks

The main conc lusion ofthi s paper is that it is hard to predict the fi nal im pact of the Agenda 2000 dai ry reform on fa rm milk prices. This impact depends on the management of export subsidies on da iry products. Fu11hermore we have shown that it also depends on substitution possibi lities between butter and skimmed milk powder on the one hand (i.e., the two dairy procl ucts regulated by the intervention mechanism), other da iry proclucts on the other hancl . These substitution possibil ities are sum marised in our mode l by the e lasticity value of the constant elasticity of transformation fonction between B&SMP and ODP. There is a lack of estimates of this parameter. As noted by [START_REF] Kehoe | A general equil ibrium analysis of the 1986 tax reform in Spain[END_REF], •'one of the most important proclucts of the general equilibrium modelling exercise is that it points out the important areas for future researc11••. Th is is c learly the case here.

( 6 )

 6 y(p) + m = d(p)+e(p)

( 7 )

 7 y(p) + m = d(p) + e(p.(1 -s))To accommodate the competitive price regime (equation 6) and the intervention price regime (equation 7) si multaneously, we use the mixed-complementarity approach as follows: (8) y(p ) + 111 = d(p) + e(p.(1-s)) (9) p °2 p. S. ( p -p) = 0 with S = p.s.e

Table 2 .1. General characteristics of the model 1

 2 . Single-country, multi-sector, static CGE mode! applied to France, benchmarked to data for 1990, focused on agricultural and food processing sectors.

	3. Two foreign markets: the Rest of the European Union (RoEU) and the Rest of the World
	(Row).

2. 22 multi-product activity sectors and 30 products: 9 agricultural sectors producing 14 agricultural products ; 6 food processing industries producing 11 food products ; 2 retai ling sectors and 5 mono-product activity sectors for the rest of the economy.

  Exports of B&SMP to the RoW decrease by a very large percentage (-80.8 %) as a result of a decreased domestic supply and an increased domestic demand. At this stage. it is important to note that French expo11s of B&SMP to the RoEU and domestic demand of B&SMP fol low the same pattern of evolution .

Intervention and domestic producer prices of B&SMP are equal, and export subsidies are still necessary to dispose of domestic excess supply of B&SMP on RoW markets. Domestic final demand increases very slightly (+ 0.2 %).

4

~ ln order to save place, simulation impacts on exports to the RoEU are not reported. They are available upon request.

Table 3 .1. Effects of a -15 % decrease in the B&SMP intervention price (results in % with respect to the base)

 3

	Ben ch mark	0 =0.1	0=0.5	0 =0.9

Table 3 .2. Effects of a -15 % clecrease in the B&SMP intervention price and of a simultaneous decrease in ODP unit export subsidies s ( a-= 0.5 ; results in % with respect to the base)

 3

		Benchmark	s=-0 %	s=-15 %	s=-100%
	Farm milk
	Producer price	1	-9.26	-11 .49	-20.30
	Domestic production Price of quota rights	52 295	0	0	-0. 19
	Specialised dairy former Mixed dairy farmer	0.25 0.20	-35.77 -44.98	-44.75 -55.82	-80.08 -100
	Buller and skimmed milk pol1'der
	Producer price	1	-15.00	-15.00	-15.00
	Domestic prod uction	24 685	-5.55	-4.96	-2.72
	Ex ports to the Ro W	3 156	-80.76	-76 .03	-5 7.76
	Other dairy products
	Producer price	1	-1.75	-3.25	-9.20
	Domestic production Exports to the Ro W	82 261 3 336	+1 .55 + 19.04	+1.40 -2.91	+0.55 -100
	We/fare change (million of French francs)		+2 685	+3 944	+ 8 765

Table 3 .3. Effects of a

 3 -15 °/4, decr•

ease in the B&SMP intervention price, a + 2 % quota Q increase and a decrease in ODP unit export subsidies s

  ( cr= O. 5 ;

results in % with respect to the base)

		Benchmark	Q=+0o/o	Q=+2%, s=-	Q=+2%
			s=-0%	0%	s=-15%
	Fcm11111ilk
	Producer price		-9.26	-1 2.35	-14.50
	Domestic production	52 295	0	+2	+2
	Price of quota rights
	Specia lised dairy farme r	0.25	-35.77	-48.4 1	-57.01
	Mixed dairy farmer	0.20	-44.98	-60.35	-71.1 1
	Butter and ski111111ed 111ilk powder
	Producer price	1	-15.00	-15.00	-15.00
	Domestic production	24 685	-5.55	-2. 86	-2.27
	Ex ports to the Ro W	3 156	-80.76	-61. 02	-56.28
	Other daùy products
	Producer price	1	-1. 75	-3.74	-5. 18
	Domestic production	82 261	+1.55	+3.37	+3.22
	Ex ports to the RoW	3 33 6	+19.04	+38.90	+17.07
	Welfare change (million of French		+2 685	+4 178	+5 422
	francs)

Abstract.

The main objective of this paper is to analyse the im pact of changes in Agenda 2000 dairy policy instruments, i.e., butter and skimmed milk powder intervention price cu ts. decreases in expoI1 subsidies and quota level increases, on milk farn1 price. The vehicle for this analys is is a computab le general equi librium mode! of the French economy wh ich high lights agricultura l and food sectors and w ith special attention given to modelling of the various CAP instruments.