Why should taxpayers prop up our inefficient farmers?

IS THE European Common Agricultural Policy, the notorious CAP, on its way out? Our agriculture minister, Nick Brown, has called a summit of British farmers, food industry leaders, consumer groups and environmentalists in London next week to discuss some very radical changes. This will be followed up in March by a meeting of all the EU's farm ministers, who, it is expected, will demolish a major pillar of the CAP, namely, farm price support. By the Spring, governments should have agreed to reforms that will force European grain and beef farmers to operate in future at world prices. This will mark a historic shift that will affect us all.

This move will be welcomed by consumers and food processors. Less welcome - I suspect I part company with many farmers and their representatives - is the farmers' demand that they receive compensation for price cuts, and that public funds must be substituted for reduced price support. By holding prices above market-determined levels, the CAP has produced surpluses - disposal has become a major burden on public funds.

Farmers are demanding compensation for the costs taxpayers have had to incur to protect high prices. To be fair, the European Commission has proposed that there should be ceilings placed on the total payments received by an individual farm. In Eurospeak this is known as "modulation", and is sensible. But British farmers are fighting fiercely to prevent any change.

Farmers are concerned about the impact on their incomes. It is hardly surprising. Reform is being driven by a rapidly changing world; increasingly the freeing-up of world trade is bearing down on agriculture. Farming, like all other industries, has to come to terms with the increasing competitive pressures involved in these changes. It must recognise that income subsidies are not only a misuse of taxpayers' funds but are eventually self-defeating, as they breed inefficiency and a reduced ability to compete.

The more exposed farmers are to world markets, the greater the need for economic stability in their production costs. That is, rather than the roller-coaster ride of the last 20 years, farmers desperately need currency stability, low inflation and low interest rates. In fact, they need the UK to join EMU sooner rather than later. We can but hope that as the UK prepares for membership of EMU, the world's financial markets are restrained from causing the pound to fluctuate widely between the euro and dollar.

Farmers, and their representatives, see incomes as the key influence on the number and size distribution of farms.

But there are more powerful forces at work. The farming industry, just like any other industry, is driven by two fundamental forces: technology; and knowledge. Over a period of time these forces combine to replace labour with capital and also steadily to increase the economically viable size of farm enterprises. Once this is recognised, it follows that policies designed to arrest the decline in the number of farms will compromise the industry's potential competitiveness.

Over the coming years technology will raise yields; it will encourage further substitution of capital for labour and will continue to increase the economically viable scale of production. Farms that are efficiently managed and have the scale and enterprise to invest to meet changing conditions face a more promising outlook than is represented by the "static" picture of taking last year's fall in farm incomes as a measure of the industry's prospects.

Once the issue of reform is viewed from an industry perspective the question of individual farm size is thrown into relief. Some 75 per cent of UK agricultural production comes from just 25 per cent of farms. These are our efficient farms; they are, in practice, the farming industry. Smaller- scale farms should be no more a concern than small businesses in other sectors of the economy. If incomes are low because these farms are too small to be viable, that is a social, not an industry issue. The numbers of smaller farms have been steadily declining for many years; the CAP has slowed the rate of decline for these farms but it has proved unable to halt the technology-driven trend towards larger, more capital-intensive farms.

The logic is inescapable. In order for some farms to expand, it is also necessary for others to fold.

This process of creative destruction is not unique to farming; it is at the heart of economic development and rising living standards. The harsh truth is that an industry will never have the incentive to strive for more efficient, cheaper methods of production if its entrepreneurs are guaranteed a living by the state. If all farms, large and small, demand and receive compensation the cost to the taxpayers will be enormous and the end result must be attempts by the EU to slow down the pace of reform.

This raises a paradox for the UK farming industry. Its larger-scale producers are highly efficient and hence potentially highly competitive. Yet they can fully exploit this advantage only if the pace of reform quickens. World markets, despite last year's setback in Asia, are developing rapidly, and in order to gain reasonable shares of these fast-growing markets, the EU must speed up the pace of reform.

Far from aiding competitiveness, government subsidies remove incentives to be efficient. In the case of larger farms, who do not need the subsidy, these payments are channelled into land and asset purchases, which increases the cost base.

Providing smaller-scale farms with full compensation will not improve their ability to compete but it will slow down their rate of exit from the industry. Many of these smaller scale farms are "managed" by a farmer who , in the vast majority of cases, will be leaving the industry over the next 10 years. Only a small proportion will be succeeded by their children. Full compensation for such farms may be justified as a social payment but it should not be used as an excuse for providing full compensation to larger farms.

Confusing social issues with production has blighted British and European farming alike for decades. Soon, though, the European Union may do the unthinkable and allow the industry to compete with world markets. Uncomfortable - for the inefficient - it will be, but this is the only real security for future generations of farmers.

The author is a former chief economist for the National Farmers Union; he is now director of the executive MBA at Cranfield School of Management