Economic Impacts of the Enlargement of the European Union - Analysing the importance of direct payments

The preparations for the enlargement of the European Union to include several of the Central and Eastern European Countries has led to a discussion of the future design of the Common Agricultural Policy. This paper addresses this issue from an economy-wide perspective focusing on the economic effects of the extent to which the direct payments are extended to the new member countries. Specifically this working paper focuses on three enlargement scenarios ranging from a situation where no direct subsidies are given to the new member countries to a scenario where the farmers in the new member states are given the same level of direct payments as under the existing Common Agricultural Policy. A third scenario analyses the effects of reducing the direct payment to two thirds of the existing level of direct payments in all member countries (both in the new as well as in the old member countries). The analyses illustrates that the Central and Eastern European Countries clearly have a solid potential for increasing their production of agricultural commodities and that the extent the direct payments are extended will affect the supply response in the CEEC’s. It is shown that the major force behind the significant crop supply response is due to very large shifts in the use of agricultural land. It is important to stress that the crucial assumption behind this result is that there are no – in economic terms – effective restrictions on the allocation of land and that the incentives for overshooting the so-called base area with crops receiving the compensatory payments is very high given the existing value of hectare premiums. The analysis also illustrates that enlarging the EU with the existing CAP is an expensive option in budgetary terms as the level of CAP related expenditures could increase by one third thereby exceeding the constraints laid down in the EU ‘Financial Perspectives’. It should be noted, however, that the analysis also illustrates that enlarging the Union leads in all cases to only small overall economic welfare losses in ‘old’ member states in spite of relative large increases in ‘old’ member states net contributions.