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Development of Latvian Agricultural Sector: Quantitative Assesment of the Accession Effects

Zinātniskais raksts. Un runājums par tā tēmu LLU zinātniskajā konferencē “Ekonomikas zinātne lauku attīstībai 2004” ### Pielikumā pievienota bilžrāde salasāmā formātā PDF failā

Development of Latvian Agricultural Sector: Quantitative Assessment of the Accession Effects

Guna Salputra, Bac.oec., Latvian State Institute of Agrarian Economics, assistant.

Danute Jasjko, Dr.oec., Latvian State Institute of Agrarian Economics, Head of Policy Analyses Unit;

Abstract

Accession of the Republic of Latvia into the EU might have significant impact on further development of Latvian agricultural sector. Within the partnership of AG-MEMOD+CEEC project developed within the EU Fifth Framework research programme, the Latvian national agricultural model was elaborated in order to simulate the effects of accession on agricultural sector.

The structure of GOLD model used as a basis for AG-MEMOD modelling approach was adapted to the national specificity of Latvian agricultural sector in order to assess perspectives for development of agriculture taking into account policy changes after accession.

Analytical estimations for Latvian agricultural sector were provided for each year until 2010 as a projection horizon. The forecasts include the set of indicators for supply and demand of main Latvian agricultural products as well as producer prices and net trade.

Key words: accession effect, agriculture, econometric model, single area payment scheme, Common Agricultural Policy.

1.     Introduction

As early as after accession of Latvia into the EU, conditions for agricultural activities in Latvia will be essentially affected by implementation of the EU Common Agricultural Policy. However, Latvia will join to common market of the EU, getting free access to consumers of other Member States including all new Member States, and will open its own market to EU producers. The first evaluation of the possible accession effect was done when Latvian position for 7^th chapter “Agriculture” in accession negotiations was prepared. An independent research “Impact of enlargement of the European Union to the development of Latvian agriculture” (Miglavs A., Jasjko D.,2002) is done as well. On the base of previous studies, in current situation with clearly defined  accession conditions for Latvian agriculture, it was logical  to participate within the partnership EU Fifth Framework Research Programme “Quality of Life and Management of Living Resources” of the project “Agricultural Sector in the Member States EU and Newly Associated States in Central and Eastern Europe – Econometric Modelling for Projections and Analysis of EU Policies on Agriculture, Forestry and the Environment” (abreviation AG-MEMOD+CEEC), where the common econometric modelling tool for all EU-25 countries was created.

For the national, Latvian level of the study the main objective was to assess the accession effect on the level of different sectors using econometric model, which structure and modelling principles are based on GOLD (Hanrahan K.F., 2001) model used in AG-MEMOD+CEEC project.

In order to reach defined objective there was necessary to analyse the mid-term perspectives for Latvian key agricultural sectors during the pre-accession and post-accession period, taking into account the policy price changes as well as different schemes for administration of direct support applicable under the conditions of the Accession Treaty.

Changes in the level of prices and support policy after the accession of Latvia into the EU might have essential impact on:

§  agricultural production structure and the competitiveness of all Latvian agricultural sectors on internal and external markets.

§  the level and structure of income for agricultural producers and rural inhabitants influencing their decision–making process and business strategies.

Qualitative analyses methods were used in order to assess the relevance of GOLD model assumptions to the Latvian case. An econometric, dynamic, commodity model elaborated for Latvia was used for quantitative analyses. The analytical calculations were done with MS Excel and Eviews software. Reference period for simulations are from 1990 - 2001, while forecasts are provided for period 2002-2010.

2.     General structure and some specificities of Latvian AG-MEMOD model

The Latvian AG-MEMOD model is an econometric, dynamic, commodity model which analyse the following list of agricultural commodities (sectors): four types of grain (wheat, barley, rye and oats), rapes (rapeseed, rape meal and rape oil), cattle and beef, pigs and pork, poultry, dairy (fluid milk, cheese, butter, skimmed milk powder, whole milk powder, other fresh dairy products). The model consists of sub-sectors relative to all sectors previously mentioned, for all submodels the set of equation (statistical model) parameters are estimated particularly for Latvian specifity.

Annual balances from the period 1993-2001 or from shorter period when data where not available become a base for information necessary for analysis of the development of agricultural sector as a whole. Balances provide the general picture of the sector and, at the same time, quite consistent set of data characterised the sector from different aspects, such as production and further utilisation of agricultural output, level of self-sufficiency, as well as foreign trade flows and stocks.

Figure1. Latvian AG-MEMOD model structure

Source: D.Jasjko, G.Salputra, LSIAE

The structure of Latvian AG model is very similar to the structure of GOLD model. GOLD model gives a possibility firstly to simulate stand-alone agricultural sector of each Member state of the EU after then combining them all into one composite model of agricultural sector of the whole EU, which is not done still. This is the reason why Latvian AG-MEMOD model runs only one cycle reflected in Figure1, which shows the general structure of the model. The structure is practically the same for all commodities or sub-models of agricultural sector in Latvia.

Prices are the core element of Block 1 of the model. The estimation of equations starts from price and income block using the exogenous European market prices (or key prices) as a factor for national price linkage to key market price. Domestic prices are closely related to the revenues of producers and are the main prerequisite for production decisions.

The production process is simulated in the Block 2 of the model (see Figure1), where supply of agricultural products is based on production amounts.

Block 3 is related to foreign trade. Production surplus is a ground for calculations of the export supply, which should be balanced with the export demand of third countries. Export demand depends on price level in foreign markets and trade agreements signed. If there is a gap between export supply and export demand, then the feedback to price block should adjust the level of domestic prices. However, modelling of export supply will be introduced in the Latvian model, when the Composite model for EU-25 will be carried out.

In order to restrict milk production within milk quota, the milk quota mechanism was introduced into Latvian dairy model as a production ceiling through the calculation of milk production surplus and adjustments of dairy cows ending stocks number.

3.     The simulation scenarios for Latvian agricultural sector

The two main policy scenarios have been simulated with the help of Latvian AG-model:

1.      Non-accession scenario (N-Ac): scenario assumes that the Republic of Latvia will stay out of the EU membership. Latvian national agricultural policy will not be changed since 2001.

2.      Accession scenario under the introduction of Single area payment scheme (A-SAPS): scenario assumes that the Republic of Latvia will join the EU in 2004. Accession of Latvia will be based on the principles defined in the Accession Treaty. CMO measures will be applicable according to the principles of “Agenda 2000”.

Non-accession scenario. As initially GOLD model approach and AG-MEMOD modelling principles were carried out for simulations of CAP policy impact on the agricultural development of EU Member States, in case of similar simulations for accessioning countries it is necessary to use factors and to analyse the policy measures applicable in both – EU and national policies (before and after accession). However, not always the factors used for simulations in the EU-15 might be relevant to consider for policy analysis in transition. This is because of two reasons: some other factors might have an important impact on economic processes analysed, and the information used for analysis is not fully reliable. Therefore in N-Ac scenario it was reasonable to combine modelling principles and factors used in GOLD model approach with national specificities of economic development and policies. Such combination is able to provide both possibilities: to leave opportunities to simulate set of “accession” scenarios on the principles of existed CAP and, at the same time, to create “business as usual” scenario where Latvian specificity is taken into account on the same methodological basis.

There are the following main assumptions for base scenario simulations:

§  The relationship between national and EU key prices levels will be kept constant for all period of simulation. Therefore the significant gap between the EU and national price level for all dairy products and beef is assumed to remain until 2010.

§  Direct acreage payments for all types of grain and oilseeds will stay at the pre-accession level depending only on exchange rate of national currency versus euro;

§  As barley is not a subject of intervention mechanism in Latvia, only wheat and rye will be the two types of grain eligible for intervention procurements. Additionally the intervention for butter, SMP, beef and pork did not and will not take place at all in Latvia.

Accession scenario. The direct payments will be administrated under the Single area payment scheme accepted by the Accession Treaty in Latvia for the whole period of simulation after accession.

The pre-accession period (until 2003) in A-SAPS scenario is simulated according to N-Ac scenario. In this case, national intervention prices, support payments and actual grant-aided amounts used as reference amounts before the accession are analysed until the year 2004.

The application of direct support payments in A-SAPS scenario is formalised on the bases of the following main assumptions:

§  In Latvia, the principles of Direct payments administration scheme during all simulation period after accession will stay the same;

§  Direct payments will increase gradually from 55% of the EU level in 2004 to 100% - in 2010. Part of direct payments financed from national budget and rural development funding is assumed to be paid at the maximum allowed level during all simulation period;

§  National price level for dairy products and beef will gradually come closer to the EU market price level after accession (since 2004): during 3 years period - for butter, cheese and SMP and during 5 years period - for beef. However, according to experts’ estimations rather small gap between national and EU price level might be still kept for all period of simulation assuming lower level of national prices per 10% and 15% respectively for dairy products and beef.

Insomuch as direct payments after the EU accession under SAP scheme are more decoupled from definite products than payments under Classical scheme, there are different multipliers introduced for assessment of the impact of direct support on production:

§  0.3 for single area payments;

§  0.6 for complementary national direct payments, paid per ha of area and not fully coupled with specific type of production (for instance fodder areas),

§  1 for acreage or hectare complementary national direct payments, which is coupled with definite agricultural sub-sector’s production (for instance grain, oilseed and suckler cow premiums).

4.     Perspectives for development of main agricultural sectors in Latvia after joining to the EU

Quantitative analysis of Latvian agricultural sectors carried out on the ground of AG-MEMOD modelling approach give an evaluation of perspectives for development of Latvian agriculture after accession.

4.1.            Latvian crop sector

As the level of grain and oilseed producer prices in Latvia were close to the EU price level during the whole pre-accession period, the price development trends in Latvia are quite similar to EU tendencies as well. Therefore, if there are no changes expected in the policy (intervention) prices for grain sector in different scenarios, then producer prices simulated in accession scenarios are similar to N-Ac scenario. Producer price level for grain excluding rye, might decrease slightly from 2001 until 2010. The price for rye will remain stable during the whole simulation period due to stability in development tendencies for correspondent key prices, while rapeseed price will decrease by 10%.

Level of basic prices including subsidies for all types of grain and rapeseed is expected lower for N-Ac compared to accession scenario during all forecasted years due to less support provided by national budget compared to the EU support level, which will even be phased-in for all accessing states.

Comparing A-SAPS and N-Ac scenarios the sown areas under grain and rapeseed could increase in 2010, because of the higher level of direct payments. The rapeseed area will grow showing the higher competitive power of rapeseed production against grain. The area of rye and oats will be decreased essentially versus wheat areas, which are expected to increase due to higher gross return per ha. 

During the simulation period, production of crops considered in the model would benefit from the productivity increase. The significant increase of yield is expected for wheat (near 20%), for oats (15%) and rapeseed (14%) in 2010. It is important to point out that there are no differences in crop yield levels between the both scenarios analysed.

Comparing the simulation results for accession and non-accession scenarios in 2010, it is necessary to say that changes in the levels of production will be fully dependent on the level of gross return (expressed per ha) setting down the area allocations among different types of grain and rapeseeds.

Domestic use of wheat will stay relatively stable after accession compared to upward tendencies in production, which is not restricted by capacity of external markets(see Table 1). The negative changes in livestock production will cause reduction of grain for feed requirements in Latvian livestock sector.

Table 1. Forecast of Latvian production, domestic use and net trade amounts of wheat, barley, rye, oats and rapeseed, 1000t

	2001	2005		2010
	N-ac	N-ac	A-SAPS	N-ac	A-SAPS
4 grains - production - domestic use  including feed use - net trade	864.5 789.3 470.6 -61.0	792.8 750.8 451.6 13.6	808.4 753.6 452.7 26.1	890.3 744.5 443.3 114.5	915.6 749.4 445.9 133.0
Rapeseed - production - domestic use - net trade	13.8 3.4 10.4	32.0 4.3 27.7	34.5 4.3 30.2	57.9 4.2 53.7	62.2 4.2 58.0

Source: LSIAE calculations.

Net trade being negative for all grains in 2001, will gradually increase in 2010 for both scenarios due to relatively sharp growth of wheat production (seeFigure 2), while the trade balance for other grains is expected to be still negative.

In 2010, due to the higher level of production caused by the increase of direct support after the EU accession, rapeseed export will grow by 8% in A-SAPS scenario compared with N-Ac one.

 Figure 2. Forecast of wheat production, net trade and level of incentive price on wheat in Latvia for years 2001, 2005, 2010 according to the different scenarios simulated

Source: LSIAE calculations.

4.2.            Latvian livestock production sector.

The increase of procurement price after accession on milk is accompanied by declining of prices for the main dairy products, such as butter and cheese due to close correlation between the EU and domestic dairy prices formalised in the model (see Table 2).

A-SAPS scenario compared to the non-accession one shows the increase of procurement price for milk by 36% in 2010. Such growth is mostly related to introduction of the European intervention mechanism after joining the EU, when intervention price level for butter and skimmed milk powder will affect the increase of the national milk procurement price. At the same time, price on milk sold through the direct sales, being quite close to the EU level, will increase only by 9%.

Being out of the EU membership, producer price for beef will remain on a relatively low level during all simulation period. At the same time, accession into the EU will arose essential increase of producer prices on beef (see Table 2).

Prices for pork and poultry will decrease by 9% and 4% respectively in N-Ac scenario during the period from 2001 to 2010. As there are no essential differences between domestic and EU price levels on pork and poultry meat before the accession, the Latvian meat price level will not be changed essentially after joining the EU as well.

Table 2. Forecasts of producer* and basic (incentive)** prices on raw milk and beef, pork and poultry meat in Latvia, EUR/100kg

	2001	2005		2010
	N-ac	N-ac	A-SAPS	N-ac	A-SAPS
Cows’ Milk - producer price - price for milk sold through direct sales - basic (model) price	16.5 18.4 16.5	18.0 18.9 18.0	24.1 20.3 25.1	20.2 19.5 20.2	27.4 21.2 28.4
Beef - producer price - basic (model) price	102.0 102.4	105.4 106.4	164.9 180.9	102.5 103.7	209.9 225.5
Pig meat - producer price - basic (model) price	157.1 157.1	145.0 145.0	145.0 145.0	143.2 143.2	143.2 143.2
Poultry - producer price - basic (model) price	175.8 175.8	172.6 172.6	172.6 172.6	169.3 169.3	169.3 169.3

 Source: LSIAE calculations.

* Procurement price paid to agricultural producer by processors or other purchasers

** Procurement price plus direct payments expressed per unit of product sold.

According to EU GOLD modelling approach the size of animal herd is the main factor determining the livestock production in Latvian AG model.

Comparing A-SAPS scenario with the non-accession one (see Table 3), reduction of dairy cow herd could be expected even more significant, because of restrictive effect of the quota on milk production and dairy cow herd as well. Essential growth in the number of suckler cows in 2010 will be caused by higher support rates for each cow paid after accession.

The absence of any direct support for pig sector and decline of producer prices on pork will lead to reduction of number of breeding sows in simulation period by 40% in both scenarios.

Table 3. Forecast of the number of cows and breeding sows in Latvia, 1000 head

Type of animals	2001	2005		2010
	N-ac	N-ac	A-SAPS	N-ac	A-SAPS
Number of dairy cows Number of suckler cows	206.1 2.1	184.2 2.5	182.0 6.8	160.5 4.3	156.9 21.1
Total cows’ herd	208.2	186.8	188.8	164.8	178.0
Number of breeding sows	37.1	30.4	30.4	22.4	22.4

Source: LSIAE calculations.

There will be no policy restrictions for milk production in case of Latvia’s non-accession in the contrast with accession scenarios where milk quota is imposed. At the same time, the share of direct sales among other milk distribution channels will have a downward tendency, but the share of processed milk will increase in Latvia for both scenarios simulated. Changes in the structure of milk allocations between factory use and direct sales will be more dependent on the shifts in consumer preferences (see Figure 3).

Figure 3. Forecasts of Latvian milk production and level of incentive price according to different simulation scenarios in 2010.

Source: LSIAE calculations.

The milk price increase after accession will affect the consumption of dairy products as well. In A-SAPS scenario, consumption of butter and cheese will be decreased by 8 % and 14% correspondingly in 2010 compared to non-accession scenario. However, changes in consumption patterns and consumer preferences might largely hold up the decrease of utilisation of fluid milk and will increase consumption of diverse range of dairy products. It is necessary to emphasise that general increase of milk prices in Latvia after accession will be relevant only under the fulfilment the obligations referred to the cross-compliance with environment, food safety, animal health and welfare, as well as maintenance of the farm in good agricultural and environmental conditions.

Irrespective of the significant increase of beef prices after the accession in Latvia, production of beef will continue to decline until 2010 as a by-product of the reduced milk cows herd. However, the decrease in accession scenarios is not so significant as in N-Ac scenario taking into account higher support for beef cow herd in Europe. The correlation between incentive price level for beef and beef production is shown in Figure 4.

Figure 4. Forecast of beef production, net trade and level of incentive price on beef in Latvia for 2010 according to the different scenarios simulated

Source: LSIAE calculations.

Production of pork might decrease as well due to the level of domestic prices going down in all scenarios and absence of support to pig-breeding sector in the EU.

Sharp increase of beef producer price in A-SAPS scenario will cause a drop in domestic consumption of beef by 47% together with increase of pork and poultry consumption in 2010 compared to N-Ac scenario as they are competing products witch substitute consumption of each other.

Since all Latvian meat sectors are far from reaching the level of self-sufficiency, net trade balance mostly depends on the level of domestic demand. Therefore changes in consumer preferences will lead to changes in import demand level for meat.

For a more comprehensive view on perspectives of Latvian agricultural sector development the projections of the structure of Latvian agricultural production in 2010 is reflected in Figure 5. Considering changes in price, support and productivity levels under different scenarios the most affected sectors of Latvian agriculture will be beef and milk production after joining to the EU. Therefore the share of beef and milk within the structure of agricultural production is expected to have a significant increase (see Figure 5) in A-SAPS scenario, which leads to reduction of the share of other sectors.

Figure 5. Projections of structure* of agricultural production according to simulation scenarios in 2010, %

Source: LSIAE calculations.

* calculated on producer price basis

5.     Conclusions

Quantitative assessment of development perspectives for Latvian agriculture with the help of Latvian AG model of made of the development Conclusions concerning to perspectives for development of Latvian crop sector after accession:

1.      Latvian level of producer prices on grains and rapeseeds after joining the EU will remain on the pre-accession level, as crop price development tendencies in Latvia are very similar to the EU.

2.      The higher EU support level for cereals and oilseeds, which might affect the increase of sown areas under these crops, could be the main factor encouraging the further development of grain and rapeseed production in Latvia. At the same time wheat production will gradually increase its share among the different types of cereals due to the higher gross return per ha succeeded through relatively high yield level.

3.      The introduction of the European intervention mechanism in Latvian dairy sector might lead to significant increase of milk procurement prices. However the increase of milk price level with simultaneous introduction of milk quota will not affect essentially the milk production in Latvia - both in absolute and relative terms (as changes in structure of agricultural production).

4.      The share of direct sales among other milk distribution channels will be reduced, but share of processed milk will increase. At the same time within the milk quota limits introduced in Latvia after accession, the further increase of productivity of milking cows will be accompanied with significant reduction of dairy cows’ herd.

5.      The significant increase of beef producer prices together with correspondent growth of direct support might essentially increase the number of suckler cows in Latvia as well as to make the Latvian beef production as more specialised and less related to milk production. At the same time the growth of beef prices will be able to cause the decline of domestic beef consumption, which can be substituted by pork and poultry meat.

6.       The abolishment of national direct support in pig sector and decline of pork producer prices will lead to reduction of number of breeding sows and pork production level in Latvia.

7.       Latvian net trade for meat will remain negative as all meat sectors are far from complete self-sufficiency level. As net trade balance mostly depends on the level of domestic demand, therefore changes in consumer preferences would lead to important shifts in structure and amounts of meat imported to Latvia.

References

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2.      Krastiņš O. Ekonometrija. – R.: LR CSP, 2003. – pp.207

3.      Miglavs A., Jasjko D. Impact of enlargement of the European Union to the development of Latvian agriculture. – LSIAE, 2002 – pp.57

4.      Roche. M.J. Econometric Modelling of the Agri-Food Sector.. – Ireland: National University of Ireland, Department of Economics,  2001. – pp.228

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6.      The portal to European Union law http://europa.eu.int/eur-lex/en/lif/index.html

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8.      unpublished material: LR Ministry of Agriculture (2004). The draft of “Regulation on implementation Complementary National Direct Payments in Latvia in 2004”pp.33 (version prepared on 20.01.2004);

9.      unpublished material: LR Ministry of Agriculture (2004). The draft of “Regulation on implementation single area payment in Latvia in 2004 ”pp.7 (version prepared on 20.01.2004).