Scottish Government

1. Introduction

This Inquiry was commissioned by Richard Lochhead MSP , Cabinet Secretary for Rural Affairs and the Environment, in June 2009. It was established to provide advice to the Scottish Government on how support to agriculture and rural development could best be tailored to deliver the Scottish Government's purpose of "creating a more successful country, with opportunities for all of Scotland to flourish, through increasing sustainable economic growth".

This introductory section explains the remit of the Inquiry, details the activities undertaken by the Committee to examine the options for future support, and sets out the structure of the rest of the report.

1.1 Remit of the Inquiry

Agricultural support in Scotland is to a large extent determined by European agricultural policy, which is likely to be reformed in 2013. The Common Agricultural Policy ( CAP ) has been subject to a long history of reform, but today new pressures on the European Union ( EU ) budget, issues relating to new Member States and questions about how the policy can help tackle emerging global challenges such as climate change, all suggest that the 2013 reform will be significant. Different Member States and institutions are reviewing the role of agricultural support in their countries and positioning themselves for forthcoming negotiations about the nature of future reform. In this context, the Scottish Government commissioned the Inquiry to make recommendations about what sort of support regime would be best for Scotland in order to inform their preparations for the forthcoming negotiations about the nature of European agricultural policy after 2013.

In broad terms, Richard Lochhead asked that the Inquiry "make recommendations to the Scottish Government on how financial support to agriculture and rural development can best be tailored to incentivise delivery of the Scottish Government's purpose of sustainable economic growth, and in particular of its vision for thriving agricultural and rural sectors based on natural resource productivity, in a world increasingly recognising the need to address the challenges of climate change and biodiversity loss" .

The specific remit of the Inquiry was to examine and provide recommendations in the following areas:

• How Pillar 1 funds (i.e. the Single Farm Payment Scheme in Scotland) might be best distributed in future, for example between regions of Scotland and/or land types, in order to contribute to the Government's purpose and vision

The issues : Due to the great geographical and agricultural variation within Scotland and to the choices that have been made about how to implement the Single Farm Payment Scheme, there is a great deal of variation in the distribution of direct support. Land managers in some areas of Scotland receive much higher payments than others, primarily because the current system-while technically decoupled-still relates to the level of production in the 2000 - 2002 reference period. But is this inequality in payment levels right? Should the future support regime replicate the current distribution? Or should the future regime focus more on a wider set of deliverables, such as public goods, which could result in significant redistribution? A related question that has arisen since decoupling, and which will provide the key to making choices about the appropriate distribution of Pillar 1 funds, is: what are direct payments for?

• The conditions to be attached to Pillar 1 payments in the future to secure public benefits commensurate with those payments, and the relationship with the Less Favoured Area Support Scheme

The issues : A lack of clarity about what direct payments are for has prompted questions about what society gets back for spending public money in this way. The current conditions for receipt of direct payments (cross compliance) are criticised by some for being too weak and effectively providing farmers with money with little obtained in return. A tightening of public budgets across Europe means that expenditure has to be robustly justified and so one way of ensuring the continuation of direct payments would be to strengthen the conditions associated with Pillar 1 in order to more demonstrably deliver public benefits in return for public investment. But what sort of conditions might we attach to Pillar 1 payments? Should more stringent environmental conditions be attached or would this confuse Pillar 1 and Pillar 2 payments? Should conditions be imposed that move the industry in a particular direction, for example towards more sustainable farming? But if more conditions are imposed how do we find the balance between more stringent conditions that ensure value for money and the greater bureaucracy and administration costs that would be generated?

• The link between payment levels and farming activity

The issues : The decoupling of payments from production means that payment rates are no longer related to activity. It is perfectly possible for a farmer to reduce his/her farming activity to a minimal level to meet their cross compliance obligations and continue receiving support. They may continue to receive public money whilst only making a minimal contribution to economic growth or delivering minimal public benefit. Clearly, if, in general terms, it is true that the more active the farmer then the more likely they are to be delivering benefits to the people of Scotland (whether they are economic, social or environmental) some sort of link between payments and appropriate activity is desirable. Yet payments that are linked with the level of production are subject to limits under international trade agreements because they are potentially trade distorting. So how is it possible to ensure that only those that are actively farming (and thereby delivering public benefits) receive payments?

• The situation of agricultural holdings currently outside the Single Farm Payment system, and new entrants to farming

The issues : Under the current historic system for allocating Pillar 1 support, payments are calculated in relation to activity in the reference period (2000 - 2002). Since people entering the farming industry since 2003 were not active in the reference period and did not qualify for the National Reserve, they do not have any 'entitlement' to direct support and, unless they buy entitlement (because entitlements are tradeable), they will not receive support through Pillar 1. This situation is criticised as unjust. A group of farmers that are highly motivated and want to get involved in the industry and who are likely to be highly active are effectively excluded from accessing the major source of agricultural support, a situation that makes it even harder for them to compete with others already established in the industry. A move away from the historic system may partially solve the problem, but the question of how best to ensure a continuing supply of new entrants in an ageing industry will remain an enduring issue.

In addition, some agricultural land uses did not receive support in the base years and accordingly there was no historic base to allocate them direct payments, notably deer farming and potato, vegetable and fruit cultivation. Deer farmers feel particularly aggrieved since they are rearing animals for slaughter and entry into the food chain in very similar ways to those that rear cattle and sheep. Again, issues of equity and fairness are raised. Should a future support regime include these previously excluded land uses or forms of agriculture?

• How to address the risk of a smaller Single Farm Payment budget for Scotland after 2013, taking into account the generally held expectation of severe pressure on that part of the EU budget

The issues : Over time the proportion of the total EU budget devoted to agriculture has gradually declined from 71% in 1984 to an estimated 33% in 2013. At the same time the number of Member States has gradually increased, meaning that the declining agricultural share of the budget also has to be shared across a growing number of recipients. New Member States are expecting to gradually reach parity within the structure of the CAP and a shift in expenditure towards the new Member States will result in declining budgets elsewhere. Add to this the global economic downturn and the current pressure to reduce public expenditure as a means of cutting Government deficits, and a smaller budget looks likely. A smaller budget subsequently raises questions about how we can do all the things we would like to do-such as address a growing list of global challenges like ensuring food security and tackling climate change. How can we achieve more with less? What are the most cost-effective ways of investing public money?

• The future balance between Pillar 1 and Pillar 2 of the CAP in Scotland, including the role of support for transformational change to agricultural businesses, for collaboration, and for engagement between businesses in the different stages of the production chain

The issues : At present, financial support is delivered to Scottish farmers and land managers through two 'Pillars'. Pillar 1 constitutes direct payments that are provided as a form of business support and which are paid from European funds. Pillar 2 provides support for rural development including agri-environment, forestry, business development and community initiatives, and is co-financed by Europe and the Member State. The amount distributed through these Pillars is unequal with the majority of funds distributed through Pillar 1 in direct payments. An important current debate therefore revolves around whether this allocation is appropriate. Some argue for a gradual transfer of funds from Pillar 1 to Pillar 2 on the grounds that public expenditure through Pillar 2 will deliver public goods and is therefore more justifiable than the support provided through Pillar 1. But is that trajectory right? Or should we retain and finesse Pillar 1 payments in order to make them deliver more but at the same time be more transparent? Again the key to answering such questions will be found in the answer to the fundamental question of what are direct payments for?

• Scottish priorities in future negotiations with the United Kingdom authorities and at EU level

The issues : Scottish agriculture is different to that of other parts of the UK , notably England, and requires a distinctively Scottish policy. In recent years, especially since the Scottish National Party came to power, Scottish agricultural policy has diverged from that of England, with the Scottish position being more defensive of continued direct support while the English position has tended to support a shift from direct support towards an emphasis on public goods. This divergence is potentially problematic because it is often English agricultural policy that comes to define the UK position, which could mean that Scottish interests might not be pursued. As we move towards the negotiations about the CAP post-2013, clarity about Scottish priorities will be important. What do we want to make sure we achieve in the forthcoming talks?

1.2 Approach

1.2.1 Evidence gathering

The Inquiry began in June 2009 with the gathering of evidence about the current state and importance of agriculture in Scotland and about the implementation of agricultural policy. This information was gathered through a series of meetings with a range of people including: Scottish Government staff (primarily in the Rural and Environment and the Rural Payments and Inspections Directorates); researchers based in the Scottish Government's Main Research Providers ( SAC and the Macaulay Institute); and representatives from the industry, environmental NGO s and government agencies (such as the Forestry Commission, Scottish Natural Heritage, Scottish Environmental Protection Agency and Scottish Water).

The Inquiry then commissioned several evidence papers that could be placed on the Inquiry web pages so that as discussions about how best to implement agricultural support developed, everyone would have access to the same information. These papers were on the following topics ¹ :

• Economic trends in Scottish agriculture (produced by the Scottish Government)
• The importance of livestock production to the Scottish economy (produced by Quality Meat Scotland)
• The Scottish arable sector (produced by the Scottish Government)
• Farming and the natural environment (produced by SNH )
• Background Paper on Forests and Woodland (produced by Forestry Commission Scotland)
• Commissioned work on the value of public goods from agriculture and the production impacts of the Single Farm Payment Scheme (undertaken by SAC )
• Overview of USA Farm Support Policy (produced by Scottish Government economists)
• Retailers perspective on climate change (produced by Marks & Spencer)
• Rural Payments and Inspections Directorate - IT issues (produced by the Scottish Government)
• Risk and risk management strategies in agriculture: an overview of the evidence (produced by the Scottish Government).

Further evidence was gathered about the debates at the European level in visits to Brussels and meetings with Dacin Ciolos and Mariann Fischer Boel (current and former Commissioner for Agriculture and Rural Development), Paulo De Castro (Chair of the European Parliament Agriculture Committee), George Lyon MEP (author of the recent European Parliament report on the future of the Common Agricultural Policy), Tassos Haniotis (Head of Agricultural Policy Analysis and Perspectives, DG Agri), Tim Render (Agriculture Counsellor at the UK Permanent Representation), Alec Page (Defra expert seconded to the European Commission), Andreas Lillig (Single Farm Payment Implementation, DG Agri) and Maeve Whyte (Director, British Agricultural Bureau). These meetings facilitated insight into the debates taking place on the future direction of the CAP and were useful in providing the context within which debates in Scotland will take place. Tassos Haniotis visited Scotland in September 2010 and discussed the key issues with the Inquiry. He was also shown first-hand the diversity and challenges pertaining to agricultural production in Scotland through visits to two farms, one of which was a productive, well-stocked upland farm, while the other had a large area of rough grazing and low stock numbers.

1.2.2 Public consultation

An initial consultation, which ran from September to the end of October 2009, sought views from the public and interested organisations on the key issues being addressed by the Inquiry. The questions were structured around the remit of the Inquiry and asked for views on such issues as the balance of Pillars 1 and 2, the future distribution of Pillar 1 payments and the conditions that might be attached to those payments. A total of 105 responses were received, comprising 58 responses from individuals and 47 from organisations. The responses were analysed by George Street Research and their findings were presented to the Inquiry Committee ² .

The Inquiry produced its Interim Report in January 2010 to provide insight into its thinking ³ . The Interim Report set out the challenges that we currently face and which agricultural policy must address, and it put forward a potential rationale for a future support regime along with an example of how direct payments might be distributed. This Interim Report provided the basis for a second consultation, which ran from January to March 2010. This sought further views on the more detailed proposals including a proposal for an area based approach to direct payments supplemented by a Top Up Fund. A total of 149 responses were received to this second consultation, comprising 99 responses from individuals and 50 from organisations. George Street Research again analysed the responses and presented their findings to the Inquiry Committee ⁴ . The online consultation was supplemented by a series of 12 public meetings across the length and breadth of Scotland. The Chairman of the Inquiry addressed all meetings (each lasting approximately two and half hours) and around 1,400 stakeholders attended. The key points from these meetings are also reported in the George Street Research Phase 2 report. Chapter 4 of this report discusses some of the key findings from the consultations which have informed the Inquiry's thinking.

1.2.3 Short-term recommendations

Although the Inquiry was asked to consider a medium to long-term question about how future support to agriculture and rural development could best be tailored to deliver the Scottish Government's purpose, the Inquiry recognised that some of the issues could potentially be addressed through currently available mechanisms to achieve change in the short-term. Consequently, the Inquiry examined the options for achieving short-term change and in June 2010 presented its recommendations on the measures that could be implemented prior to 2013 ⁵ . These recommendations were presented before the final Inquiry recommendations so as to facilitate speedy action on the part of Scottish Government if they chose to accept the proposals. The Scottish Government subsequently accepted the proposals in August 2010 and is taking action to implement them in partnership with the industry.

1.2.4 Modelling scenarios of changes to direct payments

The Interim Report highlighted the problems of the current historic system for distributing direct payments and suggested that we in Scotland are very likely to have to move towards an area based approach after 2013. The Report highlighted that any change to the current system would result in winners and losers and put forward one possible scenario for an area based system using the Land Capability for Agriculture ( LCA ) classification as the basis for ascribing value to land of different quality. This example was included with the simple purpose of providing one scenario that could highlight the sorts of decisions that would have to be made and the possible consequences. The Inquiry commissioned the Macaulay Land Use Research Institute to undertake some modelling work to explore the possible consequences of a range of scenarios for implementing an area based approach to distributing direct payments ⁶ . The modelling work provided much useful evidence in shaping the Inquiry's thinking. In particular, while the Inquiry expected that a move to an area based model would result in some redistribution of the payments, the modelling produced a redistribution which would result in quite significant consequences for the industry and which was inconsistent with the Inquiry's view of the key rationale for continuing direct payments. The work also highlighted the significant technical challenges of making area payments on the basis of the Macaulay LCA , and in particular the difficulties in accounting for spatial differences in land quality at the micro-level.

As a result, an alternative framework was required to enable the Inquiry to explore different scenarios for area payments which would be more consistent with its views on the purpose of agricultural support. Further modelling was therefore undertaken by the Scottish Government using the Farm Accounts Survey ( FAS ) data. The FAS data, based on a sample of around 450 farms, collects detailed financial and economic data for eight farm types - Specialist Sheep ( LFA ), Specialist beef ( LFA ), Cattle and Sheep ( LFA ), Cereals, General Cropping, Dairy, Lowland Cattle and Sheep and Mixed. The alternative framework uses this data as a baseline of profitability and the modelling shows the impact on profitability of scenarios which include a combination of area and other top up payments. Further details on the modelling are provided in the Appendix to this report. The Scottish Government is also currently undertaking analysis of the wider economic impact of changes to the agriculture support system, and this work will be available shortly.

1.2.5 Structure of the report

This report has the following structure:

Chapter 2 explores the changing nature of European agricultural policy, which provides the context for this Inquiry. It is the forthcoming reform that will re-shape the Common Agricultural Policy after 2013-but which has yet to be negotiated-that provides the impetus for this Inquiry. Chapter 2 therefore details the evolution of the CAP , the new challenges that any reformed CAP must address and the debates about the nature of the forthcoming reform, with a particular focus on the budget.

Chapter 3 provides information about the nature of Scottish agriculture and agricultural and rural development support in Scotland today. If we are to develop coherent and practical ideas about the nature of future agricultural support in Scotland we must have a clear idea of the current situation so that we understand the starting point for any future change.

Chapter 4 draws on published pronouncements from the Scottish Government and other stakeholders to establish a clear goal for what we want Scottish agriculture to look like in the future and to establish a direction of travel for the industry. We have to have a clear vision of where we are heading to be able to make appropriate decisions about the best way to get there. The chapter also recognises that this goal is set, and will have to be achieved within, a framework of broad characteristics established by a variety of different actors, including the EU and WTO .

Chapter 5 sets out the Inquiry's proposals on the nature of a future support regime, given the vision and direction of travel. It provides advice on the distribution of Pillar 1 payments, the conditions that should be attached to Pillar 1 payments, how payments should relate to activity and how a new regime should accommodate previously excluded land uses, and the balance of payments between Pillars. The chapter also addresses a number of other key issues, including: the future of the Scotland Rural Development Programme ( SRDP ) and particularly the Less Favoured Area Support Scheme ( LFASS ); the importance of agricultural policy in supporting the farming industry to deal with the particular risk factors that it faces; and a plea that the EU administers the budget in a more helpful way.

Chapter 6 discusses the implications of a large reduction in the CAP budget for Scotland. The Inquiry believes that, following the equity principle, Scotland has a strong case for at least maintaining its CAP budget post-2013, thus it should not experience a large reduction in funding. However, the Inquiry was asked to consider a situation where the budget is significantly reduced and this chapter sets out its priorities and suggested approach if this is the case.

Chapter 7 returns to the Inquiry's remit and summarises the Inquiry's key messages to the Scottish Government in relation to its negotiations at both a UK and an EU level (Negotiating Points) and its advice to the Scottish Government on matters where it is expected that it will have discretion (Recommendations).

At appropriate points in the report text, the Inquiry has highlighted what it has termed its 'Negotiating Points' and its 'Recommendations' using coloured text boxes:

These Negotiating Points and Recommendations are presented together in Chapter 7 of the report.