Do Agricultural Subsidies Crowd-out or Stimulate Rural Credit Market Institutions?: The Case of CAP Payments

Transcription

1 Do Agriultural Subsidies Crowd-out or Stimulate Rural Credit Market Institutions?: The Case of CAP Payments Pavel Ciaian European Commission (DG Joint Researh Centre); Eonomis and Eonometris Researh Institute (EERI); Catholi University of Leuven (LICOS) Jan Pokrivak Slovak Agriultural University; Eonomis and Eonometris Researh Institute (EERI), atarina Szegenyova Slovak Agriultural University Seleted Paper prepared for presentation at the Agriultural & Applied Eonomis Assoiation s 2011 AAEA & NAREA Joint Annual Meeting, Pittsburgh, Pennsylvania, July 24-26, 2011 Copyright 2011 by Pavel Ciaian, Jan Pokrivak and atarina Szegenyova. All rights reserved. Readers may make verbatim opies of this doument for non-ommerial purposes by any means, provided that this opyright notie appears on all suh opies. 1

2 Do Agriultural Subsidies Crowd-out or Stimulate Rural Credit Market Institutions: The ase of CAP Payments 1 Pavel Ciaian 2, Jan Pokrivak 3 and atarina Szegenyova 4 Abstrat In this paper we estimate the impat the CAP subsidies on farm bank loans. Aording to the theoretial results, if subsidies are paid at the beginning of the growing season they may redue bank loans, whereas if they are paid at the end of the season they inrease bank loans, but these results are onditional on whether farms are redit onstrained and on the relative ost of internal and external finaning. In empirial analysis we use the FADN farm level panel data to test the theoretial preditions for period We employ the fixed effets and GMM models to estimate the impat of subsidies on farm loans. The estimated results suggest that (i) subsidies influene farm loans and the effets tend to be non-linear and indiret; (ii) both oupled and deoupled subsidies stimulate long-term farm loans, but the long-term loans of big farms inrease more than those of small farms due to deoupled subsidies; (iii) the short-term loans are affeted only by deoupled subsidies, and they are altered by deoupled subsidies more for small farms than for large farms; however (v) when ontrolling for the endogeneity, only the deoupled payments affet loans and the relationship is non-linear. Introdution Agriultural subsidies have important impats on agriultural markets. Besides affeting farmers inome, studies have shown that agriultural subsidies distort input and output markets and thus alter rents of other agents ative in the agriultural setor (for example onsumers or input suppliers). The impat of agriultural subsidies on inome distributional effets depends on their type, struture of markets and the existene of market imperfetions (Alston and James 2002; de Gorter and Meilke 1989; Gardner 1 The authors aknowledge finanial support from the European Commission FP7 projet Rural Fator Markets. The authors are solely responsible for the ontent of the paper. The views expressed are purely those of the authors and may not in any irumstanes be regarded as stating an offiial position of the European Commission. 2 European Commission (DG Joint Researh Centre IPTS); Eonomis and Eonometris Researh Institute (EERI); and Catholi University of Leuven (LICOS). pavel.iaian@e.europa.eu. 3 Slovak Agriultural University; and Eonomis and Eonometris Researh Institute (EERI). 4 Slovak Agriultural University 2

3 1983; Guyomard, Mouël, and Gohin 2004; Salhofer 1996; Ciaian and Swinnen 2009). Studies also evaluate, among others, impats of subsidies on the environment and agriultural publi goods (e.g. Beers Van Cees and Van Den Bergh 2001; hanna, Isik and Zilberman 2002) or produtivity and market distortions (e.g. Chau and de Gorter 2005; Goodwin and Mishra 2006; Skokai and Moro 2006). With few exeptions (e.g. Ciaian and Swinnen 2009), most of these studies investigate the diret impats of subsidies (on pries, quantities, inome, environment, et.) by assuming that subsidies do not alter the struture of agriultural markets and do not interat with market institutions. In reality government poliies may have various unintended effets. They an hange the struture of the market organization or rowd out some market institutions. An analysis of suh effets goes beyond the fous of the urrent agriultural poliy analysis literature. These issues are related to rowding out effets of other types of govrement programs extensively analyzed in the literature. For example, the interation between private transfers and publi welfare programs attrated onsiderable attention from aademi studies (e.g. Barro 1974; Lampman and Smeeding 1983; Roberts 1984; Maitra and Ray 2003; Cox, Hansen and Jimenez 2004). The objetive of this paper is to assess the impat of the European Union s Common Agriultural Poliy (CAP) on farm bank loans. First, extending the models of Feder (1985), Carter and Wiebe (1990) and Ciaian and Swinnen (2009) we theoretially analyze how subsidies may affet farm loans. Then, employing a unique farm level Farm Aountany Data Network (FADN) panel data for the period we empirially estimate the interation between CAP subsidies and farm loans. To our knowledge, this paper is one of the first attempts to study empirially how agriultural subsidies affet rural redit institutions. The Model We build a theoretial framework of the present study on the model of Feder (1985), Carter and Wiebe (1990), and Ciaian and Swinnen (2009). Feder (1985) and Carter and Wiebe (1990) analyze farm prodution behaviour under the redit onstraint in developing ountries while Ciaian and Swinnen (2009) study how the redit onstraint 3

4 affets the inome distributional effets of area payments. In this study we extend the three models by analyzing how subsidies affet farm demand for bank loans. We onsider a representative profit-maximising farm. The farm output is a funtion of the fixed amount of land ( A ), fixed quantity of family labour (F) 5 and nonland inputs ( ), whih we refer to as fertilizer but whih aptures also other apital inputs used by the farm. The prodution funtion is represented by a onstant returns to sale prodution tehnology f ( A,, F) with f > 0, f < 0, f > 0, for i, j = A,, F. We assume that all land is owned by the farm. End-of-season profit is: (1) = pf ( A,, F) k i ii ij where k = ( 1+ i k, p is the prie of the final produt, k is the per unit prie of fertilizer ) and i is the interest rate. We assume that the eonomy is small and open, whih implies that the fertilizer prie, the interest rate, and the output prie are fixed. An important issue is the timing of various ativities and payments. We assume that fertilizer is paid for at the beginning of the prodution season, whereas the revenue from the sale of prodution is olleted after harvest at the end of the season. Beause of the time lag between the payment for fertilizer (variable inputs) and obtaining revenues from sale of prodution the farm has a demand for the short-term redit. The demand for redit an be satisfied either internally (ash flow, savings, subsidy) or externally (bank loan, or trade redit). For the sake of simpliity we onsider only external finaning through the bank loan and later on in the paper also subsidy 6. The demand for redit might not be fully satisfied, whih means that the farm an be redit onstrained. As in Ciaian and Swinnen (2009) the short-term redit onstraint implies that the farm may be onstrained with respet to the use of fertilizer, that is, redit onstraint may prevent the farm from using the optimal amount of fertilizer. Perfet Credit Markets 5 The assumption of fixed amount of land and family labour is not stritly needed to obtain the results. We introdue this assumption in order to simplify the exposition of the model results. 6 This assumption is not stritly needed to obtain the results. 4

5 To establish a point of omparison, we first identify the equilibrium without redit onstraint. With perfet redit markets, the farm is not onstrained on the quantity of input it uses. The farm hooses the quantity of fertilizer that maximizes its profit given by equation (1). This implies the equilibrium ondition: (2) pf = k In equilibrium the marginal value produt of fertilizer is equal to its prie. The ondition (2) determines the farm s fertilizer s demand funtion. Total fertilizer demand is represented by funtion D in Figure 1. Beause we assume that both fertilizer prie and the interest rate are fixed, the supply of fertilizer is horizontal urve, S. The equilibrium quantity of fertilizer with no redit onstraint is. Imperfet Credit Markets It is assumed that the maximum amount of money that the farm an borrow from the bank (C ) for fertilizer purhase depends on the farm ollateral (W ). For the sake of simpliity we onsider that banks aept only assets as ollator. 7 That is C = C( W ) where dc dw > 0. The redit onstraint is given by: (3) k C(W ) With the redit onstraint the farm maximizes the end-season profit given by equation (1), subjet to the redit onstraint (3). This amounts to solving the LaGrangean funtion: (4) Ψ = pf ( A,, F) k λ ( k C) where λ is the shadow prie of the redit onstraint. 7 This assumption is not stritly needed to obtain the results. In reality, the level of farm redit may depend on farm harateristis (e.g. reputation, owned assets, profitability). In general, the evidene from the literature shows that these fators are important determinants of farm redit (e.g. Benjamin and Phimister, 2002; Petrik and Latruffe, 2003; Latruffe, 2005; Briggeman, Towe and Morehart; 2009). For example, Latruffe (2005) finds in the ase of Poland that farmers with more tangible assets and with more owned land were less redit onstrained than others. Briggeman Towe and Morehart (2009) find for farm and nonfarm sole proprietorships in US that the probability of being denied redit is redued, among others, by net worth, inome, prie of assets, and subsidies. 5

6 When the redit onstraint is binding, λ > 0, the farm annot use the unonstrained optimal level of fertilizer and the quantity demanded of fertilizer is determined by = C( W ) k.the optimality onditions are: (5) pf ( 1 + i + ) k = 0 λ (6) k C 0. From equation (5) it follows that the marginal value produt of fertilizer is higher than the marginal ost of fertilizer k : pf > k. By inreasing fertilizer use the farm ould inrease its profit but the redit onstraint does not allow it to buy additional fertilizer. The more redit onstrained the farm is, the less fertilizer it an use, and hene the lower its produtivity level. In Figure 1 the redit onstraint urve (i.e. fertilizer supply), represented in terms of fertilizer units, is given by the bold line ka S, where onstraint, the equilibrium use of fertilizer is equal to. At S = C k. With the redit the fertilizer supply urve is vertial as determined by the redit onstraint ondition (3). Under redit onstraint the farm uses less fertilizer than under the perfet ompetition, <. Subsidies and Credit Constraint We define DS as a deoupled subsidy whih the farm reeives irrespetive of its level of prodution. With subsidy the objetive funtion of the farm beomes: (7) = pf ( A,, F) k k DS s s + where k = ( 1+ is k, is the fertilizer finaned through the bank loan C, s ) s is the fertilizer finaned with subsidies DS, i s represents farm s opportunity ost of subsidy (i.e. the return on the most profitable alternative investment opportunity), and = + s. We assume that the ost of bank loan is higher than the ost of subsidy, i > i s. This assumption is reasonable given the information and inentive problems involved in providing a loan to the farm. Subsidies affet not only the profit funtion but also the redit onstraint. If the farm reeives subsidy at the beginning of the season, it an use it for paying for the fertilizer. Reeiving the subsidies at the end of the season improves the farm s aess to 6

7 redit too. Future guaranteed payment of subsidy may serve as ollateral for obtaining loan from the bank (Ciaian and Swinnen 2009). Therefore subsidy may alleviate the redit onstraint of the farm irrespetive of the timing of the subsidy. With subsidy redit onstraint is given by the following inequalities: (8) k C[ W + ( 1 α ) DS] + αds (9) k s αds where α is a dummy variable taking value zero when farm uses subsidy to purhase fertilizer diretly or one when subsidy improves aess to fertilizer indiretly through enhaned value of ollateral. Equation (8) therefore implies that the farm an use two soures to finane the purhase of fertilizer: subsidy, DS α, and/or the bank loan, C [ W ( 1 α) DS] +. If subsidy is paid at the beginning of the season, α = 1, the farm an use it to alleviate its redit onstraint. On the other hand when subsidy is paid at the end of the season, α = 0, the farm may use it as ollateral to obtain a bank loan. In other words, subsidy inreases farm assets, improves its reditworthiness and thus inreases aess to bank loans. Equation (9) states that the use of subsidy for fertilizer purhase annot exeed the total value of subsidies DS. With subsidies and redit onstraint the objetive funtion of the farm is represented by the following LaGrangean funtion: (10) Ψ = pf ( A,, F) k k λ { k C[ W (1 α) DS] αds} λ ( k αds) where λ s is the shadow prie of the subsidy onstraint (9). The optimality onditions are given by: (11) pf ( 1 + i + ) k = 0 λ (12) pf ( 1 + i + ) k = 0 s λ s (13) k C[ W ( 1 α ) DS] αds 0 (14) k s α DS 0. s s s s The Impat of Deoupled Subsidy 7

8 First, we onsider the impat of deoupled subsidy on the bank loan under perfet redit market. Then we analyse the redit onstraint ase. We summarise our results in three hypotheses. Hypothesis 1: If farms are not redit onstrained and if finaning via bank loans is more expensive than finaning through subsidies, subsidies redue the amount of farms bank loans if they are paid at the beginning of the season; otherwise subsidies do not affet the farm loans. If finaning via the bank loan is more expensive than finaning through the subsidy, i > i s (i.e. k > ks ), subsidy an redue amount of bank loan but only in the ase when the subsidy is paid at the beginning of the season. In suh a ase the farm an use the subsidy instead of the bank loan to buy fertilizer. The situation is illustrated graphially in Figure 2. With no redit onstraint and with no subsidies, the equilibrium fertilizer use is and all fertilizer is finaned through the bank loan. Availability of heaper finaning through subsidy DS allows the farm to redue the amount of bank loans. The farm will use less loan and part of the fertilizer will be finaned with subsidy, equal to ( = DS k ). The remaining fertilizer, s s, will be bought with the bank loan. In welfare terms the farm gains area a in Figure 2. Note that with subsidy DS, the equilibrium fertilizer use is not affeted and remains at all bank loans, whih ours for suffiiently high subsidies (if. Only if subsidies rowd out DS > k ), the equilibrium fertilizer use inreases. If the subsidy is paid at the end of the season, the farm annot use it diretly to purhase fertilizer. However, subsidy an still be used as ollateral. We assume that the type of ollateral does not affet bank loan interest rate; hene the subsidy does not alter the equilibrium quantity of loans. 8 8 In reality, the type of ollateral may affet the ost of the loan. For example, if banks pereive subsidies to be more seure and/or have lower transation osts to administer them than other type of farm ollateral, then the interest rate may be lower for subsidy baked loans than for the loans baked by the other type of ollateral. In this ase the effets will be similar as those shown in Figure 2. 8

9 Next we analyse the ase when farm is redit onstrained and subsidy is paid at the beginning of the season, α = 1. Hypothesis 2: If farms are redit onstrained and if subsidies are paid at the beginning of the season, (a) farms will use the same amount of loans with and without subsidies if subsidies are suffiiently small and (b) the farm will redue bank loans if subsidies are suffiiently high. If the subsidy is paid at the beginning of the season the farm an use it diretly to finane the purhase of fertilizer. The impat of subsidy on the bank loan under redit onstraint is illustrated in Figure 3. The equilibrium quantity of fertilizer with the redit onstraint and with no subsidy is. First onsider subsidy DS 1. The subsidy DS 1 shifts the supply of fertilizer from kd S to kae s S 1, where S 1 = ( C + DS1) k. The equilibrium quantity of fertilizer is ( = C + DS ) k ). Some fertilizer is finaned diretly from s1 ( 1 the subsidy, ( s1 s 1 1 = DS k ), and the rest is finaned through the bank loan, ( = 1 1 C k ). The farm gains area ad when subsidy is used to purhase fertilizer s s = under the redit onstraint. Subsidy DS 1 does not hange the quantity of the bank loan: with and without the subsidy the farm purhases the same amount of fertilizers through the bank loan,. With subsidy DS 1 the farm is still redit onstrained ( λ > 0 ) the amount of fertilizer, 1 s1 is lower than the amount of fertilizer used under perfet market s < and thus it is profitable for the farm to exploit fully all available finaning opportunities (subsidies and loans). However, if subsidy is suffiiently high, it an redue the amount of bank loans. For example, with subsidy DS 2, where DS2 > > DS1, the supply of fertilizer shifts to kbf s S 2, where S 2 = ( C + DS2) k (Figure 3). The equilibrium fertilizer use hanges to : ( = DS 2 k ) is finaned from subsidy and s2 s 2 is finaned with the bank loan. Now, the farm uses smaller amount of loans. The amount of fertilizer finaned with the bank loan is s 2, whih is less than the total amount of fertilizer 9

10 finaned with bank loan without subsidy. Relative to no subsidy situation, the farm s gain is the area abde. Intuitively subsidy DS 2 eliminates the redit onstraint (i.e. the redit onstraint (13) is not binding with DS 2, λ = 0 ) and farm substitutes part of expensive bank loans with heaper subsidies. With subsidy DS 2 the farm is not redit onstrained and it uses the same level of fertilizer as under the perfet market situation,. Finally, we onsider the situation with binding redit onstraint when subsidy is paid at the end of the season, α = 0. Hypothesis 3: If farms are redit onstrained and if subsidies are paid at the end the season, the farm inreases bank loans. The graphial analysis is in Figure 4. The fertilizer supply without the subsidy and with the redit onstraint is ka S and the equilibrium fertilizers use is. If the redit onstraint (8) is binding ( λ > 0 ), it is profitable for the farm to use the subsidy DS paid at the end of the season ( α = 0 ) as ollateral for obtaining a bank loan for purhase of fertilizer at the beginning of the season. Hene, beause of higher ollateral, subsidies inrease bank loans from C (W ) to C ( W + DS), where C ( W ) < C( W + DS). The availability of more loans shifts the fertilizer supply to kb S 1 and the equilibrium fertilizer use to 1, where >. Relative to the situation with no subsidy, the farm 1 benefits from more loans; the gain is equal to area a. Note that for suffiiently high subsidy, the farm may beome redit unonstrained (i.e. λ = 0 ). For example, this is the ase when subsidy shifts the fertilizer supply to kd S 2 whih inreases the equilibrium use to and generates a gain for the farm equal to area ab. Extension: Long-term Loans In general, farms use long-term loans to finane long-term investments whih generate multi-annual inome stream. The impat of deoupled subsidies on the long-term loans is 10

11 similar as in the ase of the short-term loans. 9 If subsidies are reeived at the beginning of the season, they may be used to finane farm investments. If subsidies are alloated at the end of season, they may alter loans only by affeting farm ollateral value. Hene, all three hypotheses derived in the previous setion hold also in the ase of long-term loans. Eonometri speifiation Theoretially the impat of deoupled subsidy on agriultural loans is ambiguous. Agriultural subsidies paid at the end of the season have no impat on bank loans under perfet markets while they redue bank loans when paid at the beginning of the season. Under redit onstraint subsidies paid at the beginning of the season have no impat on bank loans if they are suffiiently small but they redue bank loans if they are suffiiently high. Furthermore, under redit onstraint when subsidies are paid at the end of the season they redue bank loans. The relationship between subsidies and bank loans is therefore an empirial question. Solving the maximisation problem (equations (11)-(14)), the amount of farm loan depends on farm s subsidy, profitability, and assets. We therefore estimate the following eonometri model: (15) loan jt = β 0 + βdsds jt + βaassets + βπ Π jt + β x X jt + ε jt where subsripts j and t represent farm and time, respetively; loan stands for farm bank loans, assets are farm assets and X jt is a vetor of observable ovariates suh as farm harateristis, regional, and time variables. As usual, ε jt is the residual term. 10 We are espeially interested in estimating the parameter β ds whih measures the impat of subsidies on bank loans. Statistially signifiant negative value of the oeffiient onfirms either hypothesis 1 (subsidies paid at the beginning of the season redue bank loans beause farms are not redit onstrained) or hypothesis 2b (suffiiently high subsidies paid at the beginning of the season eliminate bank loans when farms are redit onstrained). Statistially signifiant and positive oeffiient onfirms hypothesis 3 9 Although the interest rate may differ between the short- and the long-term loans, the intuition is the same for both ases. 10 The definition of the rest of the variables is the same as in the theoretial setion. 11

12 (farms are redit onstrained and subsidies are paid at the end of the season). Finally, if the oeffiient is not statistially signifiant, then the hypothesis 2a holds (farms with subsidies remain redit onstrained and subsidies have no effet on farm loans). We expet that data will onfirm either hypothesis 2 or 3 beause there is overwhelming evidene that farms are redit onstrained (Carter 1988; Blanard et al. 2006; Lee and Chambers 1986; Fare, Grosskopf and Lee 1990). Further, anedotal evidene indiates that subsidies tend to be paid at the end of the season 11 whih implies that the hypothesis 3 should hold. This is in partiular the ase of the long-term loans whih tend to finane investments with higher value than short-run loans. 12 Hene, the annual value of farms subsidies may not over the full osts of the long-term investments even if they are reeived at the beginning of the season. The hypothesis 3 is more likely to hold in the ase of the long-term loans. The estimation of equation (15) is subjet to the omitted variable bias and partiularly to the endogeneity. There are unobservable harateristis like farmer s ability that affet bank loans and may be orrelated with explanatory variables. Ignoring this unobserved farm heterogeneity bias the results. We use panel data and estimate fixed effets model whih helps us to ontrol for the unobserved heterogeneity omponent that remains fixed over time thus reduing onsiderably the omitted variable bias problem. In order to ontrol for the endogeneity we estimate the generalised method of moment (GMM) model. Fixed effets model The following fixed effets model estimation implies the following speifiation: (16) loan jt = β 0 + b j + β dsds jt + β aassets + βπ Π jt + β x X jt + ε jt where b j is the fixed effet for farm j, whih apture time-unvarying farm-speifi harateristis. These fixed effets represent farm heterogeneity. For example, they ould reflet different tehnologies for different farms, or they ould reflet different 11 There is not available onsistent data on the timing of CAP subsidies. 12 In perfet market situation, the prie of an investment good is the present value of the future returns from the investment good whih tends to be higher than the prie of a variable inputs (e.g. fertilizers). The prie of variable inputs is determined by its annual marginal ontribution to the farm profitability. 12

13 managerial skills or other unobservable fixed farm speifi harateristis. Endogeneity Three soures of endogeneity might bias our estimates. If subsidies were assigned to farms randomly, then parameter β ds would measure the impat of subsidies on bank loans. In reality, however, subsidies are not assigned randomly to farms. For example, the oupled animal and rop subsidies depend on regional and farm level produtivities. The oupled subsidies are alloated to eah MS based on regional produtivities (e.g. regional referene yield). At farm level the size of subsidies depends on the MS subsidy size (i.e. regional produtivity) and on the farms' rop hoie (e.g. supported versus non-supported rops). Similar holds for the SAPS in the new MS. Although, the SAPS is not based on farm produtivities diretly, it is nevertheless orrelated with the pre-aession average ountry/regional produtivities, beause the base for the CAP appliation in new MS was the average prodution level and intensity in the pre-aession period. This implies that the SAPS is exogenous at farm level within eah new MS but endogenous between the new MS. The deoupled SPS payments depend on the past oupled payments and on the average ountry/regional produtivities, beause the value of the SPS was set based on regional produtivities or/and farm past level of subsidies. The oupled RDP payments are alloated to farmers based on projet submission. Only those farms whih submit and have a suessful projet are granted the support. Hene the RDP is non-random beause farms self-selet to partiipate and only those with the best projets (likely the more produtive farms) are granted the RDP support. This struture of oupled and deoupled CAP subsidies implies that they are endogenous variables refleting the harateristis of ountry/regions land and farmer s behaviour. Hene, subsidies are not assigned randomly, whih implies that subsidy payments are orrelated with the error term. As a result, the resulting standard estimates of βds may be biased. To address this soure of endogeneity, we employ the Arellano and Bond (1991) robust two-step GMM estimator. Arellano and Bond (1991) have shown that lagged endogenous variables are valid instrument in panel data setting. This allows us to use lagged levels of the endogenous variables as instruments (additionally to exogenous variables), after the equation has been first-differened to eliminate the farm speifi effets. The GMM 13

14 estimator is partiularly suitable for datasets with a large number of ross-setions and few periods and it requires that there is no autoorrelation. The FADN dataset mathes these requirements, beause it is a panel data and ontains a very large number of farmlevel observations relative to the period overed. Given that the robust two-step GMM standard errors an be severely downward biased, we use the Windmeijer (2005) biasorreted robust varianes. Data and variable onstrution The main soure of the data used in the empirial analysis is the Farm Aountany Data Network (FADN), whih is ompiled and maintained by the European Commission. The FADN is a European system of sample surveys that take plae eah year and ollet strutural and aountany data on the farms. In total there is information about 150 variables on farm struture and yield, output, osts, subsidies and taxes, inome, balane sheet, and finanial indiators. Sample sizes vary from ountry to ountry (roughly between 500 and observations, while most ountries have about ) representing a population of around 5,000,000 farms, overing approximately 90% of the total utilised agriultural area and aounting for more than 90% of the total agriultural prodution. The aggregate FADN data are publily available. However, farm-level data are onfidential and, for the purposes of this study, aessed under a speial agreement. To our knowledge, the FADN is the only soure of miro-eonomi data that is harmonised (the bookkeeping priniples are the same aross all EU Member States) and it is representative of the ommerial agriultural holdings in the whole EU. Holdings are seleted to take part in the survey on the basis of sampling plans established at the level of eah region in the EU. The survey does not, however, over all the agriultural holdings in the Union, but only those whih are of a size allowing them to rank as ommerial holdings. The FADN data is a panel dataset, whih means that farms that stay in the panel in onseutive years an be traed over time using a unique identifier. In this study we use panel data for overing all EU MS exept Romania and Bulgaria. Romania and Bulgaria were exluded from the sample, beause for these ountries the data were available only for one year (2007). 14

15 The desription of onstruted variables is presented in Table 1. All variables exept for ratios are alulated per hetare of utilised agriultural area (UAA) in order to redue the potential problem of heteroskedasitiy. The dependent variables in equation (16) total loan, long-term loans, short-term loans are onstruted from the FADN data by dividing total, long-medium-term and short-term loans, respetively, with the total utilised agriultural area. Similarly, all subsidy variables (sub_total_ha, sub_deoupled_ha, sub_oupled_ha) are onstruted from the FADN data and are alulated on per-hetare basis. Every agriultural produer in the FADN survey is asked to report both the total subsidies reeived as well as to speify the amount by major subsidy types. Deoupled subsidies, sub_deoupled_ha, inlude SPS and SAPS payments. Coupled subsidies, sub_oupled_ha, inlude payments linked to farm inputs or outputs suh rop area payments, animal payments and RDP. The total subsidies, sub_total_ha, variable is the sum of oupled and deoupled CAP subsidies. The independent variables assets and inome_ha represent the value of farm assets and farm ash flow alulated on perhetare basis. The ovariates matrix X jt inludes other explanatory variables whih affet farm loans. The land rented ratio and labour own ratio are inluded in the equations to ontrol for potential differenes in inentives between own and rented/hired land/labour as well as to aount for higher ost level of farms using rented/hired land/labour. A variable apturing the eonomi size (farm size) of the farms is also available from the FADN data. The eonomi size of farms is expressed in European size units. In order to aount for the various tehnologial, setoral and regional ovariates we inlude variables aounting for effets suh as irrigated land, area under glass, fallow land, and setoral, regional and time dummies (for more details see Table 1). Preliminary results The results are reported in Table 2 for total farm loans (olumns 1-3), for long-term farm loans (olumns 4-6) and for short-term farm loans (olumns 7-9). 13 Additional to the 13 We estimate fixed effets models with heterosedastiity-onsistent standard errors. 15

16 omplete equation speifiation (16), we add an interation variable between subsidies and farm size (models 2, 3, 5, 6, 8 and 9) and the square value of subsidies (models 3, 6 and 9) to aount for indiret and nonlinear relationship between subsidies and loans. The model-adjusted R 2 s ranges from 0.10 to The most onsistently signifiant variables (prob(t) < 0.10) aross all models are assets (assets_ha), trend variable (year), own labour ratio (labor_own_ratio), and rented land ratio (land_rented_ratio). The estimated results suggest that subsidies influene farm loans but the effets are indiret and non-linear. The oeffiient for subsidies in models 1, 4 and 7, where only a linear subsidy term is used, are statistially not signifiant for all types of loans. However, when interating subsidies with farm size (models 2 and 5) its oeffiient is statistially signifiant but only for total loans and for long-term loans. At the same time, the oeffiient assoiated with the linear subsidy term sub_total_ha (the diret effet) is statistially signifiant and takes a negative value. This indiates that subsidies stimulate farm loans but only for larger farms, whereas the diret impat of subsidies has a reduing effet on total and long-term loans (models 2 and 5). For the short-term loans (model 8) both oeffiients (i.e. for the interation variable and the linear term sub_total_ha) are not signifiant. Further, the results indiate that the relationship between subsidies and loans is non-linear. A small value of subsidies per hetare redues bank loans (the oeffiient for sub_total_ha is negative and signifiant in models 3 and 6) and as the value of subsidies inreases farms use more bank loans (the oeffiient for the squared value of subsidies sub_total_ha_sq is positive and signifiant in models 3 and 6). Again this holds only for total loans and for long-term loans. The short-term loans are not affeted by subsidies also when the non-linear relationship is onsidered (model 9). These results indiate that the hypothesis 3 holds for the total and the long-term loans whereby subsidies inrease farm ollateral and thus farm loan use. Multi-annuality harater of the long-term investments allows the use subsidies by redit onstraint farms to finane investments only through loans. For the short-term loans the estimated results suggest the validity of the hypothesis 2a. However, this does not imply that farms are not redit onstraint with respet to short-term loans. Farms may still be redit onstrained 16

17 and may use subsidies to finane short-term inputs beause either reeiving them at the beginning of the growing season or beause they may use other informal soures whih may be subsidy ollateralised. On the other hand, the differene in the statistial signifiane between the long-term and the short-term loans may indiate that farms may prefer to use subsidies to finane the long-term investments and not the short-term ones possibly beause of stronger redit onstraint present in the former type of investment than in the latter one. In Table 3 we disaggregate subsidies in oupled (sub_oupled_ha) and deoupled (sub_deoupled_ha) payments and again estimate their impat on total loans (olumns 1-3), long-term loans (olumns 4-6) and short-term loans (olumns 7-9). The results indiate important differenes the two types of payments have on the farm loans. For the long-tem loans (models 4-6) the effets are similar to those shown in Table 2 where longterm loans (models 4-6) were regressed over aggregated subsidies. Both oupled and deoupled subsidies have an indiret (by stimulating farm more loans of big farms than of small ones) and non-linear impat on long-term loans. For the short-term loans, the effets of disaggregated subsidies (Table 3) differ with respet to the results reported in Table 2. The short-term loans are affeted only by deoupled payments. However, the diret effet (the oeffiient for sub_deoupled_ha in model 9) is positive and signifiant, whereas the interation term (the oeffiient for sub_deoupled_fsize in model 9) is negative and signifiant. These results suggest that the short-term loans are used as ollateral to inrease farm loans but this is more important for small farms than for big farms. The oupled payments do not affet the short-term loans: i.e. the oeffiients for variable sub_oupled_ha, sub_oupled_ha_sq and sub_oupled_fsize are statistially not signifiant in model 9. The results in Table 3 onfirm that the hypothesis 3 tend to hold for the long-term loans for both types of CAP payments. For the short-term loans only the deoupled payments imply the validity of the hypothesis 3, whereas the estimated effets for the oupled payments suggest that the hypothesis 2a may better represent the reality. The GMM estimates are shown in Table 4. Generally, the GMM results indiate different results as ompared to the ones reported for the fixed effet model. When ontrolling for the endogeneity, the importane of subsidies in determining both the long- 17

18 term and the short-term loans redues signifiantly. Only the deoupled payments affet loans and the relationship is non-linear. A small value of subsidies does not affet the loans (the oeffiients for sub_deoupled_ha and sub_oupled_ha are not signifiant in models 2, 3 and 4, 6) and as the value of subsidies inreases farms use more bank loans (the oeffiient for the squared value of subsidies sub_oupled_ha_sq is positive and signifiant in models 3 and 6). This holds for both types of loans. Conlusions In this paper we estimate the impat the CAP subsidies on farm bank loans. First, we theoretially analyse the farmers' farm loan demand under perfet and imperfet redit market assumptions. In empirial analysis we use the FADN farm level panel data to test the theoretial preditions. Aording to the theoretial results, subsidies may inrease bank loans, redue them or have no impat on bank loans depending on whether farms are redit onstrained, whether subsidies are alloated at the beginning or at the end of the growing season, and on the relative ost of internal and external finaning. If the external finaning is more expensive than the internal finaning, subsidies affet bank loans even if farm is not onstrained with respet to external finaning. This is the ase when subsidies are paid at the beginning of the season and thus allowing farms to substitute loans by heaper subsidies. With redit onstraint, farms have an inentive to expand the internal or external finaning (or both) to invest in onstrained inputs. If subsidies are paid to farmers at the beginning of the season, farms may use them diretly to purhase inputs with no effet on bank loans. However, if subsidies are substantial they may eliminate the farms redit onstraint and may rowd out more expensive bank loans. On the other hand, if subsidies are reeived at the end of the season, farms an not use them diretly to finane inputs. Instead they may use subsidies as a ollateral to obtain more bank loans thus rising availability of external finaning for inputs at the beginning of the season. We employ the fixed effets and GMM models to estimate the impat of subsidies on farm loans. The estimated results suggest the following impat of subsidies on farm loan use: (i) Subsidies influene farm loans and the effets tend to be non-linear and 18

19 indiret. (ii) Coupled subsidies affet short and long term loans differently than deoupled subsidies. (iii) Both oupled and deoupled subsidies stimulate long-term farm loans. But long-term loans of big farms inrease more than those of small farms due to deoupled subsidies. (iv) Short-term loans are affeted only by deoupled subsidies. However, deoupled subsidies inrease short-term loans of small farms more than those of large farms. (v) When ontrolling for the endogeneity, the importane of subsidies in determining both the long-term and the short-term loans redues signifiantly. Only the deoupled payments affet loans and the relationship is non-linear. (vi) In general our empirial results indiate that the hypothesis 3 holds for the deoupled payments, whereas oupled payments are found not to affet loans. Referenes Barro, R. (1974). Are Government Bonds Net Wealth? Journal of Politial Eonomy 82(6): Beers Van Cees, J. and C.J.M. Van Den Bergh (2001). "Perseverane of Perverse Subsidies and their Iimpat on Trade and Environment." Eologial Eonomis 36: Cox, D., B. Hansen, and E. Jimenez (2004). How Responsive are Private Transfers to Inome? Evidene From A Laissez Faire Eonomy. Journal of Publi Eonomis 88(9-10): hanna, M., M. Isik and D. Zilberman (2002). "Cost-Effetiveness of Alternative Green Payment Poliies for Conservation Tehnology Adoption With Heterogeneous Land Quality." Agriultural Eonomis 27: Lampman, R., and T. Smeeding (1983). Interfamily Transfers as Alternatives to Government Transfers to Persons. Review of Inome and Wealth 29(1): Maitra, P., and R. Ray (2003). The Effet of Transfers on Household Expenditure Patterns and Poverty in South Afria. Journal of Development Eonomis 71(1): Roberts, R. (1984). A Positive Model of Private Charity and Publi Transfers. Journal of Politial Eonomy 92(1):

20 Figure 1. Farm fertilizers use with and without redit onstraint k S k A S D 20

21 Figure 2. Subsidies and no redit onstraint k DS k k S a D k s s 21

22 Figure 3. Credit onstraint and subsidies with α = 1 k S S 1 S 2 DS 1 DS 2 k k k d e A B D E F a b D k s s1 s2 s1 22

23 Figure 4. Credit onstraint and subsidies with α = 0 k S S 1 S 2 k a b A B D D 1 23

24 Table 1. Desription of variables Variable name Desription Dependent variables Total loans Long run loans Short run loans Explanatory variables sub_total_ha sub_oupled_ha sub_deoupled_ha sub_total_ha_sq sub_oupled_ha_sq sub_deoupled_ha_sq sub_total_fsize sub_oupled_fsize sub_deoupled_fsize assets_ha inome_net_ha inome_net_ha_l year land_rented_ratio labor_own_ratio Farm size irigated_land glass_land land_unused_ratio land_woodland_ratio output_livestok_ratio output_ownons_ratio lu_ha Long, medium and short-term loans per UAA Long & medium-term loans per UAA Short-term loans per UAA Hetare value of farm subsidies Hetare value of all oupled subsidies on rops, livestok and livestok produts and RDP Hetare value of SPS and SAPS Square value of subsidies Square value of oupled subsidies Square value of deoupled subsidies Interation variable between subsidies and total loans (=sub_total_ha farm size) Interation variable between oupled subsidies and total loans (=sub_oupled _ha farm size) Interation variable between deoupled subsidies and total loans (=sub_deoupled _ha farm size) Hetare value of farm assets Cash flow: farm revenues from prodution sales minus payments for inputs (exluding depreiation and interest osts) Lagged value of inome_net_ha Trend variable Ratio of rented area to UAA Ratio of unpaid input to total labour Eonomi size of holding expressed in European size units (ESU) Ratio of irrigated land to UAA Ratio of the area under glass or plasti land to UAA Ratio of fallow and set-aside land to UAA Ratio of woodland area to UAA Ratio of total livestok output to total farm output Ratio of farmhouse onsumption and farm use to total output Total livestok units per UAA Note: All variable are alulated from the FADN data. 24

25 Table 2. Fixed effets estimates of loans (total subsidies) Total loans Long-term loans Short-term loans Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8 Model 9 sub_total_ha sub_total_ha_sq e-07 sub_total_fsize assets_ha inome_net_ha inome_net_ha_l year farm size labor_own_ratio land_rented_ratio 3,780 3,778 3,779 3,258 3,251 3, land_unused_ratio land_woodland_ratio -2,209-2,166-2,148-2,598-2,546-2, output_livestok_ratio output_ownons_ratio irigated_land glass_land yield_wheat lu_ha Constant -54,495-54,088-55,396-44,250-43,310-45,192 15,011 15,091 15,098 Observations R-squared Number of idn Robust standard errors in parentheses p<0.01, p<0.05, p<0.1 25

26 Table 3. Fixed effets estimates of loans (disaggregated subsidies) Total loans Long-term loans Short-term loans Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8 Model 9 sub_deoupled_ha sub_deoupled_ha_sq e-05 sub_deoupled_fsize sub_oupled_ha sub_oupled_ha_sq e-06 sub_oupled_fsize assets_ha inome_net_ha inome_net_ha_l year farm size labor_own_ratio land_rented_ratio 3,779 3,779 3,781 3,258 3,258 3, land_unused_ratio land_woodland_ratio -2,208-2,146-2,129-2,598-2,556-2, output_livestok_ratio output_ownons_ratio irigated_land glass_land yield_wheat lu_ha Constant -59,533-60,790-57,152-41,584-44,903-40,130 5,857 6,794 7,310 Observations R-squared Number of idn Robust standard errors in parentheses p<0.01, p<0.05, p<0.1 26

27 Table 4. Arellano and Bond estimates of loans (disaggregated subsidies) Long-term loans Short-term loans Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 sub_deoupled_ha sub_oupled_ha sub_deoupled_fsize sub_oupled_fsize sub_deoupled_ha_sq sub_oupled_ha_sq assets_ha inome_net_ha investment_ha L.investment_ha a labor_own_ratio land_rented_ratio 1,760 1,690 1, land_unused_ratio land_woodland_ratio -4,758-3,836-3, output_livestok_ratio output_ownons_ratio irigated_land glass_land yield_wheat lu_ha L.loan_total_ha_adj L2.loan_total_ha_adj L.loan_long_run_ha_adj L2.loan_long_run_ha_adj L.loan_short_run_ha_adj L2.loan_short_run_ha_adj Constant -1, Observations Number of idn Standard errors in parentheses p<0.01, p<0.05, p<0.1 27