The EU does not want to encourage farmers to over-produce
EU farm ministers have agreed to reform agricultural policy by shifting more subsidies away from production and liberalising the dairy market.
The deal on reforming the Common Agricultural Policy came on Thursday after marathon all-night talks.
More subsidies will be transferred to conservation, reducing the traditional EU incentives for farmers to produce.
Milk quotas will be raised initially, but later scrapped, in the biggest overhaul of farm policy since 2003.
The measures will go into effect during 2009-2013.
The changes build on a major CAP reform enacted in 2003, which broke the link between farm production and subsidies.
Critics say the subsidies distort world markets and harm farmers in developing countries, by guaranteeing prices for farmers in the EU.
Before the 2003 reforms, which "decoupled" subsidies from production, the EU was widely criticised for the accumulation of butter mountains and wine lakes.
EU reaches farm reforms deal
The latest deal was reached by a qualified majority vote - it was not unanimous agreement, officials say.
The aim is to shift more funding into rural development and conservation measures and to make agriculture more responsive to market forces.
The CAP is the biggest item of EU expenditure, accounting for about 45% of the EU's budget.
All farms qualifying for a minimum of 5,000 euros (£4,208; $6,312) in annual EU subsidies will shift 5% of their EU money into rural development projects by 2012, on top of the 5% that is currently obligatory.
So direct aid for rural development will rise to 10% of the EU farm subsidies - not the 13% that the European Commission wanted.
Arguments about milk
Reform of milk quotas has long been a thorny issue, with France and Germany especially voicing concerns about the plan to remove them altogether in 2015.
Transferring more money into rural development gives us the chance to find tailor-made solutions to specific regional problems
Speaking before the deal was reached, French Agriculture Minister Michel Barnier said he would "not allow the milk quotas to be scrapped without accompanying measures, precautions being taken".
"Some would like to lift all restrictions on milk production. We know perfectly well that if we produce a lot more, the prices drop, and everyone loses."
In order to cushion the blow to dairy farms the milk quotas will rise by 1% a year from 2009, before they expire in 2015.
Italy, which has overshot its milk quotas, will be allowed to implement the full quota increase from next year.
Meanwhile, extra support is planned for small dairy farms in mountain areas, notably in France, Germany and Austria.
EU Agriculture Commissioner Mariann Fischer Boel said the negotiations had been tough and the talks on milk quotas had been "extremely difficult", the AFP news agency reported.
EU governments co-finance environmental subsidies for farms with the European Commission, and under the new deal, the governments' contribution will be 25% - down from 50%. But the poorest countries' contributions will be cut to 10%, AFP reports.
Ms Fischer Boel said the CAP reform package "is all about equipping our farmers for the challenges they face in the upcoming years, such as climate change, and freeing them to follow market signals".
"Transferring more money into rural development gives us the chance to find tailor-made solutions to specific regional problems."
Among the rural challenges listed by the commission are better water management, protecting biodiversity and production of green energy.
The decision to abolish arable set-aside remains controversial. Farmers have been leaving some land fallow, to prevent surpluses accumulating, but that land will now be put back into production.
Conservationists say the set-aside policy has been very beneficial for wildlife.
The BBC's Dominic Hughes in Brussels says those who wanted the measures to go further, led by the UK, will argue this is a missed opportunity.
But further reform is planned for 2013 - and there is no doubt the direction of travel is towards the free market, and away from subsidy, he says.
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