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The Economics of the Organic Market

2008 Food Taipei: Organic Food Area
2008 Food Taipei: Organic Food Area
Photo courtesy of Rico Shen.

Introduction

When I turned to organic food during a brief period, the most salient trait of the whole market is that it is significantly more expensive than buying conventional food. I believed in the "Monsanto wants to take over the world" mantra being repeated back then, as well as the motto told and re-told by "health experts" in the radio that: "It may be more expensive to eat healthier, but it will be more expensive if you have health issues and end up in a hospital." For a while, with a rebellious spirit, I wanted to confront "Big Ag" and "Big Pharma" by trusting these people.

But there was this nagging question: Why is all of this SO FRIGGIN' EXPENSIVE? The answer was obvious to me at the time: because the organic industry takes more care of the food, produce with a less efficient means, but which are more environmentally friendly, and because, a lot of these products are linked to worker-owned industries, coops, and small farmers. In other words, to eat organic was the best way to promote social justice, one's own health, and the welfare of the environment. So, spending more on organic seemed to be worthwhile, even when it is more expensive.

I was so naïve back then!

But as organic food is becoming a fashion, a lot of these false convictions are starting to crumble. There are more complains today than ever against organic that it is more expensive. I eventually realized that the real reason why organic food is expensive is very obvious: because it is simply inefficient regarding food production. For this simple reason, it is not more environmentally friendly, it is not really all that good to farmers, nor does it promote social justice anywhere in the world. 

People in the organic industry want to argue otherwise. There are some studies on the matter to be sure, but the one that interests us most is the Rodale's Farming Systems Trial study. I want to use it because it is the most notorious study that alleges that organic farming methods can be (and are) more efficient than conventional, and that they have done this by using long term data. According to the booklet, here are the Farming System Trial's (FST) facts:

  • Organic yields match conventional yields.
  • Organic outperforms conventional in years of drought.
  • Organic farming systems build rather than deplete soil organic matter, making it a more sustainable system.
  • Organic farming uses 45% less energy and is more efficient.
  • Conventional systems produce 40% more greenhouse gases.
  • Organic farming systems are more profitable than conventional (Rodale, 2011, p. 04).

Of course, all of this is really impressive. But as much as I wanted to believe it (and I wanted to!), the "no cash on the table" test made me less than credulous. I invite the public to read the report itself, but here I want to make a brief exposition of why I scratched my head when I read it.

My question is, how should I test this?

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The "No Cash on the Table" Test

Cash on Table

Today, we are living in the most competitive time the world has ever seen in the past. Many people complain about Microsoft's or Monsanto's monopolistic practices. We can hardly blame them. They are corporations, and, as Adam Smith stated on The Wealth of Nations, businessmen strive to diminish competition and increase their market. Yet, as the economist Robert H. Frank points out, what Smith did not understand (as well as many progressives) is that these are symptoms of the vigorous competition in today's market. Once the MS Windows operating system dominated the market, but Microsoft underestimated the importance of tablets and cell phones. This company arrived too late after both Google and Apple dominated this sector of the market. In the economists' jargon, regarding cell phones and tablets, Microsoft was leaving "cash on the table". This means, that it left open a market opportunity that it did not invest in, "leaving cash on the table" for anyone who wanted to take advantage of it. Google and Apple took the chance.

In the same way, we can use this criterion to examine the claims by the Rodale Institute and some other claims. Yet, Rodale's statements are not convincing because of two factors (at least from my point of view): the prices of the products being sold, and the choices made by farmers today. Let's look at these in detail.

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The Price of Organic Food

If you go to the numbers provided by the United States Department of Agriculture (USDA), you can download any table you want, and the constant tendency of the organic market is being notoriously far more expensive than conventional. As I have argued elsewhere, the existence for this product in the market place is just due to fear for conventional food, and health concerns. It is not driven by actual evidence that organic may be just as good as conventional. By every scientific analysis that is available, there is no rhyme or reason why organic food should exist at all (economically speaking).

Yet, we could argue that the cost is worth it. The United Nation's Food and Agriculture Organization (FAO) has pointed out several reasons why organic food costs as much as it does. For example, since prices are high, they usually mean two things:

  • There is not enough supply for effective demand.
  • The money invested is used to benefit organic farmers.

Yet, neither of these seem to work for me as reasons why the cost of organic food is so high.  Some advocates of organic food want us to ask the question of why is conventional food so cheap, and not too much on why organic food is so expensive. The reason why conventional food is cheap is pretty obvious: its production process is very efficient. Yet, the question implies that "Big Ag" sells cheap because there is an overabundance of its supply, so that they have the luxury of selling it cheaper. On the other hand, organic food has a very small supply.

Aspects of this explanation do not seem to be true, because there is definitely and increase in effective demand all over the world, especially in industrialized countries, where there are more and more people concerned with their health, and who hold that organic food as being more healthy. If, as Rodale claims, organic famers are able to produce more efficiently, yet not supplying enough, then they would be leaving cash on the table. They would be able to supply more and more organic food to satisfy the increase in demand. After all, the organic industry has grown enough to have store chains like Trader Joe's or Whole Foods. And yet, the consumers are still not perceiving a significant pocket relief.

It seems as if, from the effective demand's end of the market, organic products fail the "no cash on the table" test. If organic produces more efficiently, even when it has limited supply, it could gradually out-perform conventional and, in times like these, just steal the market from "Big Ag". Organic food has existed ever since the 1930s, yet after six or seven decades, there seems to have been no significant reduction in market prices.

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From the Point of View of Supply

What about the farmer? What about the companies? Why aren't more farmers and companies that produce organic food? Let's say for the sake of the argument that our previous conclusion is false, that if there were more supply, then the prices would drop dramatically. That farmers and companies can actually produce far better than conventional food, and that this would be so successful, that both of these sectors would make far more money to the point that it would be great for everyone! It would be great for the farmers, there would be healthier for consumers, a better for the environment ... in other words, the best of all possible worlds.   We could argue that companies don't do this because of inertia, and that farmers don't change to organic production, because they are pressured by "Big Ag". 

When I am presented these arguments, I cannot help but feel skeptical about this. I am reminded of the structure of the arguments shown by Robert H. Frank in his book, The Darwin Economy, and his use of the "No Cash on the Table Test" when he discussed labor-managed firms. So, in many ways, I'll be using a rephrased form of his arguments, adapting them to the issue we are discussing.

Let's suppose that organic yields match conventional yields, that they outperform conventional in years of drought, that they are energy efficient, and that they are more profitable. In economy and competition (especially in a capitalist economy), efficiency and profit are the names of the game. If you produce just as much profit, perhaps more in some occasions, even in times of drought, then conventional farmers are "leaving cash on the table". Note that, for instance, in the U.S. the vast majority of farming land belong to independent farmers and their families, very few of them are actually owned by corporations. I know by reading a lot of their blogs and Facebook pages that it seems that farmers are not dumb. They are well educated, and thanks to the U.S. subsidies, they can sell their products and earn enough to make a living, many times comfortably.

Organic farming has been around in the U.S. apparently since the 1930s The Rodale Institute itself was established in the U.S. during the 40's  This means that organic farming has had a presence there for about six or seven decades, and has spread around the world since then. Let's look for those countries that dedicate most hectares of land on organic:

The ten countries with the largest areas of organic agricultural land 2013 
(FiBL & IFOAM, 2015, p. 36)

If the numbers look impressive, let's look at how much share of their farming land is dedicated to organic in each of those countries (FiBL & IFOAM, 2015, pp. 41-42):

  • Australia: 4.2 %
  • Argentina: 2.3 %
  • United States: 0.6 %
  • China: 0.4 %
  • Spain: 6.5 %
  • Italy: 10.3 %
  • France: 3.9 %
  • Germany: 6.4%
  • Uruguay: 6.3 %
  • Canada: 1.3 %

Now, let's look at the countries with most shares of land dedicated to organic, and compare them to their size (FiBL & IFOAM, 2015, pp. 41-42):

 

Countries Size (km2) Share of Organic Farming
Falkland Islands (Malvinas) 12,200 36.3 %
Liechtenstein 160 31.0 %
Austria 83,879 19.5 %
Sweden 450,295 16.3 %
Estonia 45,339 16.0 %

 

As we can see, the big countries that have the most shares of farming land dedicated to organic do not exceed the 20% threshold (although, in the case of Austria, it might cross it the next few years). Yet, those with far superior shares are reached only by very small countries. After Estonia, no other country does have more than 13% of their agricultural land dedicated to organic. Remember that, in many of the countries in the world, organic farming is heavily subsidized, and still cannot do better.

Most people who look at these data would say that the reason why organic production has not prospered quickly is because of big corporations, which do everything to exploit workers and sell pesticides. These companies would never invest in organic agriculture, which is directed mostly at fair-trade businesses or local farms. Yet, this claim strains credulity for two reasons. In places like the United States, farmers in general live well in great measure because of the subsidies provided by the federal government, and local farms comprise about 80% of farms there. The second thing to notice is that many big corporations dedicated to agriculture sell seeds. Companies like Monsanto, BASF, DuPont, and others, would have no problem at all adjusting to a prevalent organic market. As private companies, they are driven by profit. If farmers today switched to organic farming and stopped buying their pesticides, these corporations would be more than happy to respond to the effective demand. After all, all of these companies sell organic seeds today. Otherwise, they would be leaving cash on the table. Even Greenpeace in Spain used to sell Monsanto's organic seeds once! 

Also, we have to pay attention to the fact that if producing organic were more profitable, farmers in general would never give a second thought to moving to it. Even companies that own great amounts of land would have absolutely no problem starting producing that way either. If this were the case, farmers and companies would be leaving cash on the table! But here is the thing ...the stampede of farmers and companies to reorganize agriculture this way never materializes.

Quite the opposite. Numbers today indicate that the effective demand for organic products will be increasing 14% in the U.S. from 2015 to 2018, but even with this, there is an epidemic of farmers leaving organic production, mostly because of lack of profit. This is true at least in Spain, the United Kingdom, and the United States. Note that all of these countries have their organic industry heavily subsidized, and still, they are not viable for a lot of farmers.

Why is not the organic production considerably larger than it is? Why doesn't it squash conventional farming if it is far more productive and profitable than some people think? After all, it is prosperous, and we can see that because the price of organic is considerably higher, meaning that it implies more income to the farmer, right?! The explanation why this is not so is really simple, and, from an economic point of view, a no-brainer:organic farming system itself is inefficient. This explains the low level of income for a lot of farmers who abandon this enterprise, and the high prices in stores. The latter is a prevalent reality because inefficiency costs.

All of this means that the general conviction that many people have that organic production leads to higher yields than conventional cannot be true. This also means that as the effective demand increases (as it is projected), the prices will also increase, because of the inability of farmers to produce as much as the public will demand.  

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Reasons for the Inefficiencies

The Rodale Institute's claims are not true. Organic farming is highly inefficient, this has been scientifically determined in repeated studies (Gilbert, 2012; Seufert, et. al, 2012). On average, organic yields are 25 % lower than conventional.

We should mention at least which are some of the sources of the inefficiencies that drive prices up for consumers:

  • As the FAO recognizes, "Production costs for organic foods are typically higher because of greater labour inputs per unit of output and because greater diversity of enterprises means economies of scale cannot be achieved." In other words, farmers have to really work harder in order to match the equivalent output of conventional. This usually means more spending on the part of the farmer, which means less profit in the long run. In light of this, the general tendency of farmers to flee from organic is totally understandable.
     
  • As the FAO also states: "Post-harvest handling of relatively small quantities of organic foods results in higher costs because of the mandatory segregation of organic and conventional produce, especially for processing and transportation". And let's not forget that "[m]arketing and the distribution chain for organic products is relatively inefficient and costs are higher because of relatively small volumes."
     
  • Yet, we must include here other variables, for instance: the increasing number of recalls throughout the years. Recalls represent costs to farmers and companies.
     
  • Although organic farming tends to conserve the soil to keep it fruitful, the use of till also degrades the soil, turning it into a problem. Because many conventional farmers use synthetic herbicides, usually have a low-till or no-till approach to farming, which is more productive (if done correctly) while conserving the soil.

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Conclusion

In general, the economics of organic farming make no sense at all. This is all an artificial market that competes using fear and a fallacy as their main support. I don't see how it will help most farmers or the public, neither in the short or the long run. The Rodale Institute's claim that organic is more efficient than conventional is false by a simple economic analysis. It fails in many ways the "No Cash on the Table" test. As far as we can see, there are only very few people who benefit from this industry, and just like J. M. Mulet suspects, they are the big organic supermarket chains in the United States and Europe.

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References

Frank. R. H. (2011). The Darwin Economy: Liberty, Competition, and the Common Good. Princeton: Princeton University Press. [Kindle]

Gilbert, N. (2012, April 25). Organic farming is rarely enough: Conventional agriculture gives higher yields under most conditions. Nature. doi:10.1038/nature.2012.10519. Retrieved from: http://www.nature.com/news/organic-farming-is-rarely-enough-1.10519.

Research Institute of Organic Agriculture (FiBL) & IFOAM -- Organics International. (2015). The World of Organic Agriculture: Statistics and Emerging Trends 2015. Switzerland: Research Institute of Organica Agriculture (FiBL) and IFOAM, 2015. Retrieved from https://www.fibl.org/fileadmin/documents/shop/1663-organic-world-2015.pdf.

Rodale Institute. (2011). The Farming Systems Trial. Kutztown, PA: Rodale Institute. Retrieved from http://rodaleinstitute.org/our-work/farming-systems-trial/farming-systems-trial-30-year-report/.

Seufert, V., Ramankutty, N. & Foley, J. A. (2012, May 10). Comparing the yields of organic and conventional agriculture. Nature, 485, 229-232. doi:10.1038/nature11069. Retrieved from http://www.nature.com/nature/journal/v485/n7397/full/nature11069.html.

 

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