ORGANIC AGRICULTURE, INTERNATIONAL TRADE ENVIRONMENT comparative advantage

e-mail: david.vanzetti@elspl.com.au website www.elspl.com.au

Vanzetti, D. and Wynen, E. (2002), 'Does it make sense to buy locally produced organic products?'

Chapter 9 in D. Hall and J. Moffitt (Eds.) 'Economics of Pesticides, Sustainable Food Production and Organic Food Markets', pp. 195-208, Elsevier, Amsterdam.

Note: The copyright to this chapter is owned by Elsevier. Single copies of the article can be downloaded and printed for the reader’s personal research and study.

Abstract

Enthusiasts of the organically grown food industry often espouse a preference for produce grown in the local region, and suggest that consumers should buy locally produced organic products. One reason consumers buy organic products is to improve the environment. There is a perception that transporting foods long distances is wasteful, in part because transport costs are not appropriately priced to include all externalities. Does this make sense?

The focus of this paper is to examine conceptually how trade can contribute to a more environmentally-sound way of supplying agricultural products to consumers, even when transport costs are adequately taken into account. An example from the international wheat trade illustrates this point.

Key words: organic agriculture, transport, trade, wheat

JEL classification: F18

1. Introduction

There are many and varied reasons for consumers to prefer organically-grown food. Meier-Ploeger and Vogtman (1996, p.176) mention appearance, technological quality (protein or starch content) and biological quality (taste, freshness, absence of toxic substances) as characteristics of interest to consumers of organic products in former years. More recently '...ethical criteria such as the environmental, social and political dimensions of food production, processing and packaging' have become more important.

Considerations for the environment, and the issue of local consumption or transport of organically-grown produce is the focus in this paper. Preference for produce grown in the local region is espoused by some on the grounds of better environmental management (see, for example, Marsh and Runsten (1997), who quote Wilkins (1995)). Transport costs are seen as an unnecessary waste, and it is considered that non-renewable resources should be used sparingly, thus providing for future generations. The regulatory body overseeing organic standards, the International Federation for Organic Agricultural Movements (IFOAM) tends to favour locally-grown produce, although its position on this is nebulous, merely advocating the use of 'as far as is possible, renewable resources in locally organised agricultural systems' (IFOAM, 2000).

In a survey of ethical trading, Browne et al. (2000, p.76) note that several respondents within the organic movement were concerned about the 'negative environmental impact of transporting food over long distances from developing countries' . A representative statement of many in the organic movement is forcefully put by Lang (1996, p.200), who maintains that

'Food travels an increasing distance between producer and final consumer. Some - most - of this travel is ludicrous but it makes financial sense because the cost, in energy and money, is externalised onto the environment. Cheap beef or rice going from the USA to Japan relies upon cheap oil, a non-renewable resource' .

The purpose of this paper is to explore the contribution of transport costs to overall resource use. While moving goods long distances obviously increases transport costs, offsetting savings can be gained from producing goods with the use of fewer resources in distant locations. If transport costs can be shown to be sufficiently small, the policy of 'buying locally' can be shown not to be sensible, at least not for the reasons commonly espoused. However, there may be more sensible reasons for buying locally-produced organic products if consumers place a sufficiently high weight on local as opposed to global environmental benefits. The links between international trade and environmental issues are explored in this paper.

In the next section, the nature of the gains from trade in general is discussed. The role of transport and its use of, possibly underpriced, non‑renewable resources is discussed next. The link between environmental and trade policy is then examined, and finally attention is given to the policy implications for organic agriculture.

It is worth at this juncture defining the term 'locally produced', as this means different things to different people. Some believe it refers to consumers being in touch with producers, while others interpret it as meaning supplies are sourced from within the state or province. More generally it has national connotations. National borders are irrelevant for transport costs, leading to the ludicrous situation where it is deemed acceptable to transport vegetables from Wales to Scotland but not over the border from France to Germany. Some see the European Union as a single entity, and regard transport within Europe as acceptable but trade with non-members as somehow undesirable. In the following discussion we regard local production as being traded nationally rather than internationally. There are three reasons for this. First, there is a nationalistic perspective, with consumers being extolled to 'buy local' because 'the money stays at home', providing jobs for local people. Since most countries have tax policies that redistribute incomes from one region to another, most citizens are more agreeable to sharing with their fellow citizens than foreigners. The second reason is that policies can be applied at the national levels to encourage consumers to buy locally-produced products. Restrictions of trade at the provincial or state levels are less common. Finally, a pragmatic reason is that data on international trade is more readily available than regional data. Nonetheless, much of the analysis and reasoning presented in this paper can be applied to any level of aggregation, be it village, local government area, province, nation or trade bloc. The key issue is the cost of transportation versus the benefits of producing something more efficiently at a more remote location.

Unfortunately, estimates of the volumes and values of organic production and trade are unavailable, and thus this paper is limited to a conceptual discussion. However, data relating to trade in organic Australian wheat is used to illustrate the potential gains and losses.

2. Gains from trade: a conceptual analysis

What is the source of the gains from trade? Different countries are endowed with differing levels of various resources, such as land, labour, capital, minerals, water and many other factors. With respect to agriculture, the abundance and quality of the soil and the prevailing climatic conditions determine the agricultural potential. These factors influence the costs of production, and hence lead to different agricultural output prices between countries. Of importance in determining trade flows are the relative, not the absolute, costs of production. Countries that could produce everything more cheaply will find it in their interests to specialise at those products at which they have the greatest comparative advantage. Consider this illustrative analogy.

A farmer does off-farm contract work planting trees for $500 a day, and employs a labourer to do the milking for $150. Furthermore, while the labourer can milk 20 cows per hour, the farmer can milk 25 cows. Our farmer is not only a better tree-planter, but also a better milker than his employee. Should he spend some of his time milking. The answer is clearly negative. He could earn $180 per day milking (assuming earnings relate to output), but only by giving up $500 worth of tree planting. $500 is the opportunity cost of a day's milking.

Here, somewhat oversimplified, is the basis of trade: specialisation. A further illustration is presented in box 1. The key point is that an efficient use of resources allows more to be produced - and hence consumed - at the same level of input use. Alternatively, the same amount could be produced and consumed with the use of fewer inputs. As the depletion of scarce resources and environmental pollution tends to be related to input use (rather than the level of output), it is tempting to conclude that removing impediments to trade is unambiguously beneficial to the global environment. However, such a sweeping conclusion would be premature.

Box 1. The gains from trade

Assume two countries produce only two goods, and can trade only with each other. Suppose Country A can produce 10 tonnes of wheat or 4 tonnes of rice, or any combination, using a given quantity of resources. This is shown in Table 1.

Table 1: Hypothetical production possibilities

Wheat Rice Relative

prices

Country A 10 4 2.5

Country B 20 14 1.43

Relative Production

Cost A:B 2:1 3.5:1

Country B can produce 20 tonnes of wheat or 14 tonnes of rice using a similar quantity of resources. Thus, in terms of the resources used, Country B is more efficient at producing both wheat and rice. Intuition might suggest that it should produce both its own wheat and rice, and not trade with Country A. However, this is misleading. B can produce rice 3.5 times as cheaply as A, and wheat twice as cheaply. It therefore has a relative advantage in producing rice.

Country A could produce an additional 2.5 tonnes of wheat by forsaking 1 tonne of rice, whereas Country B could produce that additional tonne of rice using the resources released from giving up 1.43 tonnes of wheat. Thus, the same amount of rice and (2.5‑1.43) 1.07 extra tonne of wheat are produced with the same resources. This is illustrated in Table 2. In the pre-trade example, each country uses half its production capacity in producing wheat, and the other half in producing rice, totalling 15 and 9 tonnes of wheat and rice, respectively. In the post-trade scenario, Country A produces one tonne less of rice, and 2.5 tonnes more of wheat. Country B produces one tonne of rice more, thereby dropping 1.43 tonnes in wheat production. This arrangement yields 16.07 and 9 tonnes of wheat and rice, respectively.

The price at which the goods are exchanged and the levels of production and consumption in each country depend on the nature of consumer preferences in each country (not specified in this example). It is clearly to both countries' mutual advantage to specialise in this fashion.

Table 2: Impact of trade on production

Wheat Rice

Pre‑trade

Country A 5 2

Country B 10 7

Total 15 9

Post‑trade

Country A 7.5 1

Country B 8.57 8

Total 16.07 9

After trade has opened up, the relative prices will be the same in both countries, assuming no transport costs, somewhere between the relative prices 2.5 and 1.43. However, trade has enabled total production and consumption to increase from the same volume of resources. Clearly, trade could also facilitate a given level of consumption with the use of fewer resources.

3. Transport costs

One barrier to trade is transport. The significance of transport costs depends on the value to weight ratio of the product. Transport costs must be less than the difference in relative prices of the goods traded. If potatoes cost $100 per tonne in one country, and $110 in another, trade will not be viable if transport costs exceed $10 per tonne. Freight costs are most likely to exceed price differences on low value (per kilogram) products, such as turnips or potatoes, or on those that are difficult to store and transport, such as fresh milk, eggs, livestock or some vegetables. This implies, ironically, that there may be greater scope to transport organic produce over international borders, due to its greater value than conventional produce.

However, the price of the transport may not reflect the true costs to society. Most forms of transport cause some pollution that is not paid for by the users of the transport system. Noise, air pollution and road damage are some obvious examples. These objections apply more to land transport than sea freight. Transport by sea has resulted in some noteworthy disasters, but these generally involve the transport of oil itself, rather than goods produced in using the oil. The aggregated level of pollution associated with sea transport of commodities and manufactured goods is minimal. A further argument is that transport costs are wasteful, as transport is dependent on a non‑renewable resource, oil. Implicit in this is the view that oil is underpriced. This view has some validity, and is examined below.

4. Optimal resource use

Determining the optimal use of finite resources is a highly complex mathematical problem, and subject to considerable uncertainty. In theory at least, the interplay of market forces will provide an efficient, optimal allocation of resources over time, in the sense of providing the greatest benefits (leaving aside problems of measurement and distribution of gains). As a resource is depleted, its price tends to rise, reflecting its scarcity value. Of importance here is the likelihood of developing suitable substitutes for non-renewable resources. As the resource dwindles, the rising price encourages the search for substitutes. In the case of oil, it is difficult to think of a use for which an alternative is not available, albeit that these alternatives are currently much more expensive with current technology (for example, solar power or fuel cells).

However, the conclusion that an optimal use is made of the non-renewable resource oil can best be seen as a benchmark, as there are imperfections in the market. The existence of monopolies (which supply less and charge more than in a competitive market) and uncertainty regarding the available resources tend to underutilisation; a number of other factors lead to overexploitation.

The main factor leading to over-exploitation relates to the preference for individuals to consume now rather than postponing consumption until later. Most of us would prefer to receive $100 now than at the end of the year. This preference is reflected in the discount rate, which can be thought of as the opposite of a compound rate of interest, and is used to compare future costs and benefits with those of the present. This is especially important when environmental issues are considered, because current actions have effects stretching well into the future. A higher (discount) rate implies there is a preference for consumption to be brought forward. This rate may be lower for society as a whole than for individuals. That is, the preference of the society as a whole might be to consume less now to have more left later. Hence, the rate of resource use will be too fast if private individuals are making decisions concerning the rate of use. One factor influencing the social discount rate is the need to provide for future generations.

A second factor leading to overuse of energy resources is the underpricing of the pollution and other externalities associated with the use of energy. Externalities include the costs of accidents, congestion, noise and local and global pollution. Although there are difficulties in measuring these costs, and hence data should be used with care, an OECD report suggests costs in Germany of around 25.8 Euro per tonne per 1000 kilometre for road transport, 3.7 Euro for rail and 1.8 Euro for waterways (Quinet 1999 p. 28). This implies that the shipping of bulk commodities or processed food items by sea or rail is relatively pollution free. Another estimate suggests full internalisation of transport-related externalities would raise costs to end-users (drivers, passengers or distributors) by 15-30 per cent (OECD 1999, p.16). These costs are substantial, but the bulk of them (attributable to accidents, noise and congestion) occur in moving trucks in and out of cities, not between cities. To the extent that there is an environmental problem associated with moving food and other goods around the country or around the world, this is best addressed by encouraging the greater use of rail rather than road. This already happens to some extent. European drivers pay more than double world prices for fuel.

5. Intergenerational equity

Intergenerational transfers are largely an equity problem. One view is that all generations are linked through concern for one's children, who will in turn care about the fate of their own offspring. Thus, future requirements are taken care of by these inter‑generational concerns. Furthermore, future generations will take care of themselves, just as this generation has, through the developments of new technologies, and the substitution of capital for scarce resources. This argument may be valid for relatively short periods, such as one or two generations, but appears to have less weight when centuries are considered, where the link between generations is more tenuous, and is less convincing where irreversible decisions (such as agricultural production methods causing soil degradation) are made. Decision makers need some means of weighing current and future benefits. A discount rate provides the means. Benefits are worth postponing if they increase faster than the discount rate, which is somewhat akin to the long term rate of interest. Some commentators favour a discount rate for society that is below the private rate, because future generations are not present to represent their interests. A lower discount encourages investments with long-term benefits, such as soil conservation, and discourages activities with long-term costs, such as the application of fertiliser that may pollute water supplies 30 years hence. This raises the dilemma of assessing investment decisions against two different benchmarks, the social and the private discount rates. There is also the problem of deciding what the social discount rate should be (see Fisher (1981) for a discussion of these issues.)

Is oil under or overutilised? Is the price right? What would be the correct price if the social discount rate, intergenerational transfers, pollution, the potential for substituting alternatives in the future and other relevant factors were taken into account? One can only guess at this. It is tempting to presume that the price would rise, implying that, at present, the resource is likely to be overutilised. However, a resilient feature of almost all commodity prices is a long-term decline, occasionally interspersed with sudden price spikes. Crude oil prices have exhibited a flat trend in inflation-adjusted terms since 1870. Between 1948 and 1957 prices fluctuated between US$14-$16 in inflation adjusted (1996) dollars. Since the Gulf War in 1991 prices have generally been below their long term average of US$19.27, reaching $12 in 1998 following the Asia crisis before recovering to around US$20 per barrel in 1999 in response to the boom in the US economy (WTRG Economics, 1999). Prices rose to over $30 per barrel in early 2000 following OPEC output restrictions before falling back in 2001. With policies aimed at reducing global warming likely to lead to a shift away from carbon fuels, there is little evidence as yet that resource depletion will lead to a long-term sustained rise in real oil prices.

However, if the price of oil would rise substantially and be sustained, what effect would this have on the international food trade? We look at the world wheat trade as an example.

6. An example: the international wheat trade

In contrast to the production of many goods and services, agricultural production is particularly influenced by climate and soil conditions. Thus, a limited number of countries are the most efficient at producing any given crop, such as wheat or, more strikingly, bananas. Although production is localised, consumption is not, and hence there is scope for international trade.

Freight rates for conventional bulk wheat from the US Gulf to Rotterdam were estimated to amount to about US$14 per tonne in the mid-1980s (IWC, 1989). Later estimates indicate that average cost of freight has fallen on this route since the beginning of the 1980s and in 1995 amounted to 7 per cent (US$8-10) of landed costs (Ocean Shipping Consultants Ltd, 1996, p. 30). Fuel costs amount to about 20 per cent of the total shipping costs. A doubling of fuel costs would therefore increase freight costs by US$2 per tonne, that is, an increase of 20 per cent on US$10. This is an insignificant amount compared with the cost of production differences for products like wheat, where the world price for conventional product of around US$140 per tonne (ABARE 1999) compares with a European Community price of approximately 50 per cent more. For example, in 1998 the average price per tonne of bread-making wheat in the European Union ranged from ECU108 in The Netherlands to ECU151 in the United Kingdom (European Commission 1999). In addition, farmers receive ECU55 per tonne as compensatory payments. If the ECU achieved parity with the US dollar, this means that production costs in the EC would be around US$205 per tonne, while farmers in some countries can profitably produce one tonne for US$140.

Where does the extra cost go? It eventually returns to the owners of primary factors, land, capital, labour and natural resources (such as oil). Differences in land prices account for most of the difference between high and low cost countries, reflecting the scarcity of land in some high-cost countries. However, in some countries, such as Norway, extra functions such as the drying of grain may require additional energy.

Unfortunately, data relating to energy use in organic production in different countries are not adequate to draw conclusions. It is not possible to determine, for example, whether the production of a tonne of organic wheat in Germany uses more or less energy than a tonne produced in Argentina. This is because energy use varies tremendously depending on the situation, and there is no standard means for measuring energy use.(See Stolze et al. 2000, p. 69 for a discussion of some of the difficulties of measuring energy use.

A simplified analysis based on these figures suggests that by producing one additional tonne of conventional wheat in the European Union and importing one less, production costs in this region rise by around US$205. However, total production costs fall in the exporting regions, by around $140, and transport costs fall by around $15. The net global loss is thus the difference in prices minus the transport costs, that is, US$50 in this example.

What is the situation with organic wheat? At the present level of production, the transport costs for organic grain are greater than for conventionally-grown wheat ‑ as it is shipped in containers rather than in bulk‑ but the value of the product is also greater. The cost of shipping a container of wheat from Australia to Europe is around US$40 per tonne (Ian Diamond, trader, Organic Connections, personal communication, May 1999). With costs of production at around US$140-150 per tonne, on a par with conventional wheat, the landed costs (including transport) of Australian organic wheat in Rotterdam are therefore under US$200. In comparison, Danish producers of organic winter wheat received Dkk1859 in 1995 (Wynen, 1998 p.61), and German farmers around DM860 in 1992/93 (Padel and Zerger, 1994 p.92). These figures amount to US$230-260 depending on the exchange rate. Year-to-year price changes plus various policy impediments to trade make comparisons difficult, but nonetheless, it is clear that higher prices are required to induce European organic farmers to deliver grain to the European market than are required to induce Australian (or US or Canadian) farmers to do so.

The relative yields for organic compared to conventional produce tend to be higher in less-intensive agricultural systems such as those used in Argentina, Australia or the United States which are not so reliant on fertilisers and pesticides. This implies that the is a tendency for price differences between countries tend to be greater for organic than conventional products, providing greater incentive for trade.

The case for trade is obviously greater for products, such as bananas, that are expensive to grow in Europe. Meat and dairy products also have low transport costs compared with the cost of production. Meier-Ploeger et al. (1996, p. 212) indicate that these products are quite energy intensive in production, whereas for vegetables, fruit, sugar, beverages and grain products, the bulk of the energy use and cost between farmer and consumer goes into processing. There is a less strong case for trading these goods on the basis of minimising energy costs. However, processing is often labour intensive, and hence there is a case for developing countries processing their own goods, such as coffee, rather than exporting the raw product for processing in developed countries.

It should also be noted that, although the cost of transporting organic produce may be higher at present than conventional produce, the environmental costs of the transport are similar. The extra expense is taken up in storage, handling, packaging, insurance and commission rather than fuel. These expenses are likely to diminish as organic trade increases.

Shipping costs are likely to be a less significant proportion of the final price for products of higher value. A tenfold increase in fuel prices is unlikely to make trade in wheat totally unprofitable, although it would certainly diminish both international and national trade in wheat and other products.

In summary, transport costs provides little justification for local consumption. Even assuming that present transport costs do not reflect the true costs, total resource use for the production and transport of a good can be lower when transported internationally than produced and consumed locally.

7. Implications and concluding comments

Specialisation of production via international trade provides for substantial increases in production at a lower resource use. This is true not only for wheat but also for sugar, dairy products and beef, products for which European prices are up to two to three times world levels. Some products in Japan are 8 or 10 times world levels. This implies that resources that are required to produce these products in these areas could much more effectively be directed elsewhere. Furthermore, the over-intensive use of agricultural land is likely to lead to environmental problems that would not occur to such an extent in less intensive production systems in countries where farmers receive unsubsidised world prices.

Purchases of locally-produced products at higher prices accentuate these problems, to the detriment of people in all countries. Substantial rises in fuel costs for transport would be necessary to eliminate the potential gains from locating production more appropriately.

However, there is one further consideration that may favour the consumption of locally-produced organic products. Agriculture is environmentally degrading in production, rather than consumption (in contrast to coal, for example). A consumer concerned with the local environment should buy products grown elsewhere, whereas a globally minded consumer should buy products grown where the resource use is least. Organic production avoids some of the pollution impacts associated with conventional production. Hence, buying locally-produced organic products rather than locally-produced conventional products would appear to be beneficial to the local environment. However, if consumers in all countries think along these lines the outcome is less favourable, as resources aren't used as efficiently as possible.

Rather than espouse purchases of locally-produced products, a more fruitful approach may be to encourage governments to play a more active role by initiating polluter-pays policies. A tax on pesticide and fertiliser use is one such example in agriculture. Indeed, several countries in Europe have taken this approach. Such policies are likely to prove beneficial to European organic producers, consumers and environmentalists and to producers in developing countries. However, reducing or removing subsidies that led to overproduction in the first place would also bring about substantial environmental benefits.

There may be sound social, political and environmental reasons to prefer locally-produced goods and there may also be economic reasons not discussed here. Underpriced transport costs appear not to be an adequate justification. Consumers should bear in mind that, where locally-produced goods use more resources to be produced, global environmental benefits may be foregone.