Organic Production in a Dynamic CGE Model – Effects of the 2003 Reform of the CAP

Concerns about the impact of modern agriculture on the environment have in recent years led to an interest in supporting the development of organic farming. Besides environmental benefits, the aim is to encourage the provision of “multifunctional” properties of organic farming such as rural amenities and rural development that are spill-over benefits additional to the supply of food. In this paper we modify an existing dynamic general equilibrium model of the Danish economy to specifically incorporate organic farming. In the model and input-output data each primary agricultural sector and each secondary food industry has been split into two separate industries: one producing organic products, the other producing conventional products. The substitution nests in private consumption have also been altered to enable pair wise substitution between organic and conventional products. To receive specific subsidies for organic production the current regulation requires organic farmers to produce using organic methods for a period of five years. Failing to do so will mean that received subsidies during the period must be paid back thus practically forcing farmers to retain the organic authorization even though it might be economically optimal to withdrawn from organic farming in the current year. This means that the return to land can vary substantially between conventional and organic farming in the short run. To introduce this concept into the model we develop a theory that describes the dynamic time path of land allocation between organic and conventional farming. Agricultural land is treated explicitly as a stock and there is a stock accumulation relationship for land and an explicit modelling of the rate of stock accumulation (i.e. land investment based on expected returns). While returns can differ between conventional and organic farming in the short run we assume the land allocation adjust within organic farming to equalize return for all usage of organic land in each year. The same apply for conventional land. We use the empirical model to illustrate the land allocation theory by constructing a long term forecast for the development of the Danish economy. Moreover we simulate the effect of the recently agreed 2003 reform of the Common Agricultural Policy (CAP).